Key Tronic Corp (KTCC) 2012 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Key Tronic first quarter of fiscal 2012 conference call. (Operator Instructions) This conference is being recorded today, November 1st, 2011.

It is now my pleasure to introduce our host for today, Mr. Craig Gates. Please go ahead.

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 first quarter of fiscal 2012. We're very pleased with our strong growth in revenue driven by the production ramp-up for new programs in both new and longstanding customers. We achieved the highest quarterly revenue in Key Tronic's history and continued to diversify our future revenue base by winning new programs.

We also see more potential customers recognizing the competitive advantages of our EMS services based in North America. With our unique combination of world-class engineering, global logistics, and cost effective production we're increasingly well positioned to continue to capture market share and capitalize on emerging opportunities.

Now I would 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 October 1st, 2011. For the first quarter of fiscal 2012 we reported total revenue of $69.8 million, this is up 10% from the $63.3 million in the same period of fiscal 2011. As projected, our gross margins were impacted by a change in product mix and costs associated with moving many of the new programs into production.

For the first quarter of fiscal 2012 our gross margin was 7% compared to 9% in the same period of fiscal 2011. For the coming quarter given our anticipated growth and product mix we expect to see our gross margins continue in the range of about 7% to 8%.

Our operating expenses were $3.4 million in the first quarter of fiscal 2012, which is comparable to the previous quarters and to the first quarter of last year. Although the new program startups that fueled our revenue growth required the addition of new engineers and program managers, we've still done a pretty good job of controlling our cost.

Net income for the first quarter of fiscal 2012 was $1.2 million or $0.12 per diluted share compared to $1.7 million or $0.17 per diluted share for the same period of fiscal 2011.

Turning to the balance sheet, inventory was up $5.2 million from the previous quarter, reflecting our recent growth and production levels for a number of the new programs. We believe our inventory levels are in line with our expected revenue levels. Note that the balance on our line of credit was also up $5 million from the previous quarter, reflecting our inventory build in preparation for continued growth.

Our trade receivables were $48.2 million at the end of the first quarter. This is up $7.9 million from last quarter, reflecting our significant sales growth. Our DSOs were 53 days, which is within our target range.

Our capital expenditures for the first quarter of fiscal 2012 were approximately $400,000, and we expect CapEx to be around $5 million for the full fiscal year 2012, which is comparable to fiscal year 2011.

Moving into the second quarter of 2012, many of our new programs continue to ramp-up, while some of our longstanding customers have moderated their forecasts in the face of the uncertain macroeconomic environment. Taking these factors into consideration, we expect revenue in the range of $75 million to $80 million in the second quarter of fiscal 2012. In the second quarter we expect our gross margins to continue to be in the 7% to 8% range. We also expect operating expenses to remain relatively flat in coming periods. Taking these factors into consideration, we expect earnings in the range of $0.15 to $0.20 per share for the second quarter.

Note that our forecast may be impacted by supply chain issues, changes in customers' forecasts, changes in general economic conditions, and other risk factors outlined in the documents the Company has filed with the SEC that could result in variances to our results.

Financial health of the Company is excellent, and we believe Key Tronic is well positioned to continue to profitably expand our business. That's it for the financials, Craig.

Okay, thanks, Ron.

We're really pleased with our record $69 million in revenue in the first quarter, powered by successful ramps of many new programs with both existing and new customers. It was also a challenging quarter. We had an unusual concentration of large programs that required significant technical and supply chain efforts.

As a result, Q1 was very unevenly loaded with over half of the period's production and shipments occurring in September. We believe, however, that this first quarter represented a tipping point for us in terms of production smoothing. In coming periods we expect our program ramps to have a less concentrated technical and supply chain mode, which should result in more even production output and less costly ramps.

While many of our customers remain cautious in terms of committing to increase volumes based upon the uncertain macroeconomic environment, there are signs of cautious optimism. Optimism is not revenue but it certainly is a positive change.

Another positive trend we are seeing involves the relative cost of manufacturing at our three campuses. Many of the new programs we are ramping in Shanghai involve products destined to ship to end customers in Asia. This is a departure from the norm, even as recently as one-and-a-half years ago when most of our Asian production was shipped to the U.S. or Europe.

