Key Tronic Corp (KTCC) 2006 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Key Tronic Q4 fiscal year 2006 conference call. (OPERATOR INSTRUCTIONS). As a reminder, today's teleconference presentation is being recorded Tuesday, August 22, 2006.

At this time, I would like to turn today's presentation over to Jack Oehlke. Please go ahead.

Good afternoon, everyone. I'm Jack Oehlke, President and Chief Executive Officer of Key Tronic. I would like to thank everyone for joining us today for our investor conference call. Ron Klawitter, our Chief Financial Officer, is here with me at our headquarters in Spokane, Washington.

Today, we released our results for the fourth quarter and fiscal year 2006. After experiencing slower demand from some of our traditional customers at the beginning of the year, we saw those customers drive stronger than expected sequential revenue growth in the fourth quarter. For the year, we were particularly pleased with our improved margins and profitability. We also expect the new business we won during fiscal year 2006 to contribute to revenue in coming periods. In preparation for the growth, we're increasing our production capacity in Juarez and Shanghai and our infrastructure required to handle that growth. We believe Key Tronic is strongly positioned to continue to grow profitably and win new business.

I would like to turn the call over to Ron to review our financial performance. Then, I will come back to discuss our progress and our strategy going forward [respondedly].

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. Some of this information is included in today's press release. A recorded version of this call will be available on our website.

As Jack mentioned, we did release our results for the quarter and year ended July 1, 2006. For the quarter, we reported total revenue of $52.5 million, which is up 15% from the $45.6 million in the previous quarter. The sequential growth was driven by increased demand from a number of our existing customers in a wide variety of industries. For the full year of fiscal 2006, total revenue was $187.7 million compared to $202.9 million for fiscal 2005. While our annual revenue was less than the prior year, our improved production efficiencies drove increased margins and earnings. For fiscal 2006, our gross margin was 9.2%; this is up from 8.1% in the prior year. In coming quarters, we expect our overall gross margins to remain right around the 9% level.

We continue to do an excellent job of controlling our operating overhead. RD&E costs for the fourth quarter were $732,000; this is down 3% from the same period last year. Selling expenses for the quarter were $524,000, and these are 20% lower than the fourth quarter of fiscal 2005. Our general/administrative expenses were $1.7 million for the fourth quarter, which are comparable to the same period last year. In coming quarters, we expect to see an increase in operating expenses as we add staff to support the ramp-up of new programs. We anticipate holding the total operating expenses however around the $3.2 million level per quarter.

Despite the year-over-year decline in our revenue levels, our strong margins have driven year-over-year improvements in our bottom line. Net income for the fourth quarter of fiscal 2006 was $7.1 million or $0.71 per diluted share; this is up from $917,000 or $0.09 per diluted share in the previous quarter and $2.8 million or $0.28 per diluted share for the fourth quarter of fiscal 2005. For the full year of fiscal 2006, net income was $9.8 million or $0.97 per share; this is up from $4.4 million or $0.44 per share for fiscal 2005.

Our results for the fourth quarter and the full year of fiscal 2006 included an income tax benefit of $5 million from recognizing a deferred tax asset for the net operating loss carryforwards that we have. We made this adjustment in accordance with the accounting guidelines of FAS 109. Our results for the fourth quarter and full year of fiscal 2005 included a gain on life insurance proceeds of approximately $1.1 million or $0.11 a share.

Turning to the balance sheet, our trade receivables at the end of the year was $29 million, and this is up from $24.2 million at the end of fiscal 2005. Our day sales outstanding at the end of the quarter and at the end of the year was at 43 days, which is comparable to what we have been experiencing in recent periods. Inventory of $36.3 million at the end of the year, this is up from $29.7 million at the end of fiscal 2005. The increase is due to the inventory buildup associated with the RoHS conversion for our customers. We expect to work through this inventory in coming periods.

Our capital spending for the quarter was $148,000, and we continue to expand our capabilities to gear up for the new programs coming online. In fiscal 2007, we expect our capital spending to be approximately $4 million.

In summary, we're pleased with our improved operating efficiencies and our year-over-year earnings growth in fiscal 2006. We also continue to control our cost and make the necessary investments to support our long-term competitiveness and to maintain our strong balance sheet.

The first quarter of fiscal 2007, we expect revenue in the range of $50 million to $53 million. We also anticipate a charge of approximately $500,000 related to due diligence and related expenses incurred in connection with a potential acquisition that we decided not to complete. As a result, earnings in the first quarter of fiscal 2007 are expected to be in the range of $0.12 to $0.16 per share. Over the longer term, we believe that we are well positioned to profitably expand our business.

