Key Tronic Corp (KTCC) 2008 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Key Tronic Q1 2008 conference call. (OPERATOR INSTRUCTIONS) As a reminder, this call is being recorded, today, Tuesday, October 30th, 2007. And I would now like to turn the conference over to Mr. Jack Oehlke. Please go ahead, sir.

Okay, thank you. Good afternoon. 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 in our headquarters in Spokane Valley, Washington.

Today we released the results of our first quarter of fiscal year 2008. As anticipated, we saw slower demand from a number of our established customers, while our new programs contributed a growing portion of our revenue. We expect both our established customers and our new customer programs to drive strong revenue and earnings growth in the second half of fiscal year 2008. By the end of the fiscal year, we anticipate having a more diversified customer portfolio, spanning a wider range of industries. Moving into fiscal year 2008, we have become more competitive in pursuing new opportunities and we continue to focus on maintaining our outstanding customer service and profitability.

Now, I'd like to turn the call over to Ron to review our financial performance, and then I'll come back to discuss our progress and our strategy going forward. Ron, please?

Okay, thanks, Jack. 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. And a recorded version of this call will be available on our website.

Today we released the results for the quarter ended September 29th, 2007. For the first quarter of fiscal 2008, we reported total revenue of $44.6 million, compared to $55.5 million in the same period of fiscal 2007. As Jack mentioned, we saw slower demand from a number of our established customers, which was not yet offset in the growth from our new customer programs. However, it is important to note that new customers which were not contributing revenue a year ago, contributed over $4 million in this first quarter. As we expected, these new customers -- as we expect, these new customers will contribute a growing portion in coming periods.

Our gross margins were impacted by the decline and manufacturing levels and the corresponding reduction in fixed cost absorption. In the first quarter of fiscal 2008, our gross margin was 7%, compared to 9% in the previous quarter, and nearly 10% in the first quarter of fiscal 2007. In coming quarters we expect our overall gross margins to return to the level of around 8 to 9%.

In preparation for future growth, we continue to make the necessary investments to grow our business, while continuing to focus on controlling our operating overhead. RD&E costs for the first quarter were $677,000. This is down from $893,000 in the first quarter of fiscal 2007.

Our selling expenses for the quarter were $330,000. This is down from $520,000 a year ago.

And our G&A expenses were $1.6 million, which is comparable to the first quarter of fiscal 2007, when you exclude the charges that we took last year from an acquisition that we decided not to pursue.

In coming quarters, we anticipate holding our total operating expenses to under $3 million per quarter.

Although we remain profitable, the near term decline in revenue and gross margins clearly impacted our bottom line. Net income for the first quarter of fiscal 2008 was $200,000, or $0.02 per diluted share, compared to $1.4 million, or $0.14 per diluted share, for the same period of fiscal 2007.

Turning to the balance sheet, our trade receivables were $26.6 million at the end of the first quarter of fiscal 2008. Our day sales outstanding were at 48 days, which is comparable to recent quarters.

Inventory was $34.1 million at the end of the first quarter, which is up from $32.3 million at the end of the previous quarter. This increased inventory level was primarily due to customers de-committing to us mid-quarter for revenues for which we had already contracted to buy the materials and so, therefore, we were not able to reduce the material purchases fast enough to correspond to the customers' decline in their sales orders to us. Nevertheless, we believe that we have made real progress in improving our inventory management and expect our inventory levels to remain flat in coming quarters.

Our capital spending for the quarter was $290,000 and we expect it to be approximately $2 million for the full year.

In summary, we saw slower demand from a number of our established customers in the first quarter, but our new customers contributed a growing portion of our revenue. At the same time, we have continued to make the necessary investments to support our long-term competitiveness, control our costs and maintain our strong balance sheet. We expect both our established and new customer programs to drive strong revenue and earnings growth during the second half of the fiscal year, for the fiscal year 2008.

In the second quarter, we expect our revenue to be in the range of $45 to $48 million and earnings in the range of $0.03 to $0.06 per share. Over the longer term, we believe that we are well positioned to profitably expand our business.

That's it for me, Jack.

