Key Tronic Corporation

Good day and welcome to the Keytronic Q1 fiscal 2020 conference call. Today's conference is being recorded at this time. I would like to turn the conference over to Brett Larson. Please go ahead, sir.

Good afternoon, everyone. I am Brett Larson, chief financial officer of Keytronic. 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 10Qs, and 8Ks. 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 quarter ended September 28, 2019. For the first quarter of fiscal year 2020, we reported total revenue of $105.3 million, sequentially flat compared to the $106 million for the prior quarter, but down from $127.5 million in the first quarter of fiscal year 2019. Despite strong demand from both new and existing customers, a dramatic increase in the demand for sheet metals caused workload balancing challenges. These constraints, which are now largely resolved, resulted in production delays and were the primary reasons for the unexpected shortfall in revenue. Despite the revenue shortfall, margin percentages improved when compared with the prior year. For the first quarter of fiscal year 2020, gross margin was 8.8% and operating margin was 2.4% compared to 7.5% and 2% respectively. in the same period of fiscal 2019. The improvement in margin percentages was a result of product mix changes having a favorable impact on material costs and some labor efficiencies achieved in production. Despite the lower revenue levels for the first quarter of fiscal year 2020, net income was $1.6 million, or 14 cents per share, comparable to the same period of fiscal year 2019. Turning to the balance sheet, we continue to maintain a strong financial position. As a result of the production delays in the first quarter and the continued ramp and transfers of new programs, we did see a sequential increase in our inventory by approximately 17% from the fourth quarter of fiscal year 2019. In the second quarter of fiscal year 2020, we expect to see our net inventory levels decline and come more in line with revenue levels. At the end of the first quarter, trade receivables were down $2.2 million from a year ago, and DSOs were about 55 days. Total capital expenditures in the first quarter of fiscal 2020 were approximately $3.1 million. We continue to invest in our production facilities, SMT equipment, and sheet metal and plastic molding capabilities as well as improvements in our facilities. We plan to have approximately $10 million in capital expenditures during the fiscal year 2020. Moving into the second quarter of fiscal 2020, with the addition of new production capacity, we expect more of our new customer programs to ramp and to move into production. The disruptions and delays experienced in recent quarters have been largely resolved and we expect revenue to increase. Taking these factors into consideration, we expect that the second quarter of fiscal year 2020 will have revenue in the range of $117 million to $122 million. Our new Vietnam facility successfully began production with the first shipments leaving the new facility in September. For the second quarter of fiscal 2020, we expect to see some drag on gross margin as we continue to invest in enabling and accelerating the successful ramp of our new Vietnam facility. We anticipate earnings in the range of 13 cents to 18 cents per diluted share. This assumes an effective tax rate of approximately 20%. In summary, while we're disappointed by the disruptions to our revenue in the first quarter, we remain encouraged by our prospects for future growth. The overall financial health of the company is strong, and we believe that we are well positioned to win new EMS programs and continue to profitably expand our business over the longer term. That's it for me. Craig?

Okay. Thanks, Brett. As we've discussed in recent quarters, Concerns about the uncertain tariff situation with China continues to have mixed ramifications for us. On the one hand, the tariffs are causing uncertainty and sudden reactions across the EMS market, including our own customers. Additionally, tariffs further complicate the supply chain, particularly for China suppliers importing product back into the United States. On the other hand, the big story moving into fiscal 2020 is that, as a result of concerns over tariffs and trade tensions between the U.S. and China, a number of existing and new customers have accelerated their plans to transition from China facilities to our expanding facilities in the U.S., Mexico, and Vietnam. We see this trend as an important and very positive sign over the longer term as customers see the increasing advantages of our North American and Vietnam-based productions. While this transition caused delays in production during the first quarter, many of our current customers are experiencing a seamless transition of their business out of China operations, facilitated by our centralized command and control. This drastically reduces the risk and time associated with the transfer to our North American sites, and thus allows some leeway to respond to the rapidly changing tariff landscape. Furthermore, we are seeing that the tariffs on production in China have made our Mexico-based and Vietnam-based production more appealing to potential new customers. Our North American sites have become extremely competitive for U.S.-bound products subject to the new tariffs. This has resulted in increased interests and requests for quotes from prospective customers. On balance, we are increasingly well positioned for the returning tide of North American-based customers as they appropriately analyze the total cost for overseas production, pushing production into both Mexico and the U.S. While our marketplace remains very competitive, we continue to win significant new business both from EMS competitors and existing customers. During the first quarter of fiscal 2020, we won new programs involving electric vehicle charging infrastructure, LED lighting, oil and gas sensors, and flight controls for experimental aircraft. Our broader and more diversified customer base lowers the potential future impact of a slowdown by any one customer. While we are carefully managing our expenses, we have been preparing for growth in coming periods. During fiscal 2019, we made investments in our facilities, SMT, sheet metal, and plastic molding capabilities in Mexico and the U.S. We also deployed innovative new manufacturing equipment in each of our facilities, which has improved efficiencies and has made our production less labor-intensive. The result of this effort was a decrease in manufacturing and operating expenses of approximately $3 million annually. We also added more contiguous space in the U.S. in production equipment for growth. With respect to integrated electronics and sheet metal-centric programs, we see very strong growth and few real competitors of our size in North America. Moving into the second quarter, we are ramping up production in our new 86,000 square foot manufacturing facility in Vietnam to augment our Asian footprint and reduce production costs, as well as provide an additional hedge against uncertainty in a lingering or future trade war with China. 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, we are uniquely equipped to offer risk mitigation with our vertical integration and manufacturing facilities located in Mexico, Vietnam, and the U.S. While industry supply chain shortages and uncertainties about tariffs continue to be a factor, we expect revenue growth in the second quarter and remain optimistic about our opportunities for growth in fiscal 2020 and beyond. This concludes the formal portion of our presentation. Brett and I will now be pleased to answer your questions.