Key Tronic Corp (KTCC) 2010 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Key Tronic third-quarter fiscal 2010 conference call. During today's presentation all parties will be in a listen-only mode. And following the presentation the conference will be open for questions. (Operator instructions.) As a reminder, this conference is being recorded today, Tuesday, April 27th of 2010.

And now I'd like to hand the conference over to Mr. Craig Gates, President and Chief Executive Officer. Please go ahead, sir.

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. Joining me here in our Spokane Valley headquarters is Ron Klawitter, our Chief Financial Officer.

Today we released our results for the third quarter of fiscal 2010. We're very pleased with our strong sequential growth in revenue and earnings, driven by increased demand from both longstanding and new customers. We've remained profitable for 25 consecutive quarters by continuing to control our costs, maintain strong operating efficiencies, and improve our new product introduction processes, even as we have brought many new programs into production and grown our business. Based upon our strong financial position and continued success in diversifying our revenue base across a wide range of industries, we believe that we are well positioned to profitably grow our business.

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 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 April 3, 2010. For the third quarter of fiscal 2010, we reported total revenue of $51.7 million, up 16% from $44.8 million in the previous quarter and up 17% from the $44.2 million in the same period of fiscal 2009. For the first nine months of fiscal 2010, total revenue was $137.8 million, compared to $139.5 million in the same period of fiscal 2009. Our business was constrained during the third quarter of 2010 by industry-wide shortages in the global supply chain, which did reduce our revenue by about $5 million. In coming periods we expect these supply chain issues to continue to impact our business until the world's solid-state supply ramps up to meet demand.

Despite the impact of the supply chain constraints, our flexible operating model allows us to exceed our revenue forecast and take the necessary steps to adjust our variable operating expenses and overhead to changes in production demand. Our operating flexibility and the higher anticipated production volumes for the third quarter of fiscal 2010 resulted in a strong gross margin of 10%, up from 7% in the same period of fiscal 2009. In coming periods we expect our gross margins to be around 9 to 10%.

We continue to focus on controlling our operating expenses, while we continue to make the investments necessary to support long-term competitiveness. In the third quarter of fiscal 2010 our operating expenses were essentially flat compared to the previous quarter, even with the significant sales growth. We expect our total operating expenses to be around 5 to 5.5% of total sales in coming quarters.

Our stronger than expected revenue growth and higher gross margins in the third quarter combined with our continued success in controlling cost and improving efficiencies resulted in an operating margin of over 4%, 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 third quarter of fiscal 2010 was $4.4 million, or $0.43 per diluted share, up from $1.7 million or $0.17 per diluted share in the previous quarter and up from $0.3 million or $0.03 per share in the same period of fiscal 2009. Results for the third quarter of fiscal 2010 include a net deferred tax benefit of $2.2 million, or approximately $0.22 per diluted share. In the first nine months of fiscal 2010, net income was $6.4 million, or $0.63 per diluted share, including the net deferred tax benefit, up from $0.8 million or $0.08 per diluted share for the same period of fiscal 2009.

Turning to the balance sheet, we ended the third quarter of fiscal 2010 with no debt and with cash and cash equivalents of $4.6 million. This is down from $7.2 million at the end of the previous quarter, primarily reflecting our sequential increase in inventory of about $7 million.

Inventory increase reflects orders we could not ship due to the industry-wide supply constraints and our preparation for anticipated growth in production levels for a number of our new programs. Our trade receivables were $27.1 million at the end of the third quarter, up only $0.9 million from the previous quarter. Given the challenging credit environment, we're pleased to see our DSOs around 48 days. This is down from 52 days in the previous quarter.

Finally, our capital spending was $0.4 million in the third quarter of fiscal 2010. We expect our CapEx to be in the range of $2.1 million to $4.5 million for the full fiscal year, depending on the timing of our planned expansion of our campuses in China and Mexico.

Looking forward, we expect to see continued growth in the revenue generated by our new programs. We're also continuing to control our costs while making the necessary investments to support our long-term competitiveness and continuing to maintain our strong balance sheet.

Taking all these factors into consideration, we expect revenue in the range of $52 million to $58 million in the fourth quarter of fiscal 2010. Note that our forecast for the fourth quarter may be impacted by continuing supply chain issues that could result in variances in our results. We expect earnings in the range of $0.14 to $0.19 per share.

Note that we've had near zero effective tax rate for many years because of our profits were offset by the benefits of net operating loss carryforwards. These net loss operating carryforwards have now been fully recognized and we expect an effective tax rate of approximately 33% in coming periods.

Over the longer term we believe we're well positioned to profitably expand our business.

Okay. That's it for me, Craig.

Okay. Thanks, Ron.

As we move into fiscal 2010, we are pleased with our success at profitably growing our business by controlling costs, efficiently managing our inventories, strengthening our operating infrastructure, maintaining our strong balance sheet, and diversifying and growing our customer base. Our success with these initiatives has placed us in an excellent competitive position to continually profitably grow our business.

