Key Tronic Q4 2024 Earnings Call Transcript

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August 13, 2024

Key Takeaways

  • Key Tronic’s Q4 revenue fell to $126.7 million from $162.6 million a year ago, and full‐year sales dropped to $559.4 million versus $588.1 million, resulting in a breakeven Q4 net income compared to $1.1 million last year.
  • A cybersecurity incident in Q4 disrupted Mexico and U.S. operations, delaying about $15 million of revenue (expected to be fulfilled in FY 2025) and adding approximately $2.3 million in remediation costs.
  • Inventory was trimmed by $29 million (21%) year-over-year, liabilities were reduced by $56.1 million, and the current ratio improved to 2.8:1, bolstering Key Tronic’s balance‐sheet flexibility.
  • For Q1 FY 2025, management guides revenue of $140–$150 million and net income of $0.10–$0.20 per diluted share, driven by new program ramps, recent overhead cuts, and a weaker Mexican peso.
  • Onshoring trends and dual‐sourcing demand are fueling growth in U.S. and Vietnam production—U.S. output now represents 29% of revenue—and Key Tronic sees a strong pipeline of new contract‐manufacturing business.
AI Generated. May Contain Errors.
Earnings Conference Call
Key Tronic Q4 2024
00:00 / 00:00

There are 5 speakers on the call.

Operator

Good day, and welcome to the 4th Quarter Fiscal 20 24 Key Tronic Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Tony Voorhees. Please go ahead, sir.

Speaker 1

Good afternoon, everyone. I am Tony Voorhees, Chief Financial Officer of Key Tronic. I would like to thank everyone for joining us today on our investor conference call. Joining me here in our Spokane Valley headquarters is Brett Larsen, 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.

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 statistical information regarding our business and operations. Some of this information is included in today's press release.

Speaker 1

During this call, we will also reference slides that accompany our discussion. The slides can be viewed with the webcast and the link can be found on our Investor Relations website. In addition, the slides together with the recorded version of this call will be available on the Investor Relations section of our website. We will also discuss certain non GAAP financial measures on this call. Additional information about these non GAAP measures and reconciliations to the most directly comparable GAAP measures are provided in today's press release, which is posted to the Investor Relations section of our website.

Speaker 1

For the Q4 of fiscal year 2024, we reported total revenue of $126,700,000 compared to $162,600,000 in the same period of fiscal year 2023. For the full year of fiscal 2024, total revenue was $559,400,000 compared to $588,100,000 for the fiscal year 2023. Also previously disclosed, a cybersecurity incident caused disruptions and limited access to portions of our business applications, supporting operations and corporate functions at our Mexico and U. S. Sites during the Q4 of fiscal 2024.

Speaker 1

During the disruption, we were unable to fulfill approximately $15,000,000 of revenue during the Q4 of fiscal year 2024. Most of these orders are recoverable and are expected to be fulfilled in fiscal year 2025. During the cyber disruption, we continued to pay wages in accordance with statutory requirements. We also deployed new IT related infrastructure and engaged cybersecurity experts to remediate the incident. As a result, we incurred additional expenses of approximately $2,300,000 Partially offsetting the additional cybersecurity related expenses was a favorable weakening of the Mexican peso late in the period, decreasing expenses by approximately $600,000 We also had an insurance gain relating to a previously disclosed weather event in our Arkansas facility in the amount of approximately 700,000 dollars during the Q4 of fiscal year 2024.

Speaker 1

Despite the business disruption event, we improved our gross margin during Q4, primarily reflecting our workforce reductions in Mexico during the prior quarter and the weakening of the Mexican peso. Our gross margin was 9% and our operating margin was 2.2% for the Q4 of fiscal year 2020 for compared to a gross margin of 8.5 percent and an operating margin of 2.6% in the same period of fiscal year 2023. Our net income was breakeven for the Q4 of fiscal year 20 24 compared to net income of $1,100,000 or $0.10 per share for the same period of fiscal year 2023. For the full year of fiscal year 2024, the net loss was approximately $800,000 or a net loss of $0.07 per share compared to net income of $5,200,000 or $0.47 per share for fiscal year 2023. Excluding adjustments for certain income and expenses to measure our core results, adjusted net income was $1,100,000 or $0.10 per share for the Q4 of fiscal year 2024 compared to adjusted net income of $1,000,000 or $0.09 per share for the same period of the fiscal year 2023.

