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Operator
Good day, and welcome to the Key Tronic Second Quarter of Fiscal 2018 Conference Call.
Today's conference is being recorded.
At this time, I'd like to turn the conference over to Mr. Brett Larsen.
Please go ahead.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
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 this -- 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, 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 second quarter ended December 30, 2017.
For the second quarter of fiscal 2018, we reported total revenue of $111.7 million compared to $118.5 million in the same period of fiscal 2017.
For the first 6 months of fiscal 2018, total revenue was $220.9 million compared to $235.7 million in the same period of fiscal 2017.
For the second quarter of fiscal 2018, gross margin was 7.9% and operating margin was 1.5% compared to 8.1% and 2.1%, respectively, in the same period of fiscal 2017.
Our gross margins continue to be adversely impacted by decreasing demand of existing customers, coupled with the ramp-up cost associated with new program wins, some of which have ramped slower than previously anticipated.
Many of these new programs involve transferring ongoing production from a competitor's EMS facility to our own, which has exacerbated the length of time it has taken to get to full production volumes.
We expect to see gradually improving gross margins as these new programs move into full production, further utilizing existing production capacity.
In addition, we are taking steps to streamline our operations and reduce cost in Mexico as we expect that recently won new programs will fit into existing production equipment capacity and require less labor content.
As a result of these efforts, we expect the total cost in Mexico will be reduced by approximately 9% by the fourth quarter and beyond.
Our China facility continues to be profitable, supporting current programs and provides a competitive manufacturing option in Asia for locally sourced programs.
Moreover, our U.S. facilities are proving to be increasingly profitable, and we expect to see further growth in these locations.
The U.S. corporate tax reform in December 2017 significantly impacted our GAAP results for the second quarter of 2018.
We had a discrete charge for unrepatriated overseas earnings and a write-down of certain deferred tax assets related to U.S. tax reform and a foreign exchange adjustment totaling $1.1 million or $0.10 per share during the quarter.
As a result of these tax charges, in the second quarter, we, like many other companies, had a net loss.
In our case, we reported net loss of approximately $200,000 or $0.02 per share.
Excluding these discrete tax adjustments, net income would have been approximately $0.9 million or $0.08 per share compared to net income of $1.5 million or $0.14 per share for the second quarter of fiscal 2017.
For the first 6 months of fiscal 2018, net income was $0.2 million or $0.02 per share compared to net income of $3.3 million or $0.30 per share for the same period of fiscal 2017.
Excluding the impact of discrete tax adjustments that occurred during the second quarter, net income for the first 6 months of fiscal 2018 would have been approximately $1.3 million or $0.12 per share.
In coming quarters, we expect to benefit from the tax reform through a reduction in our estimated effective tax rate, going from 25% down to 20%.
Turning to the balance sheet.
We continue to maintain a strong financial position.
As a result of ramping new programs and unanticipated delays in shipments during the second quarter, our inventory increased approximately 3% from the previous quarter, and our trade receivables at the end of the second quarter were also up 3% from the previous quarter.
However, through managing payables during the second quarter, we reduced our debt by $3.8 million 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 similar rate.
Note that our inventory and receivable levels in recent quarters have included roughly $10 million of purchased and paid inventory and receivables due from a former customer, which is expected to be resolved by a binding arbitration hearing scheduled to occur during the third quarter.
In addition to the inventory issue and the arbitration, we're pursuing reimbursement for certain cancellation fees and other carrying costs already expensed but believed to be contractually due from the former customer.
We have not accrued for any outcomes related to this claim, which could result in a onetime gain or loss.
Legal costs are being expensed as incurred.
The ultimate disposition of this matter and any gains or losses are unknown and could have a material effect on the consolidated financial position, results of operations and cash flows.
Irrespective of the outcome of the arbitration, we expect to see our net inventory levels gradually come more in line with revenue levels as shipment delays are reduced and eliminated and new program ramps continue in coming periods.
We expect our consolidated DSOs to remain around 40 days.
