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spk00: and welcome to the third quarter fiscal 2024 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.
spk07: 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 Ms. 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 30th, 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 Keytronics 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 27 cents 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 interest expense, and by the continued strengthening of the Mexican peso. Relative to the U.S. dollar, the peso rose by approximately 5%, increasing our expenses by approximately $1.5 million, or 11 cents per diluted share. Furthermore, the temporary facility closures in the U.S. due to severe weather resulted a loss of contribution margin of approximately $1 million for 7 cents per diluted share. As a result of these factors, our gross margin was 5.8%. An 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 of fiscal year 2023. Our net loss was $2.2 million or 21 cents per share for the third quarter of fiscal 2024 compared to net income of $2 million or 18 cents per share for the same period of fiscal 2023. For the first nine months of fiscal 2024, the net loss was $802,000 or 7 cents per share compared to net income of $4.1 million or 38 cents 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, increase 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 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 to 1 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. We're $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, utilize 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 strengthened peso combined prompted us to reduce our overhead in our Juarez facilities. In the fourth quarter, we expect to incur additional severance expense of approximately $500,000 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 a year. Taking all these factors into consideration, we expect net income to be in the range of $0.03 to $0.10 per diluted share. In the fourth quarter of fiscal 2024 and moving into fiscal 2025, we expect continued sales growth in the U.S. 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.
spk05: That's it for me. Craig? Okay. Thanks, Brett. During the latter half of fiscal 2024, we are 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, which is 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 ORS site is being restructured to focus on higher volume manufacturing, while lower volume products with higher service level 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 continue to expand our customer base, winning new programs involving up to $20 million in an energy management account, around $5 million in a telecommunications account, around $3 billion in a consumer audio account, and around $5 million in an industrial manufacturing account. The strong pipeline of new business underscores a continued trend towards onshoring and dual sourcing of contract manufacturing. Global logistics problems and China-U.S. geopolitical tensions continue to drive OEMs to examine their traditional outsourcing strategies. We believe these customers increasingly realize that they have become overly dependent on their China-based contract manufacturers for not only 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 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 U.S.-Mexican border. And it has become clear that these changes in base costs of Mexican production are longstanding. 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 struggled with China production due to their flexibility needs, the decreasing cost differential between our U.S. and Mexico plants means that they will probably choose one of our U.S. sites. There we believe they can enjoy the ultimate in flexibility, engineering support, and ease of communications. Meanwhile, for those customers whose requirements had adapted to the China model of limited flexibility, challenging communications, slow 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 U.S. production facilities has increased approximately 15%. In Q3 of 2024, production in the U.S. represented about 30% of our 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 a 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 China component supply chain on an ongoing basis. 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. Once we have completed a 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, 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. 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 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 chain. In fact, most of the new customers we have onboarded take advantage of the one-stop shop capabilities we provide. We believe global logistics problems, China-U.S. 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 unfortunate 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 peso will dampen our growth and profitability in the fourth quarter. Moreover, we will continue to rebalance our manufacturing across our facilities in Mexico, the U.S., and Vietnam. We remain very encouraged by our progress and potential for profitable growth over the long term. As we 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 Keytronic to new heights. This concludes the formal portion of our presentation. Brett, Tony, and I will now be pleased to answer your questions.
spk00: Thank you. If you are dialed in via the telephone and would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, please press star 1 to ask a question. Your first question comes from the line of Bill DeZellum with Titan Capital. Please go ahead.
spk01: Thank you, Craig. You preempted my first question, but I did miss the energy management. What was the size of that one?
spk05: Gee, Bill, it was my parting gift to you. That was up to $20 million.
spk01: 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 highlights a competitive advantage that you all have or something else interesting? And I do appreciate the parting gift.
spk05: Thank you. You're welcome. The first one is an interesting one because 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. 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.
spk01: And so is this a single program, or is this up to $20 million one of the many programs that they are giving you?
spk05: It's already more than one program, and there are many more to come.
spk01: That's helpful. And the other three?
spk05: The other three are pretty much run of the mill in terms of standard reasons why they chose Keytronic.
spk07: 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 Keytronic.
spk01: 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? Sure.
spk05: This is somewhat of a COVID hangover. A lot of people, you and I have discussed this, were 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 were really COVID-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 their forecasts and orders are rebounding to the normal throughput levels that we would expect. That's really, that's the overall set of circumstances that's governing what we talked about as a softening and then a slight return, a muted return, I think we used the word.
spk01: 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 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?
spk06: Yes.
spk01: 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.
spk05: 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.
spk01: 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?
