Key Tronic Corporation — Form 10-Q Summary
Business context and period: Key Tronic provides electronics manufacturing and engineering services to OEMs across multiple industries, with facilities in the United States, Mexico and China. This unaudited report covers the first quarter of fiscal 2019, the 13 weeks ended September 29, 2018; the comparable quarter ended September 30, 2017.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Net sales | $127.5 million | $109.2 million |
| Gross profit / margin | $9.5 million / 7.5% | $7.8 million / 7.2% |
| Operating income / margin | $2.5 million / 2.0% | $1.2 million / 1.1% |
| Net income | $1.6 million | $0.4 million |
| Diluted EPS | $0.15 | $0.04 |
| Operating cash flow | $0.3 million | $1.3 million |
- Sales increased 16.7% year over year. Management attributed growth to new programs, higher demand from existing customers, and the adoption of ASC 606.
- ASC 606 contributed approximately $4.9 million of reported sales; without adoption, sales would have been about $122.6 million. Gross profit would have been approximately $79,000 higher, and net income about $79,000 higher, without the standard’s impact.
- The gross margin improvement reflected higher sales and slightly lower material-related costs, partly offset by rising Mexican utility and other overhead costs. Operating expenses rose in dollars but declined as a share of sales.
- The effective tax rate was 14.7%, versus 24.2%, reflecting the lower U.S. federal tax rate, R&D credits and foreign-jurisdiction taxes.
- Operating cash flow included $6.7 million received from an arbitration settlement. Working-capital uses included increases in contract assets and receivables. Cash-flow classification changes under ASU 2016-15 moved $1.9 million of deferred proceeds from factored receivables to investing activities; this affects comparison with the prior year.
Financial position and liquidity
- At September 29, 2018, cash was $1.4 million, total assets $251.0 million, and shareholders’ equity $123.4 million.
- Total debt was approximately $35.5 million: $18.2 million on the revolving facility, $15.0 million on the acquisition term loan and $2.4 million on the equipment loan. The filing reports a current ratio of 2.0 and debt-to-equity ratio of 0.3.
- The $45.0 million revolving facility had $26.4 million available, net of outstanding borrowings and letters of credit. The company was in compliance with its financial covenants at quarter-end. It had received a waiver for covenant noncompliance at June 30, 2018, related to a loss recognized from an arbitration settlement.
- On September 30, 2018, the company amended its credit agreement to extend the term-loan maturity to August 2021 and the revolving-credit maturity to November 2023.
- Capital spending on property and equipment was $1.7 million. Receivables sold under factoring programs totaled $22.2 million during the quarter.
Material changes, outlook and risks
- Backlog was approximately $166.3 million, up from $118.6 million a year earlier. Management cautioned that backlog is not a reliable measure of future sales because shipment timing and customer requirements can change.
- For Q2 FY2019, management expects revenue of $120 million to $125 million and assumes a 20% effective tax rate. Results remain dependent on customer orders and the timing of new-program production starts.
- Management reported that new programs, including Skybell Technologies, continued to ramp, but industry-wide shortages of key components constrained growth. Rising Mexican labor and utility costs also pressured results. The company is investing in equipment and processes in Mexico and the U.S. and reported a robust pipeline of potential programs.
- The top three customers represented 36.6% of sales, compared with 36.3% a year earlier; management said the comparable concentration would have been 34.0% without ASC 606. Customer program timing, cancellations or reduced orders could materially affect results.
- Other principal risks include component shortages and price increases, competition and pricing pressure, new-program startup costs, variable demand and production schedules, foreign-exchange and interest-rate exposure, and dependence on credit availability and covenant compliance. Management stated that the tariff outcome remained unclear but appeared likely to be favorable for U.S. and Mexican operations.
- The company had approximately $8.2 million of gross federal R&D tax credits, including $4.0 million of unrecognized tax benefits. Accounting for the Tax Act remained provisional; management expected to refine it as studies and additional guidance became available. The filing also estimates about $0.8 million of potential Chinese withholding tax on future repatriations.
- Ordinary-course litigation was not expected by management to have a material adverse effect. No goodwill impairment was recorded. Management reported disclosure controls and procedures were effective at quarter-end.
Important facts for investors to verify
- How much of reported growth and customer concentration reflects ASC 606 timing rather than underlying shipment demand, and how this affects future quarters.
- Whether component availability, labor and utility costs, and program ramps improve enough to support the Q2 revenue outlook and margins.
- The sustainability and timing of the reported backlog, given customer order flexibility and the lack of firm long-term purchase commitments.
- Cash conversion and working-capital needs, especially contract-asset and receivables growth, factoring activity, and the significance of the arbitration settlement receipt.
- Debt repayment capacity, revolving-credit availability, covenant headroom and the effects of variable interest rates.
- Final Tax Act accounting, use of R&D tax credits, and the tax cost and timing of foreign-earnings repatriation.