Our new programs continue to represent a growing portion of our revenue and a promising foundation for future growth. Over 50% of revenue in Q3 came from programs from new customers. We also had a high portion of tooling-related revenue as we gear up for bringing more new programs on line.

During the third quarter of fiscal 2010 we continued to diversify our revenue base by winning new programs involving specialty printers, motion warning systems and video communications equipment. We expect that these recent wins will begin moving into production during fiscal 2011. When they reach full production these latest program wins each represent a potential revenue contribution in the range 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 base of industries.

Although the deteriorating industry supply chain remains challenging, our aggressive allocation response program has positioned us well with many of our customers. At the same time, the pipeline of potential business remains robust and the long-term trend towards outsourcing continues to look encouraging. While the recession initially put some potential customers' outsourcing plans on hold, many companies now recognize a growing imperative to move forward with outsourcing strategies to improve their long-term efficiencies and operational flexibility.

Most analysts expect the EMS market overall to grow at around 10% annually in coming years. We expect our growth to exceed the overall EMS market expansion. We believe Key Tronic has continued to strengthen its competitive position, as OEMs placed increasing value on our success with core strategic initiatives and our strong financial performance.

In order to provide the capacity required to produce the new business that we have already won, we are planning to invest in square footage in both of our world-class campuses in Mexico and China in coming periods. We also continue to focus on 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 campuses while helping us control inventories both during and after 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 their 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 off-shore facilities.

As OEMs have struggled with IP control, assurance and supply issues, and product launch delays with standalone and independent foreign sites, our centralized approach has become 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 3 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 risk also continues to be a source of strength in the marketplace. We have no debt, cash in the bank, and an ample 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 our performance.

Going forward, we expect to continue to broaden and diversify our customer base even as we continue to focus on controlling our costs and maintaining our operational efficiency and excellence. We are optimistic about seeing growth in 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. (Operator instructions.) Bill Dezellem; Tieton Capital Management.

Thank you. First of all, I'd like to start with the program wins that you had in the quarter. You listed three categories. Did you win one win per category or did any one of those categories did you have more than one win?

One per category.

So that means that you had three wins, ranging from $5 million to $30 million. And so if we assume that two of those are $5 million and one of those is $30 million, that's $40 million of new wins, roughly speaking this quarter.

Yes.

And last quarter, I'm going off memory here, but there was roughly $50 million of new wins, again, doing the same thing that all programs are $5 million except for the one, assuming one is at $30 million.

Yes.

So that means that over the last two quarters that you've won roughly $90 million worth of new business that will be going into production starting when?

Varies across the programs -- anywhere from within the next couple of months out through 10 or 11 months from now.

And then, presumably there's also additional business that you won that we've discussed in the past on prior calls that still has not fully ramped also. So in essence there's probably $100 million-plus of new business still to ramp as we go forward?

Yes.

And then -- and is there any reason that we shouldn't think about the 9, 10% gross margin being the model going forward after you have ramped that $100 million-plus of new business?

Well, I think that's our best estimate at this point, Bill. It all depends on what we win. You know, we've had some wins where the material costs alone have been 90% of the revenue, because it's been a -- it's very competitive and it's pretty high volume or pretty high priced units. So it varies from win to win or customer to customer. But 9 to 10% is our best estimate at this point.

If we just did some real ballpark, back-of-the-envelope math, it's not unreasonable to think that that $100 million-plus of revenue should comfortably be able to generate $0.50 of earnings now after tax.

Well, how did you come with that? I guess if you're just assuming that the $100 million of revenue and --

I used 10% and then I took 35% off for taxes. That got me to $6.5 million and I rounded that down to $5 million, with roughly 10 million shares.

All right. So I could see how you got there and it makes sense.

Okay. That's helpful. And then I had one other question now and we'll let others get a shot. But you'd mentioned that you had $5 million of revenue that was delayed. Would you please discuss what components you were short of and the implications with those components on a go-forward basis, please?

Well, the main cause of the issue throughout the industry is solid-state microprocessor-type components. A number of the big manufacturers of those sold off their fabs during the downturn as a way to survive the downturn. And as business has come back they're finding it pretty hard to get the capacity back that they sold. So we are seeing lead times going from 12 to 15 weeks being pushed out to 25, to 27, to 30 weeks. So this is our -- those types of components are our worst offender in terms of causing the fall-down that we had to push into this quarter.

And then, there have been some mechanical components that are fairly random, but had a sizeable effect. We had some motor issues and that was the biggest other than the solid state.

That's helpful. Thank you both.

(Operator instructions.) Bill Dezellem; Tieton Capital Management.

Well, my apologies. I guess I should have just continued on. CapEx, the range that you gave in the quarter was pretty wide. Would you please discuss how -- what would lead to the variance of $2.1 million versus what could lead to a $4.5 million year?

