Key Tronic Corp (KTCC) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Key Tronic second quarter fiscal 2010 conference call. (Operator Instructions) This conference is being recorded today, Tuesday, January 26th 2010. I would now like to turn the conference over to our host, Mr. Craig Gates, President and CEO. Please go ahead, sir.

Thank you. Good afternoon, everyone. I'm Craig Gates, President and Chief Executive Officer of Key Tronic. I'd like to thank everyone for joining us today for our investor conference call. Ron Klawitter, our Chief Financial Officer, is joining us by telephone from our facility in China.

Today we released our results for the second quarter of fiscal 2010. We're very pleased with our strong sequential growth in revenue and earnings driven by increased demand from long-standing customers and successful production ramps with new customers. We've remained profitable for 24 consecutive quarters by controlling our costs, enhancing our operating efficiencies, and improving our inventory management. We've also strengthened our balance sheet while continuing to invest in the long-term strength of our business and winning and absorbing new programs.

Our strong financial position and continued success in diversifying our revenue based across a wide range of industries makes us confident that our profitable growth trends are sustainable in coming periods.

Now, I'd 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. Ron?

Okay, thanks Craig. 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 and 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 December 26, 2009. These results exceeded the sales and earnings estimates announced in our revised guidance of December 2, 2009.

For the second quarter of fiscal 2010, we reported total revenue of $44.8 million, up from $41.3 million in the previous quarter. We're very pleased with this strong sequential revenue growth, driven by increased demand from both new and long-standing customers. For the first six months of fiscal 2010, total revenue was $86.1 million, compared to $95.2 million in the same period of fiscal 2009.

Our flexible operating model has allowed us to take the necessary steps to adjust our variable operating expenses and overhead to changes in production demand. Our head count at the end of December 2009 was about 2,200 people, up from 2,000 at the end of September. Despite ramping up our workforce in Mexico and China, the favorable sales mix in the second quarter of fiscal 2010 resulted in unusually high gross margins of 11%, up from 8% in the same period of fiscal 2009.

In coming periods, we expect our gross margins to return to around 9%.

We continue to focus on controlling our operating expenses, while continuing to make the investments necessary to support long-term competitiveness. For the second quarter and year-to-date of fiscal 2010, our operating expenses are lower than the same periods of the previous fiscal year because of a goodwill impairment charge recorded in the second quarter of fiscal 2009.

We expect our total operating expenses to be around $2.8 million in coming quarters. A stronger than expected sequential revenue growth and gross margins in the second quarter, combined with our continued success in controlling costs and approving efficiencies resulted in an operating margin of 4% in the second quarter, up from 1% in the same period of fiscal 2009.

Our revenue growth and strong margins had a positive impact on our bottom line. Net income for the second quarter of fiscal 2010 was $1.7 million or $.17 per diluted share, up from $300,000 or $0.03 per diluted share in the previous quarter. And up from $100,000 or $0.01 per diluted share for the same period of fiscal 2009.

For the first six months of fiscal 2010, net income was $2 million or $0.19 per diluted share, up from $500,000 or $0.05 per diluted share for the same period of fiscal 2009.

Turning to the balance sheet, we ended the second quarter of fiscal 2010 with no bank debt and with cash and cash equivalents of $7.2 million, up from $1.8 million at the end of the previous quarter.

Our trade receivables were $26.2 million at the end of the second quarter, up only $900,000 from the previous quarter. Given the challenging credit environment, we're pleased to see our DSOs remain around 52 days, comparable to the same period a year ago.

Inventory was $28.9 million at the end of the second quarter of fiscal 2010. This is down from $30.1 million at the end of the first quarter, and down from $32.3 million at the end of fiscal 2009. We're very pleased to see the general improvement in our inventory management, even as we have brought on a number of new customers into production.

Finally, our capital spending was $830,000 for the second quarter of fiscal 2010 and we expect CapEx to be around $2.3 million for the full year, with most of the spending related to bringing on our new customer programs and making improvements to our facilities in China and Mexico.

