Key Tronic Corporation

Good day and welcome to the second quarter fiscal 2023 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.

Thank you. 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 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 quarter ended December 31st, 2022. For the second quarter of fiscal 2023, we reported total revenue of $123.7 million compared to $134.5 million in the same period of fiscal 2022. For the first six months of fiscal 2023, Our total revenue was $261 million compared to $267.2 million in the same period of fiscal 2022. As previously announced, our revenue for the second quarter of fiscal 2023 was impacted by a six-week delay in starting production for a large program with a leading power equipment company. This delayed revenue by approximately $20 million from the second quarter of fiscal 2023, but production for this program is currently underway and increasing in the third quarter. While constraints in the global supply chain continue to limit production, we saw some gradual improvements with respect to lead times of certain key components. For the second quarter of fiscal 2023, our gross margin was 7.2% and operating margin was 2.9% compared to a gross margin of 7.3% and an operating margin of 1.2% in the same period of fiscal 2022. The gross margin in the second quarter of fiscal 2023 was adversely impacted by business interruption and other operational losses related to storm damage in our Arkansas facility, as well as by preparations for expected sales growth in the second quarter and increased labor costs in both the U.S. and Mexico. While profitability is expected to improve in coming quarters with expected increases in revenue, higher interest rates on our line of credit and increasing wages will limit a portion of that expected improvement. For the second quarter of fiscal 2023, net income was $1 million, or 9 cents per share, compared to $0.6 million, or 5 cents per share, for the same period of fiscal 2022. Our results for the second quarter of fiscal 2023 included a gain on insurance proceeds of $2.7 million, or approximately 19 cents per share, related to equipment damage Damaged in the storm at our Arkansas facility. We are still determining determining further business interruption proceeds related to the operational losses incurred in the past two quarters as a result of the storm damage. For the first six months of fiscal 2023, net income was $2.1 million or 20 cents per share compared to $1.4 million or 13 cents per share. for the same period of fiscal 2022. Turning to the balance sheet, despite the continuing production delays due to supply chain problems and the continued ramp and transfer of new programs, we ended the second quarter with total working capital of $190.7 million in a current ratio of 2.1 to 1. Compared to the prior quarter, We're encouraged to see our receivables decreased by $4.7 million and DSOs at 78 days, down from 91 days, which we believe reflects some improvement among our customers with respect to disruptions from COVID-19 and supply chain issues. At the end of the second quarter of fiscal 2023, our inventory increased by approximately $2.5 million. or by 1.5% from the prior period, reflecting the delayed production for the large outdoor power equipment program and our preparations for expected growth in coming quarters. While the state of the worldwide supply chain still requires that we look out much further in the future than in historical periods, we attempt to carefully balance customer demand and the likelihood of successfully bringing in Parts in time for plan production in future quarters, we expect to see our net inventory turns slowly improve to more historical levels. Total capital expenditures were $1.4 million for the second quarter of fiscal 2023 and we expect total capex for the year to be around $9 million. We're also utilizing the $2.7 million gain on insurance proceeds for storm damage to modernize our operations, which should increase efficiencies in our Arkansas facility. While we are 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. Despite the ongoing disruptions from the global supply chain that will continue to limit production and adversely impact operating efficiencies, we are expecting significant growth in fiscal 2023. For the third quarter of fiscal 2023, we expect to report revenue, in the range of $160 million to $170 million, and earnings in the range of 15 cents to 25 cents per diluted share. While profitability is expected to improve in coming quarters with increasing expected revenue, higher interest rates on our line of credit and increasing wages will limit a portion of that expected improvement. While our facilities in the U.S., Mexico, China, and Vietnam are currently operating, Uncertainty does still remain as to the possibility of future temporary closures. Customer fluctuations in demand costs, future supply chain disruptions, and other potential factors, any of which could significantly impact operations in coming periods. In summary, we continue to grow our pipeline of new sales prospects and continue to increase our customer demand to unprecedented levels for Keytronic. We believe that we are increasingly 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. We're pleased with a successful ramp of new programs and our expanding customer base in the second quarter of fiscal 2023, despite