Total capital expenditures through the second quarter of fiscal 2018 were approximately $2.2 million, and we expect CapEx for the full year to be approximately $7 million.
We continue to invest in our SMT, sheet metal and plastic molding capabilities but at a more moderated level than our investments in recent years.
Moving into the third quarter of fiscal 2018, we expect more of our new customer programs to ramp and move into production.
We continue to expect softness among a few of our long-standing customers.
Taking these factors into consideration, we anticipate that the third quarter of fiscal 2018 will have a revenue in the range of $110 million to $115 million.
During the third quarter, we anticipate charges of approximately $0.7 million for legal expenses in connection with the binding arbitration hearing related to the paid inventory and receivables due from a former customer.
Furthermore, we will also be incurring approximately $0.5 million for severance costs related to streamlining our facilities in Mexico.
Taking these factors just mentioned into consideration, we anticipate earnings in the range of breakeven to $0.05 per share for the third quarter.
This expected earnings range assumes an effective tax rate of 20%.
In summary, we're encouraged by the prospects for future growth in revenue and earnings.
We also look forward to resolution in the scheduled upcoming arbitration.
The overall financial health of the company is strong, and we believe that we are well positioned to win new EMS programs and to continue to profitably expand our business over the longer term.
That's it for me.
Craig?
Craig D. Gates - President, CEO & Director
Okay.
Thanks, Brett.
While we have had recent softness among a few long-standing customers and some unanticipated delays with new customers, our new programs are gradually moving forward, contributing more to overall revenue, and we expect new programs we have won to contribute to higher revenue in the fourth quarter of fiscal 2018.
During the second quarter, we continued to win significant new business from EMS competitors, including 2 new programs involving products for new and established customers involving the Internet of things devices for consumers and commercial applications.
The details of the manufacturing ramp discussed last quarter relating to a consumer security product are still yet to be finalized.
Moving into the third quarter.
We continue to see a strong pipeline of potential new business.
We're extremely pleased to see continued strong results from Key Tronic East, which you will recall, was acquired over 2 years ago.
After closing our Harrodsburg, Kentucky facility and trimming unprofitable programs during this year, we're seeing steady growth in revenue and increased profitability from the East.
We believe that this reflects a growing appetite for U.S.-built products and the significant value of having highly efficient domestic production facilities.
At the same time, while we are carefully managing our expenses, our investments in SMT, sheet metal and plastic molding capabilities in both Mexico and the U.S. are expected to enable planned future growth.
Moving further into fiscal 2018, we continue to see a strong pipeline of potential new business opportunities.
While there continues to be uncertainty in our market, companies continue to award programs to new suppliers.
We have several new customers that have moved business to us, but it often takes time to transfer meaningful revenue from supplier to supplier.
As a result, we already incurred the expense of quoting, winning and transferring new business into our facilities while not yet enjoying the margins that will come as the customers complete the transition to us.
Going forward, our broader and more diversified customer base significantly lowers the potential risk and impact of a slowdown by any one customer.
Moreover, Key Tronic is well positioned for the returning tide of North American-based customers as they correctly analyze that total costs for overseas production push production to 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.
Moving into third quarter, we expect to see many of our new programs continue to ramp up, the continued onboarding of several new customers and a strong pipeline of potential new business.
By the fourth quarter of fiscal 2018, we anticipate growth in revenue and improving margins.
Over the long term, we believe our new programs and customers will continue to grow far beyond the 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.
This concludes the formal portion of our presentation.
Brett and I will now be pleased to answer your questions.
Operator
(Operator Instructions) And we'll take our first question from Bill Dezellem with Tieton Capital.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Let's start with my normal question.
What's the size of the -- range of size of the wins that you had here in this quarter?
Craig D. Gates - President, CEO & Director
First one is $5 million to $15 million.
The second one is very large.
William J. Dezellem - President, CIO, and Chief Compliance Officer
How does one divide or add very large into the equation?
How about a -- do you have a range you'd like to give?
Craig D. Gates - President, CEO & Director
No.
