Key Tronic Corporation

Good day and welcome to the Keytronic FY2026 Q2 investor call. Today's conference is being recorded. After the presentation, we will begin the question and answer period. At this time, I'd like to turn the call over to Tony Voorhees. Please go ahead.

Good afternoon, everyone. I am Tony Voorhees, Chief Financial Officer of Keytronic. I'd like to thank everyone for joining us today for our investor conference call. Joining me here at our Spokane, Washington headquarters is Brett Larson, 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 and quarterly 10-Qs. 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. During this call, we will also reference slides that accompany our discussion. The slides can be viewed with the webcast and the link can be found on our investor relations website. In addition, the slides together with the recorded version of this call will be available on the investor relations section of our website. We will also discuss certain non-GAAP financial measures on this call. Additional information about these non-GAAP measures and the reconciliations to the most directly comparable gap measures are provided in today's press release, which is posted to the investor relations section of our website. For the second quarter of fiscal year 2026, we reported total revenue of $96.3 million, compared to $113.9 million in the same period of fiscal 2025. Revenue for the second quarter of fiscal 2026 was adversely impacted by reduced demand from a longstanding customer and the transition of an end-of-life program. However, this impact was partially offset by new program wins and an increase in demand from other longstanding customers. As in other recent quarters, we believe customers continue to face uncertainties in the global economy and volatile trade policies. In addition, we continued ramping the Consigned Materials Program that was previously announced. For the first six months of fiscal 2026, our total revenue was $195.1 million compared to $245.4 million in the same period of fiscal 2025. In line with our long-term strategic plan, we proactively advanced our nearshoring and tariff mitigation strategies to reduce costs while maintaining the diversity and flexibility of our key locations and operational capabilities. During the second quarter of fiscal 2026, we initiated a wind down of our manufacturing operations at our China-based facility, designed to better align organizational structure and resources with our strategic initiatives. including filling the capacity recently created in Vietnam. We expect to complete this wind down in our fourth quarter, at which point we anticipate saving approximately $1.2 million per quarter. We also continue to further reduce our workforce in Mexico, as we intend to have that facility focus on higher volume manufacturing. Once these reductions are fully implemented, during our third quarter, we would expect to save approximately $1.5 million per quarter moving forward. These strategic initiatives resulted in charges for severance, inventory write-offs, and other related expenses of approximately $10.5 million for the quarter, which had a significant adverse impact on our margins. Gross margin was 0.6% and operating margin was negative 10.7% in the second quarter of fiscal 2026, compared to 6.8% and negative 1.0%, respectively, in the same period of fiscal 2025. Excluding the charges related to the China closure and the Mexico workforce reductions, the adjusted gross margin was 7.9% for the second quarter of fiscal year 2026. As top line growth returns, we anticipate margins to be strengthened by improvements in our operating efficiencies and the positive impact of our strategic cost savings initiatives. We also believe the recent cost savings initiatives have made us more competitive when quoting new program opportunities. As production volumes increase, and our operational adjustments take full effect, we expect to see greater leverage on fixed costs, enhanced productivity, and a more streamlined supply chain, all contributing to stronger financial performance. The wind down of China production, severance charges, and the reduction in revenue had a significant impact on our bottom line. Our net loss was $8.6 million, or 79 cents per share for the second quarter of fiscal 2026 compared to a net loss of 4.9 million or 46 cents per share for the same period of fiscal 2025. For the first six months of fiscal 2026, the net loss was $10.9 million or $1 per share compared to $3.8 million or 35 cents per share for the same period of fiscal 2025. Our adjusted net income was breakeven or zero cents per share for the second quarter of fiscal 2026 compared to adjusted net loss of 4.1 million or 38 cents per share for the same period of fiscal 2025. For the first six months of fiscal 2026, the adjusted net loss was $1.1 million or 10 cents per share, compared to an adjusted net loss of $1.3 million, or 12 cents per share, for the same period of fiscal 2025. Turning to the balance sheet, our inventory for the second quarter of fiscal 2026 is down $12.3 million, or by 12% from a year ago. Our current ratio was 2.0 to 1, compared to 2.8 to 1 from a year ago. At the same time, accounts receivable DSOs were at 77 days compared to 99 days a year ago, reflecting stronger collection on receivables. Total cash flow provided by operations for the second quarter of fiscal 2026 was approximately $6.3 million, as compared to $1.3 million in the same period of fiscal 2025. Our continuing ability to generate cash from operations has allowed us to reduce our debt year over year by approximately $13.4 million. In the second quarter, capital expenditures were approximately $3.3 million, bringing year-to-date total capital expenditures through the second quarter to approximately $6.5 million. We expect CapEx for the full year to be around $8 to $10 million, largely spent on new innovative production equipment and automation. 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, and make efficiency improvements to prepare for growth and add capacity. As we move further into fiscal 2026, we continue to face a lot of global economic uncertainties and volatile trade policies. Nevertheless, we are pleased to continue to see our new programs gradually ramping and our cost and efficiency improvements from our recent overhead reductions taking hold. We also expect to see growth in our U.S. and Vietnam production, have a strong pipeline of potential new business, and remain focused on improving our profitability. Over the longer term, we believe that we are increasingly well-positioned to win new programs and profitably expand our business. Due to the uncertainty of timing of new products ramps in light of the continued macroeconomic uncertainty, We are not providing forward-looking guidance in the third quarter of fiscal 2026. That's it for me. Brett?