Speaker 1

For the full year of fiscal year 2024, adjusted net income was 3 point $4,000,000 or $0.31 per share compared to $2,200,000 or 0 the Q4 of fiscal year 2024 by reducing inventory by approximately $29,000,000 or 21 percent from the same time a year ago. These improvements in inventory levels primarily reflect increased component availability and our concerted effort to drive inventory reductions. We're pleased to see our inventory levels continue to become more in line with our current revenue. 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 materials resource planning algorithms.

Speaker 1

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 Q3, we also reduced our total liabilities by a combined amount of $56,100,000 from a year ago. Our current ratio was 2.8:one, up from 2.3 a year ago. At the same time, accounts receivable DSOs was at 98 days compared to 85 days a year ago, which we believe reflects back end loaded nature of the quarter caused by the cyber event. Total capital expenditures $5,200,000 for the full year.

Speaker 1

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, utilizing leasing facilities as well as make efficiency improvements to prepare for gross and add capacity, particularly in our U. S. And Vietnam locations. For the Q1 of fiscal year 2025, we're seeing a rebound among our legacy customers relative to our Q4. For the Q1 of fiscal 2025, we expect to report revenue in the range of $140,000,000 to $150,000,000 Moving into fiscal 2025, we are pleased to continue to see our new programs ramping.

Speaker 1

Cost efficiency improvements from our recent overhead reductions taking hold and a significant weakening of the Mexican peso. Taking all these factors into consideration, we expect net income in the range of $0.10 to $0.20 per diluted share. We expect to see growth in our U. S. And Vietnam production.

Speaker 1

We have a strong pipeline of potential new business and we are focused on improving our balance sheet. Over the longer term, we believe that we are increasingly well positioned to win new programs and profitably expand our business.

Speaker 2

That's it for me. Brett? Thanks, Tony. Fiscal 2024 got off to a very promising start, though we faced some challenging headwinds. During the first half of the year, our revenue grew by 12% year over year, driven by increased production in our U.

Speaker 2

S. And Vietnam based facilities. Despite the strong top line growth, our margins and profitability were negatively impacted by increased labor costs, unfavorable foreign currency exchange rates in Mexico and higher interest rates. During the second half of fiscal twenty twenty four, we faced major disruptions to our business, including severe winter weather events that took our facilities in Mississippi and Arkansas offline for approximately 2 weeks in Q3. And then the cybersecurity event that interrupted our operations and corporate functions in Mexico and the U.

Speaker 2

S. During our most recent Q4. Together, these events disrupted production for approximately 6 weeks during the year. Despite these disruptions, we took the necessary steps to reduce our workforce in Mexico, which is expected to save more than $10,000,000 annually in labor costs. In coming quarters, we expect sales from Mexico based production to recover due to recently won new programs, but we do not anticipate needing to increase our headcount in coming periods.

Speaker 2

Moving into fiscal year 2025, we're very pleased to see overall improvements in our operating efficiencies as well as reduced inventory levels and other improvements made on the balance sheet. During the year, we continue to expand our customer base, winning new programs involving security equipment, sporting goods, environmental solutions, security products, military aerospace, industrial control systems, energy management, telecommunications, consumer audio, industrial manufacturing, industrial moving equipment, industrial storage, medical devices and consumer air filtration products. The strong pipeline of potential new business underscores the continued trend towards onshoring in a dual source and a dual sourcing of contract manufacturing. Global logistics problems and the China U. S.

Speaker 2

Geopolitical tension may continue to drive OEMs to re examine their traditional outsourcing strategies. We believe these customers increasingly realize that they have become overly dependent on their China based contract manufacturers for not only product, but also for design and logistics services. Over time, the decision to onshore or nearshore production is becoming more and more widely accepted as a smart long term strategy. As a result, we see opportunities for growth and those opportunities are becoming more clearly defined. At the same time, we are seeing a sustained trend of continued wage increases in Mexico.

Speaker 2

As it has become clear that these changes in the base cost of Mexican production are longstanding, we are rightsizing our operations in order to remain cost competitive. It has also become that customers near shoring from China may have a different calculus for selecting a geographic location for business. For those customers who struggle with China production due to their flexibility requirements, we believe our U. S. Sites offer the ultimate in flexibility, engineering support and ease of communications.

Speaker 2

Over the past 12 months, revenue from our U. S. Production facilities has increased approximately 7%. In the Q4 of 2024, production in the U. S.