Okay, thank you, Ron. We believe our near term results do not reflect the progress we have made in diversifying our business across a wide range of customers in different industries. Despite a slowdown in the first quarter, we have maintained all of our long-standing customers and expect new customer programs to continue to ramp up, particularly in the second half of this fiscal year.

Over the last year and a half we have won over 10 significant new customer programs involving data storage devices, networking equipment, specialty printers, industrial controllers, personal exercise equipment, industrial tools, scientific instruments and security surveillance. By the end of the fiscal year, we expect to have a significantly more diversified customer portfolio and less concentrated revenue base, spanning a wider range of industries.

We expect new customer programs to contribute over $30 million in this fiscal year and believe these programs will have a substantial impact on our business over the long term.

In preparation for future growth, we have continued to invest in our business and improve our asset utilization. Our SMT capability in Spokane continues to develop, both for new product introduction and development and ongoing production. Our Spokane SMT capability improved our overall asset utilization by enabling us to complete the developmental work here in Spokane and then launch that production to our facilities in Juarez and Shanghai.

In summary, we continue to execute our long-term strategic plan. We believe Key Tronic is successfully expanding its market presence and becoming more competitive in pursuit of new business, as well as maintaining strong relationships with our established customers.

At the same time, we continue to focus on controlling costs and maintaining our outstanding customer service and operational efficiency.

Moving forward, we expect to continue to broaden and diversify our customer base and feel well positioned for profitable growth in fiscal 2008 and beyond.

This now concludes the formal portion of our presentation and Ron and I would be more than happy to answer any questions you may have.

This is now our question and answer period.

Thank you, ladies and gentlemen. At this time we will conduct a question and answer session. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Bill Dezellem from Tieton Capital Management. Please go ahead.

Thank you. We have a group of questions. First of all, it appears as though revenues came in at the high end of the range that you gave at the end of the last quarter. What was behind that increase, or it being at the high end?

Okay. Ron, would you please?

Ron Klawitter. Sure. Bill, the -- included in our revenue we had over $1.5 million in revenue from tooling revenue and non-recurring engineering and also excess inventory sales back to our customer, all of which were at basically no profit. So, if you exclude that revenue, basically generating no gross margins, we would have been at the lower end of our revenue range and the lower end of our earnings, which then kind of matches up.

So, that would also explain then partially in addition to the overhead absorption issue with your gross margin, just the fact that you had some sales at zero margin certainly does not help the margin percent.

That's correct.

All right. And then, you had also made reference on the -- in the remarks, that you had about $4 million of revenue from new customers this quarter. And then for the full year, we're looking for about $30 million of revenues from new customers.

That's correct, Bill.

Just kind of thinking out loud here, if the second quarter came in slightly above the first, so let's say it went up to, say, $6 million, that way it makes my math easy here. That's about $10 million in the first half. And that leaves roughly $20 million of revenues for the second half of the year from new customers. Are we thinking about that ramp correctly? Or, in my attempt to keep the math simple, have we done something incorrect?

No, Bill. You're thinking about that ramp correctly.

And then, in the fourth quarter, are those 10 new customers that you referenced, are those going to be fully ramped at that point? Or do they continue to ramp from the fourth quarter level in aggregate? I'm sure some probably are ramped, but --

Yes, you're right. Some are ramped and some are continuing to ramp and maybe this is a good time for me to just give you an overall view of how that really happens. Basically, after we win the quote, we begin that ramp process and that can be anywhere from building 12 to like 100 pieces for our customer. Once we do that, we do that initial build, we establish our production processes, our test requirements, our final quality acceptance criteria and then we send those units to the customer for approval. If everything is fine, then we proceed. But a lot of times, collectively between the customer and ourselves, we'll make any design process and/or quality modifications to really improve that product. And then at that point, we go ahead and we schedule the production with the customer deciding exactly what the quantities are going to be, what the timing is going to be. And we purchase the materials.

Now, sometimes it feels like it takes awhile to go from winning the quote to an actual ramp up in production, and that's why it's a variable and we believe some of those will be ramped up in the second half, while others will continue to ramp.

