Key Tronic Corp (KTCC) 2017 Q4 法說會逐字稿

Good day, and welcome to the Key Tronic Fiscal Q4 2017 call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Brett Larsen.

Please go ahead.

Good afternoon, everyone.

I am Brett Larsen, Chief Financial Officer of Key Tronic.

I would like to thank everyone for joining us today for our investor conference call.

Joining me here in our Spokane Valley headquarters is Craig Gates, our President and Chief Executive Officer.

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 our results for the fourth quarter and full year ended July 1, 2017.

For the fourth quarter of the fiscal year 2017, we reported total revenue of $118.5 million compared to $123.9 million in the same period of fiscal year 2016.

For the fiscal year 2017, total revenue was $467.8 million...

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...$485 million for the fiscal year 2016.

During fiscal 2017, as anticipated, our revenue and margins were impacted by declining demand from some long-standing customers, which was not yet fully offset by the continued ramp of revenue from our new programs.

For the fourth quarter of fiscal year 2017, gross margin was 8.3% and operating margin was 2% compared to 8.7% and 2.8%, respectively, in the same period of fiscal 2016.

While the year-over-year decline in margins primarily reflects lower revenue levels, the results for the fourth quarter of fiscal 2017 also include approximately $3.2 million in revenue for shipped excess inventory for a prior customer at cost, which had no contributions to margin.

Throughout the year, our gross margin was adversely impacted by the ramp-up costs associated with our new program wins, some of which involved transferring ongoing production from a competitor's facility to our own.

We expect to see gradually improving gross margins as these new programs move into full production, further utilizing existing production capacity.

Net income for the fourth quarter of fiscal 2017 was $1.3 million or $0.12 per share compared to $2.1 million or $0.20 per share for the same period of fiscal year 2016.

For the full fiscal year 2017, net income was $5.6 million or $0.51 per share compared to $6.5 million or $0.58 per share for the fiscal year 2016.

Turning to the balance sheet, we continued to maintain a strong financial position.

As a result of ramping new programs, our inventory increased about 3% from the previous quarter.

In coming periods, we expect to see our net inventory levels gradually decline.

Our trade receivables were $65.2 million at the end of the fourth quarter, up $2.9 million from the previous quarter, which approximates the increase in sales reported during the fourth quarter.

Our consolidated DSOs were around 43 days, and we expect that our DSOs will remain under 50 days in coming quarters.

During the fourth quarter, we reduced our total debt by $1.5 million when compared to the prior quarter.

Over the longer term, we expect to continue to pay down the term loans and the revolving line of credit at a more accelerated rate.

Total capital expenditures for the fourth quarter of fiscal 2017 were approximately $1.7 million and were $9.3 million for the full year as we continued to invest in our SMT, sheet metal and plastic molding capabilities.

Fiscal year 2018 capital expenditures are expected to be around $7 million.

Moving into the first quarter of fiscal 2018, we expect more of our new customer programs to ramp and to move into production.

At the same time, we expect continued softness among a few of our long-standing customers.

Taking these factors into consideration, we anticipate the first quarter of fiscal 2018 will look much like the fourth quarter of fiscal 2017, with revenue in the range of $110 million to $115 million.

It is expected that our overall gross margin percentage will also remain essentially flat in the first quarter but will gradually improve as new customer programs ramp and further contribute additional revenue over the longer term.

Taking these factors mentioned into consideration, we anticipate earnings in the range of $0.10 to $0.15 per share for the first quarter.

This expected earnings range assumes an effective tax rate of 25%.

In summary, we're encouraged by the prospects for future growth in revenue and earnings.

The overall financial health of the company is strong, and we believe that we are well positioned to continue to profitably expand our business over the longer term.

That's it for me.

Craig?

Okay.

Thanks, Brett.

As we've discussed in prior calls, we saw decreased demand among some of our long-standing customers throughout the year.

We are also seeing a more competitive EMS marketplace.

The latest reports of U.S.-owned EMS companies indicate decreases in year-over-year sales and decreasing sales sequentially in recent quarters.

The slowdown in growth in the EMS market may be related to current geopolitical uncertainties in the market delaying outsourcing of manufacturing.

That said, most of our new customers appear to be moving forward with their new programs with us, though at a slower pace than we've historically seen.

We expect new programs we have won to contribute to higher revenue later in fiscal 2018 as we expect these new programs' sales to outpace weakness in long-standing customers.

We continued to see strong results this past fiscal year from Key Tronic East which, you will recall, was acquired just over 2 years ago.

After closing our Kentucky facility and trimming nonprofitable programs during the year, we are now seeing strong growth in revenue from these facilities.

We believe that this reflects a growing appetite for U.S.-built products.

At the same time, we continue to capture significant new business from other EMS competitors at all of our global locations, including established programs that will begin generating revenue in fiscal 2018.

