Good day and welcome to the Key Tronic Corporation Fourth Quarter and Year-End Fiscal 2021 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Brett Larsen, Chief Financial Officer. Please go ahead, sir.

Good afternoon everyone. I am Brett Larsen Chief Financial Officer of Key Tronic. I'd like to thank everyone for joining us today for our investor conference call. Joining me here in the Spokane Valley headquarters is; Craig Gates, our President and Chief Executive Officer. 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 our results for the quarter and full year ended July 3, 2021. For the fourth quarter of fiscal year 2021, we reported revenue of approximately $132.6 million up 14% from $116 million in the same period of fiscal year 2020. For the full fiscal year of 2021, total revenue was $518.7 million, the highest annual revenue in the company's history and up 15% from $449.5 million for fiscal year 2020. While demand has remained strong for both new and existing customers revenue for the fourth quarter and for the full fiscal year 2021 was significantly restrained by issues related to worldwide supply chain, transportation and logistics. For the fourth quarter of fiscal year 2021 net income was $200,000 or approximately $0.02 per share compared to $1.5 million or $0.14 per share in the same period…

Okay. Thanks, Brett. Despite the stiff headwinds during the past year, including the pandemic multiple factory shutdowns, worldwide supply chain challenges, we're very pleased with our strong positive momentum. We reported 15% year-over-year growth and record revenue for the year and generated a 40% increase in operating income. We also continued to ramp up new programs and win new business. While the COVID crisis is not behind us, we survived the waves of pandemic challenges over the past year. Along with forced government shutdowns, we work hard to keep our employees safe, implementing a variety of procedures and stop gaps to address COVID-19 and mitigate its spread. We are also impacted by an unprecedented winter storm that shut down our Juarez facility for one week during critical times for several new program ramps. During the year, we struggled to get enough labor in our production facilities as production staff were deterred by a variety of factors, including COVID-related unemployment benefits, which at times exceeded payroll in the US, endemic fears in Mexico and government oversight in Asia. Now that we're sufficiently staffed up production for the time being anyway, the industry faces persistent worldwide shortages in the supply of key components, particularly for electronic parts. These shortages have extended production timing and caused transportation cost to triple. Had it not been for the supply chain issues, we believe burgeoning customer demand would have driven revenue for the year in excess of $700 million. Unfortunately, moving into fiscal 2022, supply chain disruptions have not improved. In the face of all these challenges, we continued winning new customers and ramping new programs, more than offsetting the drop in some programs, because of the pandemic. During the year, we won new programs involving audio and video editing systems, indoor air quality, utility meters,…

Thank you. [Operator Instructions] Our first question comes from Bill Dezellem with Tieton Capital.

I'd like to actually start since we didn't have a third quarter conference call to have you discuss the new program that you won in the Q3 that led to adding an additional 145,000 square feet down in Juarez please.

I'm trying to figure out what I can say about that. It's a program that's being partially moved from China and partially new business. It is based upon response time to customization from that program's customers. And it's the first time in our history that we've done this depth of high in between us and our customers as far as commitments to square feet and commitments to equipment that is being built and moved into our facility.

Bill, I think we also disclosed this last time -- this last quarter that it's highly automated and that with that really it's truly a partner as Craig said with this customer.

Thank you. And given the amount of square footage that you're adding presumably this is rather large in terms of revenue potential, would you sale for us the revenue kind of as you have in prior quarters for the wins, specifically thinking about this one in the third quarter. My next question will be the three new ones this quarter.

So, the third quarter the big one there was between $20 million and $50 million a year. And for Q4 all of those were between $5 million and $15 million.

And were those for existing or new customers each of those? And if there was anything interesting about any of them that unique go ahead and take the opportunity and dive in.

Well, the big one in Q3 was for a different division of an existing customer. And the largest of the wins in Q4 was for an existing customer. Then the other three were new customers. Actually, no one of the other three was a new division of an existing customer.

Congratulations. And then I'm going to ask you to kind of share a little bit of the behind the scenes of, what happened with your revenue guidance. Specifically, in early May, you were guiding the fourth quarter to be $130 million to $140 million. And then the -- I think it was early July, you pulled that back to $120 million to $125 million and then you ended up doing closer to the $133 million, which was quite close to the Q3 revenue. Can you help us understand kind of all that you were dealing with behind the scenes?

