Key Tronic Corp (KTCC) 2011 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Key Tronic second quarter of fiscal 2011 conference call. During today's presentation, all parties will be in a listen only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions)

This conference is being recorded today, Tuesday, February 1st of 2011. I would now like to turn the conference over to Mr. Craig Gates. Please go ahead, sir.

Good afternoon, everyone. I am 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 second quarter of fiscal 2011. We're pleased with our strong year-over-year revenue growth for the second quarter and for the first half of fiscal 2011, driven primarily by the production ramp ups of new programs. While most of our new programs are ramping according to our projections, several of our existing customers are experiencing difficulty in forecasting their demand as the recession eases. Accordingly, we have revised our previous forecast for revenue and earnings and now expect to see sequential growth get underway in the fourth quarter of fiscal 2011.

At the same time, we continue to diversify our revenue base by winning new programs and we're seeing some gradual improvement in the global supply chain for certain electric components -- electronic components. Over the longer term, we remain well positioned to profitably grow our business, capture additional market share, and capitalize on emerging EMS opportunities.

Now I would like to turn the call over to Ron to review our financial performance. Then I'll 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 with 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 January 1st, 2011. For the second quarter of fiscal 2011, we reported quarterly revenue of $61 million. This is up 36% from the $44.8 million in the same period of fiscal 2010. For the first six months of fiscal 2011, our total revenue was $124.4 million. This is up 45% from $86.1 million in the same period of fiscal 2010.

During the second quarter of fiscal 2011, our business continued to be somewhat constrained by industry-wide shortages in the global supply chain, but we're seeing some gradual improvement in the availability of certain electronic components. During the start up and material costs -- or despite the start up in material costs associated with our new product mix, we have continued to maintain strong gross margins.

For the second quarter of fiscal 2011, our gross margin was 9%, which is comparable to the previous quarter. In the second quarter of fiscal 2011, in addition to incurring higher material costs, we also incurred higher operational expenses associated with our new product mix and product program start-ups, which included hiring new engineers and program managers. As a result, our operating expenses were $3.7 million for the quarter. This is up from $3.3 million in previous quarter and up from $3 million in the second quarter of last year.

Despite our strong year-over-year revenue growth, the increases in program start up costs and operating expenses impacted our bottom line in the second quarter of fiscal 2011. Net income for the quarter was $1.7 million or $0.17 per diluted share. This is the same as the second quarter of fiscal 2010.

For the first six months of fiscal 2011, net income was $3.5 million or $0.33 per diluted share. This was up 75% from the $2 million or $0.19 per diluted share for the same period in fiscal 2010.

Turning to the balance sheet, inventory was up $800,000 from the previous quarter. The inventory increase reflects the unanticipated decrease in demand from several existing customers as well as the growth that we're seeing in production levels for a number of our new programs.

Our trade receivables were $37.8 million at the end of the second quarter. This is up from $35.1 million at the end of the previous quarter because over 45% of our second quarter revenue occurred in December. Given the challenging credit environment, we're pleased to see our day sales outstanding at 54 days, which is up slightly from recent quarters, but is still well within in our target range.

We have drawn an additional $7 million on our credit line during the second quarter to fund working capital growth and capital expenditures. Our capital expenditures for the second quarter were $1.2 million and we expect CapEx to be about $5 million for the fiscal year 2011.

Moving into the second half of 2011, some of our existing customers have recently decreased their forecasts for the third and fourth quarters. Accordingly, we have revised our previous forecast for revenue and earnings. Taking these factors into consideration, we expect revenue in the range of $60 million to $62 million in the third quarter of fiscal 2011. For the full fiscal year, we now expect revenue of $250 million to $260 million.

In the third quarter, we expect our gross margins to be adversely impacted with the higher material and start up costs of our new programs, resulting in gross margins of about 7% to 8%. In the fourth quarter, as our revenue increases, we do expect our gross margins to improve, returning to around 9%, which remains our long-term target.