Since demand for products in Asia continues to grow, we don't see this trend as a threat to our Shanghai plant but rather an opportunity for our Juarez operation. With the continued increase in relative costs of production in China and in shipping costs to get product from China back to North America or Europe, Asian production no longer presents an unquestioned cost advantage. As a result, we see growing interest in Mexican based operations and, particularly, in our facilities in Juarez.

Our operations in Juarez, Mexico are world-class, vertically integrated, and produce exceptionally high quality products. We have been operating there since our 1993 acquisition of the facility from Honeywell and have made good use of our 18 plus years of experience in Juarez. Many of our employees have been with us since day one. In fact, I worked with today's Plant Manager back in 1985 as we designed the layout of what is now plant one of our five plants in Juarez. As a result of our operational excellence in Mexico we see the cost increases in China as an opportunity for us.

We believe that our continued investment in our business, our solid execution of our long-term strategy, and our continued profitability is being rewarded with increased confidence from existing customers and increased interest from potential new customers. During the first quarter we continued to expand our customer portfolio across a wide range of industries. We won new programs involving industrial processing equipment, medical devices, military equipment, educational displays, and consumer products.

In summary, our quote pipeline remains robust, as our prospective customers continue to value our growing design staff, our worldwide footprint, and our centralized management approach, as well as our vertical integration. We are happy with our progress in aggressively growing our Company and expect to continue to win market share and focus on profitable growth over the long term.

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

Operator?

(Operator Instructions)

Our first question comes from the line of Mike Secos with Sidoti & Company. Please go ahead.

Hi, Ron. Hey, Craig. How is everything going today?

Great. How are you doing?

I'm doing well. Just a couple quick questions for you. I know I think on the last call we were talking about how the gross margin, the long-term goal at least we're looking for is between 8% and 9%. And I know sequentially if we're just looking at gross margins it actually dipped a little, it went from 7.6 down to 7.2 this quarter. Just wanted to know when we should I guess expect to see some expansion in the margins? And for the long-term goals of 8% to 9% what time horizon you're looking at for those?

Well, the reason we just -- we only put out our projections for gross margins for the second quarter, which is the 7% to 8%. If we get to the higher end of the range we expect to be at the higher range of our gross margins. We intentionally did not talk about beyond the second quarter of the gross margins, although the expectation is is that as the production becomes I guess more ingrained into our facility, we get the kinks worked out, the expectation is that the margins will improve after that. But at this point we have -- we're not projecting beyond the second quarter but we don't expect -- we expect to have all that production really ramped up and the efficiencies worked out so that we should expect to see growth in the second half.

Okay, and regarding the cash balance, if you could just comment on that, just what you're comfortable with? Because I'm just looking at that number, getting worried, and I don't know what your needs are right now for that number?

Okay, our goal there is to keep the cash as low as possible. If we have a $30 million credit line and cash in the bank really doesn't earn us anything, so we try to use our excess cash to pay-down the revolver every day. We borrow from the revolver every day. At the end of the quarter we had a $30 million credit line, and only had $11 million borrowed, so we had over $18 million of availability. And so we have plenty of working capital and access to cash to be able to pay our bills when they're due. So that's not a concern to us.

Okay, would you say that I guess unless interest rates make a drastic change, I mean this will probably be the way that things are then, keep the cash as low as possible, pull on the revolver for anything you need?

Yes.

Okay. Okay, and then with the customers that you're signing is there like a typical length for the contracts that you're trying to sign or is there a goal that you're trying to hit as far as how long or the duration of these contracts?

There's a typical length for a contract is three years, but one of the secret sauces that are -- that's really powering our growth has been that our mission statement says we're in it for the long run, we want long-term mutually beneficial relationships. And if you look at our engagements with our customers, you'll see that almost invariably once we start with a customer we've still got them. So we're doing business with customers we've picked up 10, 12 years ago. We very rarely lose a customer. So although the contracts are three years, the business tends to go a lot longer than that.

All right. All right, terrific. Thanks a lot, guys. I'll just jump back into the queue.

You bet. Thank you.

Thank you. And our next question comes from the line of [Tony Chevrons] from Key Equity Investors Inc. Please go ahead.