Looking forward, we expect to see continued growth in the revenue contributed by our new programs. While the overall economic environment continues to create some uncertainty, we are continuing to control our costs while making the necessary investments to support our long-term competitiveness and maintaining our strong balance sheet.

Taking all these factors into consideration, we expect revenue in the range of $44 million to $47 million in the third quarter, with earnings in the range of $0.15 to $0.20 per share. We also expect to see the trend of sequential growth in the fourth quarter. Over the longer-term, we believe that we are well positioned to profitably expand our business.

Okay, that's it for me, Craig.

Okay. Thanks, Ron.

As we move into the second half of fiscal 2010, we are pleased with our success at profitably growing our business by controlling costs, efficiently managing our inventory, strengthening our operating infrastructure, maintaining our low debt to equity ratio, and diversifying and growing our customer base. Our success with these initiatives has placed us in an excellent competitive position to continue to profitably grow our business in coming periods.

Our new programs continue to represent a growing portion of our revenue and a promising foundation for future growth. In fact, over 50% of the revenue in Q2 came from programs from new customers.

During the second quarter, we won new programs involving telecommunications, industrial equipment, specialty printers, gaming, and financial transaction equipment. We expect these recent wins to begin moving into production during Q4 of fiscal 2010 and then fiscal 2011.

When they reach full production, these latest program wins each represent a potential revenue contribution of $5 million to $30 million annually. In keeping with our long-term strategic objectives, we're successfully building a more diversified customer portfolio and a less concentrated revenue base, spanning a wider range of industries.

While the global economic environment remains uncertain, the pipeline of potential business remains relatively robust and the long-term trend towards outsourcing continues to look encouraging.

The recession initially put some potential customers' outsourcing plans on hold, but many companies recognize the growing imperative to move forward with outsourcing strategies to improve their long-term efficiencies and operational flexibility.

According to a recent report in Manufacturing Market Insider, which averages a forecast of IDC, Electronic Trend Publications, and Inforum, the EMS market overall declined by around 15% during calendar year 2009 but it is expected to grow at 7% to 12% annually in coming years.

During the 2009 recession, we not only performed better than most of our peers, but we believe Key Tronic continued to strengthen its competitive position as OEMs placed increasing value on our core strategic initiatives. We believe that our perspective and current customers will continue to place increasing value on those core initiatives.

During the second quarter of fiscal 2010, we continued to invest in the long-term strength of our business by adding square footage in our world-class facilities in Mexico and China, and by increasing the efficiency of our supply chain and new product introduction processes. These improvements have increased the speed at which we can transfer new programs into our facilities while helping us control inventories both during and after those transfers.

Our focus on creating and expanding world-class manufacturing sites in three geographic areas allows customers to choose from a menu of attributes and optimize our supply chain. They increasingly recognize the value of our strong centralized management approach to inventory, IP, production control, and engineering, which has been honed and refined over decades of operating offshore facilities.

As OEMs have struggled with IP control, assurance of supply issues and product launch delays with stand-alone and independent foreign sites, our centralized approach has been a clear competitive advantage in many of our recent program wins.

In the case of many programs, we are providing design services in Spokane, building prototypes in Spokane, ramping production in both China and Mexico, cross-supplying parts for production from China, Spokane, and Mexico, and controlling the production, planning, and delivery from Spokane. This type of seamless blending of the advantages of each locale is not readily available to our customers from our tier three competitors and the value of this blend is becoming more of a competitive advantage as the marketplace gains experience in outsourcing.

Our conservative approach to managing financial and business risks also continues to be a source of strength in the marketplace. We're very pleased to be moving into the second half of fiscal 2010 with the strongest balance sheet we've had since we entered the MS business over a decade ago. We have no debt, ample cash in the bank, and a new credit facility. In a very competitive environment, we have continued to win new customers and new programs from existing customers based upon our financial stability and performance. Our successes were recently recognized by Circuits Assembly Magazine when that publication chose Key Tronic as EMS Company of the year.

