Good day, and welcome to the Second Quarter Fiscal 2023 Key Tronic Corporation Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Brett Larsen. Please go ahead.

Thank you. Good afternoon, everyone. I am Brett Larsen, Chief Financial Officer of Key Tronic. I would like to thank everyone for joining us today for our investor conference call. Joining me here in our Spokane Valley headquarters is Craig Gates, our President and Chief Executive Officer. As always, I would like to remind you that during this course -- 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 ended December 31, 2022. For the second quarter of fiscal 2023, we reported total revenue of $123.7 million compared to $134.5 million in the same period of fiscal 2022. For the first six months of fiscal 2023, our total revenue was $261 million compared to $267.2 million in the same period of fiscal 2022. As previously announced, our revenue for the second quarter of fiscal 2023 was impacted by a six-week delay in starting production for a large program with a leading power equipment company. This delayed revenue by approximately $20 million from the second quarter of fiscal 2023, but production for this program is currently underway and increasing in the third quarter. While constraints in the global supply chain continued to limit…

Okay. Thanks, Brett. We're pleased with the successful ramp of new programs and our expanding customer base in the second quarter of fiscal 2023 despite six-week delay for production from the large previously announced power equipment program. Production for that program is now back on track and rapidly ramping up. In essence, the revenue from that program simply pushed by a quarter. During the second quarter of fiscal year 2023, we continue to see the favorable trend of contract manufacturing returning to North America. Currently awarded new business has created backlog that will support over 65% growth in the U.S. sites over the next fiscal year. We won new programs involving outdoor power equipment, battery management, automated sprinklers and biometric sensor technology. We move into the third quarter with record backlog and we're seeing improvement in the global supply issues for certain components that have severely limited our production in recent periods. Global logistics problems, the war in Europe, China-U.S. geopolitical tensions continue to drive OEMs to examine their traditional outsourcing strategies. We believe these customers increasingly realize they had become overly dependent on their China-based contract manufacturers not only for product but also for design and logistic services. Over time, the decision to onshore or nearshore production is becoming more widely accepted as a smart long-term strategy. As a result, we see opportunities for continued growth. As we've discussed in prior calls, we built Key Tronic to offer the ideal solution for customers as they move to respond to geopolitical pressures. Our facilities in Mexico represent a campus of 1.1 million square feet in Juarez, most of which is [contiguously] (ph) located in nine facilities acquired over time. Our three U.S.-based manufacturing sites have also benefited greatly from the macro forces driving business back to North America. Moreover, our…

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

Thank you. Let's start, if we could, with the power equipment customer that had the delays and that led to the preannouncement. Walk us through, if you would, what happened there? And what if anything that Key Tronic could have done to influence those revenues coming in sooner?

Well, Bill, I'm not sure I can be as specific as you would like about what happened there. I can, in general, only say that it was a brand new program on a brand new product that we shared in the joint design and development thereof. There were delays all across the board. In fact, the final delay was the artwork for the packaging. So, we were six weeks off out of a 11 months design program, which was pretty annoying. But on the other hand, we got it done. And in fact, we mentioned the new programs involving outdoor power equipment, that same customer has just awarded us another piece of business on another product. And before you ask me, it's about $11 million.

That's quite helpful. And congratulations on that next piece of business.

Yes, thank you.

Continuing with them, so -- since I've never been in the position of doing artwork for packaging, six-week delay sounds like a lot, but walk us through kind of that? That just seems extreme to me.

It is actually more common than you would hope in our business, where we are manufacturing a product for a customer that is selling it to a retail customer. So, retail packaging, as you know, is very, very critical for sales and product market acceptance. And unfortunately -- or probably fortunately knowing how artistic I and the rest of my engineers are, we have no say in the artwork. And it's a joint agreement that has to happen between our customer and our customers' customer. And it's a joint agreement that has to happen between quite a few artistic people. So, it's fairly common that we are, with our backs against the wall, trying to get either packaging or artwork for packaging done and approved and actually produced. In fact, we're looking at a big upside right now for a different product, and yet again, the delay is our ability to get packaging in time with the customer's increased demand into a new market.

Fascinating. Thank you. And so, with this power equipment customer, just to help us have a perspective of the trend line that's taking place, what was the revenue level in October, then the month of November, the month of December and then in January? What does that look like?

Pretty easy, Bill, zero, zero, zero. And then, January...

Yes.

What?

At least one more month of January. Go ahead.

Yes. I'm not going to comment on what it was in January, but it was a lot more than zero.

And are you able to talk about what the peak level of production will be for this customer?

No.