I'd like to see this thing get a little bit more fully transferred and us understand the ramp and make sure we understand the full potential before I commit to a number.
William J. Dezellem - President, CIO, and Chief Compliance Officer
That's certainly very fair.
So that's maybe a good lead into -- another question that we had is that in relation to last quarter's earnings report, you did make reference to a prospective client that, if they happened, could have an impact on the December quarter results and, if that was the case, that you would alert everyone to that happening.
We didn't see a press release that indicated that, that had been formalized nor did the results this quarter look like you've had a lot of revenue from that prospective customer.
Would you talk about kind of the update with that customer -- or prospective customer and if it's even still alive?
And, if it is still alive, where it's at in the whole process?
Craig D. Gates - President, CEO & Director
Sure.
As we said in the press release a quarter ago, we have signed an MSA with that customer.
And as it stands today, we're in the midst of transferring their supply chain from the incumbent supplier to ourselves.
We're transferring that supply chain in the midst of a significant ramp in volume.
So it's, as always, complex to get all the players on the right page, to get -- figure out who's at what PO, with which supplier and figure out which supplier has shipped what stuff to which of us.
So it's a work in progress.
But the forecast in terms of revenue and our excitement about the program has not diminished in any way.
It is a case, like always, of getting the supply chain transferred, and getting the tribal knowledge transferred is a lot of work.
William J. Dezellem - President, CIO, and Chief Compliance Officer
So that answers the question of whether -- since we didn't hear anything that, that customer disappeared, the answer is definitely not.
That customer is very much alive then.
Craig D. Gates - President, CEO & Director
Yes.
William J. Dezellem - President, CIO, and Chief Compliance Officer
And is that customer 1 of the 2 that you referenced that you had won this quarter?
Craig D. Gates - President, CEO & Director
Yes.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Okay.
So that kind of answers the question of why you're not really wanting to put a real specific number on it.
It's a little bit loose at this point.
Craig D. Gates - President, CEO & Director
Right.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Okay.
When do you think you'll know more information about those variables that are creating (inaudible)...
Craig D. Gates - President, CEO & Director
Well, as you can imagine...
William J. Dezellem - President, CIO, and Chief Compliance Officer
(inaudible)
Craig D. Gates - President, CEO & Director
Yes, as you can imagine, we've been very, very frustrated and very intently focused on making this happen as quickly as we can while making sure we're not putting ourselves at risk.
And it's turned into a standing joke here.
We look at each other every day, and we say, we're closer than we've ever been.
So I can't tell you when for sure we're going to go into production.
I think we'll be into production in a couple of weeks, but I have thought that anytime in the last 2 months.
William J. Dezellem - President, CIO, and Chief Compliance Officer
So if you'll allow me to paraphrase what I think I just heard you say, is that everything is moving forward.
It's just that you have felt like -- that you've been burned, to some degree, when you're guessing when this is going to ramp.
And as a result, you're just being quite cautious at this point, even though it's large and everything looks like it's a go.
Craig D. Gates - President, CEO & Director
Yes.
And I haven't been burned.
We haven't said we were going to do it for sure.
We're very cautious.
And we don't have any lack of trust or disillusion with the players, so I don't want to give that impression because that's not the case.
We actually have grown to know both sets of people better.
We continue to trust them and think they're going to do what they say they're going to do.
But the devil's in the details, and as we get into each part and where it was made and where it came from -- and just today, we found out that the chunk of parts that we thought we were going to see today got lost somewhere, and nobody's quite sure if they're in FedEx or UPS or in a container somewhere.
So that's the kind of thing we're going through as we gather up.
And this is basically a very late-stage startup company that's gone big time, and we're helping them transform their supply chain from, I guess, you would say, a little bit of mayhem, startup company mayhem and getting everything under control and linear.
William J. Dezellem - President, CIO, and Chief Compliance Officer
That's great clarification.
I appreciate it.
And then a couple of numbers questions.
The charges that you have referenced for the March quarter, the math that I'm doing says that equates to about $0.09.