Speaker 2

Represented 29% of total revenue, up from 25% a year ago. Meanwhile, for those customers whose requirements had adapted to the China model of limited flexibility, challenging communications and less engineering support, we expect that our Mexico facilities remain the answer. Therefore, we are reconfiguring our Mexico sites to endeavor to be a lower cost and provide more commodity level service while still maintaining high quality. While our Vietnam facility continues to be a modest contributor to our overall revenue, a growing number of potential customers are actively evaluating a migration of their China based manufacturing to our facility in Vietnam. In coming years, we expect our Vietnam facility to play a major role in our growth.

Speaker 2

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 still be sourced from China. Our procurement group in Shanghai, which serves the entire corporation, remains important for managing the China's component supply chain on an ongoing basis. Additionally, our China production facility continues to be profitable and has found recent success in winning new programs with Chinese OEMs. 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 continue to invest in vertical integration and 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. We believe this expertise will increasingly set us apart from our competitors of similar size. We believe that the global logistics problems, China U. S.

Speaker 2

Political tensions and the heightened concerns about supply chains continue to drive the favorable trend of contract manufacturing returning to North America as well as 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. While the unfortunate combination of factors temporarily disrupted our growth and profitability in the second half of fiscal 2024, we move into fiscal 2025 with a strong pipeline of potential new business and we're seeing significant improvements in our operating efficiencies and also a weakening peso. Moreover, we will continue to rebalance our manufacturing across our facilities in Mexico, the U. S.

Speaker 2

And Vietnam. We remain very encouraged by our progress and the potential for profitable growth over the long term. In closing, I want to emphasize the execution of our strategy was only made possible by our investments in plants and equipment, but even more so the skills, local knowledge and talents of our people. I want to thank our exceptional employees for their dedication and hard work during this past year and our shareholders for their continued support. This concludes the formal presentation.

Speaker 2

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

Operator

We will take our first question from Bill Dezellem with Tieton Capital. Please go ahead.

Speaker 3

Thank you. Brett, would you please start by sharing with us what proportion of the $10,000,000 of annual savings or what roughly $0.70 per year? How much of that will be achieved in fiscal 2025?

Speaker 2

Through the fiscal year 2020, most of it, if not all of it, Bill. We're expecting that those cost savings to occur in the year.

Speaker 3

And some did fall into the Q4. How about just the piece that falls into fiscal 2025?

Speaker 2

I would say the majority of it fell into our Q4 since most of that severance occurred during our Q3. There was some limited amount, but the majority of it was felt in our Q4.

Speaker 3

Okay. That is helpful. And so that explains why we see revenues down pretty meaningfully, but gross margin increasing completely counter to what we would normally expect?

Speaker 2

Absolutely.

Speaker 3

Okay. Well, congratulations. That's fantastic. And the restructuring activities, I think that you mentioned on the last conference call that there may be more that needed to be done. And I wasn't sure if that was all incorporated in this savings, if that additional remainder of this year?

Speaker 2

So Bill, I think Yes. No, I think to that end, I think we are continually looking at our operating efficiencies. There is some potential of additional restructuring in fiscal 2025. It's been great to see even after the reductions in force, there really has not been any concerns, issues, problems, delays in our production. So we're continuing to look to see is there some additional restructuring that could be done during fiscal 2025.

Speaker 2

We're really not doing that right out of the gate just because we're because of the cyber event, we're on all cylinders trying to get through some of our orders backlog. But I could foresee possibly some restructuring to occur during the year.

Speaker 3

Great. That is helpful. And then I do want to make sure I have you touch on the 4 new wins this quarter. What is the size of each of those and quite interesting stories might happen with each of them?

Speaker 2

Yes. One is within our Arkansas facility. It's a fairly large program for Arkansas. It's predominantly electronics. That one is roughly about $15,000,000 win.

Speaker 2

The other large one was a metals, predominantly metals fabrication, which will go down into our Mexico facility. And then the 2 others were also for Mexico roughly between $5,000,000 $10,000,000 each.

Speaker 3

And the metal fab is how much?

Speaker 2

Sorry, that too is about $15,000,000

Speaker 3

So $215,000,000 wins this quarter?

Speaker 2

Yes. Good quarter.

Speaker 3

Congratulations. That's fantastic. And do you see foresee any of these ramping either more or less slowly than the typical wins?

Speaker 2

Out of the gate, they all look great. There can be some delays. We don't my expectation is that by this time next year, they'll be fully ramped.

Speaker 3

Okay. That's helpful. And then I did want to key in on the medical device win. Sometimes medical devices have special requirements, whether it be clean room certifications, etcetera, etcetera. Is there anything around that idea to this specific win?

