Key Tronic Corporation — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2019, ended December 29, 2018. Comparatives are the corresponding periods ended December 30, 2017. The company provides electronic manufacturing services (EMS), including engineering, procurement, manufacturing and assembly.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Net sales | $123.0 million | $111.7 million | $250.5 million | $220.9 million |
| Gross profit / margin | $9.9 million / 8.0% | $8.8 million / 7.9% | $19.4 million / 7.7% | $16.6 million / 7.5% |
| Operating income / margin | $2.6 million / 2.1% | $1.7 million / 1.5% | $5.2 million / 2.1% | $2.8 million / 1.3% |
| Net income (loss) | $1.6 million | $(0.2) million | $3.2 million | $0.2 million |
| Diluted EPS | $0.15 | $(0.02) | $0.29 | $0.02 |
Quarterly sales rose 10.1%; six-month sales rose 13.4%. Management attributed growth to new program wins, increased current-customer demand and revenue recognized under the new revenue standard. Gross margin improved modestly, while operating margin benefited from higher sales and lower SG&A as a share of revenue. Q2 SG&A declined primarily due to lower legal and commission expense; research, development and engineering expense increased.
ASC 606 comparability: Adopted July 1, 2018, the standard moved certain customer-specific production revenue from shipment-date to over-time recognition. It added $2.3 million to Q2 sales and $7.2 million to six-month sales, and increased gross profit by $0.6 million and $0.5 million, respectively. Without the change, sales would have been $120.7 million for Q2 and $243.3 million for the six months. Adoption also created $19.1 million of contract assets at December 29, 2018.
Cash flow and liquidity: Six-month operating cash flow was negative $5.1 million, versus positive $3.3 million in the prior-year period. Working-capital movements included increases in receivables ($10.8 million) and contract assets ($7.2 million), partly offset by a $7.4 million inventory reduction. The company also received $6.7 million from an arbitration settlement. Cash and equivalents were $0.2 million; current assets were $201.4 million and current liabilities $93.7 million. Management reported a 2.1 current ratio and said expected operating cash flow, borrowing capacity and leasing options should cover foreseeable needs.
Investing activities used $0.3 million, including $3.6 million of property and equipment purchases; financing activities provided $5.2 million. Cash-flow classification changed under a newly adopted standard: deferred purchase-price receipts from factored receivables are now investing cash flows. This reclassification affected comparison of operating cash flow with the prior year.
Debt: Total debt was approximately $40.2 million, including $24.4 million drawn on a $45.0 million revolving facility. Another $20.2 million was available under that facility, net of letters of credit. Term-loan maturities were extended; the revolver matures in November 2023. Interest rates on outstanding debt ranged from 4.35% to 5.50%. The company reported compliance with its financial covenants.
Management outlook, commentary and risks
- For Q3 FY2019, management expected revenue of $120 million to $125 million, assuming a 20% effective tax rate. Results remain dependent on customer orders and timing of new-program production ramps.
- Management cited ongoing industry-wide shortages of key components, but said it had adjusted lead times and brought inventory more in line with sales. It described a robust pipeline and new wins, and plans to add Vietnam capacity to lower costs and diversify production.
- Backlog was $151.2 million, up from $119.9 million a year earlier; management cautioned that orders can change and backlog is not a reliable measure of future sales.
- Top three customers accounted for 41.9% of Q2 sales, compared with 30.6% in the prior-year quarter. Excluding ASC 606’s effect, the current-period concentration was 35.8%. Customer dependence and the lack of firm long-term purchase commitments are material risks.
- Other disclosed risks include component supply constraints and cost increases, volatile customer demand and program timing, new-program ramp inefficiencies, competitive pricing pressure, foreign currency and interest-rate exposure, and operations across the United States, Mexico and China. Management noted that China tariffs had made North American production more appealing to some prospective customers.
- Tax comparisons were affected by discrete U.S. tax-reform adjustments recorded in the prior-year period. The company completed its provisional Tax Act accounting in Q2 and increased the net toll-tax liability by about $0.2 million; further changes could be required if guidance or interpretations change.
- Management said ordinary-course legal matters were not expected to have a material adverse effect. The filing reported effective disclosure controls and no material changes to risk factors from the prior annual report.
Important facts for investors to verify
- How much reported growth and margin improvement reflects ASC 606 timing versus underlying shipment volumes and customer demand.
- Whether new programs ramp as planned, and whether component shortages, program costs or customer schedule changes affect margins and cash conversion.
- Customer concentration, purchase-order durability and the quality and timing of the reported backlog.
- Working-capital needs, especially receivables and contract assets, given low cash on hand and negative operating cash flow in the first half.
- Debt availability, covenant compliance and exposure to floating interest rates as borrowings and rates change.
- The actual tax rate and potential future tax or withholding costs on foreign earnings; the filing estimates about $0.8 million of potential China withholding tax on future repatriation.