Key Tronic Corporation

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.

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.

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.