Business context and reporting period
Key Tronic Corporation provides electronics manufacturing services (EMS) to original equipment manufacturers. This unaudited Form 10-Q covers the 13 weeks ended September 28, 2019, the first quarter of fiscal 2020; comparisons are with the 13 weeks ended September 29, 2018.
Key financial results
- Revenue: $105.3 million, down 17.4% from $127.5 million.
- Profitability: Gross profit was $9.3 million, down from $9.5 million, while gross margin improved to 8.8% from 7.5%. Operating income was $2.5 million, essentially unchanged; operating margin rose to 2.4% from 2.0%.
- Net income and EPS: Net income was $1.6 million versus $1.6 million (reported amounts: $1.552 million and $1.593 million); diluted EPS was $0.14 versus $0.15. Net margin was 1.5% versus 1.2%.
- Cash flow: Operating activities used $10.3 million, compared with $0.3 million provided a year earlier. The current-quarter outflow principally reflected increases in inventory ($17.3 million) and receivables ($10.1 million), partly offset by a $13.6 million increase in accounts payable. Investing activities used $1.3 million; capital expenditures were $3.0 million. Financing activities provided $11.5 million.
- Liquidity: Cash was $0.5 million at quarter-end. The company reported a 2.0 current ratio and $13.3 million available on its $45 million revolving credit facility, after $31.3 million was drawn. Management said expected operating cash flows, borrowing capacity and leasing options should meet foreseeable requirements.
- Debt: Total debt was approximately $47.8 million, including $31.3 million on the revolver, $15.0 million on the term loan and $1.5 million on the equipment loan. Debt-to-equity was reported as 0.4. The company was in compliance with its financial covenants.
- Other metrics: Backlog was approximately $159.9 million, down from $166.3 million a year earlier; management cautions backlog is not a reliable measure of future sales. The top three customers represented 37.0% of sales, compared with 36.6%.
Material changes and management commentary
Management attributed the sales decline primarily to production delays after a sharp increase in sheet-metal demand created workload-balancing constraints. Customer transitions from China to Mexico and Vietnam, prompted in part by U.S.-China trade and tariff concerns, also contributed to transition demands. Management said margins benefited from favorable product mix and productivity efficiencies despite lower revenue.
The company reported new business wins, including programs in electric-vehicle charging infrastructure, LED lighting, oil and gas sensors, and experimental-aircraft flight controls. It is investing in capacity in Mexico, the United States and Vietnam, including expanded sheet-metal capability, and described its growth pipeline as increasingly robust. These are management expectations, not assured outcomes.
Outlook, risks and unusual items
- Guidance: For fiscal 2020’s second quarter, management forecast revenue of $117 million to $122 million and assumed a 20% effective tax rate. Results remain dependent on customer orders and the timing of new-program production starts.
- Operating risks: Customer order timing, concentration and limited long-term purchase commitments; production ramp and transfer costs; component shortages; competitive pricing; capacity constraints; and exposure to international operations, trade conditions and foreign exchange. The company hedges some Mexican-peso expenses but does not hedge renminbi expenses.
- Financing risks: Borrowings have floating rates and are secured by substantially all company assets. Credit agreements include financial covenants and restrict dividends without bank approval. Management reported covenant compliance at quarter-end.
- Leases: Adoption of ASC 842 on June 30, 2019 added operating lease right-of-use assets and liabilities; quarter-end balances were $16.1 million and $15.4 million, respectively. Management said adoption materially affected the balance sheet but did not materially affect income or cash flow.
- Hedging and comprehensive income: Unrealized hedge losses reduced other comprehensive income by $0.9 million in the quarter; comprehensive income was $0.6 million versus $4.6 million a year earlier. The company expected approximately $1.5 million of net unrealized gains to be reclassified into earnings within 12 months.
- Contingencies: The company is involved in ordinary-course legal matters and said their disposition is not expected to materially affect its financial position, results or cash flows. It reported no material changes to the prior annual report’s risk factors.
Investor verification points
- Whether sheet-metal capacity and production workload issues ease, and whether the second-quarter revenue range is achieved.
- Whether customer transitions to Mexico and Vietnam and new-program ramps deliver expected volumes without materially increasing costs or delaying shipments.
- How working-capital needs—especially inventory and receivables—affect operating cash flow, revolver usage and available liquidity.
- Debt balances, floating-rate exposure, covenant headroom and scheduled term-loan repayments.
- Customer concentration, the quality and timing of backlog, and whether major customer orders remain stable.
- Whether foreign-exchange hedges, tax positions and lease obligations develop as expected.