Key Tronic Corporation — Q1 FY2017 Form 10-Q
Business context and period: Key Tronic provides electronic manufacturing services to original equipment manufacturers across multiple industries. The quarter was the 13 weeks ended October 1, 2016; comparisons are with the 13 weeks ended September 26, 2015. Amounts below are U.S. dollars.
Financial performance and position
| Metric | Q1 FY2017 | Prior-year quarter |
|---|---|---|
| Net sales | $117.1 million | $126.2 million |
| Gross profit / margin | $9.7 million / 8.3% | $8.9 million / 7.1% |
| Operating income / margin | $2.8 million / 2.4% | $1.8 million / 1.4% |
| Net income | $1.8 million | $0.8 million |
| Diluted EPS | $0.16 | $0.07 |
| Operating cash flow | $(1.4) million | $1.3 million |
| Capital expenditures, net of asset-sale proceeds | $2.9 million cash use | $1.1 million cash use |
Sales fell 7.2% year over year, chiefly due to lower sales to a longstanding customer. Gross margin improved 1.2 percentage points, reflecting lower material-related costs and the absence of the prior-year customer’s abrupt order cancellation disruption; lower sales increased overhead costs as a share of revenue. Interest expense rose to $0.6 million from $0.5 million, primarily due to higher average revolver borrowings.
The effective tax rate was 18.6%, versus 34.5%, mainly reflecting federal R&D tax credits and adoption of share-based payment accounting guidance. Comprehensive income was $0.8 million, including a $1.0 million after-tax unrealized hedge loss.
At October 1, 2016, cash was $0.3 million, current assets were $177.7 million and current liabilities were $77.6 million; management reported a 2.3 current ratio. Total debt was approximately $48.0 million: $25.0 million term loan and $23.0 million revolving borrowings. The $45.0 million revolver had $21.6 million available, net of letters of credit. The company was in compliance with its financial covenants. Total assets were $234.3 million and shareholders’ equity was $106.5 million.
Changes, outlook and management commentary
- Backlog was approximately $130.0 million, up from $108.2 million a year earlier, but management cautioned that backlog is not a reliable measure of future sales because shipment timing and customer requirements can change.
- Top three customers represented 35.1% of sales, down from 36.5% in the prior-year quarter. Customer concentration and non-firm purchase commitments remain important exposures.
- Management reported a slight demand slowdown from some customers, alongside continued new-program ramps and three significant program wins. It expects growth in U.S. facilities as Ayrshire integration progresses in the latter half of FY2017, and plans further investment in manufacturing capabilities while reducing inventory relative to sales.
- For Q2 FY2017, management forecast revenue of $115–$120 million and diluted EPS of $0.13–$0.18, assuming a 25% tax rate. Actual results depend on customer orders and new-program production start timing.
- The Harrodsburg, Kentucky facility closure occurred shortly after quarter-end; remaining programs were transferred to other facilities.
- Operating cash flow was negative despite net income, primarily because receivables, accounts payable and accrued compensation movements used cash; inventory reduction partly offset those uses. The company factored $17.4 million of receivables in the quarter.
Risks, contingencies and unusual items
- Customer order delays, reductions or cancellations; customer concentration; program start-up costs; and production utilization can materially affect sales and margins. Most customer arrangements are not firm long-term volume commitments.
- Foreign-exchange exposure includes Mexican peso expenses; the company had $64.2 million notional of peso forward contracts with a reported fair-value liability of $12.6 million. A $3.9 million net unrealized hedge loss was expected to be reclassified into earnings within 12 months. The company does not hedge RMB expenses.
- Debt is secured by substantially all company assets and is exposed to interest-rate changes; a swap hedges part of the term loan. Revolver availability, covenant compliance and refinancing capacity are relevant liquidity risks.
- Other disclosed risks include component shortages and supplier dependence, international operations and tax incentives, competition, economic conditions, and potential product, regulatory, environmental, litigation, and information-system issues. Management said ordinary-course legal matters were not expected to have a material adverse effect; no material changes to annual-report risk factors were reported.
- The company expects to repatriate approximately $12.0 million of foreign earnings and recorded related domestic and estimated withholding taxes in deferred taxes. It reported approximately $3.8 million of unrecognized tax benefits associated with federal R&D credits.
Important facts for investors to verify
- Whether the Q2 revenue and EPS outlook is achieved, and whether new programs offset reduced business from the longstanding customer.
- Customer order visibility, backlog conversion, customer concentration, and the economics and timing of the new program ramps and facility closure.
- Working-capital and cash-flow trends, including receivables factoring, inventory levels, revolver usage and remaining borrowing capacity.
- Debt covenant headroom and the potential income-statement effects of hedge reclassifications and foreign-currency movements.
- The realization of R&D tax credits, repatriation tax estimates, and the effects of adopting new accounting standards.