And is January, probably not at the full run rate given that they were zero in December, so that will be even higher in coming months?

Yes, right now we're at about five-eighth of our required run rate after really about three weeks of full production.

Okay. That's helpful. And then, originally, if I have the right customer in mind, I think you had a press release that stated that you anticipated that they would be an annual run rate of about $80 million. Is that still this piece of business is looking like? I'm excluding the new piece of business that you won, but just this original piece of business?

This original piece of business, we expect to be somewhat less than that in this first period as far as an annualized run rate. But at the beginning towards the middle of next fiscal year, it should be up to that number for a run rate.

Okay. That's quite helpful. Thank you. And then, you did allude to the fact that I asked about the new product wins and the size. Would you talk through the other three in terms of the size? And then, whatever discussion that you have on these four wins would be helpful.

The other three were around [$5 million] (ph) each.

Okay.

Those would be headed into the Midwestern facilities. And those are pretty -- what's the right word, those are pretty representative of what the Midwestern -- the three sites in the Midwest have been winning at a really amazing rate over the last year. When we said that they're going to be over 65% growth, that's pretty astounding since they had been basically stable for the last 4.5 years, 5 years. As I've always told you, we expected everything that's happening to happen. It was a little bit delayed, but now it's actually happening to a larger extent than we thought it was going to. So, they -- the folks in the Midwest are uniquely constituted to run programs in the $1 million to $10 million range. And these size programs just continue to come in over the transom and then be gapped and hooked and cleaned. That is just an amazing rate to me. It's been really, really fun.

And presumably -- even though it's maybe more exciting for us externally to talk about a large customer, presumably these smaller ones, I'll call them bread and butter ones, are higher margin than a large piece of business?

Yes, you can pretty reliably predict that something that's going to be run in the U.S. facilities is lower volume, higher margin, stickier overall and typically quicker to develop also, unless there's a design program that went with it.

Thank you. And I don't want to take up more than -- more time than I should here. But I would like you to talk through the change that's taken place with the U.S. facilities or the Midwest facilities, going from essentially flat for a number of years to this accelerated growth. What happened? What changed to lead to this?

Well, as we said in the narrative, as more and more of the general agreed opinion is that it's risky to be overseas. And the size of the company that will command the attention that you need to be successful with that piece of outsourced business continues to grow more and more of the smaller pieces of business that just automatically went to Asia are now more automatically staying in the U.S., as Asian prices have gone up, as uncertainty with Asian supply has increased, and as the friction -- the business friction of doing business overseas has become more generally acknowledged. It's just so much different than it was five years ago when every piece of business we won, we had to dig out from under a rock. Business is now coming to us. And people aren't just kicking tires. People are -- have been given edicts by their corporate leaders and business leaders to get stuff out of Asia because it's too risky.

Thank you. And did we hear correctly that your quotes you said were up eightfold from one year ago?

Yes.

Yes, it's -- we -- as you know, we've been doing this for a while now and we used to have probably five, six years ago, we'd sit around and agonize over four or five big quotes that we had to land one of them in order to replace the leaks out of the revenue bucket and maybe grow. And now we've got four pages of single-line quote opportunities that are all of them have passed our screening process, all of them are real opportunities, and it's just -- it's hard to even fathom as you -- for somebody like me that's been through what we were going through four, five years ago, but it's really fun.

Great. Thank you very much. I'll give someone else an opportunity.

Our next question comes from Sheldon Grodsky with Grodsky Associates. Please go ahead.

Well, good afternoon, everyone. First question I'm going to ask is the Arkansas facility, is it fully up and running, or is it still being repaired or what's the status?

It's probably 90% up and running, and that's a bit more down to the weather than it is anything else. We just had the last machine arrive today in the snowstorm and everybody's home, but the General Manager and the VP are out there driving forklift trucks and getting it off of the trailer.

Okay. Well...

[indiscernible]

But, yes, it's -- like I say, it's 90% and they had a good couple of weeks, last two weeks, and so we'd expect that to continue to ramp.

Okay. And as far as the insurance situation, there may be more money coming in from that as things get determined, or do you expect it to be neutral from here?

No, I think there's going to be some more coming in. Our insurance policy was well written and the company has been very forthright and honorable, which has been a -- in the world we live in today, it was a very pleasant surprise. They've been good people.

So, anyway -- yes, I'm sorry.

So, the cool thing about that is that the equipment that we have replaced was aged, but the policy was for replacement. And as we said in the narrative, just to put some flesh on those bones, the stuff we got in there now is five times as fast. And so, that has a very massive impact on capacity and cost out of that Arkansas facility.

