Key Tronic Corporation — Q2 FY2012 Form 10-Q
Business and period: Key Tronic provides electronics manufacturing services, including engineering, procurement, manufacturing and assembly. The quarter ended December 31, 2011 comprised 13 weeks; the six-month period comprised 26 weeks. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 FY2012 | Q2 FY2011 | Six months FY2012 | Six months FY2011 |
|---|---|---|---|---|
| Net sales | $84.5 | $61.0 | $154.2 | $124.4 |
| Gross profit / margin | $6.9 / 8.1% | $5.4 / 8.9% | $11.9 / 7.7% | $11.4 / 9.2% |
| Operating income / margin | $2.8 / 3.3% | $1.7 / 2.8% | $4.4 / 2.9% | $4.3 / 3.5% |
| Net income | $3.2 | $1.7 | $4.4 | $3.5 |
| Diluted EPS | $0.30 | $0.17 | $0.42 | $0.33 |
- Q2 sales increased 38.4% year over year, primarily from new programs; six-month sales rose about 24%.
- Q2 gross margin declined 0.8 percentage points, and six-month margin fell 1.5 points. Management attributed the pressure mainly to higher material content and costs in the product mix, partly offset by improved overhead utilization.
- Operating expenses grew in dollars but declined as a share of sales, supporting higher Q2 operating margin. Six-month operating margin was lower than the prior-year period.
- The company recorded a Q2 income tax benefit of $0.503 million. Management said recognition of federal R&D tax credits was a key driver; the filing describes additional credits recognized as a discrete tax item.
Cash flow, balance sheet and debt
- Six-month operating cash flow was $0.8 million, versus cash used of $13.0 million in the prior-year period. Growth in receivables ($7.0 million) and inventory ($11.8 million) consumed cash, substantially offset by a $15.0 million increase in accounts payable.
- Capital expenditures were $2.8 million, including $1.8 million for land and a building in Juarez, Mexico. Cash declined to $0.6 million from $1.2 million at fiscal year-end.
- At December 31, current assets were $110.1 million and current liabilities $50.1 million; the company reported a 2.2 current ratio. Inventory was $53.2 million, up from $41.6 million at July 2, 2011.
- Revolving credit borrowings were $7.5 million under a $30 million facility, leaving $22.5 million available. The rate was 2.48%–3.25%; the company reported compliance with covenants. Total liabilities were $66.0 million and shareholders’ equity $68.8 million.
- On January 30, 2012, after quarter-end, the company amended its credit agreement to extend its maturity to October 15, 2016.
Outlook, risks and unusual items
- Management forecast third-quarter FY2012 sales of $92–$97 million and expected second-half growth as new programs ramped. This is company guidance, not a guarantee; results depend on customer orders, program launch timing and component availability.
- Backlog was approximately $53.2 million at December 31, compared with $37.9 million a year earlier. The filing cautions that backlog is not a reliable measure of future sales because orders and shipment timing can change.
- The five largest customers represented 71.8% of Q2 sales, up from 56.2%. Customer demand, program changes and the absence of firm long-term purchase commitments create concentration and forecast risk.
- Management cited macroeconomic uncertainty, intense competition, material cost and margin pressure, and shortages of electronic components—including supply constraints associated with events in Japan. New-program start-up costs and ramp execution may also affect margins.
- Foreign-exchange hedges had $41.9 million notional value and a reported $3.6 million fair-value liability at quarter-end. Six-month unrealized hedge losses reduced other comprehensive income by $4.1 million; management expected about $0.6 million of existing loss to be reclassified into earnings within 12 months.
- Domestic NOL and tax-credit carryforwards were approximately $10.4 million and $7.7 million, respectively. The company recorded a $0.9 million valuation allowance for certain R&D credits expected to expire unused, and had $2.0 million of additional unrecognized tax benefits associated with credits recorded during the quarter.
- Ordinary-course legal matters were not expected by management to have a material adverse effect. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether new customer programs ramp on schedule and support the stated $92–$97 million third-quarter sales outlook.
- Whether rising inventory and receivables convert to cash, and whether accounts-payable timing continues to support operating cash flow.
- Whether gross margins recover from higher material costs and product mix, particularly as new programs scale.
- Whether major-customer concentration, order changes, and component shortages affect revenue, backlog conversion or production.
- How R&D tax-credit recognition, related unrecognized tax benefits and foreign earnings repatriation affect future tax expense and cash taxes.
- How foreign-exchange hedge losses are reclassified into earnings and whether the company maintains adequate liquidity and covenant compliance.