Key Tronic Corp (KTCC) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Key Tronic Corporation third quarter fiscal 2011 earnings 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 Tuesday, May 3 of 2011.

I would now like to turn the conference over to Craig Gates, President and CEO of Key Tronic. 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 2011. We're pleased with our strong year-over-year revenue growth for the third quarter and for the first nine months of fiscal 2011, driven primarily by the production ramp-ups of some of our new programs. During the third quarter of fiscal 2011, the revenue contribution from new programs was mostly offset by temporary demand reductions from some established programs.

At the same time, we continue to diversify our revenue base by winning new programs. Moving into the fourth quarter, we are seeing some improvement in the forecast for established programs and we continue to focus on moving the new programs into production and through the ramp phase. 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 and 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 third quarter ended April 2, 2011. For the third quarter of fiscal 2011, we reported total revenue of $63.4 million. This is up 23% from the $51.7 million in the same period of fiscal 2010. For the first nine months of fiscal 2011, total revenue was $187.8 million. This is up 36% from the $137.8 million in the same period of fiscal 2010.

As expected, the startup expenses associated with ramping several of our new programs had an impact on our gross margins. Due to program ramps, Q3 was very back end loaded, resulting in inefficiencies, and unused labor in the beginning of the quarter and overtime costs during the last month of the quarter. Also as expected, we saw a negative impact on gross margin due to the product mix that is associated with this transitional period of rapid growth.

As a result, our gross margin was 7%, which is lower than the previous quarter and lower than our long-term target of around 8% to 9%. As a result of program startups, we also have higher operational expenses than a year ago. This includes hiring new engineers and program managers. As a result, our operating expenses were $3.3 million for the first quarter of fiscal 2011. This is down from $3.7 million in the previous quarter, but is up from the $3 million in the third quarter of last year.

Despite our strong year-over-year revenue growth, the increases in program startup costs and operating expenses impacted our bottom line in the third quarter of fiscal 2011. Net income for the third quarter of fiscal 2011 was $700,000 or $0.07 per diluted share compared to $4.4 million or $0.43 per diluted share for the same period of fiscal 2010. You will recall that our results for the third quarter of fiscal 2010 included a net deferred tax benefit of $2.2 million or approximately $0.22 per diluted share.

For the first nine months of fiscal 2011, net income was $4.2 million or $0.40 per diluted share compared to $6.4 million or $0.63 per diluted share for the same period of fiscal 2010.

Turning to the balance sheet, inventory was up slightly from a year ago but down $1.3 million from the previous quarter. This year-over-year inventory increase reflects our recent and expected growth in production levels for a number of our new programs, as well excess inventory resulting from some of our customer forecast reductions. In coming quarters, we expect to reduce excess inventories and bring inventories to levels in line with our expected revenue levels. Note that by the end of the third quarter, we had brought the balance of our line of credit down about $4 million from the end of the previous quarter.

Our trade receivables were $42.3 million at the end of the third quarter. This is up from $37.8 million at the end of the previous quarter due to the back-end loaded nature of our third quarter revenue. Our days sales outstanding was 52 days, which is similar to recent quarters as well as within our target range. We expect receivables to decline as revenue becomes more level loaded in Q4. Our capital expenditures for the third quarter were $800,000 and we expect CapEx to be about $4.3 million for fiscal 2011.

Moving into the fourth quarter of 2011, some of our longstanding customers have modestly increased their forecast for the fourth quarter and our new programs continue to ramp into production. Yet our customers generally remain cautious in the current macroeconomic environment. Taking these factors into consideration, we expect revenue in the range of $61 million to $65 million in the fourth quarter of fiscal 2011.

In the fourth quarter, we expect our gross margin to continue to be adversely impacted with higher material and startup costs of our new programs, resulting in gross margin of 7% to 8%. We also expect our operating expenses to remain flat in coming periods. As a result, we expect earnings in the range of $0.07 to $0.12 per share in the fourth quarter. Note that our forecast may be impacted by supply chain issues, changes in customer's forecasts and changes in general economic conditions that could result in variances in our results.

Over the longer term, we believe that we are well positioned to continue profitably expanding our business.

That's it for me, Craig.

Okay. Thanks, Ron. We're certainly pleased with our growth in revenue for the first nine months of fiscal 2011 compared to the first nine months of fiscal 2010, which has been largely powered by new programs. We've been growing faster than many of our industry peers and steadily capturing additional market share. While we are expecting our fourth quarter revenue to be up only modestly from the third quarter, we believe we are well positioned for profitable growth over the longer term.