Okay. Now I don't know how to phrase this question, but based on what you're saying, you're seeing probably at least in the short or medium term more demand than you can actually meet in a relatively short period of time. Are we looking forward to a major growth cycle for Key Tronic as far as you can tell?

Just from a macro sense of what's happening in the world and as I've gone through the various metrics that we analyze and I think are relevant, it certainly seems as if we should be looking at a very nice growth rate for us going forward.

Well, I've been following your company for a long time and it always seems that something gets in the way of getting to the bottom-line. So, I just keep on hoping every quarter that we're finally going to break out of that and get some real sense of what potential you can do here. So, I wish you good luck and that the world hasn't been an easy place to operate. So, let's hope it gets a little bit easier for you and you are able to pick the right contracts, et cetera. I'll let someone else take the floor with question.

Okay. Thank you.

Thank you.

Our next question comes from George Melas with MKH Management. Please go ahead.

Thank you. Hi, Craig. Hi, Brett.

Hey, George.

Sort of I want to follow-up on the two previous callers. And sort of want to sort of look into the future, and I think you're saying that quoting is very strong, that has an impact on pricing, on business terms, you can choose your customers better. But then, I guess you have to make some kind of balance between growth and margins. And I'm wondering how you think about that. I'm always thinking about margins and where could those margins go. And is there sort of an idea that maybe the idea would be to grow X percent in order to reach 9% margins or 9.5% margin? Can you sort of elaborate on that? I don't know if it makes sense, but maybe I'd love to have a discussion on that.

Well, what I was trying to say, I'll just try to do a better job of explaining is that five, six years ago, actually from the time we became a contract manufacturer until about a year ago, we were ahead of our time in predicting that what's happening now is going to happen. And so, very much so at the beginning of our contract manufacturing days, it lessened over time. And then, no commentary on the goodness or badness of Trump, but certainly the Trump Presidency sped up the realization of what we already knew was going to happen and then COVID accelerated it even further. So that's -- the difference between now and the old days, let's call it before the pre-realization that overseas is risky, so the difference now is that we would be sitting in a room, doing the final negotiations with the customer and the customer would say, "Well, we're close to a deal, but you need to drop your margin by a 0.5 point because you're higher than these other guys." And we would be sitting there sweating bullets trying not to show the fact that we desperately needed that deal to happen. And so, we would act as good as we could act and they would see through us or not see through us depending on how perceptive they were and how good we were acting on that day. And we would get driven down to where our margins were. At the point where -- it was basically at this point, we don't care anymore. If we lose this business even though we really want it, we're going to have to walk away. And today, the situation is quite a bit different. When our prospective customers starts down the road of -- this is…

Okay. And then, that is really driven by, A, your design capability? And two, sort of -- that you sort of becoming a one-stop shop for really being able to not just do component, but a whole box, a whole product, right? And it's interesting because you're talking about patching some delay in the artwork, in the packaging, because it means that you're going to put your product in that packaging and then it goes directly to the retailer. So, it's a finished product.

Yes.

So, those are two of the key capabilities that you have in queue sort of the real advantages that you have in the marketplace system?

Yes. And to give you an example, one of our pieces of business, new piece of business is probably the perfect embodiment of the overall macroeconomic process that we're watching and that we predicted and that we're enjoying. So probably, I'm going to just give you this for an example and I apologize, this is going to take -- I'll time it, but I can do it in less than two minutes. So, 30 years ago, a guy invented a new product that required a pretty complex manufacturing process, all kinds of welding and vacuum forming and hydro forming. And 20 years ago, that product moved to a town in China and a number of his competitors also copied him, and then moved their product to a town in China. So, that town in China became the world's preeminent location of manufacturing that type of product. And then, as time went by, in the last two or three years, that company and their competitors realized that in order to really service the market here, they needed to have a lot less than 12 weeks uncertain ship time over the ocean and a slight increase in price was more than offset by the increase in business and margin they could make by having a much quicker turn. And so, they chose us to bring that manufacturing back to Mexico. So, it left the West Coast of the States, went to a town in China, and now it's come back to our factory in Mexico. So, we are, in fact, reverse engineering the Chinese who reverse engineered the guy [indiscernible]. And I just find that to be an amazingly big circle of whatever you want to call it that's going on right now. But that is exactly what's going on in many different industries. In some cases, our customers have lost the knowledge and ability to manufacture. In other cases, they've lost not only that, they've lost the ability to design and manufacture. So, as we talked about the re-industrialization of the U.S. and the industrialization of Mexico, that's the perfect example. And that was a minute -- two minutes and 10 seconds, so I just overshot that.