Going forward, we expect to continue to focus on controlling our costs and maintaining our operational efficiency and excellence, even as we continue to broaden and diversify our customer base. We are optimistic about seeing growth in the coming periods and increasingly confident in our ability to grow our revenue and profits over the long-term.

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

Thank you, sir. We will now begin the question and answer session. (Operator instructions) Our first question comes from the line of Bill Dezellem With Tieton Capital Management. Please go ahead. Mr. Dezellem, your line is open.

My apologies. I'd like to start with revenue guidance, which you have as flat to up. And yet your earnings guidance, earnings per share guidance is essentially bracketing the December quarter. That almost implies as you expect a favorable revenue mix to continue for at least another quarter. Are we reading the tea leaves correctly? Or there's some other dynamic that we're not understanding there.

Well I think the biggest dynamic is not being able to really tightly predict what we're going to have to pay for components as we look at the market going forward, we're seeing a tightening of the supply chain. So both the revenue number and the profit number are a little bit unpredictable right now as we see some significant shortages in the electrical component area. Overall though, we expect the gross margin to move downward as we said. We don't expect to be able to continue up in the 11% range.

That's helpful. And then I'd like to shift to something here that maybe isn't necessarily as timely or appropriate, given the level of profitability that you announced the quarter. I mean clearly it was a great quarter and you maintained profitability through the recession.

But in the past, I guess this is just frustration that we have had, that we'd like to explore with you. In the past, when it has seemed as thought the Company has been close to gaining traction, the results ultimately had petered out. And here this quarter, you've talked about new customer and program wins. I think there were five of them frankly in the release. And you've had such success in the past from a press release perspective, but the results really haven't shown through and maybe this quarter is the beginning of something different, but setting this quarter aside, the results really haven't shown true until now. So what's different?

Well, there's a couple things that are clearly different from the way things have gone in the past. And I hope that we can resolve your frustration going forward. It's certainly been frustrating for us to kind of ratchet up and ratchet back down again. If you look at what's different now, we talk about improving our operational efficiencies and our ability to do NPIs.

When we look at our win rate or our, I guess, continued ownership rate of a new program, in the past we were having a real hard time with running our NPIs in any of our three factories. And of you're not familiar with this business, you're marketing is really your quote and then your NPI. And when we would get to the point of having provisionally won the business and announcing the win, we would then discover that as we tried to run the first order of product through one of our factories, that we would make a small or even a medium size mistake and that would scare the customer away.

We use the analogy that it's like a first date. If you come to the first date with a piece of space between your front teeth, that's probably a game ender. After you've been married for a couple of years, it's no big deal. And the same situation was happening to us when we ran NPIs. We would announce a win, we would all celebrate, we'd do all the work required to get all of the data into our system, and the bill of material released, and the factory set up with the new processes, and they would -- we would make some type of error that would scare our customers into believing that they had made a poor choice.

And if you put yourself in the shoes of the people who are typically in the positions at our customers to make the choice, in many cases this is a once in a career or a couple time in a career decision for them.

So when they first decided that they're going to outsource the production from their factory to a contract manufacturer, typically it's a high-level person within the procurement department along with engineering and quality folks who have to survey anywhere from five to 20 contract manufacturers who typically have gone out and visited two or three of those factories that were the top runners in the quote process. And who then had to put their reputation on the line by telling their boss and their boss' boss that yes, we're going to pick Key Tronic because they were better than the other people that went through this whole process with us.

So these people have a lot riding on that decision and any sign of their having made a mistake is terrifying to them, and rightly so. And so when we used to fail these NPIs, send products in that were something wrong with them in some way, we had misunderstood the documentation, or we hadn't got quite our processes nailed down, it was a big event and we lost a lot of customers that we had won as a result.

So as of about a year ago, we've been able to continually tighten down, improve, and modify our NPI process where I can say now in the last nine months we haven't failed a single NPI and instead of marginally passing them, we're now passing them with flying colors.