That's it for me, Jack.

During fiscal year 2006, we continued building upon our success in recent years, improving our operating efficiencies and profitability and winning new business. During the year, we retained our strong relationship with existing customers and continue to broaden and diversify our customer base. We won new programs across a wide range of industries, including specialty printers, industrial tools, networking equipment, scientific instruments and security surveillance devices. We expect these new programs to contribute revenue in fiscal year 2007 and believe these new customers will have a significant impact on our business over the long-term.

Moving into fiscal year 2007, we continue to expand our production capacity and support infrastructure in Mexico, China and the US in preparation for this anticipated growth. This is helping us become more competitive in our pursuit of new business. At the same time, we continue to focus on improving our operating efficiencies, controlling costs, maintaining outstanding customer service and increasing profitability. We believe Key Tronic is in a stronger position that it has been for many years to grow profitably and win new business. Moreover, our solid financial performance and stronger balance sheet have made it possible for us to explore acquisitions that will be accretive to our revenue and earnings and open new market opportunities for us. We are very excited about our future. Finally, I would like to thank our employees, customers, suppliers and shareholders for their continuing support and the results we achieved in fiscal year 2007.

This now concludes the formal portion of our presentation. Ron and I will be more than pleased to any questions you might have at this time.

(OPERATOR INSTRUCTIONS). Bill Dezellem, Tieton Capital Management.

To make sure that we understand things here, if you -- or if we exclude the deferred tax asset change here in the fourth quarter, it appears as though you did $0.21 of earnings and that is in relationship to your guidance when you preannounced at $0.18 to $0.20, so basically $0.01 better than your prior guidance. Is that correct?

That's correct.

That would also lead us to a full year earnings of $0.47 for fiscal '06 just completed?

Correct.

Because the stock price moved as much as it did in what is now this current quarter when you made the preannouncement, will that have an impact on stock option costs or shares outstanding? I'm still trying to, myself, get my arms around how stock price movement impacts the P&L. Can you just walk us through that?

The stock price movement won't have an impact on our P&L. It has been a while since we issued options, so we are not going to have to take any significant options expense because almost all the options that we have outstanding are already vested. But with the run-up in the stock price, it is going to have an impact on our diluted number of shares the calculation of future earnings per share.

So, going forward, it is going to have -- at least in Q1, for example, it is going to have an effect of about $0.01 per share on our earnings, having a higher dilution or higher diluted shares in the calculation.

In the Q1, if we understand correctly -- again, wanting to make sure we get this dialed in right -- the $0.12 to $0.16 that you included in the guidance in the press release, that would include $0.05 of cost for the acquisition that was not completed. Said another way, without those costs, you would be at $0.17 to $0.21 of earnings that you would have been reporting in the Q1. Is that correct?

That's correct, Bill.

That actually is higher guidance than I had originally anticipated. We were thinking that the new contracts that you would have won or that you have won and previously announced that that would have led to higher expense ramp in the first quarter. I think even in your comments/opening remarks, you both mentioned that you are going to be increasing capacity in Mexico and China and adding staff. What am I missing here as to why the guidance is as strong as it is?

As we take a look at it -- and I think we have talked about this in the past -- the ramp-up of the new programs takes a little longer than either we or our customers really anticipate. So what we're anticipating is that the ramp-up will not be as quickly. And thus, the ramp-up charges would be spread over a longer period of time.

Basically, is this a phenomenon where you are not in a rush order scenario? And as a result, you can have an orderly and more cost-effective ramp? Is that a fair way to think about that?

Yes. It works a lot better for us and the customer when that happens.

Again, to make sure we understand this correctly, given that you don't have a lot of new customer business in the first quarter and yet you are at with the first quarter roughly -- if I take that $0.17 to $0.21 without the charge for the acquisition -- that's by ballpark math $0.80 annual run rate. Yet, on top of that, you will be placing new business that will be not a drain on earnings but will be additive to earnings. Is that a fair perspective, or are we missing something here?

Yes. I think it really comes down to it's hard to really predict that far out -- number one -- for us what is going to happen. And as we look at some of the new business, I think we can also anticipate that some of the potential or some of the existing business we have right now, those programs will slow down. So, for us to be able to come out and say it's totally additive; I don't think we can say that. It's almost a quarter-by-quarter call based upon really our customer needs. Like we said many, many times before, visibility beyond a quarter we do not have at this point.

