Key Tronic Corporation (KTCC) on Q2 2021 Results - Earnings Call Transcript
Operator: Good day and welcome to the Q2 Fiscal Year 2021 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.
Brett Larsen: 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 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.
Craig Gates:
Operator: Well, thank you. And our first question will come from Bill Dezellem with Tieton Capital.
Bill Dezellem: Thank you. First of all congratulations on what I think is a record quarter in terms of revenue. I don't believe you called that out, but am I mistaken that that's not the case?
Craig Gates: Yes. Thank you.
Bill Dezellem: Yeah. Congratulations. So let's start with my normal first question please. What is the size of each of the new programs that you won in the quarter?
Craig Gates: No those are about $2 million to $8 million a piece.
Bill Dezellem: And is it correct that there were three of them, or did you have multiple wins in any of those categories?
Craig Gates: No, just two.
Bill Dezellem: Okay. Thank you. Let me let me start by asking about the comment that you just made towards the end of your comments that you said you have $150 million or have line of sight on $150 million of demand per quarter for the foreseeable future. Can you talk about kind of the gap, I guess, if you will between -- I mean, around $130 million where you're at today and $150 million? And what you see as your ability or lack thereof to be able to march towards that $150 million demand level?
Craig Gates: Sure. The gap is strictly and completely caused by the pandemic. So we have problems as I said in the comments getting parts. I don't know if you're aware that a container that used to cost $3,000 to get to use -- that make it use to ship your parts across the ocean is now anywhere from $10,000 to $12,000 when you can get it. There are multiple ships anchored offshore at the ports trying to get space to get unloaded, because the teamsters are suffering through the pandemic just like the rest of us. So we've got a logistics issue we have continued risks and unavailability of employees in order to get our products built and shipped.
Bill Dezellem: Thanks, Craig. And if we look at the $150 million if the pandemic were to instantaneously disappear and you were to alleviate the shipping and the labor problems, would there be a demand side of the equation that would also pull back? And therefore, you wouldn't have that number to hit, or do you see enough demand without the pandemic that you would be able to move in that direction?
Craig Gates: That's a tough one to answer. I would say that maybe a little would go away, but quite a bit of it looking forward is based upon new customer ramps.
Bill Dezellem: All right. Thank you. And so before we go to new customers a couple of existing at least one existing customer question, I think, in Brett's opening remarks there was a comment that increased demand from existing customers was out there. Would you talk about that increasing demand for that segment of your customer base? And then secondarily you raised the CapEx guidance by about $3.5 million. Talk to that point and where that money is going please.
Craig Gates: We've been winning new programs from existing customers. We see a trend where our business with them was shared with one or two or three other suppliers. And as our customers have been exiting those suppliers and redistributing their supply chain we've been the beneficiary of those decisions. So that means that we are going to need more equipment in order to build and increase volumes. So, there's that aspect of it. And then the ramp of new customer programs that we're just beginning to enjoy revenue for those programs is also required that we bring in more capital equipment. We are in fact right now outsourcing as not a significant, let's call it a fairly significant portion of our production parts of it anyway because we're concerned about COVID deflation as you're asking the question. But we don't want to have put too much capital in should a couple of customers decline meaning if COVID whenever goes away fully. So, we're trying to hedge our bets and not go and buy equipment to completely bring all this business completely in-house. But even with doing that we are going to have to spend a little bit more capital on some SMT lines and other things.
Bill Dezellem: Okay, great. Thank you very much. And then lastly for now on the last call you'd mentioned $100 million prospect piece of new business floating around out there. Would you talk to that point and bring us up to speed and an update on what you're seeing on that front?
Craig Gates: It's still floating around out there and we remain hopeful.
Bill Dezellem: What's the next important either decision point or milepost with that situation?
Craig Gates: It has to go from a verbal handshake award to a contract.
Bill Dezellem: So, you already have a verbal award?
Craig Gates: Yes.
Bill Dezellem: Well congratulations. I'll step back in queue and let someone else ask questions.
Operator: And our next question will come from George Melas with MKH Management.
George Melas: Good afternoon Brett and Craig. Hope you guys are well. I have a follow-up on Bill's question. This is a record revenue quarter. And if one were to add back the COVID-related cost to your operating income this is your best operating margins since 2013. So you're clearly doing something right, and you're getting some scale you're also improving your gross margin. So maybe can you talk a little bit about the profitability of the business and what has improved the profitability in the last let's say couple of years? And where you see that going?
Craig Gates: Okay. Number one, as we get farther away from breakeven our profits improved in a non-linear fashion. We've always been in the position, where if we wanted to we could cut our overhead and try to go for maximized profit rather than a balance between profit and growth. And we've always chosen the balance. But as we get farther away from breakeven, we see a continued improvement in profit, because the fixed costs become not linear. But we don't see having to add a lot more fixed costs in the labor and management side of the equation except in steps as we go up. So there's been a lot of work done on efficiencies in the factories. We're very proud of the cost that we've been achieving and the productivity that we've been achieving in all of the factories. We are through the purchase – not purchase but the whole setup and start-up of Vietnam, or through the downsizing of our China Shanghai facility. We are through a number of expensive ramps. So streamlining our domestic operations, domestic operations have been changed quite a bit. So there's a lot of really cool slides that, I'm pretty proud of that talk about cost per hour and cost per unit and on-time delivery and rolled throughput yield and everything else we measure and through a lot of work by our staff and by all of our employees. Most of those graphs are heading in the right direction. But the overall driver is in this business revenue is just king and new business although it cost you a bit more than you'd like to get it in the building. It has a non-linear impact on profit.
