Key Tronic Corporation (KTCC) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Key Tronic Second Quarter for Fiscal 2012 Conference Call. [Operator Instructions] I would now like to turn the conference over to Craig Gates, President and CEO. Please go ahead.

Thank you. Good afternoon, everyone. I’m Craig Gates, President and CEO of Key Tronic. I’d like to thank everyone for joining us today for our investor conference call. Joining me here at our Spokane Valley headquarters is Ron Klawitter, our Chief Financial Officer. Today, we released our results for the second quarter of fiscal 2012. So far it’s been an outstanding year for Key Tronic. We’re very pleased with our strong growth in revenue and earnings, primarily driven by the production ramps of new programs. We achieved the highest quarterly revenue in Key Tronic’s history, significantly increased our operating efficiencies from recent quarters, and continued to diversify our future revenue base by winning new programs. We’re continuing to capitalize on our unique combination of world-class engineering, global logistics, and cost-effective production, as well as our advanced capability to produce products that have not traditionally been outsourced. As a result, we’re enjoying profitable growth and capturing market share. Now I’d like to turn the call over to Ron to review our financial performance. Then I will come back to discuss our progress and our strategy going forward. Ron?

Thanks, Craig. As always, I would like to remind you that during the course of this call we might make projections or other forward-looking statements regarding future events or the company’s future financial performance. Please remember that such statements are only predictions. Actual events or results may differ materially. For more information, you may review the risk factors outlined in the documents the company has filed with the SEC, specifically our latest 10-K, quarterly 10-Qs and 8-Ks. Please note that on this call we will discuss historical financial and other statistical information regarding our business and operations. Some of this information is included in today’s press release and a recorded version of this call will be available on our website. Today, we released the results for the quarter ended December 31, 2011. For the second quarter of fiscal 2012, we reported total revenue of $84.5 million. This is up 38% from the $61 million in the same period of fiscal 2011. For the first 6 months of fiscal 2012, total revenue was $154.2 million, up 24% from the $124.4 million in the same period of fiscal 2011. In the prior quarters, our gross margin was impacted by changes in product mix and costs associated with moving many new programs into production. For the second quarter of fiscal 2012, we achieved a more balanced production load throughout the period. As a result, our gross margin was 8%, compared to 7% in the previous quarter and 9% in the same period of fiscal 2011. For the third quarter, we expect to see our gross margins continue to improve to around 9%. Our operating expenses were $4.1 million in the second quarter of fiscal 2012, up only 9% from the second quarter of the last fiscal year, much less than our 38% year over year increase in sales. Although the new program startups that fueled our revenue growth have required the addition of new engineers and program managers, we’ve done a pretty good job of controlling our costs. Net income for the second quarter of fiscal 2012 was $3.2 million or $0.30 per diluted share. This is up 83% from $1.7 million, or $0.17 per diluted share for the same period of fiscal 2011. Net income per diluted share for the second quarter of fiscal 2012 included $0.11 for research and development tax credits. For the first 6 months of fiscal 2012, our net income was $4.4 million or $0.42 per share, up 27% from $3.5 million or $0.33 per share for the same period of fiscal 2011. Turning to the balance sheet. We continue to maintain our strong financial position as we rapidly expand our business. Our inventory was up only 14% from the previous quarter, despite our much higher production levels and preparations for strong future growth. We’re starting to see an improvement in inventory turns. Note that we also reduced the balance on our line of credit by about $3.9 million from the previous quarter, despite our inventory build in preparation for continued growth. Our trade receivables were $47.5 million at the end of the second quarter. This is down 2% from last quarter despite our significant sales growth. Our DSOs were about 48 days. Our capital expenditures for the second quarter of fiscal 2012 were approximately $2.8 million, which includes the purchase of another manufacturing facility in Juarez, Mexico. We expect CapEx to be about $5 million for fiscal 2012, which is comparable to fiscal 2011. Moving into the third quarter of 2012, many of our new programs continue to ramp up despite continued uncertainty in the global macroeconomic environment. Taking these factors into consideration, we expect revenue in the range of $92 million to $97 million in the third quarter of fiscal 2012. In the third quarter, we expect our gross margins to be around 9%. We also expect our operating expenses to continue to increase at a slower rate than our revenue growth in coming periods. Taking these factors into consideration, we expect earnings in the range of $0.30 to $0.35 per share for the third quarter and this expected earnings range assumes an effective tax rate of 30%. In summary, the financial health of the company is excellent, and we believe that Key Tronic is well positioned to continue to profitably expand its business. All right, Craig. That’s it from me.

