Key Tronic Corporation — Form 10-Q Summary
Reporting period: Second quarter and first six months of fiscal 2017, ended December 31, 2016. Interim financial statements are unaudited. Dollar amounts below are USD unless noted.
Business context and results
Key Tronic provides electronics manufacturing services to original equipment manufacturers across multiple industries. New program ramps and wins partly offset softer demand from some longstanding customers, including a previously discussed former customer. The company closed its Harrodsburg, Kentucky facility during the quarter and transferred remaining programs to other facilities.
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Net sales | $118.5m | $116.4m | $235.7m | $242.6m |
| Gross profit / margin | $9.6m / 8.1% | $9.1m / 7.8% | $19.3m / 8.2% | $18.0m / 7.4% |
| Operating income / margin | $2.5m / 2.1% | $2.4m / 2.1% | $5.3m / 2.3% | $4.2m / 1.7% |
| Net income | $1.5m | $1.8m | $3.3m | $2.6m |
| Diluted EPS | $0.14 | $0.16 | $0.30 | $0.23 |
| Operating cash flow | Not separately reported | Not separately reported | $3.1m | $3.3m |
Financial position and liquidity
- At December 31, 2016, cash was $1.3m; total assets were $234.5m and shareholders’ equity was $106.9m.
- Total debt was approximately $46.6m: $23.8m term loan, $18.9m revolving borrowings and $3.9m equipment term loan. Debt rates ranged from 2.66% to 3.75%. The company reported compliance with all financial covenants.
- The $45.0m revolving facility had $25.7m available, after outstanding borrowings and letters of credit. Management said liquidity was sufficient for expected operations and planned growth.
- Current ratio was 2.2 and debt-to-equity ratio was 0.4. Six-month capital expenditures were $4.9m; cash used in investing activities was $4.8m.
Changes versus comparable periods
- Q2 sales increased 1.8%, while six-month sales fell 2.9%, primarily reflecting reduced sales to a former longstanding customer, partly offset by new programs and current-customer demand.
- Gross margin improved in both comparisons, which management attributed mainly to lower material-related costs, partly offset by higher overhead costs.
- Q2 net income declined despite higher sales and operating income, primarily because the prior-year quarter benefited from federal R&D credits made available by the PATH Act. The effective tax rate was 23.4% versus 5.0% in Q2 FY2016. For six months, net income rose to $3.3m from $2.6m.
- Six-month operating cash flow was slightly lower year over year. Working-capital movements included an $8.6m inventory reduction, offset in part by a $4.8m increase in receivables and a $7.8m decrease in accounts payable.
- Top three customers represented 33.8% of Q2 sales, up from 30.5% in the prior-year quarter. Backlog was $133.4m versus $123.3m a year earlier; management cautioned that backlog is not a reliable measure of future sales.
Outlook, risks and unusual items
- Q3 FY2017 guidance: Revenue of $115m–$120m and diluted EPS of $0.11–$0.16, assuming a 20% effective tax rate. Results depend on customer orders and timing of new-program production starts.
- Management described the new-business pipeline as robust, cited ongoing program ramps and wins in inventory automation and commercial lighting, and said it is investing in SMT, sheet metal and plastic molding capacity.
- A Mexican tax authority advance pricing agreement is expected to increase Mexican tax liability by about $0.4m for 2014–2016, with an estimated offsetting U.S. tax reduction of about $0.4m. Management estimated no material net consolidated impact and expected finalization late in Q3 FY2017. The agreement also led to $1.8m of additional earnings recognized in Mexico, expected to be repatriated.
- Foreign-currency forward contracts and swaps had a $65.9m notional amount and a $14.7m fair-value liability at quarter-end. The filing reported $4.8m of net unrealized loss expected to be reclassified into earnings within 12 months; hedge movements contributed to comprehensive income being $0.3m in Q2 and $1.1m for the six-month period.
- The company commenced arbitration with a former customer and certain vendors seeking reimbursement under a manufacturing agreement. Possible outcomes could not be estimated, no potential loss was accrued, and the matter could materially affect results or cash flows.
- Key risks include customer concentration and nonbinding order schedules, demand and program-start volatility, component supply constraints, foreign-exchange and interest-rate exposure, and costs or inefficiencies from new program ramps.
Important facts for investors to verify
- Whether new program ramps and customer wins can offset ongoing softness or reductions in longstanding-customer demand, and how concentrated sales remain.
- Actual Q3 revenue, diluted EPS and tax rate versus guidance, including the timing and profitability of new programs.
- Progress and potential financial impact of the arbitration, for which no loss estimate or accrual was reported.
- Cash conversion and working-capital trends, including factoring activity: $38.9m of receivables were sold during the six months.
- Debt, revolver availability and covenant compliance, as well as the effect of derivative losses and future hedge reclassifications on earnings.