And as a result, if we exclude those charges and exclude any arbitration impact, positive or negative, that you would be guiding in the $0.09 to $0.14 range.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
That's correct, Bill.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Okay.
And then the cost-reduction initiatives in Mexico that you referenced, what do you anticipate the ongoing savings to be from those as we start to think out into the future?
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
Yes.
We're taking a close look at that based on our current forecast of revenue.
And with the change in required labor content and some production capacity that currently exists, we're expecting that our total facility cost in Mexico is ought to be reduced by about 9%, which equates to roughly about $1 million a quarter.
William J. Dezellem - President, CIO, and Chief Compliance Officer
And $1 million a quarter ends up being something in the neighborhood of $0.30 a share annually.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
Yes.
If everything pans out as we expect today, yes.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Okay.
That ends up being a big number.
So to what degree would you anticipate that the growth of the business that you're talking about would consume or chew up some of that $0.30 of savings?
Or is it really an addition problem where you take your earnings and add the $0.30 on top of it?
Craig D. Gates - President, CEO & Director
Well, I wouldn't call that a problem, would you?
William J. Dezellem - President, CIO, and Chief Compliance Officer
Equation, addition equation.
Craig D. Gates - President, CEO & Director
We're reasonably hopeful that it is an addition equation.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
Yes.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Well, that is not a problem, as you point out.
Great.
I appreciate it, and I look forward to seeing this large customer come to more meaningful production and getting that cost savings in place.
Operator
Next, we'll hear from George Melas with MKH Management.
George Melas-Kyriazi - President
I'm just going to try to sort of continue a little bit along the line of Bill's export question.
In Mexico, if you take down the cost by roughly $1 million per quarter, is that because there is a significant excess capacity there now?
Or is that related to some anticipated loss of revenue?
How are you able to do that?
Craig D. Gates - President, CEO & Director
It's related to -- it's not related to a significant loss of revenue.
So it's related to excess people capacity in terms of the business getting better under control and requiring less overhead to manage it.
And it's due to the maturity of the products that are in the facility not requiring as much rework and overtime.
And it's due to better systems and controls and automation, again, not requiring so much hand-touching at the, I guess, one level above the direct labor workforce.
George Melas-Kyriazi - President
Okay.
So is it that you have to sort of throw a lot of -- sort of a lot of bodies and a lot of management, I would call it, overhead and management sort of capability because you have so many ramps going on?
And now that your ramps are hopefully going to be even better, sort of largely ramped, you're going to have fewer of these wins?
Craig D. Gates - President, CEO & Director
Well, I'd say it's that partially.
It's also partially the mix of products down there are not as in as bad a shape as they were originally.
And it's also due to the fact that when your systems and controls are better, you don't have to throw as many bodies at a problem.
And so as we've driven the integration of the East to the West, we've been adopting a lot of best practices and spreading them across every facility in the company.
And as we've been doing that, we've been taking the expenses over the last year.
But now it looks like a lot of these efforts are beginning to pay off in terms of how much headcount and particularly the supervisory and technical and parts handlers and people that are on salary rather than direct labor, that number of people has gone down quite a bit for a given amount of revenue.
And the 2 things that have changed are the mix of the revenue and our sophistication and controls in achieving that revenue.
Does that make sense?
George Melas-Kyriazi - President
Yes, yes, it does.
It does.
Has it been mostly process improvement?
Or did you have to invest in equipment and software and systems?
Craig D. Gates - President, CEO & Director
It hasn't been as much process improvement.
We've always been pretty good at that.
It was more the management of the processes with systems and the way that the systems work between Spokane, Juarez and the East, the way that we transfer products, the way that we maintain paperwork, the way that we report labor, the way that we report production, the way that we track production, all of that.
And basically, if you want to think of it in a really crude, simple way is we've gone from the old offshore model of people are essentially free, let's just throw some more people at it, to people are becoming increasingly expensive offshore.
And we need to implement the same level of sophistication in our business systems and tracking and all that that you would in a more expensive locale.
George Melas-Kyriazi - President
Got it.
Okay.
Good to know.
Okay.