spk05: 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 a year. There's been a sea change in average makeup of the customers who are interested in Mexico so take this as we're clear that 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 a management edict are now making up a significant portion of the folks that are interested in Juarez So those people were either in China or were headed to China, and they were going to China driven mainly by cost and were willing to accept the lack of flexibility in moving orders in and out, lack of ability to send their engineers into the factory in the short term, lack of ability to get their parts here in a week rather than a month and a half, lack of ability to do business in English versus a mix. So they had become used to all that or were ready to endure all that in return for the lowest possible price they could get. A lot of those people are being told it's too risky, you are not going to go to China, figure something else out. So they end up knocking on our door, but they had sticker shock when they saw the cost that we were proposing out of our Juarez plant, because our Juarez plant was configured for a different set of people. And those set of people were the ones who didn't want to go to China, knew that they couldn't live with all the disadvantages I just listed, and were willing to pay a little more to be in Mexico and enjoy all the near-shore advantages Mexico has to offer. So those people used to make up the majority of our available market share. Now the majority of our available market share, on average, is made up by the people on the other side of the fence who want to be in China but are not being allowed to go there. So that means that all of the overhead in our factory in Mexico, the people overhead, the quality technicians, the engineers, the folks who worked in scheduling and on the plant floor, material handlers, program managers, all those people that we had built up over the years to provide US-based service levels But at a cost, we're not willing to be paid for by this new set of customers. And so those are the folks that made up the majority of this layoff, which has never happened before in our history. So those folks are long-term employees of Keytronic. wage structure and laws of Mexico require a significant severance payoff for folks in that category. And you're exactly right, this is nowhere near the normal type of layoff, but it strategically positions the Mexican facility to compete and win, as we've seen in the last six months, a new breed of customer that represents a very big available market. So that's why it took longer than normal. That's why the severance was much higher than normal. And that's why you're sensing that it was different than normal.
spk01: That's really insightful. Thank you, Craig. And so these, because these are not your standard line workers that you'll bring back with higher production rates, your cost structure is permanently being lowered then, is what you're saying?
spk06: Yes.
spk01: Does it somehow also affect the capacity of the facility? And not necessarily the layoffs, Craig, but the restructuring to have essentially less flexibility. That sounds to me like you'll have more hours of lines up and running and less time down with the customer noodling over whether they ought to do something a little different or whatever. Is that a correct interpretation or not?
spk05: It is. And in fact, we have pruned a very small number of customers who no longer fit into the model that you just described. So it will result in more product being made with less line workers because every time you have to shut a line down and change it over, not only did you have to have a bunch of engineers and quality folks and material handlers out there swapping the line over, inevitably you couldn't time it perfectly so you had line workers who were milling around waiting for some part or some process to come up the way it should. So it's going to turn much more into a bang, bang, slapping parts together. And I don't want to say that in a low-quality means, but it's going to be a lot more of just run something at high volume than it is switch over every 10 minutes because the customer called up and is freaking out. That type of work is migrating back to the states because people are willing to pay even more to get that level of service than they have been in the past.
spk01: Fascinating. Okay, thank you. And then lastly, if we exclude the severance and the winter weather, shut down, then we're looking at 13 cents of earnings is what would have happened had you not had the one intended event and then the weather that surprised you.
spk06: Yep.
spk01: Okay, great. Well, thank you, and I'll let others ask additional questions, but thank you for all the time you have given me on these conference calls to ask questions over the last... maybe even 60 calls. So thank you. Appreciate it. And, Brett, we look forward to working more with you in the future.
spk05: Thank you, Bill. You're more than welcome, and we've appreciated your insightful questions also. Thank you.
spk00: Once again, if you would like to ask an audio question, please press star 1. To cancel this request, please press star 2. Your next question comes from the line of Bob Poole with BrickAlert Capital.
spk02: Hi, guys. So I'd like to apologize in advance because I'm going to ask some tough questions and make some tough comments. And I think they need to be asked and the comments need to be made. But I do apologize in advance because this is usually a pretty friendly forum. So first of all, I want to sort of wage a protest that the way you present your financial results is totally out of line with I follow hundreds of companies, and you're the only one who presents your results the way you do without making adjustments for things like severance and so forth and presenting your results and your guidance after things like severance. Nobody else does that. And I don't think that there's any special pass to financial heaven for being so puritanical in that presentation. Brett, you and I have discussed this a little bit. You know, how do you feel about this going forward?
spk05: Your comments are noted.
spk06: Next.