And so, to make sure that we understand correctly, at the end of last quarter, I think you said you had 5 new customers and then in your remarks here today you said you had 10 new customers over the course of the last year and a half, and then last quarter 5 of those came in in the fourth quarter. And so the 10 that you're referencing in the release, that's a function of that full year and a half period and you expect those customers to be, all of those now, to be ramping?

That's correct, Bill.

Okay. Thank you. I'll go back in queue.

Thank you. (OPERATOR INSTRUCTIONS) We do have a follow up question from the line of Bill Dezellem from, pardon me, from Tieton Capital Management. Please go ahead.

Thank you. I guess I'll continue down the path we were going, then. Relative to the guidance for the second quarter, or the December quarter, what factors do you see out there that could lead to either upside to that guidance or downside to that guidance?

I think, Bill, the main things that are going to drive us in that quarter is basically what's going to happen with our customers. We hope we don't see a deceleration based upon them pulling business from us. But, by the same token, we're getting prepared to handle any expedites that come in. And I think, as we discussed in previous conference calls, our ability to respond and the customers' ability to predict exactly what their needs are going to be have become a lot more short term. And it's really then our ability to expedite that material, put it in our factories and then deliver it within the quarter.

And so, with that in mind, the last quarter of, not long before the conference call, what we sensed from the last call, your customers, a few of them anyhow, came in and asked for a reduction in the quantity of product they were going to be taking.

Yes.

And to what degree has that lower run rate continued? Or have they picked up their order level? Or have they -- I presume, given the guidance, they've actually not fallen back further. What's the update on the trends that you're hearing from those customers?

What we're actually seeing is that some of those customers are coming back in and, where they had a slow down last quarter, are now expediting that product. So, we're in the process of procuring that material and bringing it in. So, they are seeing a rebound in their needs and, likewise, we're responding.

And does that rebound in their needs a function of them having burned through the excess inventory that they felt they had? Or is that a function of in demand actually increasing with their customers?

We don't have a lot of visibility on their in demand. I think what we're seeing is that they probably got a little too aggressive on their inventory reduction and are now coming back in and trying to get that inventory in place.

And when was it that you -- and was it correct that it was not long before the call that you saw the reduction from the plant, from the customers in the last quarter? And then, if that was correct, then when this quarter did you start to see the customers increasing their forecast?

No, you're correct on that, Bill. It was right after the call that we saw the drop dramatically. And what has happened as far as the rebound is, we saw at the first part of this month, but what we're doing right now is we're going out to try and get some of the unique inventory that's required to build it yet in this quarter.

Okay. And maybe you just started to answer the next question. You said unique inventory. Given that your guidance is not for the December quarter is not significantly above the September quarter, and yet your customers have come back and are actually increasing their forecast, can you help reconcile what seems to maybe be a bit of a difference in thought processes here?

Yes. Ron will answer that.

Yes, Bill, that's correct. We had -- whether or not we can get that material in before the end of our quarter still remains to be seen. So, some of that upside in expediting we did not include in our forecast. Some of it we did, because we've already got materials committed from our vendors. Some of it we have not.

The other thing that complicates this is if the material comes in late in the quarter, we have a one-week shutdown in our Juarez facility between Christmas and New Years. So, whether or not we -- so, we're going to lose a week of production and, in order to produce during that week, we have to get people to stay during the holiday, pay them a lot of premiums to stay and, even then, we don't necessarily get a really good response for people wanting to work during their Christmas vacation.

So, all that is factoring into us being able to say, the 45 to 48 is what we see right now. But, there's a lot of things, a lot of factors, that could impact that on the upside. On the other hand, like Jack said earlier, they could also come in in a month from now and start de-committing. So, that's our best estimate right now, the 45 to 48. There is upside, but there's also downside to that.

That's helpful. And do we understand correctly, I'm not super familiar with the Mexican holidays, but, between Christmas and New Years, that's the equivalent of the Christmas Day holiday that we get here in the U.S.?

Yes, yes.

Most of the workers will go back to their hometowns. Not all of them are in Juarez, natives, and so they take the whole week off.

Okay. That is helpful. And then another question, before I go back in queue. The comment in the press release that you're becoming more competitive. Would you please explain what you mean by that?

