Key Tronic Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 6, 2024

Key Takeaways

  • Total Q2 revenue rose 18% year‐over‐year to $154.4M, driven by increased production in the U.S. and Vietnam and the sale of $8.1M of discontinued program inventory.
  • Inventory and contract assets were reduced by 24% year‐over‐year, boosting inventory turns to 3.8x from 2.6x and improving working capital.
  • For Q3 fiscal 2024, the company anticipates revenue of $135M–$145M and net income of breakeven to $0.15 per share, reflecting a $1M–$2.5M severance charge for Mexico headcount reductions.
  • Mexico facilities will be restructured into a lower‐cost, commodity‐focused service provider, with severance payback expected in under six months.
  • Key Tronic is capitalizing on the trend of onshoring from China, winning new programs in security, medical devices, and military aerospace, and sees a strong pipeline in the U.S. and Vietnam.
AI Generated. May Contain Errors.
Earnings Conference Call
Key Tronic Q2 2024
00:00 / 00:00

There are 6 speakers on the call.

Operator

Good day, and welcome to the 2nd Quarter School 20 24 Key Tronic Corporation Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Brett Larson. Please go ahead.

Speaker 1

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 and Tony Voorhees, our Vice President of Finance and Corporate Controller. 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.

Speaker 1

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 ks, quarterly 10 Qs and 8 ks. Please note that on this call, we will discuss historical financial and other 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.

Speaker 1

Today, we released our results for the 3 months ended December 30, 2023. For the Q2 of fiscal 2024, we reported total revenues of 154 point $4,000,000 up 18 percent from $123,700,000 in the same period of fiscal 2023. Revenue growth for the Q2 of fiscal 2024 was driven by increased production at our U. S.-based and Vietnam based facilities, as well as by the sale of approximately $8,100,000 of inventory from a discontinued program. For the 1st 6 months of fiscal 2024, total revenue was $293,200,000 up 12% from $261,000,000 in the same period of fiscal 2023.

Speaker 1

For the Q2 of fiscal 2024, our gross margin was 8.1% and our operating margin was 2.7% compared to gross margin of 7.2% and an operating margin of 2.9% in the same period of fiscal 2023. The increase in gross margin for the Q2 of fiscal 2024 reflects a favorable product mix for the quarter and improved operating efficiencies. In recent periods, our improved production efficiencies, strategic labor cost reductions And the gradual stabilization in its supply chain have been largely offset by the strengthening of the Mexican peso relative to the U. S. Dollar and increasing labor costs in Mexico and in the U.

Speaker 1

S. For the Q2 of fiscal 2024, net income was $1,100,000 or roughly $0.10 per share compared to $1,000,000 or $0.09 per share for the same period of fiscal 2023. For the 1st 6 months of fiscal 2024, Net income was $1,400,000 or $0.13 per share compared to $2,100,000 or $0.20 per share for the same period of fiscal 2023. As we've discussed, our profitability in the fiscal 2024 continues to be negatively impacted by increased labor costs in both the U. S.

Speaker 1

And Mexico and by higher interest rates on our line of credit. Turning to the balance sheet, we ended the Q2 of fiscal 2024 by reducing inventory and contract assets, which are finished products by approximately $48,300,000 or roughly 24% from the same time a year ago. These improvements in inventory levels primarily reflect increased component availability and our concerted efforts to drive inventory reductions. Total inventory turns increased to 3.8 times in the Q2 of fiscal 2024, up from 2.6 turns a year ago. We are pleased to see our inventory levels continue to become more in line with our current revenue.

Speaker 1

At the same time, the state of the worldwide supply chain still requires that we drive demand for parts differently than in historical periods. Our customers have revamped their forecasting methodologies And we have significantly modified and improved our material resource planning algorithms. As a result, we should be better equipped for future disruptions in the supply chain, even as we continue to manage inventory more cost effectively. During the Q2, we also reduced our accounts payable, leasing obligations and overall debt by a combined amount of $51,000,000 from a year ago. At the same time, accounts receivable DSOs was at 85 days compared to 78 days a year ago, which we believe reflects some increased delays in collections from certain customers, despite continuing improvement of most customers with respect to disruptions from supply chain issues.

Speaker 1

Total capital expenditures were about $2,100,000 for the Q2 of fiscal 2024, And we expect total CapEx for the year to be around $8,000,000 While we're keeping a careful eye on capital expenditures, We plan to continue to invest selectively in our production equipment, SMT equipment and plastic molding capabilities, utilize leasing facilities as well as make efficiency improvements to prepare for growth and add capacity, particularly in our U. S. And Vietnam locations. For the Q3 of fiscal 2024, we're seeing steady demand for most established programs relative to our Q2. As previously announced, The large program with a leading power equipment company is now expected to resume materially in fiscal 2025 with a redesigned product.