We also expect our operating expenses, which increased significantly in the second quarter as we absorbed the cost of ramping new business, to remain flat in coming periods. As a result, we expect earnings in the range of $0.05 to $0.10 for the third quarter and $0.55 to $0.65 for the full year. Note that our forecast may be impacted by supply chain issues, changes in customer forecasts, and changes in the general economic conditions that could result in variances in our results. But over the longer term, we believe that we're well positioned to continually profitably expanding our business.

Okay, that's it for me, Craig.

Okay. Thanks, Ron. We got off to a good start in fiscal 2011. Our record revenue of over $124 million in the first half was up 45% from the same period last year. Our growth was largely powered by new programs and we've been growing faster than many of our industry peers and steadily capturing additional market share.

While we now expect our third quarter revenue to be at approximately the same level as the second quarter, we're preparing for sequential growth in the fourth quarter and beyond. We believe that our continued investment in our business, our solid execution of our long-term strategy, and continued profitability is being rewarded with increased confidence from existing customers and increased interest from potential new customers.

During the second quarter, we've continued to successfully build a more diversified customer portfolio, spanning a wide range of industries. We want new programs involving industrial motor controls, fire safety devices, and power supply equipment for US military applications. We expect these programs to begin contributing to revenue in fiscal 2011 and each offers a potential annual revenue contribution of $5 million to over $20 million over the longer-term. We believe our revenue diversification strategy will continue to serve us extremely well over the long run.

Despite the challenges of industry wide component shortages in the global supply chain and managing a growing number of new program production ramps, we maintained our strong operating efficiencies and dramatically increased our profitability in the first half of fiscal year.

While we face some revenue delays and related margin challenges in the third quarter, we expect our operating performance to still outpace many of our industry over the longer term. Over the long term, you can expect us to continue to maintain our conservative management philosophy that focuses on controlling costs and continuously augmenting our production processes.

Our continuing investment in enhancing our production capabilities also continues to set us apart. In recent periods, we expanded our facilities in Mexico, China, and the US. By offering world-class manufacturing from three geographic locations, we can optimize the supply chain for our customers' unique businesses. Our expertise in operating multiple offshore facilities and our centralized inventory, IP, production, and engineering management provides significant competitive advantages to our customers.

Despite customer forecasting uncertainty in the third quarter, we have strong business momentum and recent studies forecast 8% to 12% growth for the EMS market in coming years. With our unique combination of world-class engineering, global logistics, and cost effective production, we're increasingly well positioned to continue to capture additional market share and capitalize on emerging EMS opportunities.

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 remain confident in our ability to grow our revenues 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) And we do have our first question from the line of Bill Dezellem with Tieton Capital Management. Please go ahead.

Thank you. I was hoping that you would go into a bit more detail on your experience in the December quarter and then what you're anticipating in the March quarter, both relative to existing customers and what is happening with your perception of their in demand and their inventory levels. And then also relative to the new customer ramps and in terms of the rate at which those ramps are taking place compared to your original expectations.

And part of the backdrop of my question, I mean clearly the results that you are announcing and your guidance, but also there was a fair amount of discussion around the GDP numbers that came out that there was some inventory contraction that took place in the December quarter, which leads some to believe that there'll be an inventory rebuild that'll take place as we move in through 2011.

Okay. Well, that's a lot of questions in one paragraph, Bill. So I'll start to answer them and when I forget to get one of them, just prompt me and I'll try and get all of them.

As regarding existing customer business, as you know we're approaching 30 customers and each one of our customers is very unique. So it's hard for us to draw any really broad based conclusion on what's happened to us over the last quarter and what we think's going to happen in the next quarter. There is a bit of a theme of our customers believing that the recovery was going to be a bit steeper than what it has been. And that has resulted in some of those customers acquiring too much inventory from us and then being forced to slow us down again as a result.

