KTCC

Business Context and Reporting Period

Company: Key Tronic Corporation (KTCC)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three months ended September 26, 2009 (First Quarter of Fiscal Year 2010)
Industry: Electronic Manufacturing Services (EMS)
Overview: Key Tronic provides integrated electronic and mechanical engineering, precision plastic molding, assembly, and logistics services globally. The company operates facilities in the United States, Mexico, and China. The reporting period was impacted by the global economic recession, leading to reduced demand from established customers, partially offset by revenue from new customer programs.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 14.4% to $41.3 million, primarily due to lower demand from existing programs driven by the global economic environment. However, revenue contribution from new customers increased significantly to 43.5% of total revenue (compared to 19.4% in the prior year).
• Margin Compression: Gross margin decreased to 6.5% from 7.1% due to lower fixed cost absorption resulting from decreased sales volume. No provision for obsolete inventory was recorded in the current quarter, compared to a $138,000 provision in the prior year.
• Expense Reduction: Total operating expenses decreased to $2.3 million from $2.8 million. Selling, general, and administrative (SG&A) expenses dropped due to lower payroll costs from workforce reductions and the absence of a doubtful accounts charge (which was $75,000 in the prior year).
• Debt Restructuring: The company replaced its previous CIT revolving loan with a new $20 million revolving credit facility with Wells Fargo Bank. As of the period end, there was no outstanding balance on the new facility, and long-term debt decreased significantly.
• Cash Flow Improvement: Cash provided by operating activities increased substantially to $3.9 million, driven by a $2.2 million decrease in inventory levels and a $1.5 million increase in accounts payable.

Guidance, Outlook, and Risks

• Outlook: Management expects growth in the second half of fiscal year 2010, driven by increased production levels of new programs for both new and existing customers. Sales for the second quarter of fiscal year 2010 are projected to be in the range of $38 million to $43 million.
• Liquidity: The company maintains a strong balance sheet with a current ratio of 2.4 and approximately $13.4 million available under its new credit facility. Management believes internally generated funds and borrowing capacity are sufficient for future operations.
• Backlog: Order backlog stood at approximately $27.1 million as of September 26, 2009, down from $35.2 million in the prior year, reflecting the decline in demand.
• Risks:
  • Economic Conditions: Continued weakness in the global economy and credit markets could further reduce customer orders.
  • Customer Concentration: The top five customers accounted for 52% of sales in fiscal 2009. Loss of a major customer could materially impact results.
  • Foreign Operations: Significant operations in Mexico and China expose the company to currency fluctuations, political risk, and regulatory changes. The company uses forward contracts to hedge Mexican peso expenses.
  • Competition: The EMS industry is intensely competitive, with risks of price reductions and margin erosion.

Investor Verification Checklist

• New Customer Ramp-Up: Verify the actual production start dates and revenue contribution of the new customer programs cited as the driver for future growth.
• Inventory Levels: Monitor inventory balances to ensure the reduction in inventory does not lead to stockouts or inability to meet future demand spikes.
• Credit Facility Covenants: Confirm continued compliance with the Wells Fargo credit agreement covenants, specifically the cash flow leverage ratio and minimum profit threshold.
• Customer Concentration: Track the sales mix to ensure the company continues to diversify its revenue base and reduce reliance on its top five customers.
• Foreign Currency Exposure: Assess the effectiveness of the foreign currency hedging strategy given the volatility in the Mexican peso and other currencies.