Speaker 1

For the Q3 of fiscal 2024, we expect to report revenue in the range of $135,000,000 to $145,000,000 While new programs continue to ramp in our Mexico facilities, Efficiency improvements, a muted rebound to pre COVID production levels amongst existing Mexico customers and a continued pressure of a strengthened peso have combined to create an excess of overhead in our Juarez facilities. After careful consideration and analysis, we expect to incur a severance expense of approximately 1,000,000 to $2,500,000 from headcount reductions in our Mexico based operations. These severance expenses are unfortunate, but a clear requirement. Among other considerations, the payback period for this decision is expected to be under a half of the year. Taking all these factors into consideration, we expect net income in the range of breakeven to $0.15 per diluted share.

Speaker 1

In the second half of calendar twenty twenty four, we expect continued sales growth in the U. S. And Vietnam, and we have a strong pipeline of potential new business. Over the longer term, we believe that we are increasingly well positioned to win new programs and to continue to profitably expand our business. That's it for me.

Speaker 1

Craig? Okay. Thanks, Brett.

Speaker 2

During the Q2 of fiscal 2024, we continue to ramp many new programs produced in our U. S. And Vietnam facilities and we remain profitable. We're also pleased to see improvements in our operating efficiencies, inventory levels and other improvements made on the balance sheet. Moving into the Q3 of fiscal 2024, we continue to see the favorable trend of contract manufacturing returning to North America.

Speaker 2

As a result, we continue to expand our customer base and won new programs involving security products, medical devices and military aerospace. Global logistics problems in China U. S. Geopolitical tensions continue to drive OEMs to examine their traditional outsourcing strategies. We believe these customers increasingly realize have become overly dependent on their China based contract manufacturers for not only product, but also for design and logistics services.

Speaker 2

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 and those opportunities are becoming more clearly defined over time. At the same time, we are seeing a sustained trend of a strong Mexican peso and continued wage increases In Mexican wages, particularly along the U. S.-Mexico border, as it has become clear that these changes in the base cost of Mexican production are longstanding It has also become clear that customers have a different calculus for selecting a geographic location for business they are bringing back from China. For those customers who struggled with China production due to their flexibility needs, the decreasing cost differential between our U.

Speaker 2

S. And Mexico plants means they will probably choose one of our U. S. Sites. There we believe they can enjoy the ultimate in flexibility, engineering support and ease of communication.

Speaker 2

Meanwhile, for those customers whose requirements had adapted to the China model of limited flexibility, Challenging communications and slow motion engineering support, our Mexico facilities remain the answer. Therefore, we are reconfiguring our Mexico sites to endeavor to be a lower cost, high quality, but more commodity level service provider. Over the past 12 months, revenue from our U. S. Production facilities has increased approximately 15%.

Speaker 2

In Q2 of 2024, production in the U. S. Represented about 31% of our total revenue. While our Vietnam facility continues to be a modest contributor to our over revenue at approximately 4%, Production there has increased by about 29% over the past 12 months. Moreover, a growing number of potential customers actively evaluating a migration of their China based manufacturing to our facility in Vietnam.

Speaker 2

In the coming years, we expect our Vietnam facility to play a major role in our growth. While China growth has slowed and many companies have decided to take risk mitigation steps with their China manufacturers, the fact remains that many components must be sourced from China. Our procurement group in Shanghai, which serves the entire corporation remains important for managing the China component supply chain on an ongoing basis. The combination of our global footprint and our expansive design capabilities is proving to be extremely effective in capturing new business. Many of our large and medium sized manufacturing program wins are predicated on Key Tronic's deep and broad design services.

Speaker 2

And once we have completed a design and ramped it into production, we believe our knowledge of a program specific design challenges makes that business extremely sticky. We also invested in vertical integration manufacturing process knowledge, including a wide range of plastic molding, injection blow gas assist multi shot as well as PCB assembly, metal forming, painting and coating, complex high volume automated assembly and the design, construction and operation of complicated test equipment. This expertise may set us apart from our competitors of a similar size. As a result, a customer looking to leave their contract manufacturer will find a one stop shop in Key Tronic, which is expected to make the transition to our facilities much less risky and cobbling together a group of providers each limited to a portion of the value chain. In fact, most of the new customers we have onboarded take advantage of the one stop shop capabilities we provide.

