Business Context and Reporting Period
Company: Key Tronic Corporation (KeyTronicEMS, Co.)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Second quarter and six months ended December 30, 2006.
Business Overview: An independent provider of electronic manufacturing services (EMS) for original equipment manufacturers (OEMs). Operations include facilities in Spokane Valley, Washington; Juarez, Mexico; and Shanghai, China.
Key Financial Metrics
| Metric (in thousands) | Q2 2006 | Q2 2005 | 6 Months 2006 | 6 Months 2005 |
|---|---|---|---|---|
| Net Sales | $49,829 | $45,360 | $105,341 | $89,610 |
| Gross Profit | $4,201 | $4,100 | $9,495 | $7,952 |
| Gross Margin % | 8.4% | 9.0% | 9.0% | 8.9% |
| Operating Income | $747 | $1,286 | $2,564 | $2,256 |
| Net Income | $345 | $1,018 | $1,764 | $1,720 |
| Diluted EPS | $0.03 | $0.10 | $0.17 | $0.17 |
| Cash & Equivalents (End of Period) | $1,792 | $2,428 | $1,792 | $2,120 |
| Revolving Loan Balance | $17,111 | $10,069 | $17,111 | $10,069 |
| Operating Cash Flow (6 Mo) | Used $5,326 (vs. Provided $240 prior year) |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 9.9% in Q2 and 17.6% for the six-month period compared to the prior year, driven by winning new programs while maintaining existing customer demand.
- Profitability Decline: Q2 Net Income dropped 66% to $345,000 from $1.018 million in Q2 2005. This was primarily due to one-time charges totaling approximately $940,000 related to a customer bankruptcy (receivable reserve of $536,000 and inventory/tooling reserve of $404,000).
- Margin Compression: Q2 Gross Margin decreased to 8.4% from 9.0% due to the aforementioned bankruptcy reserves. Without these charges, the margin would have been 9.3%.
- Operating Expenses: Increased significantly due to the receivable reserve and higher Research, Development, and Engineering (RD&E) costs to support new customer programs.
- Cash Flow: Operating cash flow turned negative ($5.3 million used) compared to a positive $240,000 in the prior year, driven by increased inventory levels and a reduction in accounts payable.
Guidance, Outlook, and Risks
- Outlook: Management expects lower seasonal demand in Q3 2007, partially offset by new programs. Sales are projected to range between $42 million and $47 million.
- Capital Expenditures: The company purchased a new manufacturing facility in Juarez, Mexico, for approximately $2.1 million during the quarter to replace a leased building. It is also establishing a new SMT line in Spokane Valley.
- Liquidity: The company maintains a $25 million revolving credit facility with approximately $3.6 million available as of December 30, 2006. It is in compliance with loan covenants.
- Risks:
- Customer Concentration: The top three customers (Zebra Technologies, Lexmark, International Gaming Technology) accounted for over 55% of sales for the six months ended Dec 30, 2006.
- Inventory Risk: Reliance on customer forecasts creates risk of obsolete inventory if forecasts are overly optimistic.
- Competition: Intense competition in the EMS industry may lead to price reductions and margin pressure.
Investor Verification Checklist
- Customer Bankruptcy Impact: Verify the extent of exposure to the bankrupt customer and the adequacy of the $940,000 reserve taken.
- Inventory Levels: Review the increase in inventory ($39.3M vs $36.3M prior year) and the company's ability to convert this into sales given the negative operating cash flow.
- Debt Utilization: Monitor the utilization of the $25M revolving credit line, which increased from $10M to $17.1M, and the associated interest expense.
- Customer Concentration: Assess the stability of the top three customers, which represent a significant portion of revenue.
- Q3 Guidance: Track actual Q3 sales against the $42M-$47M guidance to gauge the success of new program ramp-ups.