Business context and reporting period
Key Tronic Corporation provides electronic manufacturing services, including engineering, procurement, manufacturing and assembly. This Form 10-Q covers the third quarter and first nine months of fiscal 2018, ended March 31, 2018; each comparable period was 13 weeks or 39 weeks, respectively. The request metadata says “2017 Q3,” but the filing itself reports fiscal 2018 Q3.
Financial performance and position
Amounts below are in millions of dollars, except per-share data and percentages.
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Revenue | $108.4 | $113.6 | $329.3 | $349.3 |
| Gross profit / margin | $8.2 / 7.5% | $9.1 / 8.0% | $24.8 / 7.5% | $28.5 / 8.1% |
| Operating income / margin | $0.8 / 0.7% | $1.8 / 1.6% | $3.6 / 1.1% | $7.2 / 2.1% |
| Net income | $0.6 | $1.0 | $0.9 | $4.3 |
| Diluted EPS | $0.06 | $0.09 | $0.08 | $0.39 |
- Q3 cost of sales was $100.2 million; operating expenses were $7.4 million and net interest expense was $0.7 million. The quarter recorded a $0.5 million income tax benefit; the effective tax rate was unusually negative at 423.6%. The nine-month effective tax rate was 50.7%, versus 21.9% a year earlier, principally reflecting discrete U.S. tax reform adjustments.
- Nine-month operating cash flow was $9.9 million, compared with $7.6 million. Investing used $2.2 million and financing used $7.8 million; cash declined $0.1 million to $0.3 million.
- At March 31, total assets were $241.7 million, current assets $188.9 million, and current liabilities $90.5 million. Management reported a 2.1 current ratio and 0.3 debt-to-equity ratio.
- Total debt was approximately $35.3 million: $17.5 million term loan, $15.0 million revolving credit borrowings and $2.8 million equipment loan. The $45.0 million revolving facility had $29.6 million available, after $0.4 million of letters of credit. Debt interest rates ranged from 3.88% to 4.13%; the company reported covenant compliance.
- Inventory increased to $115.0 million from $101.6 million at fiscal year-end, while accounts payable increased to $69.2 million from $53.1 million. The company sold $81.2 million of receivables through purchase programs during the nine-month period, versus $59.7 million a year earlier.
Changes versus comparable periods
- Revenue fell 4.6% in Q3 and 5.7% for the first nine months, driven mainly by lower demand from existing customers, partly offset by new program wins.
- Q3 gross margin declined 0.5 percentage point and nine-month gross margin declined 0.6 point. Management cited lower sales, higher overhead and Q3 Mexico facility streamlining severance costs.
- Nine-month operating income fell about 50% and net income declined from $4.3 million to $0.9 million. Interest expense rose to $1.9 million from $1.7 million, mainly due to higher average revolver borrowings.
- Q3 results included approximately $1.1 million of arbitration-hearing and severance expenses, which management said reduced diluted EPS by approximately $0.10. Industry-wide component shortages and an unexpected delay from a large new customer also hurt productivity.
- Other comprehensive income included gains on hedging instruments; nine-month net hedge gains were $4.1 million. These gains are not equivalent to operating earnings.
Outlook, risks and unusual items
- For Q4 FY2018, management forecast revenue of $112–$117 million and diluted EPS of $0.11–$0.16, assuming a 20% effective tax rate. It expected growth from increased demand by a longstanding customer and continued new-program ramps; results remain dependent on customer orders and production-start timing.
- Backlog was $129.2 million at March 31, up from $126.9 million a year earlier. The company cautioned that backlog is not a reliable measure of future sales because shipment timing and customer requirements can change.
- Management expects adoption of the new revenue recognition standard in FY2019 to change EMS revenue recognition from point-in-time delivery to over-time recognition. It anticipates a material financial-statement impact, including higher contract assets and lower finished-goods and work-in-process inventory; it plans modified-retrospective adoption.
- A former customer arbitration concerns approximately $9 million of inventory and $1 million of receivables, plus cancellation fees and carrying costs. The hearing was completed; a decision was expected by the end of Q4 FY2018. No gain or loss was accrued, and the outcome could materially affect results, financial position or cash flows.
- Tax Act accounting included a $0.8 million discrete expense and a $2.1 million benefit from reversing a previously estimated repatriation liability. The company was studying accumulated foreign earnings and tax pools; it said potential toll-tax adjustments remained uncertain. It expects to repatriate approximately $14.2 million of foreign earnings over time.
- Key risks include customer concentration and nonbinding purchase commitments, component shortages, new-program ramp costs, pricing and utilization pressures, foreign-exchange and interest-rate exposure, and dependence on credit availability. The top three customers represented 30.6% of Q3 sales, down from 32.8% a year earlier.
Important facts for investors to verify
- Whether Q4 revenue and EPS guidance was achieved, and whether customer demand, component availability and new-program ramps improved.
- The arbitration decision and any resulting recovery, expense, or cash-flow impact.
- Working-capital trends, particularly inventory growth, supplier payables and reliance on receivables sales to support operating cash flow.
- Debt repayment, revolver availability and continued compliance with financial covenants.
- The final tax treatment of foreign earnings and the implementation impact of over-time revenue recognition in FY2019.