I think nobody was keeping track, Craig, but that's great. Okay. Let me push you a little bit more on margins. What are the margins goal that you would like in, let's say, fiscal '24? What is it from a gross margin perspective -- because they've fluctuated, and I think we were always trying to gunning for 9% or slightly above 9%, but we fall in short. What would be your goal?

I don't know, George. I keep telling you, I'm not going to give you a number for your equation because I can't. I hope it's better than that. From what -- if I look forward from what I'm seeing, if nothing goes wrong, it should be better than that. But something always goes wrong.

Okay. And then, from a growth perspective, how much growth is too much growth? How much growth would be very difficult to manage? Is 20% growth sort of a good number? I mean, 20% is a lot.

Well, if you take the Midwestern site as an entity, which they used to be, they are going to manage 65% plus growth in the next half a year. And I don't see that there's going to be any significant problems within the operations in doing that. There may be problems with getting parts, but in terms of managing it, I don't see an issue.

Okay.

There are -- every piece of business is different. Some of it is highly IQ point intensive to bring in. Some of it is just a simple slam dunk moving a PCB assembly from our competitor to us. So, all those factors go into my answer of, I don't know, but certainly a lot more than what we've done in the past is possible.

Okay. Great. Okay. Thanks for those very precise guidelines.

Yes. 9.276%, so just plug that in there, we'll be good.

Exactly. Thank you very much.

Okay. Bye.

Thanks, George.

Our next question comes from Bill Dezellem with Tieton Capital. Please go ahead.

Thank you. So, you had mentioned that the outdoor power equipment company had awarded you another $11 million piece of business. Given that you have -- they presumably awarded that before you had actually produced any of the current program for them, what led them to, to want to give you more business before you had done any?

Well, we've been interacting with them for over a year now. We've had people in their factory and they've had people in our factory for over a year. We've been in the design process for over nine months. We started quoting on this new piece of business while we were still trying to get the current design done. But in fact, it wasn't awarded to us until just last week. So, it wasn't really awarded until they saw the first chunk of [indiscernible] first chunk of product go off the back door.

Congratulations. Okay. That does help. And then, let's talk a little bit about Vietnam. You had mentioned that customers or prospective customers can now go and tour the factory. What does the prognosis look like for filling that factory?

It looks very hopeful to the point that we have looked at, land availability close to the factory.

And since I have not been to that factory, what does the availability of land facilities and labor look like in that near area? Is it as convenient as Juarez where literally everything is contiguous?

So far, yes.

And what level of expansion are you currently considering?

We're not currently considering anything. We're just beginning to think it would be wise to have a good understanding of what's close and how fast it's going to get gobbled up by other folks.

And then, what about the labor factor, Craig? What...

Labor still looks good in the region we're in. Some of the other regions are getting tighter, but where we're at looks very good so far.

Okay. That's helpful. Thanks. And then, speaking of labor...

Hey, Bill, speaking of labor, maybe we're going to the same place. In the last two months, we've hired 1,000 people in Juarez.

And how does that compare to a normal amount of hiring that you would do? Because presumably some of those people are replacing those who have left and just the whole great resignation concept, but talk to us about that.

I'd say the normal number over that period would be maybe a couple of hundred.

And that period was what again?

Couple of months.

I thought you said. So, normal run rate of 100 people a month, you'd be hiring and now you're hiring 500.

Yes.

That might -- okay. So, that might start to answer my next question, which is wage pressure in Mexico accelerating, decelerating or kind of what's your view of what's happening there?

Well, it feels to us as if the wage pressure is flattening out.

And what do you attribute that to?

Too many factors to mention.

Okay. And are you a bit surprised that as you're trying to hire five times as many people as you normally would in a period of time that you're sensing the labor pressures or wage pressures are mitigating? I mean that sounds pretty positive.

Well, I'm kind of enthralled with the whole demographic situation across the globe. And if you spend some time looking at that Mexico and the States are basically uniquely positioned compared to the rest of the world, and the fact that we aren't about to age ourselves into oblivion. And so, I would expect that even though they may raise prices by law in Mexico, the availability of generally younger people who are looking to start their professional life continues to be good in Mexico and in the States compared to the rest of the world.

Right. Yes. Okay. Well, thank you. Appreciate it, and look forward to seeing the coming quarters growth. Thank you.

Yes.

Thanks, Bill.

Our next question comes from Sheldon Grodsky with Grodsky Associates. Please go ahead.