We've recently won 2 new programs involving gaming and seismic monitoring devices.

Moving into fiscal 2018, we continue to see a strong pipeline of potential new business opportunities.

While it is perhaps an overreach to draw global conclusions from our window into the market, we believe our experience does point in a consistent direction.

In the run-up to the election and the aftermath, we saw a slowdown in the award and transfer programs.

We believe uncertainty drove our market towards stasis as our companies waited to see how new rules, regulations, public pressure and international gamesmanship would impact sourcing decisions.

In our experience, companies continued to quote new suppliers and, in fact, award programs to new suppliers, but they moved very slowly to transfer meaningful revenue from supplier to supplier.

We have several new customers that have moved business to us in this mode.

As a result, during the last year, we incurred most of the expense of quoting, winning and transferring new business into our facilities, while enjoying very little of the margin that will come as the customers complete the transition to us.

In other cases, customers have made decisions based on uncertainty.

This has involved moving product from one of our sites to another along with all the costs associated with that process.

We believe this unrest is beginning to subside.

In fact, we are in the midst of unwinding some of those moves from our customers, and in other cases, making changes to minimize the effects of those decisions.

Going forward, our broader and more diversified customer base significantly lowers the potential risk and impact of any slowdown to any one customer.

Moreover, Key Tronic is well positioned for the returning tide of North American-based customers, correctly analyzing the total cost of overseas production and pushing production into both Mexico and the U.S. Our steady pipeline of new business opportunities continues to be boosted by our unmatched level of vertical integration, our multi-country footprint and the excellence of our manufacturing sites in comparison to other EMS competitors of our size.

As OEMs face an increasingly uncertain geopolitical landscape, Key Tronic is uniquely equipped to offer risk mitigation with our manufacturing facilities located in China, Mexico and the U.S.

To continue to capitalize on our diversity of locations, however, has required significant capital expenditure, training expense and management attention in recent periods.

During the past 3 years, we've made significant investments in expanding our SMT, sheet metal and plastic molding capabilities in anticipation of increasing demand.

Throughout fiscal 2017, we also made significant investments in improving our customer support organization.

We expect to see utilization of this new capacity in coming periods, which will enable us to grow with lower levels of capital expenditures in coming years.

Moving into fiscal 2018, we expect to see many of our new programs continuing to ramp up, the continued onboarding of several new customers and a strong pipeline of potential new business.

By the second half of fiscal 2018, we anticipate a return to growth in revenue and improving margins.

Over the long term, we believe our new programs and customers will continue to grow far beyond their revenue levels today, with our increased capacity and stronger operations potential to accommodate a more diversified customer base.

Overall, we remain optimistic about our growth opportunities and our competitive strengths.

I want to take this opportunity to express my gratitude to our employees for their dedication and hard work during this past year, to our valued customers who continue to honor us with their trust and to our shareholders for your continuing support.

This concludes the formal portion of our presentation.

Brett and I will now be pleased to answer your questions.

(Operator Instructions) We will take our first question from Paul Carter with Adaptable Capital Management.

So your SG&A as a percent of revenue was above 5% again this quarter, if you adjust for the $3.2 million of 0 margin revenue.

Last quarter, I think, it was elevated because of legal expenses.

Was that the same situation this quarter?

Yes.

So how much were these sort of nonrecurring or unusual sort of legal fees this quarter?

I don't know the exact amount.

It's going to be somewhere between $200,000 and $300,000.

Okay.

And then what was the impact this quarter to your cost of goods sold of realized foreign exchange contracts?

Similar to what it was in the third quarter of fiscal '17.

Okay.

And then in your third quarter 10-Q, you said that the expected net amount of FX losses to hit earnings over the next 12 months was, like, $3.5 million or about $900,000 per quarter on average.

Do you expect that -- what do you expect that to be now?

I expect that to continue for the next approximately 3 quarters.

Okay.

Great.

And then your effective tax rate the last couple of years were, I think, 22.5% and 20% a year ago.

Why do you think it will increase to 25% going forward?

Are you expecting your proportion of profits to shift away from Mexico somewhat this year?

No.

It's actually the fact that we are paying a few more taxes within Mexico.

So the tax by jurisdiction is slightly different than it has been in the past.

I'm expecting it still to be somewhere around 25%.

That's a good estimate.

Okay.

Great.

And just final question.

So in the past, I think, about a year ago or so, in a presentation, you articulated your financial targets as sort of 9% to 11% gross margins and, I think, 4% to 7% operating margins.

Are these still your targets?

And do you expect to get to these levels and sort of stay there within the foreseeable future?

Or are they more sort of, like, everything would have to go right in order for you to hit them?

I don't think everything would have to go right.

Probably about half of everything would have to go right.

We're not expecting, as we've shown, that it's going to happen this quarter, but we certainly still have quite a bit of optimism that it will.

Okay.

So that's still your longer term sort of objective?