Okay. Thanks, Ron. We’re really pleased with our record revenue of $84 million in the second quarter, which is powered by the successful ramps of many new programs. In fact, we set a new revenue record in each of the last 5 quarters. As a result, we are now reaching an annualized revenue run rate that is elevating us from the Tier 3 EMS category into the Tier 2 category. At the same time, we continue to maintain our Tier 3 responsiveness to customer needs, along with our virtual Tier 1 production and logistic capabilities. The second quarter also represented a tipping point for us in terms of production smoothing, with less concentrated technical and supply chain loads than prior quarters, which resulted in more production output and less costly ramps. While some of our customers remain cautious in terms of committing to increased volumes based upon the uncertain macroeconomic environment, demand from our new customers and new programs continues to drive our growth. We also continue to see that many of the new programs we were ramping in Shanghai involved products destined to ship to end customers in Asia. As demand for products in Asia continues to grow, we see this trend as beneficial for both our Shanghai and our Juarez operations. At the same time, with the continued increase in the relative cost of production in China, and in shipping cost to get product back from China to North America or Europe, Asian production no longer presents an unquestioned cost advantage. As a result, we see growing interest in Mexico-based operations and particularly in our facilities in Juarez. Our operations in Juarez are world class, vertically integrated, and produce exceptionally high quality products. During this fiscal year, we continued to invest in updating, strengthening, and expanding our capacity in Juarez. Specifically, we acquired, on very favorable terms, another 110,000 square foot manufacturing facility to replace a 70,000 square foot leased facility. We believe that our continued investment in our business, our solid execution of our long term strategy, and our continued profitability, is being rewarded with increased confidence from existing customers and increased interest from potential new customers. During the second quarter, we continued to extend our customer portfolio across a wide range of industries. We won new programs involving rechargeable power storage devices, irrigation equipment, gaming devices, and military equipment. During the second quarter, the number of discrete programs generating revenue for us increased from 135 to 149. The number of different customers generating revenue for us increased from 36 to 40. In summary, our quote pipeline remains robust, as our prospective customers continue to value our growing engineering staff, our worldwide footprint, our centralized management approach, and our vertical integration. As we grow our business, we remain focused on maintaining outstanding customer service, carefully managing our operating expenses, and maximizing our return on invested capital. We’re very pleased with our progress in aggressively growing our company, and we expect to continue to win market share and focus on profitable growth for the long term. This concludes the formal portion of our presentation. Ron and I will now be pleased to answer your questions.

[Operator Instructions] Our first question is from the line of Mike Cikos with Sidoti & Company.

Before I ask any questions, I just want to do some quick fact checking. The numbers you had given as far as the programs and customers that are currently generating revenue for you, at the end of the second quarter the programs were 149 and the customers were 40. Compared to a year ago -- I don’t know if you have those numbers in front of you -- I think it was 26 customers at the end of the second quarter in fiscal ’11 and 89 programs. Is that correct?

Yes, that’s about right.

And the other thing I wanted to ask was with the increase that you’re seeing in revenue, I guess how much can you actually add before we’ll see a significant increase in your operating expenses? How flexible is this business model?

Well, what we’re seeing right now is we can continue to add more revenue ratio metrically than our fixed expenses go up. So I don’t know how those 2 curves intersect at one point, and it also depends on the type of programs you get, because there are certain programs that have high revenue and reasonable profit and almost no extra requirement for people, because they’re pretty easy to manage, and other lower revenue programs that are people-sinks. So I can’t really answer the question for sure, but it is pretty sure that we can continue to add revenue faster than we have to add cost.

Okay. And regarding order flow, if you could comment on that during the second quarter. I guess the consistency of it, if it was more focused in one month compared to the others. Are you definitely seeing a smoothing out?

We mentioned that in the commentary, and that is for sure the case. Our second quarter was much, much more evenly loaded amongst the 3 months than previous quarters have been. And that’s certainly allowed us to produce product a lot more efficiently and to sleep a lot better at night.

The next question is from the line of Bill Dezellem with Tieton Capital Markets.

I have a group of questions. First of all, nice quarter, but not to rain on the parade, in the past Key Tronic has had some good quarters and then, due to various factors, the follow-through just wasn’t there. What’s different this time?