Good afternoon.

Hi.

Hi. Can you explain what the comprehensive loss was due to in the first quarter?

Yes, we have -- we take-out our Mexican Peso futures contracts.

Okay.

And the Mexican Peso fluctuated quite a bit compared to the U.S. Dollar over the last couple months because of the turmoil that's taken place in Europe. And so our average rate that we've locked in on the Peso contracts over a period of about two years is a little over 13, 13 Pesos, 13.1 Pesos to the Dollar. And as the exchange rate fluctuates up and down then the value of those contracts will change. It's really not a cash issue, it's just we buy the Pesos at whatever we contracted at and that's what we pay our bills in Mexico with.

Okay, so you're just marking it to market, basically?

That's exactly right.

Okay, I understand. Now you mentioned that there's been a little bit of slow-down and then some concern by customers, so are you seeing a slow-down or is that typical with most customers or is it just a small proportion?

We're not really seeing a slow-down, we're continuing to see nervousness in our customers, but actually we're starting to see a little bit of optimism. So there, you know, it really has to be split into two things, is what -- how do people feel and what do they think is going to happen versus what do they actually give you in POs. It's kind of like consumer spending, if you talk to the consumers everybody says they're terrified and they're not going to spend any dollars, but then if you look at what they're actually spending consumer spending is up a little bit.

Right.

So our customers, although they have pretty much -- our existing customers has pretty much stayed flat, we see that they're starting to sound a little bit optimistic now compared to six months ago, a year ago, a year-and-a-half ago. So that's why we try to say it's not orders, but it is a sentiment.

Is it different regionally or, in other words, in Asia versus Europe or versus the United States, or is it pretty much the same in each region?

I don't think I could parse it fine enough to say if it was regionally because a lot of these customers sell multinationally, so it would be -- I'd have to get into a lot of specific detail by customer and I can't do that for you.

Okay, I appreciate it. Thank you very much. Good luck.

You bet. Thank you.

Thank you. And our next question comes from the line of Bill Dezellem from Tieton Capital Management. Please go ahead.

Thank you. I've got a group of questions. The first one, of your five customer wins or program wins, I should say, would you please give us the range of dollar value that those represent?

This quarter it was from $3 million to $20 million.

And you had five different wins this quarter, and it's been quite some time that you have had that many wins. Is that an indication of business strengthening or is it just a coincidence in the way the timing worked?

It's more coincidence of the way the timing worked. Business has been really strong and continues to be really strong as far as winning new programs and new customers. So if you look back a year, fiscal year 2011, Q1, we had 26 customers that were producing revenue. Today Q1 I mean we had 36 customers that were producing revenue, so that's interesting and good. But then if you look at the number of programs for those two time periods it's 84 versus 135. So we've been clicking off the wins as we've said every quarter, pretty steadily, and we're just now starting to see the impact of all those wins start to produce revenue. But in terms of win rate it's been pretty much the same for the last year-and-three-quarters.

Okay, so my small group of questions just got larger. So if we remember correctly at the end of the June quarter you had 30 revenue producing customers. So is it correct that you added or brought six new customers into the revenue production column?

You cut out on part of that, Bill. I said that we went from 26 to 36 in the last year.

Yes, and I was specifically dialing into the last quarter. I was thinking at the end of the June quarter you had 30 revenue producing customers.

Well, I think, Bill, the press release and what Craig talked about, we talked about program wins in those specific industry categories, but not new customer wins. Some of those program wins were from existing customers.

Since this always create a line of questions for me, Bill, we went back and actually have some data that we're going to continue to keep up every quarter so we can refer to it. So in Q4 in going back and looking at our records we had officially 33 customers that were producing revenue. In Q1 now we've got 36. If we go back a little bit further, if we start in Q1 of fiscal year 2011 it goes 26, 26, 29, 33, 36.

Those are customers.

And that's customers producing revenue. And then if I give you the same set of numbers for programs producing revenue it goes 84, 89, 104, 119, and 135.

And ultimately if we understand correctly the programs is really what matters?

They both matter because we would like to have more and more customers spread amongst more and more programs, but both matter to us in different ways.

That's helpful. And if we look at the five wins that you referenced this quarter how many of those are for brand-new customers, a, and then, b, how many of those are replacing existing pieces of business?

