Key Tronic Corporation

and welcome to the Q2 fiscal 2020 Keytronic Corporation 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.

Thank you. Good afternoon, everyone. I am Brett Larson, Chief Financial Officer at Keytronic. I would like to thank everyone for joining us today for our investor conference call. Joining me here in the 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 December 28, 2019. For the second quarter of fiscal year 2020, We reported total revenue of $116.7 million compared to $123 million in the same period of fiscal year 2019. For the first six months of fiscal year 2020, total revenue was $220 million compared to $250.5 million in the same period of fiscal year 2019. However, sequentially we did see a $12 million increase in revenue when compared to the first quarter of fiscal year 2020, and we expect revenue growth to continue into the third quarter. For the second quarter of fiscal year 2020, net income was $0.8 million or $0.08 per share compared to $1.6 million or $0.15 per share for the same period of fiscal year 2019. For the first six months of fiscal year 2020, Net income was $2.4 million or 22 cents per share compared to 3.2 million or 29 cents per share for the same period of fiscal year 2019. As previously announced in January, the lower than anticipated earnings for the second quarter of fiscal 2020 was primarily a result of increased factory spending in our Juarez metal fabrication departments. This spending was necessitated by both new and existing customers exiting their manufacturing arrangements in China and ramping their production in Juarez. While the near-term financial impact was significant, the long-term relationship with these customers was strengthened by the performance of the Juarez facility under extreme pressure. Additionally, we incurred unfavorable foreign currency losses related to the unhedged portion of our Mexican labor expenses as a result of the strengthening Mexican peso over the quarter. The unanticipated increase in factory spending adversely impacted our margins. For the second quarter of fiscal year 2020, our gross margin was 7%, and our operating margin was 1.3%, compared to 8% and 2.1% respectively in the same period of fiscal year 2019. Nevertheless, it is important to note that we have made significant improvements in our operating efficiencies in recent quarters through investments in new equipment. Several of these investments were made in the metals area, and the resulting efficiencies combined with the completion ramps of several new metals programs lead us to expect our margins to improve in the coming periods. Turning to the balance sheet, we continue to maintain a strong financial position. Despite the production delays in the second quarter and the continued ramp and transfers of new programs, we did see a sequential reduction in our inventory, including revenue recognition contract assets by $12.2 million, or 8.8% from the prior quarter. In the third quarter of fiscal year 2020, we expect to see our net inventory levels continue to come more in line with revenue levels. At the end of the second quarter, trade receivables were up by $3.4 million from the prior period, reflecting the increased revenue, and DSOs remained about 54 days. Total capital expenditures in the second quarter of fiscal 2020 were approximately $2.3 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 make a total of approximately $10 million in capital expenditures during the full fiscal year 2020. Moving into the third quarter of fiscal 2020, with the addition of new production capacity, we expect more of our new customer programs to ramp and move into production. The workload balancing challenges and capacity issues experienced in recent quarters have been largely resolved, and we expect revenue to increase. Taking these factors into consideration, we expect that the third quarter of fiscal 2020 will have revenue in the range of $117 million to $121 million. For the third 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 17 cents per diluted share. This assumes an effective tax rate of approximately 20%. I would like to note that Keytronic is working closely with its employees, customers, and key suppliers to ascertain delays attributable to the recent outbreak of the coronavirus in China. Potential delays in production and extended transit times of critical parts could significantly affect results in each of our production facilities. In summary, while we are disappointed by the disruptions to our earnings in the first half of the year, we remain encouraged by our prospects for the 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 to continue to profitably expand our business over the longer term. That's it for me. Craig?

Okay. Thanks, Brett. Moving into the third quarter of fiscal 2020, the issues impeding our production efficiencies in the first half of the year have diminished, and we see potential revenue and earnings growth in coming periods. Furthermore, uncertainty over tariffs and trade tension between the US and China continues to drive a number of existing and new customers to accelerate their plans to transition from China facilities to our expanding facilities in Mexico and Vietnam. We see it as a very positive trend over the longer term as customers see the increasing advantages of our North American and Vietnam-based production. While this transition caused delays in production during the first half of the year, Many of our current customers are experiencing a positive transition of their business out of China facilities facilitated by our centralized command and control. This centralization drastically reduces the risk and time associated with a transfer to our North American and Vietnam sites and thus allows some leeway to respond to the rapidly changing political and health landscape. We've significantly advanced the efficiencies of our Mexico and U.S.-based facilities in recent quarters and we're increasingly well-positioned for the returning tide of North American-based customers as they appropriately analyze total costs for overseas production and, as a result, push production into both Mexico and the U.S. Also, we continue to ramp up our production in Vietnam. While our marketplace remains very competitive, we continue to win significant new businesses, both from EMS competitors and existing customers. During the second quarter of fiscal 2020, we won new programs involving consumer medical devices, Wi-Fi enabled signage, and temperature control devices. 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 2020, we have continued to invest in our facilities, including the expansion of SMT sheet metal and plastic molding capabilities in Mexico and the U.S. 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. 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 has been decreased manufacturing and operating expenses of approximately $3 million annually. Moving into the third quarter, we are continuing to ramp 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, pandemic risks, and uncertainties about tariffs continue to be a factor, we expect revenue growth in the third quarter and remain optimistic about our opportunities for growth going forward. This concludes the formal portion of our presentation. Brett and I will now be pleased to answer your questions.