Well, as you say, various factors. So in no particular order of importance, but probably all amongst the top 3. In the past we were not nearly as diversified as we are today, so if you go way back, 5 or 6 years ago, we would see quarters that would be powered by one customer who had up to 50% of our revenue, and that’s not the case here today. Probably another point that’s different is in the past we would be running from what was a probable departure of a big customer or a big program because even though we didn’t know these customers were leaving us, there was a mismatch as we looked at our catalog of customers. There was a mismatch of a couple of the big customers between us, our capabilities, our size, and the size of their business and the strategy that they were following. So even before we knew that they were leaving, as I looked at the roster of customers, I always had a cold chill going down my spine because I knew at some point the mismatch was going to jump up and bite us. So today, when we look at our roster of companies, there’s no mismatches. I can never guarantee that tomorrow I might not get a horrible call from somebody. I’m not expecting that. Things are going great, but from the pure strategic matchup between our customers, the accounts that we have with them, the programs that we have with them, and our capabilities and direction we’re taking the company, I don’t see any big glaring mismatch that would predict that somewhere down the road I am going to get a nasty phone call. And then finally, there have been times in our history where we’ve been doing pretty well as we looked at the current quarter, but when we looked at our funnel, and where we were in bringing in new business, where we were on the forecast from customers that we hoped to get new business from, we could see a pretty big gaping hole 9 months or a year out, and so that’s not the case today either. Today, we have a strong funnel, as you can see from the nice geometric progression of the number of customers and the number of programs that we continue to see that going forward. There isn’t a gaping hole in the funnel or in the pipeline that we had before. So it’s all 3 of those things combined together to make us feel quite a bit more comfortable about the future. And there’s always bumps and things happen that you don’t expect, but it’s a lot less of a high-risk proposition than it was 2, 5, or 10 years ago.

Then relative to this quarter, revenues came in above your guidance. What were the dynamics that led to that?

Well, as we’ve talked, we’re in a number of very steep ramps for high volume accounts, and so when you’re looking at laying out the production plans, the plans for filling the supply pipeline with parts from various components of buyers, the maturity of the designs that are coming to us from our customers, and the maturity of the production processes that are being transferred to us, it’s pretty easy to be off by plus or minus 10% even if you’re super, super skilled at the process of transferring programs. And when you’re looking at a very steep ramp, being off by 10% on your dates can have a pretty big effect on the amount of revenue you see that quarter. So in this quarter, as opposed to the previous quarters -- we’ve had 3 of them that were a little bit slower than what I thought. I thought we would do better than we did. This quarter we actually did better than we thought because we had a handle on quite a few of these programs and the ramps are now in the fun phase, where it’s just watch the volume go up instead of in the panic phase where it’s try and solve some law of physics that’s being violated by some process or some product. So that’s the big reason we were off, just a little bit of a miscalculation of how fast the products and the ramps were going to happen.

Then continuing down the revenue front, the first questioner asked about revenue generating programs and customers a year ago, and if one puts a calculator to those numbers, the rate of growth of your revenue generating programs, the 149 versus 89, and the growth in the revenue generating customers, 40 up from 26, is substantially higher than the revenue growth that you experienced this quarter. Is that indicating to us the immaturity of a number of these programs, and kind of coming back to your point, you’re now in that phase of ramping revenue and this is almost a window into the future revenues, which you’ve also provided in your outlook?

If you go back over the last couple years, we’ve been pretty consistent in talking about the number of programs we’ve won and the low high side revenue that we had thought we had won during that time period. And so if you add all those up, you’ll have a pretty good idea of what’s still hanging around in the pipe. You have to put a little bit of landing [ph] up on that, because customers tend to have us quote the highest volume and end up at the lowest volume, but that’s the point of us giving you all those numbers, is so you can do your own projection of what we think will happen, although we’re not going to commit to it anymore, because looking out a year doesn’t work. But that’s where the numbers are coming from.

Bill, if you look at our projection for Q3 ’92 to ’97 [ph], that’s up about 50% from last year’s Q3, so there you’ll see that revenue year over year more closely matches the increase in customers and programs.

And I guess that’s also a really good segue. You did announce 4 new programs this quarter. What’s the revenue range on those?

Yes, I kind of broke our rule there, because I’m not sure. Those could be as low as 2 and up to 25 on all those.

Literally, all 4 could be 25 or all 4 could be 2 in the most extreme?

Yes, and the issue is that we’ve kind of embraced the slow burn approach to programs. So if you look at what’s happening to us, we used to talk about how our gestation period was 9 months to 1 year. And now we’re seeing that 9 months to 1 year is when you start business, but it may take 3 years to ramp a business to full maturity in terms of how much you’re going to receive from a revenue base. A lot of these are wins that have a customer consolidating their production from 3 or 4 or 5 different CMs to one CM, and it takes forever to do all the work that’s required to get those products pulled out of the current guys, who aren’t happy to let them go, and get them consolidated into our one factory. So it’s a clear fact now that some of these programs take up to 3 years to reach maturity.

