Key Tronic Corporation — Form 10-Q Summary
Business context and period. Key Tronic provides electronic manufacturing services, including engineering, procurement, assembly, and testing. This unaudited filing covers the 13 weeks ended September 26, 2015, the first quarter of fiscal 2016; comparatives are the 13 weeks ended September 27, 2014. Results include a full quarter of Ayrshire Electronics, acquired in September 2014.
Financial results
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Net sales | $126.2 million | $86.3 million |
| Gross profit / margin | $8.9 million / 7.1% | $4.2 million / 4.9% |
| Operating income (loss) / margin | $1.8 million / 1.4% | $(1.7) million / (2.0)% |
| Net income (loss) | $0.8 million | $(1.5) million |
| Diluted EPS | $0.07 | $(0.14) |
| Operating cash flow | $1.3 million | $(2.1) million |
- Sales rose 46.2% year over year: about $23.5 million came from including Ayrshire for the full quarter, and about $16.4 million from new programs and higher demand in existing programs.
- Gross margin improved 2.2 percentage points, which management attributed to lower material costs, Ayrshire’s contribution, and unfavorable product mix in the prior-year period. Operating expenses were $7.1 million, up from $5.9 million, but lower as a share of sales.
- Interest expense increased to $0.5 million from $0.2 million, primarily reflecting higher average borrowings related to the Ayrshire acquisition and working capital.
- Operating cash flow improved by $3.4 million year over year, but depended substantially on a $13.4 million increase in accounts payable; a $9.6 million increase in inventory partly offset the cash benefit. The company also received $12.3 million from receivables sold during the quarter.
- Cash was $0.1 million at quarter-end. Current assets were $196.5 million and current liabilities $100.7 million; management reported a 2.0 current ratio. Debt totaled approximately $42.1 million, including $30.0 million on the term loan and $12.1 million on the revolver. Of the $45.0 million revolving facility, $32.5 million was available; the company reported compliance with loan covenants.
- Investing activities used $1.1 million, including $3.5 million of equipment purchases, partly offset by $2.4 million of proceeds from an equipment sale-and-leaseback. Comprehensive loss was $2.2 million, including $3.0 million of after-tax unrealized hedge losses recorded in other comprehensive income.
Changes, outlook, and risks
- Unusual customer event: A longstanding customer requested an abrupt production ramp for a new program and then cancelled the orders. Key Tronic estimated about $2.0 million of related unanticipated expense and gross-margin erosion.
- Outlook: Management expected second-quarter FY2016 revenue of $115–$120 million. It expected the customer-related decline to continue affecting growth in the second and third quarters, with new-program revenue expected to more than offset lost revenue by the fourth quarter. Management also anticipated improved operating efficiency and profitability. These are forward-looking expectations, not guarantees.
- Backlog was approximately $108.2 million, versus $96.8 million a year earlier; the filing cautions that backlog is not a reliable measure of future sales because shipment timing and orders can change.
- Management cited a robust pipeline and wins in telecommunications and security equipment, while noting reliance on customer orders, program start-up timing, and industry-wide supply shortages. The top three customers represented 36.5% of sales, down from 40.9% a year earlier; customer concentration and order cancellations remain risks.
- Other key risks include component shortages, price and competitive pressure, foreign-currency and interest-rate exposure, dependence on Mexico and other international operations, and potential costs from new-program ramps. Foreign-currency forward contracts had a $71.7 million notional amount and an $11.1 million fair-value liability; the company expected approximately $2.9 million of net unrealized losses to be reclassified into earnings within 12 months.
- The company expected to repatriate approximately $10.5 million of foreign earnings and had recorded related estimated taxes in deferred taxes. It reported $3.5 million of unrecognized tax benefits associated with federal R&D credits. Management said the annual goodwill impairment test found fair value more likely than not exceeded carrying value. Ordinary-course legal proceedings were not expected by management to have a material adverse effect.
Important facts for investors to verify
- Whether the cancelled customer program creates further costs, excess inventory, or additional lost revenue beyond management’s stated expectations.
- Whether forecast new-program ramps and the expected fourth-quarter revenue offset materialize, and how the backlog converts into shipments.
- Whether operating cash flow improves without continued reliance on supplier-payment timing, receivables sales, or other working-capital changes.
- Revolver availability, covenant compliance, debt repayment, and interest costs as operations and working-capital requirements change.
- How hedge losses are reclassified into earnings, and whether currency movements, supply shortages, or customer concentration affect margins.