Key Tronic Corporation — Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2014, ended March 29, 2014. The filing compares the quarter with the three months ended March 30, 2013, and the nine-month period with the corresponding prior-year period.
Business context and results
Key Tronic provides electronics manufacturing services, including engineering, procurement, manufacturing, assembly and testing. It acquired substantially all assets of Sabre Assembly & Manufacturing on July 1, 2013, adding sheet-metal fabrication capabilities. The $6.0 million cash acquisition included customer relationships, equipment, inventory and other assets; no debt or liabilities were assumed.
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Net sales | $77.0 million | $84.3 million | $233.3 million | $276.4 million |
| Gross profit / margin | $6.6 million / 8.6% | $7.9 million / 9.3% | $20.2 million / 8.7% | $26.8 million / 9.7% |
| Operating income / margin | $2.2 million / 2.9% | $3.6 million / 4.3% | $7.0 million / 3.0% | $14.6 million / 5.3% |
| Net income | $1.4 million | $2.9 million | $6.2 million | $10.2 million |
| Diluted EPS | $0.13 | $0.26 | $0.57 | $0.94 |
| Operating cash flow | Not separately stated | Not separately stated | $2.4 million | $20.8 million |
Financial position and liquidity
- At March 29, 2014, cash was $2.2 million, down from $10.8 million at June 29, 2013. Current assets were $111.9 million and current liabilities $39.9 million; management reported a 2.8 current ratio.
- The company had no balance outstanding on its $30.0 million revolving credit facility, with the full amount available to borrow. It reported covenant compliance. Other long-term obligations were $0.6 million.
- Nine-month investing cash outflow was $10.5 million, including the Sabre acquisition and $4.5 million of property and equipment purchases. Financing cash outflow was $0.4 million. Cash declined by $8.6 million over the nine months.
- Accounts receivable rose to $52.6 million from $47.0 million, and inventory rose to $46.1 million from $44.7 million. Management attributed the sharp year-over-year operating-cash-flow decline mainly to working-capital movements.
Material changes and management commentary
- Quarterly sales fell 8.7%; nine-month sales fell 15.6%. Management attributed the weakness mainly to reduced demand from existing programs, including two large customers. In the nine-month comparison, program losses also reduced sales. New programs and Sabre partially offset the declines.
- Management said lower revenue reduced fixed-cost absorption and weakened gross margins. Overhead costs rose as a share of sales, partly offset by lower material costs. Engineering and SG&A spending increased as a percentage of sales, including added staffing to support new programs.
- The top three customers accounted for 54.2% of quarterly sales, down from 55.3% a year earlier. The company had 192 revenue-generating programs, versus 177. Backlog was $64.6 million, compared with $64.2 million a year earlier; the filing cautions backlog is not a reliable measure of future sales.
- The nine-month effective tax rate was 10.8%, versus 29.1%, mainly reflecting a $1.5 million discrete benefit from Mexico’s repeal of the IETU tax regime. The quarterly rate was 35.6%, compared with 19.5%, partly because the prior-year quarter included a federal R&D tax-credit benefit.
Outlook, risks and contingencies
- For fiscal Q4 2014, management expected revenue of $78 million to $85 million and sequential growth, as new-customer and new-program growth was expected to offset and exceed reduced demand from large customers. Results depend on orders, production start timing and industry-wide supply shortages.
- Key risks include customer concentration and nonbinding purchase forecasts, variable demand and fixed-cost absorption, component shortages, competitive pricing, new-program ramp costs, and operating exposure in Mexico and China. The company also identified foreign-exchange, tax, financing, personnel, regulatory, product-quality and operational risks.
- The company had $67.4 million notional of Mexican peso forward contracts outstanding through June 2017. Their reported fair value was approximately $2.8 million; management used them to hedge expenses, not for speculation.
- Management reported ordinary-course legal proceedings and believed their disposition would not materially affect financial position, results or cash flows. It reported no material changes to the prior annual report’s risk factors, no material changes in internal controls, and effective disclosure controls as of period-end.
- Management expected approximately $9.9 million of foreign earnings to be repatriated in the future and had recorded related estimated taxes in deferred taxes. It also disclosed approximately $3.1 million of gross unrecognized tax benefits tied to federal R&D credits.
Investor verification points
- Track whether the forecast Q4 revenue range was achieved and whether new programs offset continuing customer-demand declines.
- Monitor customer concentration, program starts and cancellations, backlog conversion, and the actual impact of component shortages.
- Assess working-capital needs and operating cash generation, given the substantial year-over-year decline in nine-month operating cash flow and lower cash balance.
- Review margin recovery, facility utilization, new-program ramp costs, and the sustainability of the tax benefit and effective tax rate.
- Verify the terms, performance and accounting impacts of the Sabre integration and the company’s foreign-exchange hedges.