Business context and reporting period
Key Tronic Corporation provides electronics manufacturing services, including engineering, procurement, assembly, testing, plastics molding and sheet metal fabrication. This unaudited Form 10-Q covers the 13-week second quarter and 26-week first half of fiscal 2014, ended December 28, 2013; comparable periods ended December 29, 2012.
Financial results and liquidity
| Metric | Q2 FY2014 | Q2 FY2013 | Six months FY2014 | Six months FY2013 |
|---|---|---|---|---|
| Net sales | $78.3 million | $94.6 million | $156.2 million | $192.1 million |
| Gross profit / margin | $7.0 million / 8.9% | $9.5 million / 10.0% | $13.6 million / 8.7% | $19.0 million / 9.9% |
| Operating income / margin | $2.4 million / 3.0% | $5.3 million / 5.6% | $4.8 million / 3.1% | $11.0 million / 5.7% |
| Net income | $3.1 million | $3.6 million | $4.8 million | $7.3 million |
| Diluted EPS | $0.28 | $0.33 | $0.44 | $0.67 |
Q2 FY2014 net income included a $1.5 million discrete Mexican tax benefit; the quarter otherwise reported $2.35 million of pretax income and a $764,000 income tax benefit. The reported effective tax rate was negative 32.5% for the quarter and negative 0.6% for the half year.
- Cash flow: Operating activities used $0.5 million in the first half, versus $12.4 million provided a year earlier. Investing activities used $8.6 million, including $6.0 million for Sabre and $2.6 million of capital expenditures; financing activities used $0.2 million. Cash declined $9.4 million to $1.4 million.
- Balance sheet and liquidity: At December 28, cash was $1.4 million, current assets $109.3 million, current liabilities $38.2 million, total assets $138.8 million and total liabilities $39.0 million. Management reported a 2.9 current ratio. No revolver borrowings were outstanding; the full $30.0 million facility was available. Other long-term obligations totaled $0.7 million, in addition to current obligations.
- Backlog: $56.0 million at quarter-end, down from $64.9 million a year earlier. The filing cautions that backlog is not a reliable measure of future sales.
Material changes versus prior periods
- Q2 sales fell 17.3%; first-half sales fell 18.7%. Management attributed the declines principally to weaker demand from existing customers and program losses, partly offset by new programs and Sabre revenue.
- Q2 gross margin decreased 1.1 percentage points and operating margin decreased 2.6 points. Lower fixed-cost absorption amid lower revenue, higher overhead as a share of sales, and increased program-management and engineering staffing weighed on results. Material costs as a share of sales declined, partly offsetting overhead pressure.
- First-half net income declined $2.5 million. The prior-year first half included a nonrecurring $0.5 million benefit from reversal of a deferred compensation liability.
- Top three customers accounted for 49.2% of Q2 sales, versus 63.5% a year earlier. The company reported 57 customers and 190 programs, compared with 52 customers and 169 programs.
- The July 1, 2013 Sabre acquisition added sheet metal fabrication capabilities. The $6.0 million cash purchase included customer relationships, non-compete agreements and $1.6 million of goodwill; purchase-price allocation remained preliminary.
Outlook, risks and unusual items
- Management expected Q3 FY2014 revenue of $73 million to $78 million and anticipated sequential growth in Q4 FY2014 or Q1 FY2015 as new-customer programs ramp and offset recent reductions at large customers. These expectations depend on orders, program start-up timing and supply conditions.
- Management cited a robust pipeline and new program wins, while noting greater-than-anticipated reductions in orders from some longstanding customers and industry-wide electronic-component shortages.
- Major risks include customer concentration and the absence of firm long-term purchase commitments, demand volatility, fixed-cost underabsorption, program start-up costs, component supply constraints, competition and international operating, currency and tax risks. Foreign-currency forward contracts had $68.0 million notional value and a reported fair value of approximately $2.5 million; they hedge peso-denominated expenses and are not held for speculation.
- Management said it was in compliance with credit covenants and expected operating cash flow, borrowing capacity and leasing to meet foreseeable requirements. It also expected to repatriate approximately $9.9 million of foreign earnings over time, with related taxes accrued.
- The company reported ordinary-course legal proceedings; management did not expect their disposition to materially adversely affect financial position, results or cash flows. Disclosure controls were assessed as effective, with no significant quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether new customer programs ramp on schedule and offset continued order reductions from large customers.
- Whether margins and operating cash flow recover as utilization improves, given first-half operating cash use and the reduced cash balance.
- Whether customer concentration and backlog continue to decline, and how much backlog converts to shipments.
- The recurring earnings impact after excluding the $1.5 million Mexican tax benefit, and the effects of the changed Mexican tax regime and planned foreign-earnings repatriation.
- Sabre integration, acquisition returns and final purchase-price allocation, as well as ongoing component availability and foreign-exchange exposure.