We believe that our continued investment in our business, our solid execution of our long-term strategy, and continued profitability is being rewarded by increased confidence from existing customers, and increased interest from potential new customers. During the third quarter, we continued to successfully build a more diversified customer portfolio spanning a wide range of industries. We won new programs involving mobile device accessories, aerospace, and household products. We expect these programs to begin contributing to revenue in fiscal 2011 and each offers a potential annual revenue contribution in the range of $5 million to over $20 million over the long term.

We expect to be generating revenue from 30 EMS customers in the fourth quarter compared to 20 EMS customers contributing to fourth quarter revenue in fiscal year 2010 and believe our revenue diversification strategy will continue to serve us extremely well over the long run.

Despite the challenges of managing a growing number of new program production ramps, our operating performance has still outpaced many in our industry. Over the long-term, you can expect us to continue to maintain our conservative management philosophy that focuses on controlling costs and continuously augmenting production processes. Our continuing investment in enhancing our production capabilities also continues to set us apart.

With our facilities in Mexico, China, and the US, we can offer world-class manufacturing from three geographic locations, and 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 provide significant competitive advantages to our customers.

Although some customers' forecasts during the second half of fiscal 2011 reflect uncertainty about the economy, 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 believe 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 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.

Thank you. I have a few questions, but one that may require a little back of the envelope math so I'm going to start with that and then we can move to the others and maybe the answer you can circle back with this one. But the 30 customers or 30 programs that you're expecting to be in revenue production in the fourth quarter, if each of those 30 programs or customers, excuse me, was fully ramped, what would the sales level be versus the approximately $63 million midpoint of your revenue guidance? If you have that answer right off the top of your head, go ahead. Otherwise, I'll move onto my next question while maybe someone can work on that.

Well, it's kind of hard to answer, Bill, no matter how much time we have to do the math because, I'll give you an example why it's hard. Let's say that we won one program with a new customer and that new program is going to take a year to ramp and that program is going to ramp up to $5 million. But that customer has told us that there are going to be more follow-on programs as long as we succeed on this first program. So I don't know how to answer your question. Do you want the $5 million of the first program or do you want the eventual business ramp that we expect to result from winning that new customer?

Well, of course the easy answer is to say both if you had it, but I was thinking about just the $5 million.

Okay.

And so if there's a way that you can come up with a ballpark understanding that it wouldn't be a concrete number, that would be great. And if you are able to do so later in the call, I'll let you come back to that. But my next question is Japan, and the earthquake and tsunami there. Now that a little bit of time has passed, what impact from supply chain perspective and/or your customer's own revenue level for them selling over there or any other impact that you can see or foresee from that?

Well, we have made it through the first round of widespread fear among the supply base. We've had a couple of components that are causing problems. We haven't seen widespread shortages affect us yet. But some of the industry over there was a very base industry, silicon wafers, and things that are not going to show for six to eight months, and it's questionable if they're going to show up at all or they could be a disaster. So right now, we're cautiously optimistic and haven't seen a lot of impact on our revenue both current and for the next quarter based upon what happened in Japan.

And if in fact it is a disaster, presumably that's a disaster scenario, not just for you, that's an industry comment you were making there?

Yes, definitely.

And then the next question, relative to your three new customer wins that you, or new program wins that you detailed in the release, would you provide some additional commentary around each one of those, if possible, or the ones that you feel comfortable discussing?

I don't really feel comfortable discussing much of them at all. It's a molding business for one of them and that's about all we're willing to say at this point.

And would you be able to attach which of those three the molding business belongs to?

No.

I'll consider that a zeroed out. Next question for now is, is --- thinking about your revenue forecast for the fourth quarter, if existing programs, you're seeing some upward bias to the forecast and if you are ramping additional new programs and some of the existing new programs that are in ramp phase are continuing to ramp, what's the offset to all of that that's creating essentially a flat revenue forecast for the fourth quarter versus the third quarter? Because it seems like all of those have an upward bias to them. Or are you just essentially being conservative after the challenges of the last couple of quarters?

Well, we said that some of the existing customers are ramping up their demand slightly. It's not a broad based swell of demand coming back at us and even though we continue to ramp new programs, there's a lot of new programs ramping that are only going to have $100,000 of revenue in Q4 as we get the tools done just barely at the end of the quarter and up and running. So even though the ramp effort and expense is significant, the revenue payoff in Q4 is not necessarily significant from these new programs.

Also, some of the new programs that we ramped last quarter, there's kind of a natural burst rate that happens where you do a lot of work and get it done just in time as we did last quarter. We talked about it being backend loaded. So we cranked out a whole lot of product at the back end of the last quarter to fill pipelines and that doesn't necessarily mean that we're going to continue to run at that speed in Q4. So there's a lot of different reasons for our best guess at a revenue plan and I'd say last quarter, this quarter, and the coming quarter have a bigger statistical variation than what we've seen probably in the past with all the new business coming on in terms of trying to predict exactly when it's going to hit and what size it's going to be on what date.