Quick question, Brett.
You talked about the inventory dispute with your large former customer.
Maybe you can't answer that.
But what would be your confidence that you will actually win in arbitration?
And also how much could be the additional claims related to cancellation fees and carrying costs that you guys have had to incur?
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
So George, you got to remember, well, we have our lawyer in the room with us.
The finger is poised over the mute button.
So you already know what we could say on that.
Craig D. Gates - President, CEO & Director
Yes.
There's really not more we can say.
We tried to say as much as we could.
George Melas-Kyriazi - President
That is fair to say that you wouldn't be spending all that money if you had some -- you have pretty high level of confidence that you could win.
Craig D. Gates - President, CEO & Director
Well, that certainly makes logical sense.
George Melas-Kyriazi - President
Okay, logic is good.
Okay, great.
Can you tell us how much the top 3 and the top 5 revenue contributed this quarter?
Craig D. Gates - President, CEO & Director
Yes, give us a second to look up the numbers.
George Melas-Kyriazi - President
Okay, great.
While Brett is looking, let me ask you a quick other question.
So your gross margin did rebound a little bit from last quarter but is still quite a bit below sort of previous levels.
But you made sure, in your prepared remarks, Craig, to say that you're expecting the fourth quarter to sort of start to see revenue growth pick up and margin improvement.
What is the kind of margins that you guys are targeting, I don't really want to say long term because I don't know what long term is, but in the next 12 months?
Could we get back to a 9% gross margin?
Or is that just too high?
Craig D. Gates - President, CEO & Director
No.
I think we can if you add in the $1 million a quarter that we're going to save out of Juarez, and if you add in some revenue growth from these new customers, I think that's a very reasonable goal.
George Melas-Kyriazi - President
Okay.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
And George, looking through the quarter-to-date results, top 3 customers contributed just around 30% of our revenue.
So that really has not changed over time.
George Melas-Kyriazi - President
The top 3 customers were 30%, you said?
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
That is correct.
George Melas-Kyriazi - President
But they were 36% last quarter, right?
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
Roughly.
George Melas-Kyriazi - President
Okay, okay.
Is there anything that requires an explanation for the 36% to 30% or...
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
We discussed that there was some softness in some long-standing customers, I think, and now we're replacing that with revenue from new customer programs as they ramp.
George Melas-Kyriazi - President
Okay, very good.
And is the component shortage that you guys talked about in the last quarter, is that still impacting gross margins and just production and revenue and customers?
Craig D. Gates - President, CEO & Director
Yes, yes, yes, and yes.
Okay.
For those, it's industry-wide.
It's actually gotten worse rather than better, and all of the pundits, including us, say it's going to be worse for the next year to 1.5 years.
It's being driven by the fact that there's now roughly 25 computers in every car.
There was about 12 3 or 4 years ago.
George Melas-Kyriazi - President
And specifically, what parts are being sort of -- are particularly short or maybe you don't want...
Craig D. Gates - President, CEO & Director
Big issues are all the electronic parts, and specifically, microprocessors started the whole problem.
But now it's beginning to spread into diodes and even resistors and things like that.
George Melas-Kyriazi - President
Okay.
Is that affecting you guys in a bigger way than some of your larger competitors that have sort of more purchasing power?
Craig D. Gates - President, CEO & Director
I don't think so, because the larger competitors, again, are buying for their customers.
It's the customer who has the power, not the competitor.
George Melas-Kyriazi - President
Okay.
And then I'm just going to ask a really strange question, which is a follow-up to Bill's question from last quarter.
Last quarter, you mentioned you're signing up an exercise equipment controller contract to a customer that could have -- could potentially be quite big.
I think you said it was $15 million to $50 million fully ramped.
Are those numbers still in the realm of possibilities now that you know a little bit more about that customer?
Craig D. Gates - President, CEO & Director
Yes.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
Yes.
George Melas-Kyriazi - President
Okay, very good.
Craig D. Gates - President, CEO & Director
But that's -- again, remember, the answer to the question was this is going to be a long, slow ramp.
