Business context and reporting period
Key Tronic Corporation provides electronics manufacturing services to original equipment manufacturers across multiple markets, with manufacturing operations in the United States, Mexico and China. This unaudited Form 10-Q covers the 13 weeks ended September 30, 2017, the first quarter of fiscal 2018; the comparable quarter ended October 1, 2016.
Financial performance
| Metric | Quarter ended September 30, 2017 | Prior-year quarter |
|---|---|---|
| Net sales | $109.2 million | $117.1 million |
| Gross profit and margin | $7.8 million; 7.2% | $9.7 million; 8.3% |
| Operating income and margin | $1.2 million; 1.1% | $2.8 million; 2.4% |
| Net income | $0.4 million | $1.8 million |
| Diluted earnings per share | $0.04 | $0.16 |
| Cash from (used in) operating activities | $2.7 million | $(1.4) million |
| Cash used in investing activities | $0.3 million | $2.9 million |
Revenue declined 6.8%. Management attributed the decrease to lower demand from existing customers, partly offset by new program wins. It also reported about $4 million of unexpected shipment delays related to Houston flooding and industry-wide shortages of key electronic components. Lower sales, overhead and material costs, and approximately $0.3 million of statutory severance expense at the Juarez facility pressured gross margin and earnings. Interest expense was $0.6 million, broadly unchanged year over year; the effective tax rate was 24.2%, versus 18.6%.
Financial position and liquidity
At September 30, 2017, cash was $1.0 million and total assets were $231.7 million. Total debt was approximately $41.3 million gross ($41.2 million net of issuance costs), consisting of term loans and revolving borrowings; cash-adjusted debt was approximately $40.3 million. The company had $18.0 million drawn on its $45.0 million revolving facility, with $26.6 million available, plus $0.4 million in letters of credit. Management reported a 2.3 current ratio and 0.3 debt-to-equity ratio and stated that the company complied with its financial covenants.
Operating cash flow improved from the prior-year quarter, supported by a $9.7 million decrease in receivables and a $3.6 million increase in accounts payable, partly offset by a $4.1 million inventory increase and a $2.4 million decrease in accrued compensation. The company sold $28.0 million of receivables during the quarter, compared with $17.4 million a year earlier; these sales are reflected in operating cash flow. Capital expenditures were $1.3 million, partly offset by $1.0 million of asset-sale proceeds. Management said available operating cash, borrowing capacity and leasing arrangements should cover foreseeable operating and capital needs.
Changes, outlook and key risks
- The top three customers accounted for 36.3% of sales, up from 35.1% in the comparable quarter. Backlog was $118.6 million versus $130.0 million a year earlier; management cautioned backlog is not a reliable measure of future sales.
- Management forecast second-quarter fiscal 2018 revenue of $110 million to $115 million and diluted earnings per share of $0.07 to $0.14, assuming a 25% effective tax rate. Results depend on customer order levels and the timing of new-program production starts.
- Management cited a strong new-business pipeline and expected renewed revenue growth, while warning that electronic-component supply constraints continued. A consumer security product agreement and customer-funded tooling had begun, but details were not finalized; management said the program could materially benefit results from the remainder of the second quarter onward if it proceeds as planned.
- A former customer arbitration concerns approximately $9 million in inventory, receivables, cancellation fees and related costs the company says it is owed. No gain or loss was accrued, the range of possible outcomes was undetermined, and management expected more clarity by the end of fiscal Q3 2018. Resolution could materially affect financial position, results or cash flows.
- Other material exposures include customer concentration and nonbinding order patterns, component shortages and price increases, production utilization and new-program ramp costs, foreign-currency and variable-rate debt exposure, and the possibility of delayed or cancelled customer orders. The company hedges some peso expenses and part of its term-loan interest-rate exposure.
- The company expects to adopt the new revenue standard in fiscal 2019. It anticipates a change from recognizing EMS revenue upon delivery to recognizing it over time, which it expects may materially affect the financial statements, including higher contract assets and lower finished-goods and work-in-process inventory. The transition method had not been selected.
Important facts for investors to verify
- Whether shipment delays and component shortages ease, and whether new programs ramp on schedule and deliver the expected revenue and margins.
- Customer demand, concentration, backlog conversion and the extent to which future operating cash flow depends on receivable sales and working-capital movements.
- Developments in the former-customer arbitration, including potential recovery or exposure and any eventual financial-statement recognition.
- Compliance with debt covenants, available revolving capacity, variable interest-rate exposure and scheduled debt repayments.
- The scale and timing of the new revenue-recognition standard’s effect once the company completes its implementation assessment and selects a transition method.