All right, that's helpful. And before I step back in the queue, do you happen to have any perspective on fourth quarter, if the 30 customers were fully ramped, what the revenue ballpark might be?

It's going to have to be crude, but it would be somewhere between $75 million and $90 million.

$75 million to $90 million.

Yes.

All, right. Thank you. I'll step back in. I'll let someone else ask.

Thank you. Our next question comes from the line of Buzz Heidtke of MidSouth Investment Fund. Please go ahead.

Yes, you're talking about your margins around 6. You're looking for them to maybe go on up around 8 or 9. Is that going to be next year you think?

Yes, as we get into next year, as we get these programs ramped, as the new programs balance out there's some programs we've won that are high margin, some programs we've won that are high volume and lower margin, but as things start to get more to a steady state we believe we'll be back up into that range again.

Okay, thank you very much.

(Operator Instructions) Thank you. Our next question is a follow-up question from the line of Bill Dezellem with Tieton Capital Management. Please go ahead.

Thank you. SG&A, in the opening remarks there was a reference to it being down $400,000 sequentially but I didn't catch what were the dynamics behind that?

Well, we had quite a bit of legal expense in our Q2 that didn't repeat in Q3.

All right, thank you. And then as we look at the third quarter here, you highlighted several costs and most of those appear to be temporary in nature. But if there are any that you would consider long-term in nature or more permanent in nature, would you please call those out? And the reason I'm posing the question is a prior quarter you had roughly the same revenue level and yet had over $0.20 of earnings. So either we have a lot of temporary impact or maybe there's some permanent nature to some of the costs.

Well, there's a number of things going on there all at once. It's a multivariable equation. So we'll take them in no particular order just as they come to mind. So first of all, we did over $30 million of revenue in the last month. So instead of being spread evenly, we had to do half of the quarter in a month. So we had a lot of overtime costs in that month and at the same time, we had a lot of excess people sitting around in the first two months. In addition, the balance of powers required between Mexico and China didn't match the workforce that we had in place in Mexico and China. So that was one chunk of it.

The next one was a significant freight charge due to the ramping and expediting parts in here at the last week, the last day in order to meet some increases in demand from new customers and new programs that were just launching.

The next variable to consider is that the amount of money that we're spending on material as a percentage of revenue is in flux as we talk about our product mix and our new mix of customers, as I said to the other gentleman, we have in Q3 and Q4, we are launching high volume, lower margin businesses and we are yet to launch some lower volume, higher margin business. So that's a big factor in our gross margin floating around compared to being pretty steady as it was before.

So there's a lot of change happening at one time that we're trying to juggle and make sure we meet our expectations, but all these pieces of businesses that are coming are good and we're glad we have them. It's just that as a whole menu they're a great menu, but if we only have a few of the pieces of business coming out of the kitchen, the menu doesn't look as great as it used to.

So we talked about this being a transitional period in our history and that's why. We've got all these conflicting things happening along with increases in fuel prices, along with increases in resin prices that are impacting what's going on with our Company and I don't think it's possible to say that it has been a permanent change. But if we were to say at this revenue level with this current mix of customers, we'd say it's a permanent change, but we're not staying there. So I have a rough time answering your question without talking for a long time.

That is helpful though, and actually as a follow on to that, knowing what you know today, what would you have done different over the last nine months in terms of how you are running the business?

I don't think we would have done a whole lot different. The bets that we made on ramping programs in Q3, I would have placed the same bet then that I placed now. It would have been nice if we hadn't have had as much labor excess, but at the same point we couldn't plan for it because we are captive to our customers' ability to move their programs from the current supplier to us. So I don't think we could have foreseen very much of what happened to us and I think we've done a pretty good job of managing our way through it and at the same time driving our revenue up, at the same time driving our inventories down and driving our borrowing down.

Thank you both.

Thank you. (Operator Instructions) Our next question comes from the line of George Melas from MKH Management. Please go ahead.

Good afternoon, gentlemen. It's sort of a follow-up to the previous question. If we look at the business, you are adding a lot of new programs and as you mentioned some of those seem to be high volume, low margin. If we look at the, I'm not sure if we can think about it as the legacy business, but the business that you've had for quite some time. Is there a way to see how much that has declined? Have you lost some customers there or is it mostly sort of volume decline because of maybe some of their -- some of your customer's problems or the general economy?