It's hard to say overall what's going to happen with each of those various customers in some type of a complete statement for Key Tronic because they are so unique and they're in so many different markets.

So right now we see that the majority of them think they're going to burn off the excess inventory they have as we get towards March. But who knows? This is -- we're two layers removed from the end marketplace and we can only go on what they tell us.

That's what we know in terms of existing customers. Did I answer your questions there or do you have more in that area?

Craig, actually you did answer them, but I'm going to circle back to the December quarter. Was there a period within the December quarter that they were cutting production to pull inventories back? I think in the opening remarks there was a reference to 45% of revenues in the month of December and so that would potentially imply either no or yes they did, but it was in the October/November time period.

Well, we've got a pretty complicated balancing act going on as we bring these new programs on and as our current customers are trying to react to the response -- their response to the recession kind of ending.

What happened in the December quarter and the fact that 45% of the quarter was shipped in December is that earlier on in the quarter we started to see the erosion in our existing customers' forecasts. And we had planned to bring new programs up in the December quarter, which we did, but they didn't happen until actual December. So we lost a lot of existing revenue out of the first couple of months from existing customers, but replaced some of it with new revenue in the month of December. But that new revenue was pretty costly because we had people sitting around for the first two months and then we had to work them overtime in the final month.

So it's as we're shifting to new programs we didn't expect to also be seeing declines in existing programs and we haven't lost any existing business, it's just that the customers are having a rough time forecasting their inventories and pull levels.

And so if I understand what you're saying correctly, the existing customers actually did start to pull back a bit in the December quarter, but it's actually going to be accentuated in the March quarter. Is that correct?

Yes.

All right, thank you. And then relative to new customers, you've begun to answer what you experienced in the December quarter. Maybe as a segue to that you could help us understand what caused the delay to where it was late in the December quarter before that ramp began. And then kind of what you're seeing as we work our way through the March quarter here.

Well, there's more than one ramp, so there's more than one reason. There are typical delays, technical difficulties as we pull from a factory that's not happy to be losing the business as we move it to ours. There weren't a whole lot of material delays for the new business ramps. Those are pretty well managed into the business that ramped in December. And then the readiness of our customers to help with the ramp was also an issue. But that's -- those are all pretty typical.

If we look at -- I went back and did a pretty in-depth analysis of what's gone on. If we look at what's happened to our revenue, less than 10% of the effect that we're seeing is due to slow ramps. Majority of what we're seeing is due to forecasts that are different than what we'd originally been told. So we're getting better at forecasting. I probably shouldn't say that because I'll be proven wrong next time, but we think we're getting better at forecasting ramp rates of new business. We were surprised this time by the difficulty our customers are having with controlling their inventory and the pull rates they're seeing.

Does that phenomenon of customers having trouble controlling their inventory also spill over to some of the new programs that you've won where those customers also having trouble forecasting and therefore you're not ramping as quickly as what they were originally anticipating?

It's less the speed of the ramp as in more the end point of the ramp. So even though we're ramping at the speed we predicted, we may not end up with as big of a piece of business as we had originally been forecasted.

And is that due to the economy or some other issue?

Well, it's all kinds of things. The -- again, we have so many different customers in so many different markets. One of them is due to the so far limited impact of the flu season this year. So there's all different factors that impact these products that we build.

Great, thank you. I've taken a lot of time. I'll let the next person come in.

(Operator instructions) And we do have a follow-up question from the line of Bill Dezellem with Tieton Capital Management. Please go ahead.

Okay, thanks. I guess I will come back with a couple others then. In the September quarter you had some start up costs that were semi unanticipated from new programs that were ramping. Would you please discuss the magnitude of the start up costs that you experience in the December quarter relative to the September quarter?

And then Ron, I believe that as part of your opening remarks you made reference to an anticipated weaker gross margin in the March quarter, and so really carrying the start up cost question on through to the March quarter.