Yes, I think, Bill, we've made some changes in our materials organization and we're broadening our reach as far as distributors that we're using to procure the components and the materials. So, we're seeing ourselves more competitive down that path.

And, likewise, the decision to put the prototyping or the new product introduction lineup here has been beneficial from improving our efficiencies both in Juarez and Shanghai. But also we found it very competitive locally and we're winning new business that we're bringing in to actually produce production here in our Spokane facility.

Great. Thank you, both. I'll go back in queue.

Okay. Thank you.

Thank you. (OPERATOR INSTRUCTIONS) Our next question is a follow up question from Bill Dezellem from Tieton Capital Management. Please go ahead.

All right. Thank you. I guess I'll come back with a few more then. So, if we look now at the full year in the fourth quarter press release, or year-end press release, you made reference to the fact that you expected fiscal '08 to be above, or have profitable growth, relative to fiscal '07. And I believe on that call you referenced that that was both in terms of revenues and in terms of earnings. So, that would have at that point implied you expected fiscal '08 to be above $202 million of revenues and $0.50 a share of earnings.

To what degree do you have confidence in that continuing to be the case, given that we're looking at not even $0.10 of that most likely falling in the first half of this year?

Well, I think there's a couple of factors out there, Bill, that's impacting this. We feel very comfortable with the new customers that are coming on board and the forecasts that they're giving us to work with right now.

I think another outside factor is that the outsourcing industry really continues to grow and, while our new customers are coming on, we're really diversifying our customer base and we don't have the concentration we had before where we were impacted by one. So, we feel that, with the new customer pipeline, the growing revenues we see from that, that right now our revenue should exceed, like you said the $202 and our earnings exceed the $0.50 we discussed. So, that's, again, our best estimate. We're going out a little further than we normally do, but it's based upon the strength of the new customers coming on board.

And given that you historically have not provided any guidance or commentary beyond the one quarter in front of us, we would take this to imply that you have a very high level of confidence in the second half of the year to continue to say that you're going to be above that $202 and $0.50 a share of EPS?

Yes. Well, again, Bill, let me just qualify that. From the standpoint, that's based upon the best information we're getting from our customer base at this point. And we don't really have to weather any of the surprises we did in the first quarter.

Right. Okay. That's helpful. And so, if in fact you do the high end of the second quarter guidance of six pennies, add that to the two pennies that you've got, that still leaves $0.43 at the bare minimum you would need for the second half, in the second half for the full year to be above the $0.50 to get just to 51 pennies. And that's roughly 22 pennies per quarter. And may we presume that the third quarter would be something less than 22 pennies, the fourth quarter would be more than 22 pennies? We're trying to think about just from a conceptual standpoint that there is a continual ramp that takes place, I guess just as we were thinking relative to the new customers making up that $30 million of revenues.

Yes, we expect, Bill, we expect that revenue to [inaudible] each quarter in the second half to be a little bit higher than the first half. So, you expect to have growing revenues the further along we go. Also, there are some costs associated with ramping the new programs as well. So, as far as what the earnings will be for each quarter at this point, I wouldn't want to tell you what it's going to be third quarter versus fourth quarter, but I do see -- we still feel confident that, based upon the customers' forecasts that we -- and our earnings should come in a little bit above last year's earnings. And so, the second half will be stronger than the first half. We just haven't broken it down by quarter for you.

I don't mean to push the topic here, but it would seem as though, given that you are in a ramp, that the fourth quarter revenues and earnings should be higher than the third. Not putting numbers to it, or were you basically just saying that there's, you think there's a chance that fourth quarter revenues could be higher than the third, but because of startup costs, actually the fourth quarter earnings EPS might be lower than the third quarter EPS?

We just, yes, we don't what you said second is correct. We expect the revenues to continue to ramp. But as evenues ramp, there are some costs associated with that, that our one-time costs, as Jack laid out the program for you. And there's a lot of iteration back and forth, small runs, get the customer's feedback, put it back into the factory. So, what the mix is of earnings between Q3 and Q4 it's hard for us to say right now what exactly it's going to be, but we do feel confident that, based upon the customers' forecasts, our second half should be enough to bring our entire fiscal year above last year's earnings.