Sure. It's all basically related to component availability and new program ramps. The day-to-day life in manufacturing, is now sit at your desk and wait for the phone to ring from the supplier who's decided he has to de-commit today and then scramble around and try and find a replacement part, see if you can find those parts in the gray market and the black market. If you can find a way to get those parts certified to make sure they're not counterfeit, talk with your customers, see if you can find a way to convince that customer to pay anywhere from 10% to 2000% purchase price variance to get these parts out of the black or gray market. And then when that one is behind you, wait for the phone to ring again. And basically, I'd say on any given day, we have two or three new de-commits from a supplier somewhere around the world or a logistics snafu where parts didn't get on a boat or didn't get offloaded or stuck at port. So we really don't know from day-to-day, what we're going to be able to build, which causes us to have a really hard time giving you folks an accurate prediction of how much we're going to sell. At the same time, the customers need the parts, need the products. So when we get the parts in the door finally, we end up working a lot of overtime to try to get the products built and we end up having a lot of people sitting around with nothing to do when the parts don't show up on time. So, that's why we can't be more accurate on, what we're going to build, when we're going to build it and how much it's going to cost us to build it?

So that's actually quite helpful and kind of helps frame up the -- what seems like conflicting statements in the press release of costs due to downtime and costs due to overtime those two generally don't go hand in hand. But relative to the most recent guidance of $120 million to $125 million and then actually doing $133 million that's a great surprise. What happened to allow that -- that positive surprise to take place?

Parts came in that we were thinking we're not going to come in product got built that we didn't know if were going to get done by the end of the quarter. The product got shipped that we didn't think was going to get done by the end of the quarter.

And presumably from what you've described, just the opposite could happen in any quarter in the future so we shouldn't take too much enthusiasm for, what was accomplished this quarter then? Is that -- we should be enthusiastic but not necessarily imply that it's going to repeat quarter after quarter?

We sit together every morning talk with our staff. And every day we all have a pretty good idea of, which suppliers are in trouble, which shipments are held up how far lead times are being pushed out. Lead times for example, for some of the hot components like, integrated circuit that we use in one of our larger product revenue lines is also used in the automotive industry. And when that chip is holding up the shipment of an $80,000 truck versus holding up the shipment of our $800 product, GM or Ford are a lot more willing to pay $150 premium for a $10 chip than our customer is. So as we look over this landscape of logistics, and wind fabs are coming online and which countries are pulling their people out of the factories or restricting how many people are being allowed to go into the factories, how far lead times are being pushed last time we talked with a given supplier, we've convinced ourselves over the last probably three weeks that things have stopped getting dramatically worse every day. We are not convinced, we've turned a corner and things are getting better. But at least, we don't think every day is worse than the last. And there's a lot of factors that go into that too, because when this first started, there's always a secondary market for parts that has parts that have ended up in excess for some reason and brokers are looking to move those parts to somebody at a higher price. And as this first began, that whole market was still pretty full of parts. And as it got worse and worse and worse, that market got drained down to where there is no secondary gray, black market to speak of with reputable…

Great. That's more than I asked for and very helpful. Thank you. So let me just be clear here, you are not experiencing any sort of a demand issue? It is all on the supply front correct?

We are -- we see the highest demand we have ever seen in the company's history.

And so, for this quarter that you've just guided $125 million to $135 million, the September quarter, what's your current guess of what end customer demand is?

If we could get all the parts we wanted and if the -- all the employees were available to us, we could be doing in excess of $160 million this quarter.

So that's up from, I think, what you've put in prior press releases of $150 million?

Yes.

Well, congratulations on that front. So let me ask one additional question and I will step back in queue. What's getting in the way of hitting a 10% ROE? And let's start with the long term. I think you may have just answered in the short term. But long term, what's going to preclude you from accomplishing that?

I don't know how long all the pandemic and supply issues are going to be. I don't know, if you could take long term is a quarter or a year or what. Certainly, if we were running $150 million, $160 million in revenue, our profitability and everything else that you wanted to measure would be a whole different world of betterness.

Let me actually break my own promise, I said I would just get back in queue and ask an additional question. In the release you made reference to $700 million or so of demand in the year just completed. Had you been able to satisfy that demand? What -- and you did not have the internal investigation costs. What would earnings have looked like?

That's like saying what would happen, if I hadn't hit the buoy at for ball. There's no...

That would require a lot of speculation.

Yeah, there's no use really thinking about it. You can just say that the arrow would point way up and leave it at that.

All right. That's fair. Thank you very much for talking all my questions.

You bet.

Thanks, Bill.

[Operator Instructions] We'll take our next question from Sheldon Grodsky with Grodsky Associates.

Good afternoon everybody. I have a few quick questions. Have you tallied up how much the internal investigation and all related items cost you for the year?

Yes, we have. We've -- it's in excess of $1.5 million.

Was anybody fired as a result of the investigation?

We have taken remediation including control design enhancements, maintenance of and control, system upgrades, training just a whole variety of things that we've already publicly disclosed.

Okay. And going to the components problem that you're having. Is this primarily emanating from Chinese suppliers, or is this across the board around the world?

It's across the board around the world.

Okay. Thank you.

Yeah.

We'll take our next question from George Melas with MKH Management.

Hi. Good morning, good afternoon guys.

Hey, George.