spk02: Okay. So the guidance is very hard to understand, and I'll tell you why. You're basically projecting flat revenues from the third quarter to the fourth quarter, and on $140 million of revenues, you had a $575,000 loss. Q3. That included 3.7 million of Mexican severance. So that should not exist in the fourth quarter. You're taking out 10 million a year or two and a half million per quarter in Mexican labor. That should not be there in the fourth quarter. I think the impact of the peso is likely to be, you know, you've probably taken out half of your expenses in Mexico. If the impact of the peso, assuming it stays around the same level, there hasn't been a significant – it seems to be pretty flat so far this quarter. That should be $750 better in the fourth quarter, which should bring – if something else wasn't going on, that would bring operating income to $6.4 million, $6,375,000. You know, taking into account the 1% increase in your bank spread, you know, that's probably about $1.2 million a year or $300,000 a quarter. So that takes your interest from 2.8 to 3.1. That brings pre-tax income to 3.275. 20% tax rate brings you to roughly $2.6 million in after-tax income on 10.8 million shares. That's $0.24 a share. You're talking about 3 to 10 cents a share. If I make the adjustment for the new information that Brett gave about 500,000 to a million more in severance in the fourth quarter, if I take that out, that gets you to 19 cents a share. So what am I missing? What haven't you told us that is negative in the fourth quarter that accounts for the difference between 3 to 10 cents and 19 cents?
spk07: Well, that's a lot of moving pieces. I will let you know that. I don't know that I agree with all of your adjustments.
spk02: Our expectation is... Take them all then, please, Brett. Brett, you know, tell me where I'm wrong.
spk07: Well, I'm not going to get in an argument here. It's not worth it, but I will let you know that the peso recovery of $750,000 is not accurate. You know, and I'm also ensuring that, you know, the cost structure, the year anticipating of the $10 million, that's not immediate. That is ramping over four quarters. So both of those, I think, are likely incorrectly calculated. And no additional material events are included in that. projection of fourth quarter results.
spk02: So can you explain why, if you've terminated all of these people, why you're not, and the savings in a year is $10 million, why is it not $2.5 million a quarter?
spk07: Because it's not, we're not done with severance. As we mentioned, that we still have $500,000 to $1 million of severance to occur in the fourth quarter. Those have not been fully done, even as of today. And we also mentioned that that would take up to six months to fully recover that severance amount. So, you know, to be able to say that we're recovering $2.5 million of expenses in the fourth quarter, net of what we're paying in severance, that is just not accurate.
spk02: So actually, Brad, if you go back, you've paid $3.7 million in severance so far, and let's say you pay another million, that's $4.7. If you're going to get that back in six months, that's about $2.5 million a quarter, Brad.
spk06: Again, it's radically different.
spk02: I'm working with your numbers, Brad, so it's not like I'm making this stuff up, you know?
spk07: Bob, we were talking a few hundred thousand dollars of your 19 cents and our 10 cents.
spk02: That's over a million dollars.
spk06: That fourth quarter severance is still in process. Right. So, yeah.
spk02: So I've taken that out to get to the 19 cents.
spk07: I disagree as well with your effective tax rate. I think you need to go back and recalculate that, particularly coming off of a loss in third quarter. You told us in your guidance that it will likely be 25%.
spk02: Is that with the – yeah, so you need to update your business outlook because it said 20%, Brett. So I'm working with your numbers. I mean, you guys got to get this together. It's really bad. Okay, next question. You know, you're sort of talking about a strong backlog business coming back, yet revenues really, if you account for the fact that you lost 5 million of revenues last quarter, that should have been 145 for the quarter, and now you're projecting, you know, sort of 140 at the midpoint. Bill kind of asked this question, but it's hard to reconcile You know, your comments about, you know, business getting better and having a strong backlog and, you know, another 3% to 4% decline in revenues. How do you reconcile those?
spk06: I think the words I used were muted.
spk02: Well, that's negative. That's not muted benefit. You know, that's muted decline benefit.
spk05: Well, as you said, Bob, this is becoming unpleasant and I don't intend to argue with you semantics of what we said. We're giving you a true representation of our belief of the revenue going forward. We're giving you a true representation of the backlog we have, and we're giving you a true representation of the new customer pipeline we have as well with new quotes.
spk06: So that's that.
spk00: Thank you. Your next question comes from the line of George Melis with MKH Management. Please go ahead.
spk04: Thank you. It is just a question about the layoffs and the severance. And Craig, you mentioned $10 million in savings. When do you expect to get that $10 million in savings? And how much do you expect in the June quarter and in the quarters after that?