Well, the December quarter start-ups costs were quite a bit more than the September quarter. And we had thought that they would be swapped out by the overall growth we would see in revenue, which instead of growth all we did was replace existing business with new business. Not replace, but trade it for probably a quarter-and-a-half to two quarters.

So when we looked forward, the start up costs in Q3 we continue to ramp all the new business we've talked about in the past and we've won more since then, but we continue to be putting a lot of new programs into our factory. We expect that in Q3 we're not going to have a lot of existing revenue to absorb those costs and in Q4 we expect to start to see our existing customers forecasts to come back. They believe they're going to come back and in that case with the new business added to the better resurgence in the older business we should be back at our normal gross margin percentages.

And so you're anticipating that the March quarter start up expenses will be more similar to the December quarter?

Yes.

Or to the --?

Yes.

Okay.

Another thing, Bill, is with some of the new programs that we've got coming on, as Craig mentioned, different types of products, different markets, our material costs as a percentage of our revenue because of the mix change is starting to -- is a little bit higher in Q3 than it was in Q2. So that's contributing to the erosion in the gross margin in Q3 as our existing customers do come back to demand like we're seeing now in Q4 but it comes back like we're -- they're telling us now, that should have a less impact in Q4.

Thank you. And then given all of the new business that you do have that you are ramping, I think every quarter for the last couple of years now you have won new business. And I'm curious to what degree do you anticipate requiring to expand your capacity over the next nine months? And where in that nine-month window would you anticipate that to be happening?

In terms of bricks and mortar, we think we're good for the next 12 months.

Okay.

In terms of capital equipment, we talked about $5 million in CapEx, that's what we see coming and that's to both buy new equipment and upgrade some existing equipment to handle the requirements of newer business.

And of that $5 million we've already spent this year about $2.7 million. There is some additional equipment that we're going to buy for the new programs, but that really isn't a couple of million dollars more for the rest of the fiscal year really isn't that much additional CapEx for -- to handle that new business we've got coming at us.

So in essence, you're halfway through the year and you've halfway spent your CapEx budget, so it's a reasonably smooth ramp.

Yes.

From that standpoint.

It looks lumpy to us because it's this machine or that machine, but overall the cash is about even, as you say.

Right, okay. And then a final question for now. Given all of the business that you have won and that the business is now ramping and at some point your existing customers will in aggregate bounce back a bit, especially given that it does appear as though the economy is directionally improving. It seems as though there's an inflection point coming here where I mean all of a sudden a number of things could start coming together, potentially quite dramatically. And clearly it's not going to be the March quarter, but in your mind is that the June quarter or does that push out to the September quarter? Or in your mind is there never truly an inflection, it just kind of continues to work its way up as you continue to bring new business on board? How does that road map look to you folks?

Well, I think I'm getting out of the business of forecasting inflection points and I'm just going to grow the business as fast as I can. It's too hard to predict what's going to happen with this customer, with that customer and all I can say at this point is we keep winning new business, we haven't lost any existing business. And we think it's going to keep growing. But I can't -- I just can't tell you what month or what quarter it's all going to hit the bottom line. It's too hard.

And given what you're experiencing this quarter I can understand that but let me ask this. Do you believe that the basic premise of the question has merit it's just that you're not feeling comfortable picking a time period to tie in with the question?

That's correct.

Okay. Well, we'll eagerly anticipate when we can get to that point.

Us, too.

Thank you.

Thank you. (Operator instructions) And at this time I'd like to turn the call back over to management for any closing comments.

Okay, thank you. I'd like to thank all of you participating in today's conference call. Ron and I look forward to speaking with you again next quarter. Thank you and have a good day.

Thank you. Ladies and gentlemen, this concludes the Key Tronic second quarter of fiscal 2011 conference call. If you'd like to listen to a replay of today's conference, please dial 303-590-3030 or 1-800-406-7325, followed by a pass code of 4398252. ACT would like to thank you for your participation. You may now disconnect.