Key Tronic Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and first six months ended December 26, 2015. The comparable periods ended December 27, 2014. Amounts below are in U.S. dollars.
Business context and results
Key Tronic provides electronics manufacturing services to original equipment manufacturers across multiple industries. Its September 2014 acquisition of Ayrshire expanded printed circuit board assembly capacity and diversified its customer base. Management said new program growth more than offset weaker demand from a longstanding customer; the top three customers represented 30.5% of second-quarter sales, down from 36.9% a year earlier.
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Net sales | $116.4 million | $114.3 million | $242.6 million | $200.7 million |
| Gross profit / margin | $9.1 million / 7.8% | $9.2 million / 8.1% | $18.0 million / 7.4% | $13.5 million / 6.7% |
| Operating income / margin | $2.4 million / 2.1% | $2.5 million / 2.2% | $4.2 million / 1.7% | $0.8 million / 0.4% |
| Net income | $1.8 million | $1.6 million | $2.6 million | $0.1 million |
| Diluted EPS | $0.16 | $0.14 | $0.23 | $0.01 |
| Operating cash flow | Not presented quarterly | $3.3 million | $5.2 million |
Financial position and liquidity
- At December 26, 2015, cash was $1.2 million, current assets were $174.2 million, and current liabilities were $83.2 million; management reported a 2.1 current ratio.
- Total debt was approximately $41.4 million: $28.8 million under the term loan and $12.7 million under the revolving facility. The company reported a 0.4 debt-to-equity ratio and compliance with all debt covenants.
- The $45 million revolving facility had $31.9 million available, after $12.7 million of borrowings and $0.4 million of letters of credit.
- Six-month investing cash outflow was $1.4 million, including $7.5 million of equipment purchases and $6.2 million of proceeds from equipment sale-leasebacks. Financing cash outflow was $1.1 million; cash increased by $0.8 million.
- Receivables declined by $12.0 million during the six months, while inventory increased by $6.8 million and accounts payable declined by $4.7 million. The company sold $34.8 million of receivables under purchase programs during the period.
Material changes and management commentary
- Second-quarter sales rose 1.8% year over year, but gross margin fell 0.3 percentage points. Management attributed the margin decline chiefly to costs and inefficiencies during new-program ramp-ups, partly offset by lower material costs.
- Six-month sales increased 20.9%; management attributed the increase to new programs and inclusion of Ayrshire for the full six-month period. The prior-year comparison included Ayrshire for only part of the period.
- Six-month operating income rose to $4.2 million from $0.8 million. SG&A as a share of sales declined, partly because the prior-year period included about $0.8 million of nonrecurring Ayrshire acquisition costs.
- Backlog was approximately $123.3 million, versus $97.8 million a year earlier. Management cautioned that backlog is not a reliable measure of future sales because shipment dates and customer requirements can change.
- Management reported a robust pipeline and four recent program wins. It expected new-program ramps to outpace the previously discussed decline from a longstanding customer and anticipated gradually improving operating efficiencies.
Outlook, risks and unusual items
- Guidance: Management expected third-quarter fiscal 2016 revenue of $117 million to $122 million. Results remain dependent on customer orders, timing of new program starts, and industry-wide global supply-chain shortages.
- Tax item: The second-quarter effective tax rate was 5.0%, versus 23.0% a year earlier; management attributed the decrease primarily to federal R&D credits made available under the December 2015 PATH Act. The six-month effective rate was 16.8%, versus 53.0%.
- Hedging: Foreign-currency forwards had a $66.5 million notional amount and a reported fair-value liability of approximately $10.3 million. The company expected approximately $2.8 million of net unrealized losses to be reclassified into earnings within 12 months. A $25 million interest-rate swap hedged part of its debt exposure.
- Principal risks: Customer concentration and nonbinding purchase expectations; demand changes or order cancellations; new-program ramp costs; component shortages and supplier concentration; competitive pricing and margin pressure; foreign-currency and interest-rate exposure; and the ability to maintain financing and manage growth. The company also cited operational, regulatory, environmental, product-quality, and litigation risks.
- Management said ordinary-course legal matters were not expected to have a material adverse effect. No material changes to the risk factors in the prior annual report were reported. Disclosure controls were assessed as effective, with no significant changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether new program wins and the reported backlog convert into shipped sales, and whether ramp inefficiencies improve margins.
- How much demand weakness from the longstanding customer persists and whether customer concentration continues to decline.
- Whether inventory growth, receivables factoring, and supplier payment timing affect working-capital needs and operating cash flow.
- Debt covenant headroom, availability under the revolving facility, and sensitivity to interest rates and foreign-exchange movements.
- The sustainability of earnings after the R&D tax-credit benefit and the timing and earnings impact of derivative losses reclassified from accumulated other comprehensive loss.