Speaker 2

We believe global logistics problems, China U. S. Political tensions and heightened concerns about supply chains will drive We'll continue to drive the favorable trend of contract manufacturing returning to North America as well as to our expanding Vietnam facilities. We continue to see improvement across the metrics associated with business development, including a significant increase in the number of active quotes with prospective customers. We move into the second half fiscal twenty twenty four with a strong pipeline of potential new business.

Speaker 2

While we're seeing some improvement in our gross margin, recent wage increases, higher interest rates and a strong peso will dampen our growth and profitability in the near term. Moreover, we will continue to rebalance our manufacturing across facilities in Mexico, the U. S. And Vietnam. We remain very encouraged by our progress and potential for growth over the long term.

Speaker 2

In preparation for our future, we recently announced our leadership succession plan beginning June 30. I'm very pleased that our Board of Directors named Brett to succeed me as President and Chief Executive Officer. I expect to remain a member of the Board. We're most fortunate that Brett joined Key Tronic in 2,004 and has served as our Executive Vice President of Administration, Chief Financial Officer and Treasurer since 2015. He has assumed ever increasing roles and responsibilities over the past 20 years.

Speaker 2

Fred and I have worked very closely and he has been a critical member of the management team formulating and executing our strategies over the years. In addition, Tony will be promoted to Executive Vice President of Administration, Chief Financial Officer and Treasurer. Tony has served in various financial management roles with us since 2010 and has worked closely with Brett for many years. I am confident Brett, Tony and their outstanding team will continue to take Key Tronic to new heights. This concludes the formal portion of our presentation.

Speaker 2

Brett, Tony and I will now be pleased to answer your questions.

Operator

Your first question comes from the line of Bill Dezellem with Tieton Capital. Please go ahead.

Speaker 3

Thank you. First of all, congratulations to all 3 of you for retiring and promotions. So let's start with my normal first question. Would you discuss each of the 3 program wins In terms of size and then any interesting details around them, please?

Speaker 2

Yes, the security products are between $10,000,000 $20,000,000 a year And that's with an existing customer. The medical devices are around, I don't know, 2 to 5 And military aerospace is around 3 to 10. So the medical devices and the military are both new customers.

Speaker 3

So many military and or aerospace products have very high level of qualifications that are required. I mean, sometimes we wonder if it's to the point of excess And then next thing you know, a door blows off the plane and maybe it's not the excess. So my question is, did you go through some higher level of qualification than would be normal for a security product or HVAC product or anything of those nature?

Speaker 2

Yes.

Speaker 3

And would you like to expand on that further?

Speaker 2

Okay. There are two aspects of that. One is we were concerned since this was, I guess, really our first significant Military Aerospace program in quite some time that the contractual requirements would be So far, our line that we can never reach a common ground with the customer. And that turned out to be unfounded. So even though we started a long way apart, it seems like We're going to be able to make that work as far as a contractual relationship goes.

Speaker 2

Then as far as the actual manufacturing capabilities and qualification capabilities And in fact, in this case, specialized manufacturing equipment did go through a significant qualification period and analysis by our new customer to determine if indeed we could get there. And then the some of that is going to continue to serve us well with other prospective military customers and aerospace customers.

Speaker 3

And Craig, is this a customer that is of a size That would give you the opportunity for a significant amount of business over the coming years if this program is successful?

Speaker 2

Yes, it's one of the big guys.

Speaker 3

Great. Thank you. And then I believe on the last conference call, there was a fair amount of uncertainty that you interjected into what you were seeing in the macro environment and with your customers, many or I shouldn't say many, some of which that you said that you were seeing a pullback in demand. At that point, I believe you said it was nothing that You were panicking over, but directionally the arrow was pointed the wrong way. This quarter, did we hear correctly that demand is stable and so you would have a different perspective now than you did then and I'm hoping you'll kind of talk around those various points, please.

Speaker 2

Okay. This quarter, We would say that the demand has stabilized. There are still ups and downs, but there's not a consistent down. We're still confused about the directions of the economy overall. Our customers are still confused.

Speaker 2

There has been, I think part of why we say our arrow is horizontal rather than down or up Is that a couple of the larger customers had been Tightening up inventory as they feared an oncoming recession and or as they burnt off some COVID driven inventory. And now that seems to have gotten behind them and us. And so they are increasing their orders again. But saying that, one of those customers, one division is hacked their forecast almost a third of what it was, well, the other 3 divisions are increasing their forecast. So it's not a I don't think we're at a time right now where we can say it's stabilized.