Add a little bit to what Ron is saying, to give you a better feel, Bill, is that a lot of these new programs that are ramping, we don't really totally know what to expect in the robustness of the designs, our ability to produce to their expectations. But, when I look at that, I think that's also a comparative advantage for us from the standpoint that we're willing to work with those customers to really optimize it, to make sure that, when we get there, they have a product that they're satisfied with, that goes to their marketplace and is successful.

That's helpful. And then, we spent a fair amount of time discussing the new customers, but in the release and I think in your opening remarks, you made reference to confidence in existing customers also driving that revenue growth that you expect in the second half of this fiscal year. What's behind that strength with the existing customers?

I think it's, Bill, what we had touched on before is that we were surprised in the first quarter, there were some inventory reductions and we believe those from their current forecasts are coming back.

And so that would basically bring them back to a more normal level. We would have new customers that would be ramping, actually not even fully ramped. And so it sounds like, if we start looking at the third and fourth quarter of this year, which could be in very significant, especially in terms of earnings per share, that that's starting to appear like that may be a new run rate for the company. Are we off base with our thinking here? Or with all the potential caveats, that might be an okay way to think about your business.

Yes, we've already stepped out a little bit giving us some visibility for the second half of our fiscal year. For us to be able to say what's going to be beyond that, like fiscal year '09, it's way -- we are just not comfortable doing that at this point, Bill. But, I can see where you could draw that conclusion, and if I were stepping in your shoes I'd probably draw the same conclusion. But, we're not prepared to talk about what the run rate's going to be in the fiscal year '09 at this point.

Okay. That's certainly fair. And then one additional question, please. The pipeline of prospective customers. How would you characterize that pipeline today versus, say, a year ago and versus the conference call last quarter?

At this point, Bill, what we see is really the pipeline is pretty much reflective of what we have seen in the last several quarters. And the funnel is giving us new opportunities, new customers, as we go forward. So, not much of a change from the previous two quarters. And if you try, I think as we discussed in the previous quarters, it depends upon when you take a look at that funnel. It's a variable from how many come in, how many are we able to complete through the quote process and respond to and then wait for the customer to respond, or how many just came in that we have in the process of quoting. So, if I told you one week it was this number, the next week it will be a different number. And what we do is look at the average over that quarterly period.

Great. Thank you both.

Okay. Thank you, Bill.

Thank you. And I'm showing that we have no -- actually, pardon me. We do have a question from the line of Larry Brooks from Maloney Securities. Please go ahead.

Thank you. Good afternoon.

Good afternoon.

I'm wondering, with your customer base, what are you seeing -- which of your customers are being significant orders or which are the hotter areas of interest at this point?

As we look at it, it's -- and the reason I'm hesitating -- it's a variable within the various industries because some of the customers we have that produce like products are actually seeing increases, while other of those customers are seeing stable to just maintaining. So, it's not a real clear picture out there which industry or one industry is exceeding the other.

Another thing, Larry, is that for us, if we get to naming specific industries, we also will then identify who our customers are, because we have named some of our larger customers and we really don't want to talk about a specific customer. When we talk about industry in general and that sometimes will narrow down to a specific customer. We just don't feel comfortable doing that.

I see. Okay. One thing I would want to just make a comment about the estimates for the year is that I think it's very difficult to do. I think it's tough enough doing quarter-to-quarter. So, I would have my suggestion, from what little I would know, is that you don't want to get into, dig yourselves in a hole where you're over-projecting something may occur. I think stocks tend to get jammed when that tends to happen. So, that's my only comment in reference to that. I don't know if you wanted to remark about that. But, I've seen so many companies get into trouble because of over-extending themselves like that.

Yes, we agree with your assessment.

Yes. I would rather go quarter-to-quarter, then you don't see me get into trouble. But, that's the only comment. I hope you continue some good and better stuff. So, thank you.

Okay. Well, thank you.

Thank you. And we have no further questions at this time. Please continue with any closing remarks that you may have.

Okay. Again, Ron and I would like to thank you for participating in today's conference call. And we look forward to speaking to you at the end of our current fiscal quarter. Thank you and have a good day.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and you may now disconnect.