George Melas-Kyriazi - President
Okay.
And then my last question, as the ramp is coming from taking some business from other contract manufacturers, you would think that they would have their ducks in row or they would have good documentation, good processes that would somewhat facilitate their transfer to a new manufacturer.
Is that not the case?
Craig D. Gates - President, CEO & Director
It can be the case.
I'd say it's more the case when we're coming from a contract manufacturer, competitor to us than it is when we're coming from a OEM to us.
It is certainly the chance is better that we're going to get better documentation.
On the other hand, you've got a competitor who's not real happy about losing something, so there is not a lot of help.
And we find that, in many cases, the OEM has completely abdicated his responsibility to maintain his own design and his documentation.
So particularly, if it's been a product that's been in China for 10 or 15 years and the OEM has gotten more and more complacent with keeping that documentation up and then suddenly discovers that he could save quite a bit of money or he's having problems with assurance of supply or he just saw his product on the shelves with an exact duplicate, which has been one of our OEM's unpleasant experiences just in the last month, then when you go in and try to pull that information from the other CM to us, it's worse than if it had come from the original OEM.
Operator
Next, we'll hear from Sheldon Grodsky with Grodsky Associates.
Sheldon Grodsky
I don't know if you're being diplomatic about the tax plan that Congress has passed.
But are you going to be affected by any excise tax coming out of products from Mexico or China?
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
At this point in time, we are continuing down the same road of current excise taxes.
None of the recent executive orders have affected any of our specific products that we build.
Sheldon Grodsky
So you don't think there's any change as far as -- the tax bill was passed in such a double secret manner that most American have no idea what's in it.
But I remember there were some threats about imports from Mexico and China, so, so far, you don't see any additional pressure on costs because of excise taxes from Mexico and China?
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
Sheldon, we kind of -- we -- those are 2 separate events in our minds as -- while they definitely correlate, but there's the tax reform, which is in fact the significant benefit to Key Tronic as we'll be paying less cash, and our effective tax rate will also be -- will decrease by at least 5%.
The excise tax from China or Mexico, I think, is another thing that continues to be negotiated and worked on.
And at this point, you probably know as much as we do.
Sheldon Grodsky
That's too bad for you.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
Yes, I know.
Sheldon Grodsky
Okay.
Let me -- the inventory increase in the quarter was unplanned.
This is companies not taking what you produce for them.
Craig D. Gates - President, CEO & Director
It was more the case of we had every part except for one, so we couldn't build it.
So we had 99% of the value, and we couldn't get 1 last resistor, so it sat there in inventory.
All of the other parts sat in inventory.
Sheldon Grodsky
Okay, so this inventory is stuck.
Okay.
And...
Craig D. Gates - President, CEO & Director
It's not necessarily is permanently stuck.
It was just that we were delayed in getting the last part of -- last part in, in time to get the inventory built and out the back door.
So as these...
Sheldon Grodsky
It's the 21st century.
What's happening to us?
We can't manage our supply chains anymore.
Craig D. Gates - President, CEO & Director
Well, you're going to have to take that up with some IC suppliers somewhere, not me.
Sheldon Grodsky
Okay, okay.
The last question for today from me will be our -- regarding your arbitration.
Are there counter claims asking for money from you?
Craig D. Gates - President, CEO & Director
We have no more comment on arbitration.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
Yes.
Operator
Bill Dezellem with Tieton Capital has a follow-up question.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Yes.
I would like to just get some clarification on something that I heard, and then I'm going to try to pin you down a little tighter.
I think in response to my question about the Mexican cost savings that the answer was $1 million per quarter.
But then later in the remarks to one of the other questioners, I believe that $1.25 million per quarter came up.
Not to split hairs, but if I heard that -- I've heard that's $1 million a year.
Craig D. Gates - President, CEO & Director
It's $1 million in a quarter.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
Per quarter.
William J. Dezellem - President, CIO, and Chief Compliance Officer
I understand.
My apologies for poor hearing.
Brett R. Larsen - Executive VP of Administration, CFO & Treasurer
No, it's all right.