Which -- and I know I’m taking a lot of time here and I apologize. Just a couple more. But what you just said indicates that this ramp that we have seen in number of programs and number of customers could not only be a window into the near term future, but potentially gives us some confidence in revenues continuing to grow for many quarters to come.

I think that would be going too far down the road of giving forecasts more than a quarter out.

All right. And given the solid results that you have been demonstrating over the last several quarters on the revenue front, and now gaining the earnings traction, and with the guidance that you had, in light of all that, have you all considered being more proactive with the investment community, whether that be a roadshow of some sort or anything of that nature?

Yes, we in fact are headed out to Boston and New York in a little bit. Ron and I are going to go to the big cities and see how we play out there. This will be the first roadshow that both of us have done together and the first roadshow we’ve done in quite some period of time. And so we wanted to time it right so that when we were talking to the analysts we had some proof under our belts of what we were projecting was actually happening. So it will be exciting and interesting to see how that goes.

[Operator Instructions] The next question is from the line of Aaron Martin with AIGH Investment Partners.

I just had a clarification on the guidance. I assume that that’s the EPS numbers assuming no new R&D tax credit or any other one-time item like that. You don’t see any of that as of now?

No, that effective tax rate assumes that there’s nothing else, no other unusual items.

And then a follow-up in terms of the deal flow. You said obviously things are smoothing out, but I assume if you’re in the middle of a ramp like this, you should see some sort of linearity in the quarter that -- so your June being quite a bit higher than April, or I would say March being quite a bit higher than January. Is that fair to say?

Well, there seems to be a quarterly aspect to our customers’ ordering pattern also, so even if we have a program fully ramped, if we look at their forecast, it always seems to be back-end loaded.

Okay, so March will actually be itself a run rate which is probably over $100 million.

We’re on a 4-4-5 basis , so our third month of our quarter has 5 weeks in it.

Okay, so it would be that way anyway.

Second quarter, we did about a little over 40% of our revenue in the last month, which is pretty comparable to the 5 weeks out of the 13 weeks in a quarter. So it was fairly smooth, although it was not exactly linear, every month of the quarter. It was much better than our first quarter…

And if you don’t mind, in the first quarter what was it like month to month?

Over 50% of our revenue happened in the last month of the quarter, in our first quarter, and in our second quarter, it was only about 40%. So it is getting a better flow, and that’s part of the reason why our gross margin improved from 7% to 8% in Q2 from Q1.

Understood. And on that item, I’m sure you obviously don’t want to go too far in the future, and obviously it depends on each program, but at some point I would expect that we’re going to get closer to perhaps a 4% or 5% operating margin. Do you have any long term goals for an overall model?

Well, we’re predicting 9% gross margins for Q3. And that’s close to our all-time high that we’ve been running in the past. Our operating expenses for Q2 was about 4.8%, but our operating expenses grow a lot less than our revenue grows, and so we get some benefit out of that, so that has potential to…

But if I’m understanding you, you’re looking for a little bit of operating margin expansion, but that’s only going to come from an OpEx, not necessarily from a gross margin expansion.

No. We’re going from 8% in Q2, and we’re predicting 9% in Q3, so there’s going to be some margin expansion as well as getting the leverage benefit of the fixed costs that we have in our operating expenses.

I’m asking from the March quarter and on. Obviously 9% is where you’ve topped out in the past. I’m asking if that’s going to be where we’re going to top out as we grow. We don’t know where we’re going to be, but if revenue grows to $125 million a quarter, are we going to be topped out on the gross margin and get our leverage in the OpEx? Or are we looking to get a few more points on the gross margin itself?

Should be able to see benefits on both our cost of goods sold as well as operating expenses, because a portion of our cost of goods sold is also fixed cost. So if we grew to $125 million, which is a pretty big growth, I’d expect to see some benefit at the gross margin line as well as at the operating expense line.

I think as you go out to speak to the investment community, obviously you’ll have something nice to tell them, so that always makes your job easier.

That’s why we waited until then. We’re lazy.

There are no further questions at this time. I will turn it back over to management.

Okay. Well, thank you all for participating in today’s conference call. Ron and I look forward to speaking with you next quarter. Thanks, and have a good day.

Ladies and gentlemen, this does conclude the conference call. If you would like to listen to a replay of today’s conference, please dial 1 (800) 406-7325 or (303) 590-3030, and enter in the access code of 4503180. Thank you for your participation.