the six-week delay for production from the large previously announced power equipment program. Production for that program is now back on track and rapidly ramping up. In essence, the revenue from that program simply pushed by a quarter. During the second quarter of fiscal year 2023, we continued to see the favorable trend of contract manufacturing returning to North America. Currently awarded new business has created backlog that will support over 65% growth in the U.S. sites over the next fiscal year. We won new programs involving outdoor power equipment, battery management, automated sprinklers, and biometric sensor technology. We move into the third quarter with record backlog, and we're seeing improvement in the global supply issues for certain components that have severely limited our production in recent periods. Global logistics problems, the war in Europe, China-US geopolitical tensions continue to drive OEMs to examine their traditional outsourcing strategies. We believe these customers increasingly realize they had become overly dependent on their China-based contract manufacturers, not only for product, but also for design and logistics services. Over time, the decision to onshore or nearshore production is becoming more widely accepted as a smart long-term strategy. As a result, we see opportunities for continued growth. As we've discussed in prior calls, we built Keytronic to offer the ideal solution for customers as they move to respond to geopolitical pressures. Our facilities in Mexico represent a campus of 1.1 million square feet in Juarez, most of which is contiguously located in nine facilities acquired over time. Our three US-based manufacturing sites have also benefited greatly from the macro forces driving business back to North America. Moreover, our new Vietnam facility continues to increase production levels, and the abatement of COVID-related government restrictions in Vietnam is allowing us to travel there and tour the plant with potential customers. Our Shanghai plant has added capabilities in management, staff, and systems that allow it to serve Chinese customers directly. Shanghai has replaced the business that we moved to Vietnam, and our procurement group in Shanghai, which serves the entire corporation, is important for managing the supply issues that crippled many of our competitors without boots on the ground in China. The combination of our global footprint and our expansive design capabilities is proving to be extremely effective in capturing new business. Many of our large and medium-sized manufacturing program wins are predicated on Keytronic's deep and broad design services. And once we have completed a design and ramped it into production, we believe our knowledge of a program's specific design challenges makes that business extremely sticky. We also invested in vertical integration and manufacturing process knowledge. including a wide range of plastic molding, injection, blow, gas assist, multi-shot, as well as PCB assembly, metal forming, painting and coating, complex high-volume automated assembly, and the design, construction, and operation of complicated test equipment. This expertise may set us apart from our competitors of a similar size. As a result, a customer looking to leave their contract manufacturer will find one-stop shopping in Keytronic which is expected to make the transition to our facilities much less risky than cobbling together a group of providers, each limited to a portion of the value change. Moving further into fiscal 2023, the headwinds from the global supply chain continue to present uncertainty and multiple business challenges, but do show some signs of gradually abating, particularly with respect to the recent price stabilization for some commodity components. At the same time, these price reductions are offset by increasing wages at our North American facilities. We believe global logistics problems, China-US political tensions, and heightened assurance of supply concerns will continue to drive the favorable trend of contract manufacturing returning to North America, as well as to our expanding Vietnam facilities. The fact that we see record-level backlogs and expect record revenue in the third quarter indicates our growing momentum. Along with the records we are setting for backlog and revenue, we see a dramatic improvement in all metrics associated with business development. For example, over the past year, the number of active quotes with prospective customers has increased eightfold. This unprecedented increase in demand for our unique mix of skills, location, and people has powerful implications beyond the obvious revenue growth potential. In particular, we have been able to negotiate more favorable pricing terms and business parameters than in the past, as well as to be much more selective in the new customers we bring on. While this shift in leverage will not manifest in the short term, its effect on our long-term performance should be profound. As the implacable effects of global demographics combine with the unique attributes of the North American economy to drive the re-industrialization of the U.S. and the accelerating industrialization of Mexico, Keytronic should be uniquely positioned for significant growth in fiscal 2023 and beyond. This concludes the formal portion of our presentation. Brett and I will now be pleased to answer your questions.