It's probably my muffled mouth.
William J. Dezellem - President, CIO, and Chief Compliance Officer
So you had referenced a long slow ramp with regards to the exercise equipment control.
Wall Street, we all think a long ramp is a month.
What is a long ramp in your world?
Craig D. Gates - President, CEO & Director
So right now the product that we've been awarded is just going through its final design phases.
We'll go into production sometime -- we'll go into prototype production sometime middle of our Q4.
And then we'll actually go into production, production sometime in the middle of our Q1, and that's the first product that will come to us.
Then over time, there'll be more new products that get designed that we expect to win also.
So a long ramp to us is 1, 2 years.
William J. Dezellem - President, CIO, and Chief Compliance Officer
That is quite helpful.
And would you consider that a normal level of ramp just in terms of us keeping our expectations properly contained?
Craig D. Gates - President, CEO & Director
That one I think is a little bit longer than normal because we're taking over a product that is not quite yet designed.
When we're taking over an existing product from somebody else, then a 6-month to a 9-month ramp is more reasonable.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Understood.
Now if you are involved in the design process, does that also, though, help you with a quicker ramp when production actually begins, so you're not having the surprises that come about from the customer having lost control of a blueprint, et cetera?
Craig D. Gates - President, CEO & Director
Yes.
William J. Dezellem - President, CIO, and Chief Compliance Officer
And then I do want to ask about one other thing that was in the press release, and I think you made reference in your opening remarks, about the U.S. operations becoming increasingly profitable.
Would you talk a little bit more about that and how we on the outside should be thinking about that?
Craig D. Gates - President, CEO & Director
Sure.
Number one, we talked about how we were able to achieve the same revenue with less of the management/support people in Mexico.
And that implementation of systems and management processes and all that is also happening on -- in the East.
Meanwhile, we have been winning new programs steadily in the East and implementing them, so we are seeing the blanket of revenue being spread more evenly and more effectively over the East overhead structure and therefore, driving higher profitability.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Craig, that improved system implementation that you're referring to, is that actually leading to you having more success winning business and so these 2 actually go hand-in-hand?
Or are they not correlated?
Craig D. Gates - President, CEO & Director
Certainly, the existence of a bright and shining facility with bright and shiny processes and systems that can be audited and stand up without any hand waving is all part of a -- the opposite of a death spiral.
So you've got a new customer, who comes in and looks at the last new customer you just brought in 6 months ago.
He can call up that new customer who's happy and hears that, yes, they did a great job of bringing those guys in and blah, blah, blah.
This is all a real momentum business to be in.
Business brings business, and buildings that are clean and neat and have great processes and look good bring more business.
And spiffy machines inside of them that run twice as fast than the machine you had before, particularly when you're paying U.S. labor to man them, means you can quote at a lower price.
And all that just kind of swirls into a death climb rather than a death spiral.
And the final cog in that wheel is we've taken a big leap and added some personnel into our quoting and pricing process that I'm probably the most excited about as I've been in the last 10 years in getting that to be a world-class facet of our marketing.
We -- over my tenure, we've taken it from a really, really bad weakness to kind of a neutral.
And I think a year from now we'll be able to point at it and say that's another piece of a happiness climb rather than a death spiral.
William J. Dezellem - President, CIO, and Chief Compliance Officer
So expand on that a bit more, if you would, in terms of -- and I'm going to expose my ignorance here.
It seems as though a quoting process is the simple part as long as you don't...
Craig D. Gates - President, CEO & Director
Oh, a quoting process...
William J. Dezellem - President, CIO, and Chief Compliance Officer
You all said --- go ahead.
Craig D. Gates - President, CEO & Director
Because you're so wrong, I couldn't even let you finish.
William J. Dezellem - President, CIO, and Chief Compliance Officer
Excellent.
Please.
Craig D. Gates - President, CEO & Director
The quoting process is horrendously difficult, particularly for us, because we're not just quoting a PCB.
