Key Tronic Corporation (NASDAQ:KTCC) Q3 2024 Earnings Call Transcript

Key Tronic Corporation (NASDAQ:KTCC) Q3 2024 Earnings Call Transcript May 7, 2024

Key Tronic Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the Third Quarter Fiscal 2024 Key Tronic’s Corporation Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Brett Larsen. Please go ahead.

Brett Larsen: 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 and Tony Voorhees, our Vice President of Finance and Corporate Controller 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 three months ended March 30, 2024. For the third quarter of fiscal 2024, we reported total revenue of $140.5 million compared to $164.6 million in the same period of fiscal year 2023. Revenue for the third quarter of fiscal 2024 was constrained by approximately $5 million, due to severe winter weather events that took Key Tronic’s facilities in Mississippi and Arkansas, offline for approximately two weeks. In addition, we saw a softening demand for a number of different programs produced in Mexico. For the first nine months of fiscal 2024, our total revenue was $433.7 million compared to $425.5 million in the same period of fiscal 2023.

For the third quarter of fiscal 2024, our margins and profitability were significantly impacted by an unusual combination of events. First, we incurred severance costs of approximately $3.7 million or $0.27 per diluted share as we reduced our workforce by over 450 employees in Mexico. The severance costs were incurred late in the third quarter, which limited the payroll expense reduction that could be recognized for the quarter. We also continued to be adversely impacted by high labor costs and the interest expense, driven by the continued strengthening of the Mexican peso. Relative to the US dollar, the peso rose by approximately 5%, increasing our expenses by approximately $1.5 million or $0.11 per diluted share. Furthermore, the temporary facility closures in the US, due to severe weather resulted a loss of contribution margin of approximately $1 million or $0.07 per diluted share.

As a result of these factors, our gross margin was 5.8%, and operating margin was a loss of 0.4% for the third quarter of fiscal 2024 compared to gross margin of 8.7% and an operating margin of 3.1% in the same period in the fiscal year 2023. Our net loss was $2.2 million or $0.21 per share for the third quarter of fiscal 2024 compared to net income of $2 million or $0.18 per share for the same period of fiscal 2023. For the first nine months of fiscal 2024, the net loss was $802,000 or $0.07 per share compared to net income of $4.1 million or $0.38 per share for the same period of fiscal year 2023. As we also noted in today’s earnings release, we cured a breach of our fixed charge coverage ratio covenant in our asset-based revolving credit facility as of the end of the third quarter by executing a new amendment to the agreement with our lender today.

This amendment will provide relief on the financial covenants for the next 12 months, increased the interest rate by 100 basis points and advance the maturity date of the agreement to September of 2025. Turning to the balance sheet. We ended the third quarter of fiscal 2024 by reducing inventory by approximately $39 million or roughly 22% from the same time a year ago. These improvements in inventory levels primarily reflect increased component availability and our concerted effort to drive inventory reductions. We’re pleased to see our inventory levels continue to become more in line with our current revenue. At the same time, the state of the worldwide supply chain still requires that we drive demand for parts differently than in historical periods.

Our customers have revamped their forecasting methodologies, and we have significantly modified and improved our material sourcing – materials resource planning algorithms. As a result, we should be better equipped for future disruptions in the supply chain even as we continue to manage inventory more cost effectively. During the third quarter, we also reduced our accounts payable leasing obligations and overall debt by a combined amount of $57.1 million from a year ago. Our current ratio was 2.8 times compared to 2.2 a year ago. At the same time Accounts Receivable DSOs was at 83 days compared to 79 days a year ago which we believe reflects some increased delays in collections from certain customers despite continuing improvement of most customers with respect to disruptions from supply chain issues.

Total capital expenditures were $0.7 million for the third quarter of fiscal 2024 and we expect total CapEx for the year to be around $5 million. While we’re keeping a careful eye on capital expenditures, we plan to continue to invest selectively in our production equipment, SMT equipment and plastic molding capabilities, utilizing leasing facilities, as well as make efficiency improvements to prepare for growth and add capacity, particularly in our US and Vietnam locations. For the fourth quarter of fiscal 2024, we’re seeing a rebound among our legacy customers relative to our third quarter and a strong backlog of new customer program opportunities. For the fourth quarter of fiscal 2024, we expect to report revenue in the range of $135 million to $145 million.

While new programs continue to ramp in our Mexico facilities, efficiency improvements a muted rebound to pre-COVID production levels amongst existing Mexico customers and the continued pressure of a strengthening peso combined prompted us to reduce our overhead in our warehouse facilities. In the fourth quarter, we expect to incur additional severance expense of approximately $500000 to $1 million from additional headcount reductions in our Mexico-based operations late in the fourth quarter. The payback period for this decision is expected to be under half of the year. Taking all these factors into consideration, we expect net income to be in the range of $0.03 just two $0.10 per diluted share. In the fourth quarter of fiscal 2024 and moving into fiscal 2025, we expect continued sales growth in the US and Vietnam and we have a strong pipeline of potential new business.