Well, there's three new customers and none of it is replacing existing pieces of business.

Congratulations.

Yes, thank you.

And then the margin pressure here this quarter it sounds like you had just a challenging confluence of events with big programs but not only were they large in size, revenue volume that is or large in volume but they were also more technical you said, and also had some supply chain issues that were more complicated. And so the issues that you're experiencing here are a bit more challenging than you had originally anticipated, is that a fair interpretation?

I don't think they were more challenging than we anticipated because we were right in the middle of our guidance pretty much. We anticipated that it was going to be a particularly 7% to 8% margin. But they were a challenge in that it was more expensive to get them into the factory than is normal for that size of business.

So as we, if and as we continue to grow this rapidly and if we kind of revert to the mean of cost per dollar implemented into the factory we think that our implementation cost should go down as a percentage of the revenue that we're adding. And that's because the programs we put in place last quarter were either engineering heavy, so we spent a lot of time on prototyping and start and stop in the factory, or they were parts challenged and we spent money on expedites of parts to get them in here, air freighting them around the world, and things like that.

So that always happens when you put new products from either a competitor of ours or from our own customer's factory that's being closed, but in this last quarter it seemed to be, it was a little worse than normal on a relative basis for how much revenue we've brought in.

And then you had mentioned that your longstanding customers, you're starting to sense they -- an improvement in their sentiment -- when you look back over time what's been the lag, and I'm probably dialing this tighter than you'd like but the lag time between an improvement in their body language and actually converting that to revenue?

Yes, I'm afraid that's too detailed and tight of a question. I don't have that data, and I wouldn't bet my life on it if I did.

All right. Thank you, both.

Yes.

(Operator Instruction)

Our next question comes from the line of [George Nell] from MKH Management. Please go ahead.

Hello, good afternoon.

Hello.

First of all, sort of a housekeeping question. In your guidance of $0.15 to $0.20 what is the tax rate that's implied in your model?

We're assuming a 32% tax rate.

Okay, very good.

And to compare that to Q1, Q1 our effective tax rate was about 17.5%.

Okay, was there a particular reason why it was so low in the first quarter?

Yes, we had some foreign tax benefits.

Okay, very good. Just looking at the balance sheet and working capital it seems that your cash cycle had come down for a few quarters but picked up again, particularly your AR and your inventory went up. Is there sort of a story behind that?

Well, as Craig mentioned, we had over half of our revenue for the quarter shipped in the last month, so when you got that much in the last month, all those are going to be sitting in your receivables because our DSOs are right around 50, a little over 50 days. So when you've got that much revenue in the last month of the quarter it kind of distorts it for the full quarter. You think those receivables went up, but if you look at it the composition of it there's so much in the last month of the quarter, it really had a negative impact on the receivables.

Sure.

As we get more -- as the revenue becomes more smooth we expect to see the -- you won't see as much in receivables at the end of the quarter.

Okay, makes sense. And then just to sort of pick-up on the discussion that you had on the number of programs going from 84 a year ago to 135 in this quarter, if I look at the revenue per program it seems to have come down quite a bit. Is that because you've been bidding on some smaller programs or is that because you had a few very large programs in prior year that have come down quite a bit? The difference seems fairly significant in revenue per program.

Yes, so part of the story here that's like the duck swimming on the calm surface of the lake, is that although you haven't seen our revenue go crazy as of yet, we've been working really hard underwater, so to speak, and putting a lot of these new programs into the factory.

So if you remember the metric here, it was programs that were producing revenue, which is a lot different if we had used the metric of programs that are fully ramped. So we've got a lot of new programs that are in the factory that are up and running but they are not yet fully ramped. So that's why it looks as if the average revenue per program has dropped and the reality is that the revenue that we expect to enjoy from the program has yet to materialize because we haven't finished ramping it within our factory.

Okay, and I think then your guidance suggests that some of that ramp is going to occur in the December quarter. If you look at the programs that you have right now and if they are -- I wouldn't say all of them fully ramped but let's just say running at a good rate, what revenue would that imply for you guys?

You mean farther out, past this quarter we're in now?