Speaker 3

And the spirit of this question is

Speaker 2

Bill, we've always had some medical production. We're extremely interested in pursuing that industry. This was a good win for us. I don't think it's any more complex than what we build today. We are certified in 2 of our locations to manufacturing of medical devices.

Speaker 2

This one isn't much more as mentioned isn't any more complex than what we're building today.

Speaker 3

Thank you, Brett. I'll hop in back in queue and congratulations on making it through the cyber incident. So such a short window.

Speaker 2

Thanks, Bill.

Operator

And we will go back to Bill Dezellem with Tieton Capital. Please go ahead.

Speaker 3

Okay. I'm happy to ask more here. So in the release, one thing that I was surprised to read, Brett, was that Vietnam is being used for lower production. I would have thought that would have been your lowest cost facility and therefore, for those who can have the longer lead time that they would that you'd find some much bigger runs potentially coming there. Did I misread what you were trying to communicate or am I some learning I need to do here?

Speaker 2

No, that really is our intent of Vietnam is to be our lowest cost facility. I think to your point, they need to have some ability to have increased transportation time. There are a few smaller programs in Vietnam, but longer term, my expectation is that as that grows, those will really be more higher volume, less mix type products that are better suited for our lowest cost site. Did that answer it, Bill?

Speaker 3

It did. Thank you. And then let's jump to cyber incident for a moment. Dollars 2,300,000 cost, where did that fall within the P and L?

Speaker 2

Predominantly in cost of goods. So I would say 2 thirds of it is in cost of goods, 1 third of it is in G and A. So the outside advisory firm falls into the general administrative the operating expenses, whereas the required wages that we paid to keep workers was captured in cost of goods.

Speaker 3

Understood. And then you think that you referenced in the release that you would anticipate that the $15,000,000 of revenues that you believe that you missed out on, that those will be recaptured over the course of fiscal 2025. Is that correct or should you be able to recapture the vast majority of that here in the 1st fiscal quarter?

Speaker 2

No, it's going to take us more than just a quarter to get caught up. So granted, those specific orders will be made up in the Q1, but then there's a delay possibly of things that our customer wanted then in the Q1. So to get completely caught up on that $15,000,000 of lost orders, it may take us the better part of the year. Okay. So

Speaker 3

Okay. So where I was hoping to go with that was that $15,000,000 dollars you add that to what you just did in the quarter and that puts you already to the low end of your guidance. You have legacy customers that are showing some signs of rebounding. You have new business ramping that disappeared like there may have been some conservatism built into the numbers. And I suppose to some degree that still stands a little bit, but maybe not to the full $15,000,000 magnitude as I was thinking.

Speaker 2

Yes, that's accurate.

Speaker 3

And then one nitpicky question, if I may. There was a restructuring cost reversal that was, if I read it correctly, severance expense reversal of 223 $1,000 Are we reading that right? And what led to that reversal? It's not often that we see that.

Speaker 2

Sure. No, that is correct. That was a reversal of expected severance expense. So due to the cyber event and then also to the recovery of some of our legacy customers in Mexico, planned reductions in force of a few of our people did not occur. So that is actually a recovery to the income statement.

Speaker 2

So included in the Q4 is that rough $200,000 worth of benefit because we didn't go through severance that was anticipated.

Speaker 3

Okay, that's helpful. And then one additional question. So talking about the legacy customers rebounding, provide a little more detail and perspective on that. And the spirit of this question, of course, is that if you look in the last couple of weeks, there's been an awful lot of question marks about the economy, at least in the popular press. Would love to get your view of what you're seeing from your customers and what your sense is of their end demand and that whole phenomenon.

Speaker 3

So as much perspective and color that you can provide, we'll take all of it.

Speaker 2

Yes. At a real high level, Bill, we saw some retraction of our legacy customers forecast. It began to occur late 2023 and then I would say probably the 1st 3 or 4 months of this calendar year. We're now seeing some increased demand from many of our customers. Just we're actually seeing some demand that's coming back from maybe a dip that occurred earlier in the calendar year.

Speaker 2

I think I definitely see that our customers

Speaker 4

are

Speaker 2

far more they have far more concerted focus on those forecasts in making sure that they aren't over inventoried. So I think there is a little more ebbs and flows. But at a really high level, we're feeling far more confident that there really is some strong demand, some returning demand from those legacy customers in the forecast that we're seeing from them. There are definitely peaks and valleys, But I think for the most part, our anticipation is that we'll get back to 2023 levels in the next 6 months.