Over the longer term, we believe that we are increasingly well-positioned to win new programs and to continue to profitably expand our business. That’s it for me. Craig?

Craig Gates: Okay. Thanks Brett. During the latter half of fiscal 2024 we were taking necessary steps to reduce our workforce in Mexico due to the softening demand for a number of different programs with high support labor content with an expected to save us more than $10 million annually. In the coming quarters, we expect sales from Mexico based production to recover due to recently won programs and we do not anticipate needing to increase our headcount in coming periods, reflecting the significant improvements to our operating efficiencies. At the same time our work site is being restructured to focus on higher volume manufacturing, while lower volume products with higher service loan requirements will migrate to our other sites.

We’re also pleased to see overall improvements in our operating efficiencies and inventory levels and other improvements made on the balance sheet. During the quarter, we continued to expand our customer base, winning new programs, involving up to $20 million in energy management account, around $5 million in the telecommunications account, around $3 billion in consumer audio account and around $5 billion in industrial manufacturing account. The strong pipeline of new business underscores that continued trend towards onshoring and dual sourcing or contract manufacturing. Global logistics problems in China US geopolitical tensions continue to drive OEMs to examine their traditional outsourcing strategies. We believe these customers increasingly realize that they have become overly dependent.

Are there China-based contract manufacturers for that only product but also for design and logistics services? Over ime the decision to onshore nearshore production is becoming more widely accepted as a smart long-term strategy. As a result we see opportunities for growth and those opportunities are becoming more clearly defined. At the same time, we are seeing a sustained trend of strong Mexican peso and continued increases in Mexican wages particularly along the US Mexican border. And it has become clear that these changes in base cost of Mexican production are long-standing. It has also become clear that customers have a different calculus for selecting a geographic location for businesses that they are bringing back from China. For those customers who struggles with China production due to the flexibility needs of the decreasing cost differential between our US and Mexico plants means that they will probably choose one of our US sites.

They are we believe they can enjoy the ultimate flexibility engineering support and ease of communications. Meanwhile for those customers whose requirements had adapted to the China model of limited flexibility, challenging communications, small motion engineering support, our Mexican facilities remain the answer. Therefore, we are reconfiguring our Mexico sites to endeavor to be a lower cost, high-quality but more commodity level service provider. Over the past 12 months, revenue from our US production facilities has increased approximately 15%. In Q3 of 2024, production in the US represented about 30% of the total revenue. While our Vietnam facility continues to be a modest contributor to our overall revenue, a growing number of potential customers are actively evaluating the migration of their China-based manufacturing to our facility in Vietnam.

In coming years, we expect our Vietnam facility to play a major role in our growth. While China growth has slowed, and many companies have decided to take risk mitigation steps with their China manufacturers, the fact remains that many components must be sourced from China. Our procurement group in Shanghai, which serves the entire corporation remains important for managing the Chinese component supply chain on an ongoing basis. The combination of our global footprint and our expansive design capabilities is proven to be extremely effective in capturing the business. Many of our large and medium-sized manufacturing program wins are predicated on Key Tronic’s deep and broad design services. And once we have completed the design and ramped it into production, we believe our knowledge of the program’s specific design challenges makes that business extremely sticky.

We also continue to invest in vertical integration and manufacturing process knowledge, including a wide range of plastic molding, injection below gas assist multi-shot as well as PCB assembly, metal forming, painting, and coding, complex, high-volume automated assembly and the design, construction and operation of complicated test equipment. We believe this expertise will increasingly set us apart from our competitors of a similar size. As a result, a customer looking to leave their contract manufacturer will find a one-stop shop in Key Tronic, which is expected to make the transition to our facilities much less risky and tabling together a group of providers each limited to a portion of the value chain. In fact, most of the new customers we have on-boarded take advantage of the one-stop shop capabilities we provide.

We believe global logistics problems, China-US political tensions and heightened concerns about supply chains will continue to drive the favorable trend of contract manufacturing returning to North America as well as to our expanding Vietnam facilities. We continue to see improvement across the metrics associated with business development including a significant increase in the number of active quotes with prospective customers. While the enforcement combinations of factors temporarily disrupted our growth and profitability in the third quarter, we move into the fourth quarter of Fiscal 2024 with a strong pipeline of potential new business while we’re seeing improvement in our operating efficiencies, recent wage increases, higher interest rates and a strong pace that will dampen our growth and profitability in the fourth quarter.