Well, it depends on the timing of when we acquire the extra square footage.

So it's property rather than equipment, primarily, that you're --

Yes.

-- looking at there?

For the most part.

Okay. And then, I guess a little bigger picture question -- would you please discuss the quantity and the quality of your customers today versus in the past?

Well, the quantity is now above 30. And if you look at that list of customers in terms of quality, I don't think you mean the moral integrity of the people running the business. I think you mean the long-term income-producing potential of the business. And going under that definition of the list of customers, up until about two years ago, a year and a half ago, three years, somewhere in there, when we look back at our customer base there was always a concern that there was a mismatch between one or more of our big customers.

And today when we look at our list of 30, to our knowledge there isn't the mismatch between any of those customers and us. So we're not planning to have to replace a large piece of revenue at any time in the next year from our existing customer base. Bad things always happen unexpectedly and it could be the case that that does happen, but right now -- and this is probably the first time since we got into the contract manufacturing business -- right now when we look at that list, there isn't any one big customer that we feel is currently at risk.

And when you're referencing a mismatch and at risk -- and by the way, you did identify, I guess, my definition correctly. But relative to that mismatch risk, you've talking customers that are substantially larger than you are, Fortune 500 or otherwise. And Key Tronic clearly does not fit that category. And ultimately they reach a conclusion that they're going to move away from you to one of the Tier 1 manufacturers and therefore just one day you get a phone call and lose the business, whereas you just don't see that happening today?

Yes. We don't see that happening today. Not all of the risk was because they were -- one of these big customers was going to a Tier 1, but that is the major cause of the departures in the past. And you seldom in this business one day get a phone call that says it's gone. Typically it took two or three years to get the customer into our factories at full speed. And so it takes two to three years to get the customer back out. So it's more of an ongoing process that we know about as it's happening. And right now there are none of those processes going on.

That's helpful. Thank you. And then, additionally, you'd mentioned in the release and I believe in the opening remarks also that you are seeing revenue increases from your existing customers. And I haven't looked back in your prior releases, but I believe this is the first time in a few quarters that you have referenced existing customers ramping on the revenue front. And so I was hoping, number one, that you would remind us how much they dropped during the downturn. And then, what are the implications that -- of you all seeing the existing customers now ramping?

Well, the first thing is that overall we kind of view what's going on with who's on the other end of the phone when it rings and what they say. So up until late summer of last year, every time the phone rang it was somebody who needed to cancel or delay an order. And then from summer through somewhere around November, December the calls were pretty much evenly split between "push it out," "cancel it," or, "Hey, I may actually be able to take this order." So we were basically bouncing along in the trough at the bottom of the recession. And then around December, January, we started to see the trend of the calls switch over to more people looking to confirm their forecast and maybe pull it in a little bit and increase it.

So what we're seeing today is not a wild exuberance of people bumping their forecasts up by 30% or 40%. But what we see is a very careful response by our customers to what they see as increased demand. But it's tempered by the fact that any nonforecasted increase is going to be controlled by our ability to obtain those solid-state components I was talking about earlier. So it's -- our existing customers in general reflect the economy. I don't think they're leading or following. I think they seem to track pretty much by what I read in the press in terms of the state of the economy.

But as far as how far they dropped, most of them are still far below where they were at their peak in recent history. There were some of our customers who dropped over 50%. I'd say the average existing customer drop was in the 30 to 35% range if we look out overall.

And I guess that leads to a couple of additional questions. The first one is, given that you're now starting to see as what I'll characterize as modest, cautious pull-ins, is there any reason we shouldn't work our way back up to where customers -- and probably not all of them. It's probably customer-specific. But in many cases have those customer work back up to where they were, meaning that if we had a 35% drop, the math probably says there's roughly a 50% increase to get back to that prior peak?

Well, that'd be nice but I think a couple of customers have permanently lost market share during the downturn. And there's been some I think permanent changes in the marketplace overall that will affect a few of our customers, and they're not going to get back to where they were.

All right. And then, additionally that leads to the question relative to the $100 million-plus of new business that you've announced just in the last couple of quarters. Presumably when you are calculating the revenue range for those, you're also looking back at the recent past and there may be upside just with the economy if they were to get back to their prior peaks. Is that a fair reading between the lines?

I don't know that I'd read that hard between the lines. Because --

It will come back some, but (inaudible - multiple speakers.)

It will come back some, but I don't think it's going to come back as much as we would hope.

Fair enough. Again, thank you.

Thank you. And Management, I'm showing no further questions in the queue. Please continue with any further remarks.

I don't think we have any more.

All right. Then, ladies and gentlemen, this does conclude the Key Tronic third-quarter fiscal 2010 conference call. If you'd like to listen to a replay of today's conference you may dial 303-590-3030 or 1-800-406-7325 and enter the access code 4282480. Thank you for your participation and you may now disconnect.