Speaker 3

And with these lower costs, that's going to create some pretty meaningful flow to the bottom line? Absolutely. Thank you again and congratulations again. Look forward to seeing that develop. Thanks, Bill.

Operator

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

Speaker 4

Brett, congratulation on your first call as CEO. And Tony, very nice meeting you on the call.

Speaker 1

Good to meet you as well.

Speaker 4

Just a follow-up on Bill's question regarding the cybersecurity expenses. So if we take those out from cost of sales, gross margin then was actually well above 9%. And I was looking back at my model and the last two quarters where you had a gross margin above 9% was in June 2014 and June 2020. So basically over the last 10 years, you've had 2 quarters of a 9%. And here you are at 9%, including significant amount of extra costs.

Speaker 4

So where does gross margin go from here, Brett?

Speaker 2

George, that's a great question. Our expectation is that we want to continue to keep that gross margin to the 9% to 10% level. It is great to see some significant improvement. As you mentioned, we haven't seen this for upwards of 10 years. The weakened peso definitely helped.

Speaker 2

But I think as well the reduction in force

Speaker 3

that we

Speaker 2

did was critical in getting us back to the profitability that really that we're seeking. Where it goes from here, I'd love to be able to have a crystal ball and be able to understand what the peso is going to do and what are we going to be able to continue to take advantage of as far as operating efficiencies. But I think our goal is to continue to drive that gross margin above 9%, the 9% to 10%. That really is what we will be seeking going forward.

Speaker 4

Okay. But I mean, if we I'm just trying to do the math. Take out some of the costs that you related to the cybersecurity event and the cost of sales and we're talking about revenue of just $126,000,000 We see that to be 10 or even slightly above. So it seems like you're well positioned for fiscal 2025 beyond.

Speaker 2

Yes. Right now, I would agree, George, it looks like we're well positioned to have a good year with that increased margin. I'd caution I'm also hoping to be able to include some incentive compensation, which is not in there today. That's not going to change it materially. There will be some additional costs as we become more profitable.

Speaker 4

Yes, yes, great. Maybe talking just about this incentive comp, you had a small reversal in the June quarter. Does that mean that there was basically almost no incentive comp for the entire fiscal year of 2024?

Speaker 2

Yes. So our stock compensation expense has been a stock appreciation rights. That may change a bit in the future. But yes, there's very limited, very little stock comp that's run through our most recent fiscal year.

Speaker 4

Okay, great. Makes sense. Maybe talking about the SG and A, it has usually hovered around $6,000,000 $6,500,000 Is that how you see it in the future? Or how do you think about it?

Speaker 2

Well, our SG and A this last quarter did include roughly about $500,000 of cyber expense. So it would have been just over that. But again, that doesn't include any incentive compensation, which I'm hoping to be able to pay this year. So that may grow a little bit. We are seeing across the board to be able to retain good talent that there have been some labor increases.

Speaker 2

So I wouldn't that 6.5 seems light to me.

Speaker 4

Okay. And then maybe a question, I guess, I'm asking a question about the numbers. What about the interest expense? That seemed pretty high this quarter, it seemed.

Speaker 2

Yes. We with the most recent amendment with Bank of America, our costing did go up. We'll be anxiously awaiting what the Fed does over the next few months and few quarters. That will step down with the Fed fund rate as soon as changes are made. But we're also actively trying to pay down that debt because it is very costly.

Speaker 4

Great. Okay. And Brett, you've been at Key Tronic store very low for quite some time for a long time. So but there's a change in leadership going on, right, with Craig. Sort of stepping down.

Speaker 4

He's still being involved. But any particular thoughts about the next year or 2 or sort of certain things that you see? I like the just the press release and having the net income. I think it's very helpful. So I want to commend you for that.

Speaker 4

Any change you think to any desire you have and that you may want to communicate with us?

Speaker 2

No, I appreciate that. I think George, I think the succession was a plan that was done over a number of years. And I think one of Craig's greatest legacies is the staff that he created. I am not anticipating any big changes in leadership anytime soon. Tony has been well prepped to become probably a better CFO than I ever was.

Speaker 2

But I think our strategy going forward is going to be far more on profitability to ensure that and that's more on the economic value add basis of how much capital is required to make that much profit And is it a good fit for Key Tronic? I think that will definitely be our focus going forward. And we've got we're headed in the right direction, but we've got a lot of work still to do.

Speaker 4

Great. Okay. Will be part of the journey. Thanks a lot.

Speaker 3

Thanks, George.

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