Speaker 2

It's just that right now the puts and takes are about balancing out. There's a lot of go ahead.

Speaker 3

After you, please.

Speaker 2

There's a lot of data that says that even though unemployment looks good, the actual job market is Quite a bit tighter than what we've gotten used to post COVID. There's a lot of data that's people, everybody was the great retirement, rate separation that data has switched to people are staying in their jobs. The data that says that people even though they don't like it are coming back to the office would seem to contradict the data that says unemployment is very low. Wage increases Seem to have taken a pause over the last quarter and a half. So it's very hard for us to say we have a handle on what's going to happen next.

Speaker 3

And those wage pauses, I presume you're to the U. S. And that is not talking to Mexico, correct?

Speaker 2

Correct. That's correct. Yes.

Speaker 3

So let's use that as a segue to Mexico. Would you please expand on what you are doing in Mexico kind of With in the near term with the restructuring and then longer term, how you are thinking about it? Really looking for more detail than you had in your opening remarks, please. Okay.

Speaker 2

So, boy, Bill, I worked long and hard on those two paragraphs. I hope they were self

Speaker 3

They actually were and they actually created a whole bunch more questions. So Okay.

Speaker 2

Once you ask me a few of those questions, maybe we'll kick off that way.

Speaker 3

All right. So, what was the point that made you decide now is the time as opposed to 6 months from now or waiting longer to make the decision?

Speaker 2

We started trying to look At all of the quotes we were seeing and really, really dig hard into where are we coming out on just pure cost versus our competitors. It's always a mix of service level, Trust in the company, personal interrelationships and everything else that goes into a win or a loss on a bid. But we decided it was time with the increasing wages and peso that we needed to take a hard look at Just separating that one component of a decision, which is price. And after we did that, Dug into it hard. We started looking at that in relation to The choices people were making on where they wanted their product to go.

Speaker 2

And It's kind of an interesting thing. It's a split between the products that didn't ever really belong in China. And before COVID, we had a hard time and we did it, we drew the company doing it, but we had a hard time selling against the downsides or the upside to China with the downside to China. And now that people are paying more attention to the downsides, They're willing to pay more to avoid those downsides. So a product that shouldn't have been in because it was either an immature product or it was impossible to forecast the demand well or Say changes in style required instantaneous changes in production.

Speaker 2

Even though it went to China, it still had all those disadvantages. And when the company, the customer made the decision to come back, When there isn't that massive delta between Mexico and the States, Those customers who really wanted all of that extra service are willing to pay for that service out of the states. And that's why We see the growth in our U. S. Sites.

Speaker 2

And it's not only customers that went to China and then came back, it's customers who would have gone to China and who are now happy that they don't have to. When I say they are happy, it's Folks that have to deal with the day to day business of getting product made and getting it to where it needs to be to get sold on time.

Speaker 1

So that

Speaker 2

I guess hurdle has increased to the point where we used to see New business opportunities for the U. S. Sites that were in the $1,000,000 to $3,000,000 range. And anybody with a bigger volume than that and I know volume isn't the same as revenue, but let's just say that as it is now. So those smaller programs were making it into our U.

Speaker 2

S. Sites, but the bigger ones we were competing or out of our Mexico site only. In the last year, We've seen a shift in that hurdle to where people are now wanting to put $10,000,000 programs, dollars 15,000,000 programs into our sites in the states because they recognize the value of The service level that the states can provide at a price that is no longer so much higher than Mexico. On the other hand, that means that the hurdle rate to stay in Mexico has gotten higher. And therefore, the people who want to stay in China, I meant to say Mexico.

Speaker 2

The people who want to say in Mexico are willing to deal with the type of service they got used to out of China. So they're not willing to pay for the extra services that we had put in place in Mexico over time. And to make that clear, For example, if you're a customer and you call us up and say, hey, I know I had 10,000 widgets that I wanted next month. I need them next week. And the way we would make that happen is through a lot of A lot of people in the salaried ranks who would hustle around and get parts across the border quickly and get lines changed over and monitor the switch and we would move employees and train employees and all that would happen and the customer would be happy, But it costs more.

Speaker 2

And now those customers who need that type of service are willing to pay U. S. Prices. That leaves the folks who aren't willing to pay for those prices with our Mexico facility competing against other commodity type service levels out of Mexico. So that means we can take a lot of this added service cost out of our Mexico facility without harming the customers who were willing to pay for it before because they're not there anymore.