Okay. Well, you're tempting me as I listen to all these questions and answers and you've mentioned that your bidding activity is going up at an extraordinary rate and your backlog is growing rapidly. How much do you think you could increase unit volume? I know units are all different in this business, but how much do you think you could increase unit volumes if you had the contracts in hand in -- let's say, in the next two years? Are we talking 50% or 100%? It sounds like you're not -- we're not talking about 20%.

Sheldon, I don't want to be dismissive of your question, but in the reality that we face, I can't answer it. Because we have pieces of business that are $8,000 per printed circuit board and we have other pieces of business that are $0.15 for a sensor. So, when I talk about -- when you ask about unit volume, it's just -- it's impossible for me to even answer. There is square footage that we have availability of. The equipment to replicate lines continues to get faster and faster for a given dollar of expenditure. And the availability of that equipment, which used to be almost unobtainium is now getting better. The big question for us and you as an investor is, do we see a big recession coming or do we see the improvement in commodity availability and unemployment and everything else kind of swamping over the efforts of the Fed to drive inflation down, that's more to the question of what's going to happen to our growth, then is our ability to add three or four SMT lines in $1 million a piece.

What do you think the -- aside from the macro economical, you've just been dealing with a few years of craziness between COVID and supply chain difficulties. What do you think would be the major constraint? Again, aside from the general macro economy, what would be the biggest constraint on your growth? Would it be in the design side? Would it be on the manufacturing side? Or just on the marketing side?

I think the major constraint at this point would be continuing to absorb programs while providing the level of service that a new customer expects and demands. I don't think you guys had -- it's not to say that you're foolish or dumb or anything, because I'm not saying that, but I don't think you have an appreciation -- I don't think you have an appreciation for what has to happen to move a program from a competitor to our factory or to start up a new design and move it into our factory, it's incredibly complex. I think -- I don't know if I shared with you guys that we buy over 2 billion components in a nine-month period. So, every one of those components has to get into our system, has to get purchased at a timely period, has to be purchased at the right price, has to be delivered through whatever delays are happening, and has to get through our incoming inspection, and has to be used in a way that has been documented and laid out by our engineers. So that process is incredibly taxing and time consuming. So, it's a soft constraint rather than a, do we have enough square feet? Do we have enough mold machines? Do we have enough placement machines? Do we have enough stampers? And each piece of business can be dramatically different. You can have a customer who doesn't even have his bill of material anymore, because he's been in China so long that he's just been counting on his China suppliers to do it for him, doesn't have any engineers anymore. So, there's really nobody we can even talk to about what's important and what's not important about the design. Doesn't have a pipeline of components ordered. So, depending on lead times, it could take nine months to a year to get components here, and who has got a bad relationship with the supplier he's leaving. And so, the ability for us to step into that pipeline and just assume POs is very minimal. So, I guess that's a very long-winded answer, but it's why I can't just give you a simple percentage.

Okay. I won't hold it against you.

I'm trying my best.

Thank you.

Our next question comes from Bill Dezellem with Tieton Capital. Please go ahead.

Thank you. I thought I was done. But Craig, I'm going to take the bait. You referenced the economic environment. What insights or indicators do you have of weakening economic environment versus not?

I read all the stuff I can get my hands on as far as what people are predicting and then I try to compare that to what we're seeing from our customers. We have yet to see any indication whatsoever of a broad-based slowdown or push out of orders. We have seen people who cut their forecast coming back with, "Oh God, we need upside now." That has been more prevalent than people cutting their forecast and leaving it cut. We do see a better availability, as I said previously, on SMT equipment, which is said to be a leading indicator. We do see a better availability of componentry, but better is a relative term, it still sucks. We still see inflation in component costs. We see people coming in just today a component that goes on one of our highest volume products, that integrated circuit manufacturer came in with the about a 4% increase, and it's not a less negotiated about it. It's a take it or leave it. We got other people that want to buy it. So, as of right now, I don't see a broad-based slowdown coming. But that seems to be in conflict with everything I read and hear from people that are talking about it. So, right now, we've become as a result of everything we learned during COVID, we've become very hardcore on forcing our customers to pony up for any upsides or on the [comforts] (ph) we make. Because we're being extra cautious due to the fact that the world thinks a recession is coming. So, I don't know, you're the more economist than I am, but that's what we see from our order book and from our purchase book.

Thank you. Appreciate the insight.

Less insight and more data. But, anyway.

Appreciate the data.

Yes.

This does conclude today's question-and-answer session. I will turn the call back to Mr. Gates for any additional or closing remarks.

Okay. Thanks again to everybody for participating in today's conference call. Brett and I look forward to talking to you all next quarter.

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