Thanks, Tony. During the second quarter of fiscal 2026, we continue to provide our customers with options to better manage macroeconomic uncertainties and enhance our potential for profitable long-term growth. We are excited about the significant investments made to our U.S. and Vietnam locations. During the quarter, we witnessed the increasing number of customer program starts in Springdale, Arkansas, started a new production line in Corinth, Mississippi in support of a growing consignment customer, and we shipped our first batch of medical products from Da Nang, Vietnam. Due to ongoing geopolitical tensions and tariff uncertainties, we began to execute our long-term strategy to wind down manufacturing operations at our China facility and continue to right-size our Mexico facility. Demand from a specific long-standing customer has declined in recent periods, but we believe that recently won programs more than offset the loss in revenue in future quarters. Moreover, the continued market uncertainty and shifts of tariffs have unfortunately impacted the timing and launch of new programs, but those programs continue to slowly proceed. We are doing our best to work with suppliers and with our customers on options for manufacturing their products from different locations in mitigating the impact of tariffs. Our changes made to our manufacturing footprint and cost reductions have enabled us to offer improved mitigation options, particularly when our customers consider the varying implications of current and future potential tariffs. As part of our long-term strategy and in recognition of the continuing geopolitical tensions, tariff uncertainties and increasing costs associated with China-based productions, we have begun winding down our facilities there and transferring several programs to Vietnam. As part of our global sourcing strategy, we will continue to operate in China with a small team focused on sourcing critical components locally. Over the past 18 months, we have also reduced our total headcount by approximately 40% in Mexico and have begun transferring some of the programs from Mexico to the U.S. and Vietnam. Our Mexico facility continues to offer a unique solution for tariff mitigation under the existing USMCA tariff agreement. Given the sustained trend of continued wage increases in Mexico, we have streamlined our operations increased efficiencies, and invested in automation in order to be more cost competitive in the market. Due to the successful cost reductions and streamlining production processes, we have recently seen an increase in the quoting volume and probability of landing new programs manufactured within our Mexico facilities. We've also seen an influx of new customer visits and audits of our Juarez campus as of late, that demonstrates we are competitive for a growing variety of quoting opportunities. Our improved cost structure in Mexico is anticipated to lead to new programs and growth over the longer term. We are very excited about the recent investments made in the U.S. and Vietnam to build up capacity and new capabilities to meet evolving customer demand. You will recall that we opened our new technology and research and development location in Arkansas during the first quarter of fiscal 2026. Our U.S.-based production provides customers with outstanding flexibility, engineering support, and ease of communication. We expect double-digit growth in our facility in Arkansas during the latter half of this fiscal year. You also recall that we have recently doubled our manufacturing capacity in Vietnam that now has the capability to support medical device manufacturing. Our Vietnam-based production offers the high-quality, low-cost choice that had been associated with China in the past. In coming years, we expect our Vietnam facility to play a major role in our growth. We anticipate these new facilities in the US and Vietnam will enable us to benefit from customer demand for rebalancing contract manufacturing and mitigate the severe impact and uncertainty surrounding the tariffs on goods and critical components. By the end of fiscal 2026, we expect approximately half of our manufacturing to take place in our U.S. and Vietnam facilities. These initiatives reflect both the longstanding customer trend to nearshore, as well as de-risk the potential adverse impact of tariff increase and geopolitical tensions. During the second quarter of fiscal 2026, we won new programs in automotive technology, pest control, and industrial equipment. As already noted, we continue to ramp our recently announced manufacturing services contract with a data processing OEM that consigns its materials to our Corinth, Mississippi manufacturing facility. As we discussed, the consigned material model is new for us at this scale, and if successful, will considerably improve our profitability in coming quarters. It has the potential to grow to over $25 million in annual revenue, roughly the equivalent of a $100 million turnkey program. Despite the many uncertainties and disruptions in global markets, our strong pipeline of potential new business underscores the continued trend towards onshoring and the dual sourcing of contract manufacturing. We expect that global tariff wars and geopolitical tensions will continue to drive OEMs to re-examine their traditional outsource strategies. Over time, the decision to onshore production is becoming more widely accepted as a smart, long-term strategy. We believe our manufacturing footprint and cost competitiveness will allow us to take advantage of these opportunities. The combination of our flexible global footprint and our expansive design capabilities continues to be extremely effective in capturing new business. Many of our manufacturing program wins are predicated upon Keytronic's deep and broad design services. And once we have completed the design and ramped it into production, we believe our knowledge of a program's specific design challenges makes that business extremely sticky. We anticipate a continued increase in the number and capability of our design engineers in coming quarters. We also continue to invest in vertical integration and manufacturing process knowledge, including a wide range of plastic molding, injection, flow, 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 that this expertise will increasingly set us apart from our competitors of a similar size. While the global market uncertainties have created some delays to new product launches for us, our suppliers, and our customers, we believe geopolitical tensions and heightened concerns about tariffs and supply chains will continue to drive the favorable trend of contractor manufacturing returning to North America, as well to our expanding Vietnam facilities. We are expecting revenue growth in the coming quarter from new programs launching in the U.S., Mexico, and Vietnam. We move forward with a strong pipeline of potential new business, and we are anticipating significant improvements in our operating efficiencies. Over the long term, we remain very encouraged by our cost reductions made over the past few years to become more price competitive, our increasing cash flow generated from operations, enhanced global manufacturing footprint, and the innovations from our design engineering. All of these initiatives have increased our potential for profitable growth. This concludes the formal portion of our presentation. Tony and I will now be pleased to answer your questions.