Yes, exactly. If you just look at the programs that you have now in the factory, not counting any new programs that you might get what revenue would you expect to have just based on these programs?

Let's just say this, George, I think that we expect the revenue to continue to increase but right now all we can see from visibility from our customers is the second quarter. But just the intuitiveness of those programs that's going to eventually convert into revenue, I would tell you that it's going to continue to go up but we only see visibility in the second quarter right now.

Okay, but clearly by the end of the second quarter they would not all be fully ramped up?

That's correct.

That's correct.

Okay, very good. And on the gross margin is there, let me say between 7% and 8% for the coming quarter, that's -- it's a pretty big range in a way.

Yes.

Is there a way to think about it or just to get a sense of how to think about it, how it could go up or what you expect?

Well, the way it could go up is there's a number of ways. We've talked about them a couple times before, but let's do it again to make sure. First of all, once a program is in and ramped our margin on that program improves because we're no longer spending money training our people, expediting parts in, figuring out from an engineering basis how to get yields up in the factory, figuring out how to get our throughput in the factory to increase as we get practice in building it. So that's one way.

The second way the margins can go up is that as we get control of a product from our customer in many cases we're successful in redesigning a part of that product or the whole product, or a part of the production process, that we then implement with our customer's approval, and we then get to hang-on to either a portion of all the savings that accrue from those improvements. And that's kind of a part of our secret sauce that in many cases the win programs that we've bid at a tight margin and then over time we end-up with better margins as we are able to improve the design of either the process or the product.

And then, third, as we get the control of the procurement of the parts that go into the product under our own wing a lot of times we're able to combine that with our spend in the case of customers that are smaller than Key Tronic's revenue base and we're able to drive [PTV] out of the material costs that go along with the product.

So there's really three ways that we expect the margin on a particular program to improve. And then the fourth way, that's probably just as important, is as you see our fixed costs have remained relatively flat, and as we continue to grow in revenue just the natural ratio of revenue versus fixed costs should lead us towards higher volume, and I mean higher margins as our revenue volume improves.

Okay, great. Thanks for that, for the explanation.

Thank you. And we have a follow-up question from Bill Dezellem from Tieton Capital Management. Please go ahead.

Thank you. I wanted to tag on to the last questioner there. Would it be fair to generalize and say that programs that are associated with new customers, so it's not only a new program but also a new customer, that they would have lower initial margins. And, again, just generally speaking, whereas with existing customers they might be a bit higher, not because of pricing, more because of your familiarity with the type of products associated with those customers?

Yes, I'd say in general, but I'd be really careful about how much you bank on that because it's all -- it's kind of all over the board. Because sometimes we have a longstanding customer who has a very simple product and it tends towards a commodity, so no matter how long we've produced it and no matter how long we've known that customer, and no matter how efficient we get, since it's a commodity it's hard to drive anything but commodity margins out of that product.

And there could be other cases where it's a new customer but it's a highly specialized product and we're one of the few companies in the world that can make it for that customer. And in those cases even though it's a brand-new product we would be seeing a very nice margin out of it. So those are some examples of how your generalization would be incorrect. But, in general, your generalization is probably correct.

Well, if we're generally correct with our generalization that doesn't sound very specific.

Yes, sir, general.

Let me shift back to the 135 programs that you have in production today. How many of those are fully ramped today or, more importantly, how many of those are still [too fully ramped]?

I can't tell you off the top of my head, but it's probably -- I'm not even going to guess. It's a reasonable chunk that are not fully ramped.

And would it be a fair -- I'm going to come back to generalization, a fair generalization that even those programs that began, came into production over the course of the last year, and I think Q1 of last year you said you had 84, Q2 89, so call it that mid to upper 80s level, from that point forward very few of those would be fully ramped since that's only a year?

That's probably pretty safe, yes.

Great. Thank you.

Yes.

(Operator Instructions)

And I do not show any further questions. You may continue.

Okay, well, thank you, all, for participating in today's conference call. And Ron and I look forward to speaking with you again next quarter. Thanks and have a good day.

Ladies and gentlemen, that does conclude today's teleconference. If you'd like to listen to today's replay the phone number is 1-800-406-7325, access code 4476291. Thank you for your participation. You may now disconnect.