Speaker 2

They've migrated. Does that make sense?

Speaker 3

It I believe it does make sense. Let me try to play that back to make sure that I'm hearing it correctly, which is customers that are willing to pay or who demand a higher level of service are willing to pay the extra price for the U. S. The customers who want the lowest price, They're going to Vietnam, which you had built Mexico on a higher service model to higher service, lower cost, but not the lowest cost. And that really has left Mexico in a no man's land and therefore now you're needing to make an adjustment.

Speaker 3

It sounds like, if I'm hearing correctly, you are taking The extra cost that went along with the higher level of service out of the Mexican cost structure and will allow you to run bigger the big programs and less changeovers taking place because those changeovers will probably be in the U. S. Or The super low cost in Vietnam. Am I hearing that somewhat close?

Speaker 2

Yes.

Speaker 3

Okay. So I guess that leads to 2 additional questions and my apologies for dominating here so long. So First of all, does that put Mexico In a strange place for now given that it's 2 thirds of your revenue And yet a little bit of no man's land? And then secondarily, how quickly Do you foresee Vietnam filling up? And I guess thirdly, coming back to Mexico, Would you anticipate that the changes that you are making with this restructuring will then accelerate growth In Mexico that you otherwise wouldn't have been able to win because you just weren't positioned correctly?

Speaker 2

So the third question is the most important.

Speaker 4

Yes.

Speaker 2

And that is exactly what we expect. We have already seen that as we've been pricing as if we had the new model completely put in place, which we will by the time these programs actually hit. So that's the main impetus for doing this is that we have to have Juarez able to compete on a commodity basis. And that doesn't mean that they won't be able to provide the extra services that some customers will want, But that will be on an optional pay by the time you use it rather than baked into the basic cost structure of Juarez. So it's a switch from we're standing there ready to and we'll do it for free We can do it if it's important enough that you want to pay for it.

Speaker 2

But that comes down to A split in the customers of people who make the decision and people who have to live with it. Typically, the guy that makes the decision is mainly focused on price only and the folks that have to live with the decision are focused on the service level that they can get. And as the makeup of the customers coming back from China has changed over the years or as I should say the makeup of the people that are interested in Mexico has changed over the years. The person making the decision that's interested only in price has got the louder voice, Whereas in the past, it was more of a shared decision because the people that are coming out of China have sticker shock When they're ordered to move, then they have to come to Mexico and our price and anybody else's price is more than China and they don't like it. And trying to sell a baked in service level that's better than China to the person who's Only evaluated on price is an uphill battle, didn't used to be as much as it is now.

Speaker 2

So that's why we're making the change. I don't think it's going to drive any change in the attractiveness of Vietnam For the United States, I don't think the 2 are that much interconnected because they pretty much stand on You're all right.

Speaker 3

Craig, does this put you in the enviable position where the upfront decision maker, you can win them, because you have a lower price. And then when the operator is basically being told you need to get Something done and your job is on the line, if you're not able to accomplish it, they can come to you and you'll have the ability. And they say, I don't care what it costs, Loosely speaking. And you're able to charge for that. So you kind of win on both sides?

Speaker 2

That's certainly the intent.

Speaker 3

Okay. And one additional question and I'll step back in queue. Do you see a place for an additional facility or an additional geography Within Mexico or somewhere else near, and I'm thinking inland, where the And when I say inland, I mean non border, where the labor costs are lower And yet you can still have the relative nearness of Mexico? Or do you believe what you're doing here accomplishes all that you need from a geographic dispersion?

Speaker 2

Well, anytime over the last 20 years, we've Kept an eye out on opportunities deeper within Mexico. And We continue to see after much analysis and hand wringing that the delta in direct labor wages That you received by going deeper inland as you say to Mexico is mainly offset by the increase in salaries you have to pay to get people who want to work in salaried positions deeper into Mexico. And then you have the further offsetting disadvantage of shipping time and the further offsetting disadvantage of getting engineers across the border and 8 hours in New Mexico. So as of right now, we are staying pat on our ORES hand, But that could change at any time as various factors that we don't control change. So we're prepared to change our decision.

Speaker 2

Right now, after looking at it pretty hard, it appears that Juarez is the right answer for us.

Speaker 3

Understood. And I told you that would be my last question. I am going to renege on that and say relative to the restructuring That you're doing, is this primarily the labor that you're laying off hourly labor or primarily salaried labor?

Speaker 2

Here's a quiz, which do you think it is?