Moreover, we will continue to rebalance our manufacturing across our facilities in Mexico, the US and Vietnam. We remain very encouraged by our progress and potential for profitable growth over the long term. As we’ve previously discussed, Brett will succeed me as President and Chief Executive Officer at the end of June, while I expect to remain a member of the Board. Additionally, Tony will become our Chief Financial Officer. Since this will be my 60th and last quarterly investor conference call, I want to express my deep gratitude to our shareholders, customers and vendors. I want to express my sincere thanks to our outstanding employees for their dedication and commitment to our success. It has been a great honor to lead this team, and I have full confidence that Brett, Tony and their outstanding team will continue to take Key Tronic to new heights.

This concludes the formal portion of our presentation. Brett, Tony and I with I’ll be pleased to answer your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] The first question comes from the line of Bill Dezellem with Titan Capital. Please go ahead.

Bill Dezellem: Thank you. Craig, you preempted my first question, but I did miss the energy management. What was the size of that one?

Craig Gates: Bill, it was like parting gift to you. That was up to $20 million.

Bill Dezellem: Okay. That’s excellent. Thank you. Would you please walk through each of these and highlight maybe important aspects to them, whether they’re existing customers or whether they are new customers? What was — what, if anything was unique about these wins that highlight the competitive advantage that you all have or something else interesting. And I do appreciate the parting gift.

Craig Gates: Thank you. You’re welcome. The first one is an interesting one because this — it’s a new customer. This customer came to us almost two years ago and had an edict that they needed to significantly increase their outsourcing in Mexico. And – they played a significant role in helping us upgrade our metal coating capability because they have a very high-end requirement for withstanding the salt spray test. So after a number of changes to our chemistry and in our painting process, we were able to pass that long-term salt spray test. And since then, the floodgates have opened and they have been giving us more quotes and awards than we can handle. So that’s been a two-year success story that we were never sure was really the pot of gold at the end of the rainbow the customer was telling us, but our technical folks hung in there. And in the end, it’s going to be a very nice and longstanding program.

Bill Dezellem: And so is this a single program? Or is this up to $20 million, one of the many programs that they are giving you?

Craig Gates: It’s already more than one program, and there are many more to come.

Bill Dezellem: That’s helpful. And the other three?

Craig Gates: The other three are pretty much run of the mill in terms of standard reasons why they chose Key Tronic. The consumer audio is a customer in-house today. This was just a new program, right? The other two are new customers and new programs for Key Tronic.

Bill Dezellem: Thank you. That’s helpful. And then if I may, jumping to the softening demand that’s referenced in the press release and then possibly Brett, in your opening remarks, you referenced that, that has maybe even turned to a rebound, would you pull all of that together for us, please?

Brett Larsen: This is somewhat of a COVID hangover. A lot of people, you and I have discussed this. We’re concerned a year ago that there was a massive COVID hangover. And what we found is that it’s scattered and spotty. A couple of our large customers did have too much inventory that they had built or had us build for them as parts became available and what we’re really come driven false demand signals, tempted them to continue building at a high rate, but it wasn’t widespread and as we’ve seen just in the last two or three months, those customers have drawn their inventory down of the products we make for them to the point that they’re forecast and orders are rebounding to the normal throughput levels that we would expect. So that’s really — that’s the overall set of circumstances, it’s governing what we talked about as a softening and then a slight return of muted return, I think we used toward.

Bill Dezellem: So from your standpoint, if you were to look out just from an overall economic view, is it your sense that demand continues reasonably strong, I’ll call it, end demand, and now you’ve worked through some inventory, excess inventory and so we — that volatility, if we were to exclude that, we’re discontinuing with more of the same of decent demand. Is that a fair way to look at what you’re experiencing?

Brett Larsen: Yes.

Bill Dezellem: Great. Thank you. And then let me jump to the severance, if I may. Severance came late in the quarter, as you pointed out. Why was that? Because this is something, if I recall that we talked about on the last call, and so I would have expected it maybe to happen sooner.

Brett Larsen: Well, when you affect people’s lives and many of these people have been with us for quite some time, you want to be absolutely sure, you’re doing the right thing and you’re doing it with the right people. So it took us a little longer than we thought to get it done, but we are confident that we have done it in a caring and professional manner and done what needed to be done.

Bill Dezellem: And Craig, this sounds a little bit different than layoffs that you have had in the past where demand falls off and line workers are laid off. I’m just getting a different vibe than historical layoffs. Am I over reading into this? Or is there something more to be discussed here?

Craig Gates: There’s a lot more to be discussed because these layoffs represent a significant strategic change in how we view Mexico versus America versus China versus Vietnam. We tried to get at it in my prepared remarks, but actually the way I think about it is a little bit more simpler and crude, I think in the flowered way we put it. That is in the past year, six months to the year there’s been a C change in the average makeup of the customers who are interested in Mexico. So take this as clear as this is the average. It’s not every customer, but what’s happened is that the people who wanted to be in China, but are not being allowed to do so by management, [indiscernible] are now making up a significant portion of the folks that are interested in more ads.