spk05: So the quarter we're in right now, we're going to get a portion of it. And as we get into July, August, September, we should be seeing most of it per quarter.
spk04: Okay. So does that mean that by September, you're at the full run rate of $10 million?
spk05: Yep, that's correct. Yep.
spk04: Okay. Great. That's helpful. And roughly how much are you getting in the June quarter?
spk07: It is roughly between a million and a half and $2 million. Okay.
spk04: And why is that? Is that because you've established the new office, but you haven't You didn't let go everybody as of March 1st. Is that what it is?
spk07: That is correct.
spk04: Okay. Very good. Then the question that relates to what Bill was asking, do you actually have some customers migrating from Mexico to the U.S.? Because as I look at... if you are reducing your capability in Mexico, having fewer people to handle the project, the customers that you still have there that have these expectations, how do you manage that? I mean, are we going to have like a bifurcated service almost in Mexico and the legacy customers have a certain kind of
spk05: expectations and for the new customers it's a different set of expectations yeah that's a very perceptive question what we're moving from is a factory that was loaded with the overall ability to handle anything happen to any customer at any time and we're moving to a factory that is specifically loaded with by customer to provide whatever services the customer decides that they would like to pay for. So it's almost impossible, at least we found it to be so, to control costs when you're peanut buttering it over the entire facility or nine facilities. When you have specifically talked with existing and new customers about what is it you're looking for and this is your base price, And if you want to be able to call us and switch back and forth in a day, we're going to have to add this much support labor. And if you're not willing to pay for it in Mexico, but you want it, then you probably ought to go somewhere else. And if you do want to pay for it, maybe it makes more sense at the levels you think you're going to need to move to the states. And so we have seen some customers who have decided to move their production to one of our facilities in the States.
spk03: From Juarez to Mexico, from Juarez to the U.S.?
spk05: Yep. Not a large amount, but some.
spk03: Okay.
spk04: Yeah, I'm just still confused about how you ran the plan like this, or nine facilities with sort of different set of expectations among different customers. And in a way, I sort of loved the fact that we were sort of like had a real differentiation on design and handling difficult jobs that then were sticky. But it seemed that these new customers is not really that. They're pretty commodity-oriented guys.
spk05: Well, it's a really good question and I want to make sure we're perfectly clear on it because it's a very key strategic portion of our thinking. So we talk about design capabilities with difficult designs and difficult products. that make those products sticky. Those designs and those processes come out of the engineering staff in Spokane. The ability to manage a poorly designed or dodgy product that Keytronic didn't design that we just transferred, that has to come out of the folks in Juarez. So when we cut our ability to provide service on a peanut butter level, that means that if a customer wants to transfer to us a product that has a dodgy process, we now up front say, yeah, we don't want to call your baby ugly, but your baby's kind of ugly. And we realize that you have quotes from other suppliers that are lower than our quote, and we are happy to give you a quote that would be dirt floor levels of engineering support, but you're not going to succeed building this product with this design in a factory without engineering services. So we're either going to have to agree that our price is going to be higher than what you're hoping for, or we're going to have to help you change the design, or you're going to have to go somewhere else with this product. So that's, I don't know if that helps you, but that's a little bit of insight into how we're doing it. And then secondly, with customers that have said, yeah, we want this level of service, it's much easier to control the cost since we already have a lot of practice in creating miniature factories within factories. So we have a little factory inside a big factory that we can say, all right, we're going to put one or two people on the support for this department. And they're not just on the overall salary supporting the whole company whenever a problem comes up. They're only going to be full-time on this department department building this product for this customer because this customer is paying for it. So it's much easier to control the cost and much easier to calculate the cost when you've got it basically laser pointed onto a product and a customer rather than smeared across an overall strategic intent of being high service for everybody. So we haven't lost the ability to market ourselves as a high service supplier out of ORAS. What we've changed is our ability to provide a low service cost for those people who want it. So it's kind of like one of the few things I took away from business school was if you can't be niche, you have to be low cost. But we now have the ability, if we are not niche by virtue of design or service levels, to be low cost. out of Juarez by clearly defining to the customer upfront that if you're going to want this, it's going to cost this.
spk06: Does that make sense?
spk04: It does make sense. It's an interesting thing to manage. Let me ask a question there that's related to that. Does that mean that the conversation that you have with your customer is meaningfully different than it was before.
spk06: Yeah.
spk04: It's almost like you're proposing alternatives for them, and they can choose from that, but you didn't do that really before.