It's mainly based on volume. What we think, we hope is a temporary volume decline amongst current customers that we didn't foresee back in Q1 and halfway through Q2. We think, and this has been born out by discussions with high levels within some of our customers, that if you'll recall nine months ago, a year ago there was a severe shortage of electrical components, selected electrical components. So there was a lot of fear amongst our customer base in their ability to get the finished product from us based upon our ability and their ability with us to source these scarce components.

So there was a significant amount of over-forecasting being done out of fear and a lot of it wasn't really overt and acknowledged by the customers. It was more or less of everybody put a little bit of a [windage] on the forecast to be safe, and by the time we got the final number it was 30% too high. So a number of our large customers have gone through and are still going through an inventory correction at their plant over Q3 and into Q4. And the actual outgoing sales of their products, if we look at them, and some of them do allow us to look at their numbers, outgoing sales haven't really changed that much. But there was kind of a semi-fear induced over-ordering a quarter and a half ago, two quarters ago that resulted in extra inventory that is now being bled off through this Q3 and into Q4. And in terms of major losses of customers, no, we haven't.

Okay, that's very helpful. So in a way are you suggesting that once this inventory correction is over or at least largely done by the end of next quarter, you could have some nice ramp or some nice volume increase in your existing customers?

That is certainly what they are telling us today.

Okay, and is that pretty much across the board or does that particular -- ?

There's a group of about three of them who were the worst impacted by the phenomena, but those three are pretty big.

Okay, can you tell roughly how much of your revenue or maybe how much of your gross profit those three customers make up? Maybe that's too granular a question, but --

Yes, I think we'll shy away from that one.

You'll pass that. Okay, very good. And in terms of the difficulty in balancing the revenue and the expenses during the March quarter, do you expect any of that to recur in the June quarter or do you think it should be more balanced?

It's looking a lot better. We're expecting it to be better and so far our expectations are being met.

Okay, great. Thank you very much.

Thank you. Our next question is a follow-up question from the line of Bill Dezellem.

Thank you. I wanted to follow-up on your comment about the lower margin, higher volume business that is currently ramping.

Hey, Bill, we can't hear you.

Are you there?

No, I can't hear you, Bill.

Hello?

Here, now I can hear you.

You can hear me now?

No, I can't hear you now.

Hello?

Now, I can hear you.

Hold on. Is that any better?

Yes.

So I'd like to follow-up on the point that you've been ramping some higher volume, lower margin business and the question is whether that's business that is permanently low margin or if that's just part of the phenomenon of ramping the business that it initially starts at lower margin and then after time the margins would improve. And I guess somewhat tied into that question, if it is business that longer-term will be lower margin, does it happen to be with customers that have additional business, as you referenced, that they might be giving you in the future if you do well that might be of a more profitable nature? So this is part of the pain one has to accept to get the better business later on.

Well, you're asking me questions today, Bill, that require me to talk forever. So I'm sorry, but here comes the answer to this one.

All right, thank you.

There's a number of different scenarios on the high volume, lower margin business. One of them is a customer that we have some lower volume, higher margin business and we competed for and won a different program that's much higher in volume, much lower margin. So it can be viewed as a defensive move in that respect, but we have also bet on our ability to invent some new technology that this customer might use that if these inventions work out that margin could increase dramatically. There are other pieces of business that we took higher volume, lower margin that we believe will drive medium volume higher margin business in the future. But again, that's a bet we've placed on our ability to delight these customers and to attract more business.

And there's some business that is just high volume, low margin and we took it because we have capacity and it helps our bottom line. So they're all three different scenarios that are currently in play, but all three of them have been business that we've taken with our eyes wide open and we're not sending dollar bills or pennies out with anything we're shipping. It's just lower gross margins than what we used to do.

Thank you. I appreciate it.

Thank you. (Operator Instructions) The next question is a follow-up question from the line of George Melas with MKH Management. Please go ahead.

Thank you. Just to follow-up, these high volume low margin businesses or contracts, do they have similar payment terms and similar sort of working capital implications in terms of AR/AP and inventory?

For the most part, yes.

Okay. And when you bid on these customers, do you look just primarily at the gross profit contribution in terms of dollars or do you also look at sort of the return on assets that they imply?

No, we look at the return on invested capital. We've got a pretty sophisticated quoting model. Ron and I sign off on an every quote that goes out and we definitely do not just look at our gross margin.

Okay, great. Thank you.

And I'm showing no further audio questions at this time. I'll turn the call back to management for any closing remarks.

All right, well, thank you again for 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, sir. Ladies and gentlemen, this does conclude our conference for today. If you'd like to listen to a replay of today's conference, please dial 1-800-406-7325, or 303-590-3030 and enter in the access code 4422531. We thank you for your participation and you may now disconnect.