So that's one big factor, a huge factor in the difference between the past that frustrated you and hopefully the future that won't frustrate you.

The other part of the past and the future contrast is that in the past, we were coming from a keyboard manufacturer and we had a very, very narrow customer base. And along with that narrow customer base, we had a narrow group of projects within those customers. So even if we would get the NPI done right, we would still be walking around with the threat of a very big loss with one phone call.

If you look at our customer base now, we've got over 29 customers and the other interesting part of it is that even with some of those big customers, we have a lot more programs that tend to be counter cyclical and are also not linked to the market. So even if one program fails because the product doesn't sell well, it's not something that's going to take $20 million, or $30 million, or $40 million out of our revenue base. And in the past, we've been in a position where anyone of five people could call me up in the morning and say, "Yes, we've got a problem." And we'd be looking at a $30 million loss of business.

So today, this is the first time that we can say that we don't have that size of a potential threat that we're worried about. There's always threats of something happening and there's always things that could happen that we won't be able to anticipate. But it's so much more diversified now that we're a lot more confident in the fact that the wins that we've got are not just going to turn into replacements of big chunks of business that we lost. So those are the two really big differences in the Company now versus what we've had to transition ourselves through as we went into contract manufacturing.

And then finally, we went through the worst recession since the depression, and even though it's not over yet, it certainly appears to be getting at least more stable and people are making decisions to outsource without the panic in their eyes that they had a year ago. So those are the three reasons that we think what we did this quarter is possible next quarter, and the quarter after, and the quarter after. There's nothing other than the fact that this is the best we've been since we started this to convince us of that, but as far as we can tell, that's the difference.

Okay, that's helpful, Craig. I can certainly understand the reduced customer concentration and frankly I presume there might even be some benefit to not having the big -- the huge big name customers as a big percent of your revenue. But I don't think I fully appreciate -- I guess I heard the words that you said relative to improving your new product introduction process, but I don't think I really grasped what you are now doing different so that you don't make the mistakes that you had made in the past and using your analogy, walk into that first date with the spinach in your teeth.

Okay. Well, I guess you'd probably have to be an operations guy to fully get this, but the difference is that we were previously running our NPIs with the same level of oversight as we were long-term production. And once you've been running something long-term, people don't have to refer to all the documentation every time. And people have had a chance to learn the subtle nuances of visual defects. And people become used to dealing with more or less a de facto standard of visual quality and paperwork quality, based upon their knowledge of the customer.

So part of what we've done is we've changed the standards for NPIs so that we make the parts now so that they're almost perfect. That as we get into production with the customer and have a better understanding of what they really require for their specs, then we can start to dial the notches back a little bit and get to profitable production.

So in the past, we were a little bit too concerned about making sure we were making our rates and our routings. And we weren't concerned enough about making sure the parts were perfect, even though they maybe took us 20% or 30% more than we thought they should have eventually. So it's as much a mindset in our factories and in our engineering groups as it is anything, and that mindset is that it's a first date and we've got to look our best no matter if it takes us extra time in front of the mirror to get our cowlick laid out or not.

So that's a big chunk of it and even though it drives the factory budgets a little bit wonky during the first four or five production runs of the parts, that's not important. What's important is that you maintain the customer.

So it's a mindset thing, we've also invested in better equipment so that we have the ability to produce parts that are closer to perfection based upon our equipment's ability. We had capable equipment before, but now we have equipment that goes above and beyond the capability we need to make acceptable parts.

So it's two things. It's investment in capital, and it's investment in expense in order to fuel the mindset. And that's the best I can explain it to you.

That is very helpful. And thank you for taking the time to do that. I'd like to actually move to something a bit more positive here, if you would allow a little extra time.

That'd be wonderful in fact.