David Cohen, Value Line.

Congratulations on an excellent quarter. The only follow-up question I would have because most of my questions were answered is -- is there any seasonality to the businesses so that if we were trying to see whether there would be sequential improvement in the second, third or the fourth quarter? Because it does seem the fourth quarter today is the strongest, but I was just wondering if you could address that.

We do have a little seasonality in some of the customers we have, where there is a slight ramp-up for the Christmas season. So that does tend to happen in the fourth and first quarters.

Well, fourth and first quarters of the calendar year. Our third fiscal quarter, which is January, February and March, generally sees a drop in some of our customers due to the seasonality related to Christmas.

(OPERATOR INSTRUCTIONS). [Trager Watson], Watchpoint Asset Management.

A great quarter, congratulations. I just had a couple of quick questions because if I look at your guidance and your run rate, are you seeing any signs from slowdown from your existing customers? I'm not talking about the toy business at this point; I'm talking about not new customers either.

It is a variable answer if it looks like we are avoiding it. But in reality what we're seeing is a slight slowdown in some of our customers and some are maintaining. But again, we really get nervous calling much more than a quarter out.

As far as the -- I know in your fiscal Q1 and Q2, the toy business -- are you seeing anything different from current trends versus past trends? Because I know historically, that has added quite a bit to your revenues in these next two quarters.

Yes, I think the difference being that in the previous year there was more of a ramp-up where there was a new product going through the marketplace, where this is just more of a continuation of the existing product.

Now as far as the toy business is concerned, have you picked up any new product lines? God knows I actually checked with Wal-Mart, and I know that your Hummer is basically selling like hotcakes. But I also see they have some other products. Did you all think of some other products with them?

No, we have not.

JD Delafield, Delafield Hambrecht.

I had a follow-up on the first question, which is on the Q1 guidance. To get from the middle of the range in the gross margin numbers that you offered sort of similar to the fourth quarter of last year, that would have to be your operating expenses actually fall, I think, to get to the middle of the EPS range. Maybe I have a tax rate problem. Are you assuming -- what sort of taxes are you assuming in the--?

Yes, we're assuming a zero tax rate.

So you reversed the allowance, but you won't actually run a tax rate?

We didn't reverse 100% of it. We got approximately $60 million in net operating loss carryforwards, and the tax impact of that $60 million is approximately $20 million of future tax benefits. We only recognize $5 million of that $20 million at this point.

So you will be reporting zero taxes for the back?

No. We will reassess at the end of each quarter where we are with our net operating losses. We will reassess the valuation allowance. But for purposes of predicting next quarter, we are at this point saying it's going to be a zero tax rate. But until we get to the end of the quarter to make that determination, we really can't call it at this point.

[Giles Charbonnay], Private Investor.

I just have a question regarding the deferred income tax asset that shows in your assets, which is $3.5 million and yet you reported a benefit of $5 million. Where is the difference between that $5 million and $3.5 million?

The difference is in our other current assets. So that deferred tax asset, a portion of it is long-term; a portion of it is short-term. So the portion that we expected to use up in the next 12 months is in short-term, and the estimated amount for beyond 12 months' usage is going to be in long-term.

So that means you would plan to use $1.5 million in the short-term. Does that mean that you would declare a tax provision of $1.5 million and credit that to your assets?

Yes, the way it would work is that we would record income tax expense every quarter, and that current portion would assume the approximately $1.5 million of tax provisions that would be hitting through our income statements. But then at the same time, we're going to then have to reassess our valuation allowance against our deferred tax assets and then again may have to recognize additional benefits in the future. So for purposes of trying to predict what's going to happen during the coming year, we just have -- as part of our projections for this coming quarter, we assumed a zero tax rate -- a net zero tax rate. But then as I mentioned, every quarter end, you have to reassess your valuation allowance.

But when you say that next quarter you would have a zero tax rate, is that you would have a tax but you would credit that to your short-term tax credit?

What would happen is you would have a tax expense related to the first quarter's income and then have to make the assumption that you would also recognize approximately the same amount of additional deferred tax benefits that we've put back on the balance sheet.

I understand. But if you did that, wouldn't that mean that your profit per share would be after that tax, even though you don't pay it?