Speaker 3

I would guess it would be more salaried labor is Just how I'm thinking about what I thought I heard you say.

Speaker 2

Perfect. That's exactly right. We are communicating.

Speaker 3

And So if you are laying off that salaried workforce, essentially the fixed cost or some portion of the fixed cost there, When a customer who historically been able to say to you, gosh, I really need this quickly, How do you respond since it was in part because of those salaried people? I suspect some of them that will no longer be with you. We're making that happen.

Speaker 2

So we're not laying them all off. We're laying quite a few of them off. And we've already seen that the customers who need that and who are willing to pay for it create much less of a workload than what we were giving away as part of the total business proposition a year ago. So we still have the capability to do it just on a smaller scale. And that scale is smaller because customers now have to pay for it in many cases versus getting it for free previously.

Speaker 3

Well, congratulations on the learnings. And it sounds like this is a little bit like the difference between going to an alacarte restaurant and a buffet That we probably do all of us tend to eat a little bit more at the buffet simply because we can.

Speaker 2

That's a true statement. Part of it is learning, but part of it is what has changed in the marketplace as people have come out of China who were there before. So it's not so much learning as it is analysis of the change and reacting to it.

Speaker 3

Great. Thank you. I'll step back in queue and queue back in again. Thank you.

Operator

Your next question comes from the line of George Melas with MKH Management.

Speaker 4

Good afternoon, guys. That was a very, very interesting discussions earlier with Bill. Thank you for that. Thank you, Bill. Quick, I have some questions that are much more numbers oriented.

Speaker 4

The $8,100,000 in inventory sales, Was that at no gross margin?

Speaker 1

There was no gross margin on it, but we were able to charge a few fees for the transportation and recycling of that. So there wasn't that much dilution in the actual gross margin when you offset those 2.

Speaker 4

Okay. Because I was trying to say I was trying to see that if your gross margin if you had no If you had no profit on those sales, your gross margin really was 8.6% instead of 8.1%. So if you exclude those inventory sales, roughly what would have been the gross margin?

Speaker 1

Roughly about 8.3%, 8.4%.

Speaker 4

Okay. So it's a little bit more than that. Okay, great. Okay. Looking at the OpEx, I think your SG and A are expected to be sort of flattish sequentially, but it was up.

Speaker 4

But your Development is at the lowest level it's been in 3 years at 1.8. Is there Some chargers, some can you help explain those numbers?

Speaker 1

We've taken a real serious look at, of course, salaried positions. The other is that there have been some changes in payroll benefits We've been able to reduce some costs there as well. I would anticipate prospectively that we will see a slight increase to our OpEx, but nothing substantial. We really have taken a sharp pencil to our operating expenses.

Speaker 4

Okay. Okay. So essentially, you see The SG and A being relatively flat, it may be product growth and coming up just a little bit.

Speaker 1

Correct.

Speaker 4

Okay. Now I want to try to understand the guidance, including the charger. If I look at the guidance of 0 0 to $0.15 that implies a net income of 0 to, let's say, 1.6. And if I add back the charges of 1,000,000 to 2.5 I think in the midpoint, I get to roughly $2,500,000 in what I would call adjusted net income. And to get to $2,500,000 And if you have interest expense of 3,000,000 and the tax rate of 20%, that implies an EBIT of roughly 6,000,000 And then if we add back the OpEx of 8,000,000 That implies a gross profit of $14,000,000 which implies a gross margin of 10.

Speaker 4

So I'm just trying to see if I got the numbers right or maybe where I'm off.

Speaker 1

No, we are expecting an increase in gross margin in this quarter. 1, because of the layoffs, because of the actual cost reductions that are going to transpire. So roughly, we mentioned it was going to take less than a half a year or so roughly 60% of those costs decreases 60% of the severance is offset by payroll cost reductions in the quarter. Additionally, we expect our debt to continue to decrease as we continue to drive inventory down. My expectation is that interest won't be $3,000,000 It will be something less than that

Speaker 4

Okay. For this next quarter.

Speaker 1

And again, I think Your OpEx of roughly $1,000,000 is probably a good guess.

Speaker 4

Okay. But then that implies a gross margin that's well north of 9%.

Speaker 1

That's our expectation.

Speaker 4

Okay. So that would be a really nice improvement compared to just more recent quarters?

Speaker 2

Yes. We've been in a situation where we make money out of America, we lose money in Mexico and then we make money in Mexico, we lose money out of America. And It looks like we're heading towards a position where we're going to make money out of all the sites. So Hopefully, that comes to fruition and we don't get another surprise.