Okay, you last year -- calendar year, during either one or two of the quarters had several new customer wins that you announced. And I believe that the reference was at that time something to the effect of $5 million to $30 million. And if one did the math at that time and assumed that to have a range of $5 million to $30 million, one of them had to have been $30 million. And then we assumed all the others were at the low end. That worked out to about $50 million of incremental revenue.

Now interestingly this quarter, we have five new wins that you made reference to $5 million to $30 million. If we assume that one of those is $30 million and every other one is at the very bottom end, that's another $50 million. So that implies that we have potentially $100 million of incremental revenue that's coming down the pike, unless some of that has started to flow through the $45 million or so that you reported this quarter. So I guess I've got multiple questions here.

Number one, am I even close to correct on my math? Or have I done an egregious error? The second question, if the math is correct, how much of that first $50 million is in the -- is in that $45 million that you just reported in the December quarter? And it would -- and then would you concur that the remaining whatever -- well, $50 million from this quarter, plus what has not flowed through from the prior announcements, that that comes through at an incremental margin? I think in the past, you've been somewhere close to 20%. So a gargantuous number could flow to the bottom line.

Yes, Bill, the -- to answer your -- you had a number of questions there. But let me try to take them piece-by-piece. The new customers that we announced a year or so -- or more ago, those -- some of those customers are generating revenue right now as Craig mentioned in his words. We've got in Q4 over 50% of our revenue did come from new customers.

You didn't really see the revenue growth because at the same time a couple of large customers -- long-time large customers that Craig had referred to were declining. Their revenue was going away. In the case of one, they were bought out by a -- by HP. In the case of another customer, they were -- picked another tier one manufacturer when they decided to go full box build and we were really already too much of their -- they were already too much of our business, at least in their eyes.

So some of that new revenue from a year ago or new customers from a year ago was really replacing revenue that was going away. And as far as the new business that we just announced, I don't think you're missing it. I think that we expect to see that new business be incremental this time and not replacing revenue that's going away. And as far as our incremental profits that you are referring to, that is a -- that's a pretty good estimation of our variable margin, anywhere from 15% to 25% incremental margin on incremental revenue. So I think your numbers are pretty accurate there.

And so -- thank you. So if we think about the new customers announced a year or so ago and just assume that that's fully built-in to the sales numbers today, we're still looking at the customers announced in the release today as an incremental $50 million of revenue and a 20% margin kind of taking that midpoint of the 15% to 20%. That's an extra $10 million, which on 10 million shares, since you're not paying taxes, that's somewhere in the neighborhood of an incremental $1 a share. Is that accurate?

That's accurate on figuring. It's -- obviously it -- when you --once you start getting some of these customers into production, they may not fit the norm with the 15% to 25%. The larger customers or the larger ones tend to be not quite as much incremental because it's a lot more price competitive when you try to pick them up. So they may not be the -- at the 20% variable margin.

All right. That is helpful. Thank you both for allowing me to take the extra time here. It seems as though to me that you're at an inflection point and I just wanted to assure myself that something really was different as it appears as though it is with the business and there's some sustainability. That actually, I suppose since you provided some commentary about the June -- I'm sorry, about the March quarter and the June quarter that that implies that your confidence level is also increasing.

Yes, when we look back at past press releases, I think this is the most confident we've been in our ability to predict more than the next couple of weeks. So certainly nothing you can take to the bank, but a lot better than it's been in the past.

Well, thank you. Thank you for letting me be a -- kind of be a little testy there to begin with and I stand corrected. And very nice job.

Thank you.

Thank you. (Operator instructions) One moment please. Mr. Gates, I show there are no further questions at this time. Please continue.

Okay. Well, that's the end of our conference call today. Thank you all for listening with us. And look forward to speaking to you next quarter.

Ladies and gentlemen, this concludes the Key Tronic second quarter fiscal 2010 conference call. If you'd like to listen to a replay of today's conference, please dial 1-800-406-7325 and for international participants, 1-303-590-3030 and entering the access code 4197912 followed by the pound key. The replay will be available until March 3, 2010.

ACT would like to thank you for your participation. You may now disconnect.