If all you're doing is quoting stuffing a PCB, you can pretty much assume that it's $0.015 replacement and you can just crank out your quote and you're done.
In our niche of the business, which takes a long time to grow as we've seen but is wonderfully sticky as you do it, it takes a long time to -- let's just use a slot machine as an example.
So you've got a product that could cost anywhere from $1,000 to $5,000 per piece.
And most of the mechanical parts in that product are custom.
So they have to be formed and painted, and they typically have custom coating, a lot of them.
And typically, the drawings aren't perfect, so there's a bunch of talkback between the customer's engineers and my engineers to figure out is this a 90-degree bend, does it have a [10,000ths] radius or did you mean that in millimeters.
And this is that black crinkle coat.
Is that black crinkle coat that stands up to a year in saltwater?
Or is it 10 years in saltwater?
And it just goes on and on and on.
And then there's probably a bill of material that has over 1,000 individual line items on it that are currently being purchased by the incumbent that we're quoting against, so he has the inside track on the price of each of these components, and we have a couple of weeks to go figure out what the inside track price is on each of these components.
Then there's the actual manufacturing processes that are typically not well documented.
So I have a team of mechanical and manufacturing engineers, who have to -- from prints, typically they don't even get a part.
They have to, from prints, figure out how many hours it's going to take us to put this thing together and test it.
And that's what's required to quote an electromechanical product.
And so that if you want to...
William J. Dezellem - President, CIO, and Chief Compliance Officer
Like...
Craig D. Gates - President, CEO & Director
Go ahead.
William J. Dezellem - President, CIO, and Chief Compliance Officer
No, go -- I'll let you finish.
Craig D. Gates - President, CEO & Director
So if you want to think of our marketing expense, in any contract manufacturer's marketing expense, we all pay our sales guys and we all pay our reps.
But you don't see a lot of ads in the Wall Street Journal for Key Tronic in terms of trying to gain our customers that way.
Our marketing expense is mainly quoting.
William J. Dezellem - President, CIO, and Chief Compliance Officer
So that really helps to highlight the complexity, and so I'm glad you saved me from myself with the question.
Let me now take this a step further and understand what is it that you believe you are now doing better in that process that will make a material difference to your success going forward?
Because, clearly, your comment was not intended to be a light comment when you said it's one of the things you're most excited about you have been in the last decade.
Craig D. Gates - President, CEO & Director
So a lot of this can be automated if you can get your systems together and your people on the same page and figure out how to undo the sins of 25 years in the past.
So let me give you an example.
So let's say that 1 customer has 1 part but he has 3 approved vendors from whom we can buy that part to put into his product.
And so we've got part number A with vendor 1, 2 and 3. And then we have another customer who uses the same part number A, but he has 2 approved vendors, and they're vendors 3 and 4. So now Key Tronic has to some way figure out how we can take volume advantage by linking together the demand for part A on vendors 3 and 4 while making sure that we don't throw vendors 1, 2 and 5 out with the bath in case something comes along like what's happening to us today with the shortage of parts.
So if you can imagine the complexity of that times I think it's 250,000 parts, I don't remember what the number is, just automating that is a massive improvement in our ability to quickly say, oh, look, we've got another quote for part A. Looks like this guy will let us use supplier 3. But supplier 3 is more expensive than supplier 1. Let's call him back and see if he's okay with supplier 1. Well, that's just one little piece of everything that goes on that we can automate.
And so mashing together the East's catalog of parts, China's catalog of parts, Mexico's catalog of parts and the processes that'll let them do this automatically and share the best cost, best price is something that we've been doing in the past.
And almost everybody has some kind of automation system ranging from crude to elegant, and we're moving from crude to elegant.
Operator
That will conclude the question-and-answer session.
I will now turn the conference over to Mr. Gates for any additional or closing remarks.
Craig D. Gates - President, CEO & Director
Okay.
Thank you again for participating in today's conference call.
Brett and I look forward to speaking with you again next quarter.
Thanks, and have a good day.
Operator
That does conclude today's conference call.
Thank you for your participation.
You may now disconnect.