Speaker 4

Okay, great. And The Mexican peso, I mean, I was just doing the math, it's up double digit year over year. It's Down just a little bit and nudge sequentially.

Speaker 1

We do have some hedge contracts that will help us in Q3.

Speaker 4

You have some hedge, okay. Because at some point, I think you had stopped hedging, right?

Speaker 1

Yes, we entered into some hedges a few months ago that will take us through the March quarter.

Speaker 4

Okay. So maybe when you talk a little bit about your hedging philosophy, it's just not been hard to hedge and it's expensive. How do you guys sort of think about it? In an ideal world with

Speaker 1

ample liquidity and we would have hedged Roughly 50% of 3 years Mexican expenses.

Speaker 4

Yes.

Speaker 1

We're far from that. We did take advantage of a blip In the softening of the peso that occurred a few months ago, I wish we would have made more contracts, But it's difficult to project the future. Yes.

Speaker 2

When we can't figure out what the economy is going to do, then we can't figure out what the Mexican peso is going to do. We can't out what to hedge.

Speaker 3

Sure.

Speaker 1

So we do have some hedges in place That will help us during this Q3. And we'll continue to monitor The peso to the dollar and enter into more contracts if we can.

Speaker 4

Okay, great. Good. And just from a customer concentration perspective, on the last quarter, we talked about just One customer right now being 10% of in the 10% category, is that still pretty much the case?

Speaker 1

That is still correct. We have one customer about 10%.

Speaker 4

Okay, great. Great. And Brett, congratulations. Very excited about your promotion and wish you all the best.

Speaker 1

Thank you.

Speaker 4

Thank you, guys.

Speaker 2

Thank you.

Operator

Your next question comes from the line of Bob Pool with Brickellar Capital.

Speaker 5

Hi, guys. Congratulations. It looks like things are like all arrows, maybe except for revenues here in the very near term are pointed in the right direction, which is great. Of course, I'm referring to inventories down, margins up and pipeline up. So that's all great.

Speaker 5

And with that, Craig, I would ask you, we haven't spoken before, but I've Spoken to Brett about the timing of your retirement. You've gone through the storm and it appears that the sun is coming up and you choose that as your time to step aside. Can you talk a little bit about The timing of the transition and then Brett, if you would care to comment at all about What if anything you put as like priorities as under your new leadership?

Speaker 2

Okay. Well, I'm 65. I've been working since I was 8 years old, started in my dad's trailer court, and I've had enough. So I actually was thinking about retiring quite a bit earlier and then COVID and everything else came along and I thought I needed to stay to make sure everything was to make sure I could feel proud of how I was leaving the thing when I did leave. So this last year has not been as much as a glide slope as I hoped it would be.

Speaker 2

But as you say, we've had a major victory in driving inventory down. I think we've had a major victory in Growing our U. S. Sites and even with the wage increases in peso issues in Mexico, I think we're as you say, the arrow is up there and what's going to happen there is proven by the previous big wins down there. So my timing is strictly based on the fact that I'm 65 years old.

Speaker 2

I got 2 grandkids that live in town And they get old really fast. So it's time for me to quit. There's no issue With where the company is headed, I'm very confident in Brett and the team we've got put together here. And as we said, I'm going to be staying on the board. So it's not like I got beat.

Speaker 2

I'm running into the bushes in defeat.

Speaker 4

And it was nice of

Speaker 5

you to leave Brett with a 6 times inventory turn goal.

Speaker 1

Yeah. It is. I'll have to remind you, Bob, that that never occurred during his tenure. I would reiterate that this was a well planned transition. It's comforting to know that Craig will remain on the Board and still provide a lot of the technical support that I think he adds so much value to.

Speaker 1

I would not anticipate any real sea changes in the direction we're headed. As Craig has mentioned, We are extremely impressed with the management team at Key Tronic. And we've been hit with a lot of Things in the market, including a very strong peso, considerable amount of inflationary pressure, interest costs, But yet still we continue to drive profitability and expect that to improve. This is really a well planned transition.

Speaker 5

Okay. That's awesome. In the last quarter, Conference Call. You talked about making some changes in Mexico then that potentially we're going to save you $5,000,000 a year. I was expecting to see possibly some severance type things in the quarter just reported.

Speaker 5

Was there any severance or unusual expense in the quarter just reported?

Speaker 1

Nothing material. I think there was a small amount of Severance, but not to the level that we expect in Q3.