Yes, but the resumption is that the income tax expense that we would record, we would also record approximately the same amount of additional deferred tax assets or deferred tax benefit, so they would kind of offset so that there would be a net zero income tax in coming quarters.

In other words, that $1.5 million that you have taken for short-term, let's say you have made a profit of $5 million next quarter. Would you say $5 million minus $1.5 million, you make $3.5 million? But you don't pay that $1.5 million because you credit it to your short-term asset?

I think you're confusing the cash impact of the taxes versus what gets recorded to our income statement. I don't want to go into all the detail accounting of it. But the net impact on the income statement in Q1, the projections that we put out, the $0.12 to $0.16, assumes that there would be a net zero income tax expense. So any income tax expense that we would record would be offset by additional income tax benefits related to the deferred tax assets -- additional recognition of deferred tax assets.

Bill Dezellem.

The new business that you have won in prior quarters, what quarters do you anticipate that that will begin to meaningfully impact revenues in fiscal '07?

At this point, it's really hard to predict that from the standpoint it depends upon, I think, as we explained in previous quarters -- as we bring a new product up, it really depends upon that cycle with the customer by which it gets approved. Any design changes that have to be made, we go back and requalify that product. So it depends upon how many times you have to go through that cycle prior to going into full production. It's really a variable based upon the new business we have won. Some products are more established in the marketplace. And hopefully, that will ramp up without too many problems. Others are yet new in the marketplace, and we will take many iterations before we're successful for us and the customer.

Would it be unreasonable for us to be thinking that in the December quarter, we should begin to see the early signs of that ramp beginning to take place, given what you know today? Granted, this can change at a moment's notice.

Yes. At this point, we just want to talk about Q1, our ability to look that far out really ends up being very questionable.

In Q1, the new programs contributes less than $1 million in our projections going -- in Q1. But beyond that, as Jack mentioned -- because some of these programs have to transfer from other manufacturers, and so it's hard to say how smooth it will go.

Then update us, if you would please, on new business that you won here in the June quarter or even in July and August so far.

Basically, we had one new customer that we brought on board, and we're in the process of working through the contract, looking at the product and deciding how fast we can work together on bringing it out.

Then, since it hasn't been asked yet, let's shift to acquisitions if we could please. First of all, what caused the deal that you were reviewing to not come to fruition?

We found in our due diligence process that it was not going to be as accretive to both revenue and profit as we had anticipated.

In our due diligence of trying to verify the revenue, some of the long-term customers, we were concerned about them not being as [thought] -- too concerned about that longevity.

That may also lead into the next question, which is -- explain to us if you would please the strategic issues that you focus on as you're exploring acquisitions and what it is that you would like to see.

First of all, will it be accretive to both revenue and earnings? Secondly, the overlap of customer sets, our deal situation is that we would not have any customer overlap and there would be new customers we could add. Then finally, does it really allow us to go into markets in the EMS industry that we are not participating in today?

JD Delafield.

When you say accretive to revenue, could you explain that to me?

When it's accretive to earnings in that we don't have a lot of customer overlap where there's the potential for a customer to be concerned that -- gee, I have got too much exposure with that customer. So the net of the two, you would end up losing some of the revenues. But really it's accretive to earnings and then added to our customer base without a lot of overlap is what we really mean by that.

The new customer that you just won, where will you manufacture that product?

That's going to be in our Mexico facility in Juarez.

How is the sale of the parcel of land that you have been marketing going?

At this time, we do not have any offers on it.

(OPERATOR INSTRUCTIONS). Bill Dezellem.

The new business for the one new customer that you won here in the quarter, what do you anticipate the rough annualized revenue of that customer to be?

At this point, I don't think we want to really make any estimate. It depends upon our ability to ramp it up and the success of their product. So it would be just a guess.

So even asking not specific to the fiscal '07 but just on a normalized 12-month period, given the product, it makes it a bit difficult to predict that there with any degree of certainty?

That's correct.

Management, at this time, we have no additional questions in the queue. We will turn the conference over to you for any further remarks.

Thank you. Again, I just want to thank everyone for joining us today and participating in today's conference call. Ron and I look forward to talking to you again at the end of first quarter of our fiscal year 2007. So thanks again and just have a great day.

Ladies and gentlemen, we will conclude today's conference. If you would like to listen to a replay, please dial 1-800-405-2236 or 303-590-3000 with access code of 11062653. (Repeat replay information.) We thank you for your participation on the program. At this time, we will conclude. You may now disconnect, and please have a pleasant day.