Yes.

We will take our next question from Bill Dezellem from Tieton Capital.

Couple questions to begin with here.

So my standard, you won 2 new customers.

What's the range of size for those customers?

The first one is probably $6 million to $10 million.

The second one is $10 million to $15 million.

And you haven't said, which one is the seismic, but I'm presuming given how weak the seismic industry is today, that your estimate, whatever it is, for that customer is based off current level of activity?

And so if activity levels pick up, as they historically have for energy, then that could be significantly larger?

Or are you already taking that rebound into account?

No.

We're -- the number I quoted you, which was one of the 2 numbers I quoted you, was based on the current level of oil and gas.

That would be -- if that were to take off, there'd significant upside from that customer.

And given the volatility that seismic has even relative to the energy industry, I mean, literally it could have 3 to 4x the magnitude of what you've listed here.

Is that correct?

3.

That's helpful.

And then you did mention in the press release that you'd made investments in SMT, metal and plastics.

Would you talk in some detail about what you did in each of those 3 areas and what you were trying to accomplish with those investments?

In the SMT area, we were buying some of the latest equipment because the advances in speed have made the capital equation versus cost reduction equation worthwhile.

We've also added some automatic inspection equipment, which allows us to produce much finer pitch components with a higher quality level.

In plastics, we've been migrating away from hydraulically operated presses to electrically operated presses, which up to about 450,000 tons have a lot -- better degree of controllability in terms of shaft size and shaft speed and a lot lower maintenance costs and better power draw too.

And then in metals, we've added some pretty high-end inert gas blanketing technology into the laser cutters, so that we can dramatically increase the speed at which the lasers can cut and the thickness of the steel that they can cut, so it also reduces our costs and, therefore, makes our ability to quote aggressively a lot stronger.

And were any of the items that you described specific for new customers that you had won?

Yes.

And one of the SMT lines was specific to a customer.

The others, I would say, are more general.

Great.

And then in your -- I think in your comments, you made reference to customers that are moving -- moved product to other facilities of your own to accommodate the political environment, and then some of that's actually been unwound slowly now.

Would you talk in some more detail about what you saw there?

And how it is that customers seem to be thinking at this moment in time?

I think there was some panic during the election and after the election about what might happen to duties coming out of Mexico, coming out of China and availability of product coming out of those 2 locations.

So people were making moves in -- where we were going to build their product based more on panic than they were on sound financial analysis of shipping costs and expedite costs and the costs of getting their engineers to a site when you need to.

So as the noise out of D.C. has turned into more noise and less panic, people have started to rethink some of those decisions and running the numbers again and driving a bit more logic rather than fear into what they're doing.

Are you sensing that fear is still a part of the process in the back of some of these buying decisions?

Or is it really putting pen to paper and it's a -- it's really a financial decision now?

I think fear is still a big part of what everybody's doing.

But it's like living in a war zone, eventually you become a little bit numb to the bombs, and you still go down and buy milk in the market.

So I don't really know.

All I know is it's the worst I've ever seen it.

And then let me switch to a couple of questions and Brett, I wouldn't want you to feel left out.

The gross margin increased sequentially.

What caused that?

And is there anything that we can read into that improving margin?

And granted, it's small, but it's directionally the right way.

Directionally, a couple of things that helped us this quarter.

One was, we were able to take advantage of some material savings, which we profited from.

Also the results of Key Tronic East were the -- acquired.

Ayrshire also was up in profit.

Our expectation is that, as we continue to grow the revenue line, that we will see incremental improvement in that gross margin.

We have capacity.

Great.

And the margin improvement.

That would not have fallen under the noise category, but it really was an indication of, like you said, material costs and things improving in the East?

That is correct.

And then the last thing.

You've mentioned that you were anticipating that you would pay debt down at a faster rate.

Would you talk about how you plan on doing that?

Yes, in the last 3 years we've -- we spend a lot in capital expenditures, as Craig mentioned, in the 3 vertical manufacturer arenas.

Our anticipation is that based on our forecasted revenue, that we most likely will not have to spend at the same rate we have been.

We feel confident in the capabilities and the capacity of our current equipment set.

It'll allow us to not spend as much annually in CapEx.

And the other is, coupled with the expectation of increased profitability with more revenue.

Great.

I look forward to that last part in particular.

As do we.

(Operator Instructions) And we have a question from Buzz Heidtke with Heidtke & Company.

My question is on R&D spending.

You all spend quite a bit on R&D spending.

Are you continuing to spend about the same amount in relation to your revenue?

Yes.

(Operator Instructions) And with no further questions at this time, actually, we will turn the call back over to the management team for any additional or closing remarks.

Okay.

Thank you, again, for participating in today's conference call.

Brett and I look forward to speaking with you again next time.

Thanks, and have a good day.

And that does conclude today's conference.

Thank you for your participation, and you may now disconnect.