Speaker 5

Okay. And then would it be Reasonable to tie when you talk about 6 months and you talk about sort of the upper end of the severance range being 2,500,000 Is that does that tie then to the $5,000,000 a year savings in Mexico?

Speaker 1

Yes, roughly does.

Speaker 5

And if the severance is smaller, does that mean the savings is smaller? Or is the savings the savings and it's just a question of how much severance you have to

Speaker 2

give at the end of the day?

Speaker 1

I think it's a combination of those things, Bob. But we're still trying to make the final determination of what positions, trying to also ascertain the pipeline and how soon New programs will be started down in Mexico. So there still is some unknowns there. But severance, whatever we do, we'll be there's a return of roughly a couple of quarters. So at the high level, yes, you would expect to have some $5,000,000 of savings annually.

Speaker 5

Okay. Well, if George's calculations are correct and they are consistent with my back of the envelope, Craig, thanks for getting the table set for And delivering this quarter hopefully the kind of profitability that you've been saying for some time was The high popping profitability that was out there for you guys to achieve, it looks like you're going Maybe do it in your last quarter. So congratulations for that and have a happy retirement.

Speaker 2

Thanks. I'll talk to you one more time. This is my penultimate.

Speaker 1

Gerald? He's not up to door yet.

Speaker 5

Yes. Well, I'm happy that you will get to take the victory lap for George's quarter. So, yes, that'll be great.

Speaker 2

I think George may be a little bit overexcited, but I still think things are headed in the right direction. So I'm happy with the way I'm leaving it.

Speaker 5

Yes. I think George's math is pretty Straightforward. So I'm I'm going with George.

Speaker 2

Okay.

Operator

Your next question comes from the line of Bill Dezellem with Tieton Capital. Please go ahead.

Speaker 3

Thank you. On the Line of questioning that was just there. I would also like to say congratulations and thank you for Doing something a little bit unusual, Craig, which is leaving when things are on the upswing and Positioning them well and then stepping aside. So often, I think that CEOs leave at the top and then have a crumble after they leave or just the opposite end of the spectrum. So well done.

Speaker 3

Coming back to the Mexico, Vietnam phenomenon or situation, Do you see customers moving production from Mexico to Vietnam or the Vietnam success in the future is really going to be from new business going into that facility?

Speaker 2

Well, it's a little bit more of a complicated answer. Vietnam is growing, but it would be growing much faster if we had more critical mass in Vietnam. But we missed out on a big deal last quarter, not because The customer was unhappy with what we had, but it was the old battle we used to fight when we first started in this deal in this business, which was, well, I don't see that you're doing $100,000,000 here. So I don't feel comfortable putting my $20,000,000 here. So that's part of the stumbling block in getting a new site up and running and growing The way it should be growing on paper is there's a critical mass problem.

Speaker 2

We do expect one of our larger customers to move a significant portion of their business to Vietnam and that would be the business that they serve Asia with. We're not quite done with that discussion, but I would expect that decision to be made probably by the end of June. And that would give us what we think is a required critical mass to make Vietnam be Much easier to sell rather than trying to sell it before somebody can look at it and go, oh, I'm already buying into a known thing rather than I'm

Speaker 3

Craig, how is it that the Other contract manufacturers that are starting greenfield in Vietnam are winning business. It seems like that would be a For this massive movement of firms wanting to go to Vietnam is the common problem.

Speaker 2

So I'm not sure who's winning what in other Vietnam locations, so I can't speak to that.

Speaker 3

Yes, no problem. And then one point of clarification that I think is super obvious, I just want to make sure that I'm not misreading That your guidance for this quarter of the $0.0 of earnings to $0.15 of earnings includes The $1,000,000 to $2,500,000 headcount reduction severance, which at the 20% tax rate equates to $0.07 to $0.18 So the $0 to $0.15 includes $0.07 to $0.18 of cost. Is that correct?

Speaker 2

Yes.

Speaker 3

Okay, great. Thank you. Appreciate the time and letting me come back in the queue.

Speaker 2

Yes. And if you're wondering If you're too polite to ask it, but if you're wondering what the hell these guys do and how come they can't figure out what the severance cost is, The labor law in Mexico is quite a bit more convoluted or complicated than that here in the States. So it's an iterative process on determining how many, who and how much it will cost. So we're not feckless. We're just working our way through a pretty complex situation.

Operator

This concludes today's question and answer session. I will now turn the call back to Craig Gates for any additional or closing remarks.

Speaker 2

Okay. Thank you. We appreciate your time and questions. And Brett, Tony and I look forward to speaking to you again next quarter,

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