Business context and reporting period
Key Tronic Corporation is an electronics manufacturing services provider with facilities in the United States, Mexico, China and Vietnam. This Form 10-Q covers fiscal 2021’s second quarter and first six months, ended December 26, 2020 (13- and 26-week periods). The filing was signed July 6, 2021, after the company delayed filing while its Audit Committee investigated inventory accounting.
Financial performance and position
| Metric | Three months ended Dec. 26, 2020 | Six months ended Dec. 26, 2020 |
|---|---|---|
| Net sales | $128.3 million; up 9.9% | $251.5 million; up 13.3% |
| Gross profit / margin | $10.6 million / 8.3% | $20.6 million / 8.2% |
| Operating income / margin | $2.7 million / 2.1% | $5.5 million / 2.2% |
| Net income | $1.6 million; diluted EPS $0.14 | $3.3 million; diluted EPS $0.30 |
| Interest expense, net | $0.8 million | $1.5 million |
For the comparable 2019 periods, sales were $116.7 million and $222.0 million; gross margins were 7.0% and 7.8%; and net income was $0.8 million and $2.4 million, respectively. Quarterly gross-margin improvement reflected higher sales and Juarez facility streamlining, partly offset by pandemic-related costs. Six-month operating expenses were $15.1 million, versus $13.4 million; research and engineering expense increased, while SG&A declined as a share of sales.
For the six months, operating cash flow was negative $16.8 million, compared with negative $8.4 million a year earlier. Working-capital outflows included a $14.0 million rise in receivables, a $10.3 million decline in accounts payable and a $4.9 million increase in inventory. Capital expenditures were $7.0 million; financing provided $28.2 million. Cash at period-end was $5.0 million.
At December 26, 2020, current assets were $267.1 million and current liabilities $93.8 million; management cited a 2.8 current ratio. Total debt, net of issuance costs, was approximately $100.1 million, versus $70.9 million at June 27, 2020. The company had $89.9 million outstanding on its revolving facility and $3.1 million available; it reported compliance with financial covenants. Shareholders’ equity was $123.2 million.
Material changes, outlook and risks
- Growth came from new program ramps and stronger demand from existing customers, including healthcare, industrial controls and telecommunications. Government shutdowns and labor shortages in Juarez constrained revenue. The top three customers represented 35.9% of quarterly sales, down from 37.0%.
- Management expected continued strong revenue growth in fiscal Q3 2021 and continued investment in capacity, while noting ongoing COVID-19 uncertainty. No quantified revenue or earnings guidance was provided.
- The company reported approximately $1.8 million of COVID-19-related costs in the quarter. Backlog was $218.7 million versus $145.5 million a year earlier, but management cautioned that backlog is not a reliable measure of future sales.
- The Audit Committee found inventory and cost of sales had been improperly recorded at the Oakdale, Minnesota facility in fiscal 2020’s fourth quarter and fiscal 2021’s first six months, understating cost of sales and overstating inventory. Other inventory errors were also found. The errors resulted from control deficiencies; management said they did not require restatement of previously issued statements. The filing does not provide a clear quantified financial impact of these errors.
- Management concluded disclosure controls were ineffective as of December 26, 2020 and identified a material weakness in inventory accounting and monitoring controls at domestic facilities. Remediation was underway. The company was cooperating with SEC inquiries; investigation-related costs and possible regulatory or litigation consequences remain risks.
- Other key risks include pandemic-related demand, staffing and supply disruptions; customer concentration and limited firm long-term commitments; component shortages; working-capital and financing needs; variable interest rates; foreign-exchange exposure; and execution risks from program ramps. The company hedged some peso exposure using $23.8 million of forward contracts, with a reported fair value of $4.6 million.
Important facts for investors to verify
- Review subsequent filings for the quantified effects, if any, of the inventory errors and progress in remediating the material weakness.
- Check for updates on SEC inquiries, investigation-related expenses, and any resulting proceedings or claims.
- Monitor operating cash conversion, receivables and inventory, revolving-facility availability, debt balances and covenant compliance.
- Assess whether backlog converts to shipments and whether customer demand, Juarez staffing and component supply support management’s stated Q3 growth outlook.