Hey. If you take that $700 million of demand in fiscal 2021, how much of that was related to COVID-related products? So what I'm trying to figure out is if you didn't have COVID would specific programs related to COVID like some sort of handheld thermometers and things like that, how much would have been -- how much would that $700 million been?

That's kind of hard to answer because COVID hurt some customers really badly and helped other customers a lot. And some of the customers that it helped, obviously we weren't able to get parts. And the question is would that demand have been there? Would it stay there if COVID goes away? I have a hard time answering that question. I don't want...

Or the correlation too.

Yeah, or the correlation -- I'm not sure, I could answer. I think it'd be -- my guess would be and this is just an instinct rather than any type of statistical analysis that I've done on it. I guess, it'd be that $700 million would probably drop down to $600 million.

Okay. Okay. That helps a little bit. A quick question for Brett. How much in your guidance for the September quarter, how much did you bake in for internal investigation fee?

We're expecting somewhere in the neighborhood of $300,000 to $400,000.

Okay.

And again, a broad estimate and that's our best guess at this point.

Okay. Great. Thanks. And do you think of that you've added, how do you think about what is your revenue capacity right now in your plants?

We don't. Because every new win is a new adventure. So some wins are highly square footage intense and other wins are low square footage intense. So we don't think about it that way.

Okay. In given constraints that you have that may be equipment, space, slope when you bid for work, when you choose work that you bid on, is there some, kind of, emphasis that you have now? Are you trying to bring a certain, kind of, business to complement what you have?

I don't think I -- the answer to your question, I'm not sure you're going to appreciate, but the answer is that we look for a business that has a strange process in it. So you want me to explain that more? Do you want to give up on that one?

No, I'm willing to understand. I think it's try to use your design capabilities and add value through that process right?

Yeah.

What percentage of your business has that characteristic?

I'd say, hang on I'm adding. So at least two-thirds.

Okay. And if you take that two-thirds Craig, does it have a higher margin than the rest of the business?

It seems to eventually. In some cases it's -- again there's so many different customers and so many different situations. I guess, it's not fair to say that it seems to because sometimes the volume gets so big that the margins get tighter.

Okay. That sounds not imputed to me, because it looks like if you have a bigger program the margins would benefit from that.

If you have a bigger program your customer gets more interest from people around the world, gets a lot of unsolicited bids. And so the competition becomes stiffer…

Okay.

…Sometimes. It depends on how unique the process is.

Right. And that's why you really want the strange process where you add value when you help design?

Yeah. It takes us out of the commodity contract manufacturing world and puts us into a different space.

Okay. And so if you look at the wins that you were describing to Bill and maybe you look at your wins in the last 12 months, have they been the bids or wins that you really wanted? I mean, have they been these strange processes where you have certain unique capabilities?

Yes. A lot of them have been.

Okay. So now I guess it's really difficult to talk about margins given all the supply chain issues and -- but help us think about what gross margin you were targeting, because you're clearly targeting above 8%. And in fiscal 2022 or maybe in the back half of 2022 what would be your call [ph] for gross margins for the business?

Well, I think our goal has always been to be above a 9% gross margin. That's our long-term goal. Now to say that we're able to achieve that towards the back of 2022, we're just -- we're not equipped to be able to give that type of an estimate.

Okay. You can look at it another way and say if we didn't have to deal with all of the supply chain issues we have right now that number would be easy to hit.

Meaning if you don't have a supply chain, your gross margin would exceed 9% now, right?

Yes.

Yeah.

Are you able internally to quantify, how much is -- how much freight is costing you more? How much -- I guess you can probably be over time and all that stuff. You can do that internal analysis.

Yeah.

Yeah.

Okay. Now on freight, your incoming freight is probably in your cost of goods sold and your outgoing freight is in SG&A. Can you talk a little bit about the FX rate?

Let me correct you. Actually both sides, any freight would be through cost of goods sold.

Okay.

But often the customer pays freight usually picked up at our facility, and then they would pay freight outgoing to their own distribution center.

Of our finished goods.

Yeah.

So typically, we're paying the freight to get components and raw material to our facilities.

And then back northbound in Mexico up to El Paso for our customers for them to pick up.

Okay.

The big jump there is – go ahead.

No, you go ahead Craig. Please?

The big jump there is, if you're interested in Board look at how the shipping companies are doing in terms of revenue and profits and you'll be amazed. A container used to cost somewhere around $3,000 to $4,000 to prance and ship parts from China to the states that's now up to $16,000 to $18,000 per container.

Yeah. Yeah, it's amazing. Yeah.

And that's when you can get one. And that's when you can get somebody to put it on a boat, and that's when you can get somebody to take it off of a boat and load it on to a choo-choo train.

Yes. How much freight cost, did you have that you were not able to pass along to customers in this quarter?