spk05: We didn't have the opportunity to say, if you want to come to Juarez and be a low-cost, low-service customer, here is your new price. because we didn't have the capability of removing all of that peanut buttered overhead from our cost structure on a given quote. And even if you could do that, it takes a while to figure out on a given product what that cost should be if you're trying to come up with a new formula. And if you can't do that quickly, it's hard to convince a customer that you actually are going to have that ability to give them what they want in very, very low cost, low service. So we have right now almost 80 active quotes. And people want two to three weeks of response time on a quote. And if you're trying to recalculate your cost structure every time you get a weird product, you can't do it quick enough. It's much easier to add than it is to try to find a way to subtract.
spk04: Okay. And if you look at your customers now in Juarez, they are mostly the niche. They're mostly the high service customers. The low cost is still a very small group, but do you think that's where the growth will come?
spk05: No, that's not true. It's a mix. And part of the revelation on this is that as we were being forced by the wage rates and the peso, as we were being forced to raise prices across the board on customers, we realized that the low-service customers were going to bolt. And as we struggled to figure out how we could keep those customers in the face of these wage and peso problems, that was part of our revelation on, okay, wait a minute, we're in a different market now.
spk04: Got it. Okay. Super interesting.
spk06: Yeah. I had one more question. Let me see.
spk04: But in a way, if we look back two years ago, this would have come to you guys a little bit as a surprise. Well, I guess it was forced upon you, as you said, partly by the wage rates and the peso, and then accelerated by the demand of some of the people who were operating in China.
spk05: It actually goes back four years to the beginning of COVID and the gradual and accelerating end to the answer every single procurement agent we spoke with to the question of where should I be, the answer was China. And as COVID and Trump and China and the states and tariffs and supply chain and all of that is added together. And I'm not, I'm not sure the general public knows this, but it used to be a 100% in fashion call. If you got a bunch of OEM CEOs together five years ago, it would be almost embarrassing for them to say they were building anywhere but China. they would be asked, what are you thinking? Their board would be asking them, what are you thinking? Why are you not in China? That has changed dramatically now as a result of all those economic and political and physical events that have happened in the last four years so that the market we are operating in is dramatically different than the one we were in five years ago, four years ago. And that's why We were doing what we were doing five years ago, and that's why we're changing what we're doing now.
spk04: Okay, great. And then maybe a couple more questions. From a gross margin perspective, and I think the idea is to try to get back to a 9% gross margin or maybe even higher, is that still a possibility or does that sort of new strategy actually impair that?
spk05: I think it's still a possibility. I don't think the strategy impairs it. And I think the ability to build more faster with less people is a help rather than a hindrance to that.
spk06: Okay.
spk04: Okay, great. Craig, thank you very much for everything, for your time, for your answers. And you're not going away, so I'm happy about that. And Brett and Tony, best of luck with everything. We'll have many more conversations.
spk06: Thanks, George. It's been good knowing you. Thank you. Yep.
spk00: Thank you. Your next question comes from the line of Bill DeZellum with Titan Capital. Please go ahead.
spk01: I actually have a follow-up relative to something that I believe, Craig, you said in one of your remarks, that by structuring Juarez to be lower cost, you're opening yourselves up to a much larger market. Number one, did I hear that correctly? And then secondarily, by default, also structuring the U.S. maybe to be more of that high touch in maybe a more obvious way? I know it's been that all along, but maybe a more obvious way. Is that in any way expanding your potential market?
spk05: I don't think the changes to the US-based facilities are any more obvious than they have been in the past. They were structured to be high service at a price. The changes to Juarez that flow through and result in bids and quoting being lower than what they used to be is a change that results in a bigger available market to us.
spk06: Do you have a quantification on that? No.
spk01: And then one additional question, please. You mentioned you have 80 quotes today. How does that compare to what we would have seen over the course of the last couple of years?
spk06: It's much higher.
spk01: By a factor of? two or five or five percent?
spk05: Oh, no, it's probably a factor of... There were times where we had quotes maybe 20 or 30 in the funnel.
spk01: This is at least double, if not quadruple, maybe what you were accustomed to running at before. Yep.
spk06: Great.
spk01: Well, congratulations and congratulations I look forward to a few more of those at the up to $20 million mark.
spk06: Us too. Enjoy retirement. Thanks.
spk00: This concludes today's question and answer session. I will now turn the call back to Craig Gates for any additional or closing remarks.
spk05: Okay. Thank you, everyone, for participating in today's conference call. I'll speak for Brett and Tony when I say they look forward to speaking with you next quarter. Adios.
spk00: This concludes today's call. Thank you for your participation. You may now disconnect.
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