We're going to try to recover as much as possible. Many of our manufacturing agreements in fact, most of them allow us to for cost reimbursement. At the point in time, there are cost increases that we can't control. Most of that is always a battle. I would just rough guess, I'd say, more than half has been reimbursed, and we're seeking for additional reimbursements as we go.

Just to understand, what you said 1.5 numbers – you mean $1.5 million?

Sorry, more than 50%.

More than 50%?

More than 50% of our cost increases related to freight have been reimbursed by our customers.

And how much would that 50% be? What would be a number for that?

That would be difficult to quantify.

Okay. Okay. Great. Okay. And – so if your gross margin could be in normal circumstances with your current demand north of 9%, what would be the main factor that would make that difference?

It would be the ability to actually build revenue that we could sell. It would be the ability to build it without a bunch of overtime and downtime. And it would be the ability to pay normal shipping costs, and it would be the ability to not have so many increases coming at us, at once that we could efficiently negotiate with our customers and pass along those costs that are actually or seen in our contracts, but just because it's in the contract doesn't mean you don't have to go negotiate it and prove it.

Okay. And then just one final question for me. I mean this has been amazing to China times from an operation perspective. Are you a stronger organization now than 18 months ago because of all that you've had to do? And, sort of, what have you learned that will help you become even better in the future?

We've gotten a lot better at forecasting and at understanding how to deal with uncertainty in the supply chain and how to lay off risk. That's why we're anticipating being able to drive inventories down. We've gotten better at moving people around in the factory. We've gotten better at talking with our customers about -- this is -- we have to work on this together. This isn't just a situation where Key Tronic can take the hit. We've gotten better at understanding how to make it clear to somebody who is in crisis because of choices they made years ago to over centralize their outsourcing. That's a tricky conversation to have with the customer. And we've got quite a bit better at that because it's been happening so much more.

Okay. Great. Thank you very much.

Yes. Thanks, George.

We'll take our next question from Bill Dezellem with Tieton Capital.

Thank you. Two additional questions. First of all, what's the backlog at the end of June and versus March?

We gave up looking at backlog because our customers do it so many different ways depending on the contract we have.

I don't have that readily available Bill. It doesn't mean a lot to us just based on timing of when we actually get purchase orders and forecasts and the likes.

So I was under the impression that say two years ago backlog really wasn't that relevant. But as the logistics and supply component issue tightened up then it did become more representative. Is that now changing? And so when the 10-K comes out we shouldn't focus on that like we would have in the past couple of quarters?

We've been pretty clear all along I think is we don't want you to focus on backlog.

You of course can look at it from a directionally – directionally, but definitely not to be able to define how much future growth Key Tronic will have.

Great. Okay. Thank you. And then secondarily with the COVID Delta variant starting to pick up are you seeing any increase in demand from your customers that have products that would benefit from health emergencies?

No. We don't see -- I'm trying to think about how to answer that because -- some of the products that had a massive increase in demand were over forecasted and are now burning off inventory. So I can't really tell you if that inventory is burning off quicker, because Delta has come along or not. We are seeing pretty big whipsaw between where we were six months ago where we are today and what's forecast for next quarter on some of those health care products. So way high a sudden drop as everybody thought COVID was over and inventory should be burned off and then a pickup again that may be stronger than what it was originally forecast in our Q2, but I can't be certain of that.

Thank you. So these customers that do have health care related products, do they tend to sell them domestically or are they selling them globally? So if Indonesia, for example, has a pickup in COVID that becomes real problematic they just shift sales in that direction?

Tends towards being global and it's shiftable if that's a word in many cases, but not all, because sometimes packaging and certain features are specific to the location.

And would it be fair to guess that the shiftable, I like that term is really between countries that have the economic wherewithal, and some of these countries that are less economically vibrant just aren't going to be getting the products?

No, that doesn't seem to be the factor there that drives it. It seems to be more the demand it needs for the product.

All right. Thank you for taking additional questions.

You bet.

[Operator Instructions] We'll take our next question from George Melas with MKH Management.

Thank you guys. Just two quick follow-ups. The customer that you got in the third quarter that you were talking about earlier that required a lot of new square footage has that customer ramped up in the fourth quarter?

No. We don't expect to have revenue from that customer. I think we've disclosed until latter half of fiscal year 2022.

Okay. So that means for that customer you have some cost right now, but you have no real revenue?

Correct.

Okay. Great. And then just a question about concentration, do you have more than one 10% customer in this quarter or just one?

We do not, just one.

So just one? Right. Thank you very guys.

Thanks, George.

At this time, we have no further questions in queue. Mr. Craig Gates, at this time, I will turn the conference back to you for any additional or closing remarks.

All right. Thanks everybody for participating in today's conference call. Brett and I look forward to speaking with you again next quarter.

This concludes today's call. Thank you for your participation. You may now disconnect.