George Melas: Okay. Great. Thank you. That's very helpful. And I think you had – I think if I remember right you had two new $100-million prospects floating around. And remind me if that's correct. And what are the characteristics of these two prospects?
Craig Gates: Well, if we're going to stick with the analogy one of them sync.
George Melas: Okay.
Craig Gates: Yeah. The other one is floating and it's coming up on plane nicely.
George Melas: Okay. And what would be the characteristic of this new customer program? Does – is it one that requires design on your part? Is this one that is very complicated? Maybe can you characterize it for us?
Craig Gates: Sure. It did require design in our part that played a major role in our win the handshake agreement. It's another example of a product that you would look at and say, well gee not many people have experience in doing this. Why is it that Key Tronic thinks they can do this? So it's not necessarily complicated, but it is in a different market than where we've been before. And that kind of slots it into our most successful customer relationships as I said in my comments where we run into a customer who has a unique product not necessarily a product that you would look at and go, My God that's really strange, but a product that is not really that easily outsourced because it has some really unusual process that's not in the wheelhouse of normal contract manufacturers who grew up as a Board stuffers. We really shine on those. So this is an example. This is actually on top of the one we won previously which also required our design expertise are adopting learning and capitalizing a new and wonderous process to us. This is the exact twin of that in terms of those characteristics.
George Melas: And that's -- Craig that's very encouraging because that's where you guys shine in this combination of design expertise and complex processes.
Craig Gates: Yes.
George Melas: Great, and nothing else, sounds really good. Thank you very much.
Craig Gates: Thanks, George.
Operator: And our next question comes from Bill Dezellem with Tieton Capital.
Bill Dezellem: Thank you. So I do want to circle back to that $100 million prospect. What will it take to move from the handshake where you're at now to an actual contract?
Craig Gates: That's always a beautiful mystery to understand. It's -- we've done everything we can and have to do. Now we're waiting for our customer to finalize a couple of their supply agreements and I'm told and I believe that that's all it's required.
Bill Dezellem: And nothing else once they make it through those supply agreements that you all will need to do other than get out of Japan and sign the contract?
Craig Gates: Sure. That sounds easy, but -- yes okay.
Bill Dezellem: Essentially that's the short version.
Craig Gates: That's a really, really, really short version but yes. Okay.
Bill Dezellem: I'll get the pen and hand it to you if that's helpful.
Craig Gates: Yes, thanks.
Bill Dezellem: Let me actually shift to the other part of the press release that we haven't discussed yet which is all thanks COVID. It referenced in the release government-imposed shutdowns. I'm familiar with those -- with restaurants, but that doesn't seem to apply to you all and I don't have a lot of familiarity with Mexico. Would you talk us through what you experienced in terms of shutdowns? And how much of the $1.8 million came from whatever shutdowns you dealt with?
Craig Gates: Sure. So we have about 5,000 employees in Juárez, right now. Last quarter – it was last quarter or…
Brett Larsen: Yes last quarter the weekends.
Craig Gates: So last quarter we had – sorry the quarter we're talking about here, we had two weekends that we were forced to shut down. Those are pretty critical weekends to us because we had planned on installing a number of pieces of capital equipment and we weren't able to do that. So as a result, we had to run through the last week of the December quarter, which is really, really hard in Mexico. People really like to observe their Christmas holiday. So over time and bonuses and all different kinds of costs mount up pretty quickly. So that's what happened in this last quarter. Previous to that, I don't know if you remember but we had our Juárez facility shut down for almost two and a half, three weeks. So those are the kind of things that can happen. The good news is that the infection rate, hospitalization rate and death rate in Juárez is falling dramatically. So we are hopeful that's going to continue. They have adopted a very intelligent approach to public safety that I'm not going to get into because I sound like I'm preaching on top of the soapbox, but they're doing really well in terms of controlling the pandemic spread. We're really proud of the fact that we've had almost zero transmissions within all of our facilities. And then we're talking about 5,000 people, that's a lot of work to make that happen right? So I'm really proud of our team and what they've done in Juárez. But that's what we're talking about, when we're talking about government-imposed closures of our facilities.
Bill Dezellem: All right. That's helpful. And this next question I'll just apologize in advance for my ignorance. On the surface, if you were shut down for nearly three weeks in the prior quarter and this quarter you were only shut down for two weekends. It seems like the cost impact would have been less but you called it out as $1.4 million in the prior quarter and $1.8 million in this quarter. Would you reconcile those two for us?
Brett Larsen: Yes, absolutely, Bill. So during those three weeks we were not required to pay all of the labor and/or overhead during those three weeks, the plant was shut down. Included in this quarter are a number of employees that due to pre-existing conditions are excluded from coming to work. Those are – we are paying to stay at home. In addition to what Craig mentioned is if you are open during that Christmas week in Juárez, you're going to have to pay double, if not two and half times to get people to show up. And you're also going to likely have a bunch of yield issues and inefficiencies. So those all combined into having a little more of an impact in our second quarter than our first quarter.
Bill Dezellem: That's helpful. Thank you very much. So let me take something else that was said and try to understand it better that you had equipment that you were going to install on those weekends that you weren't allowed to be open. Presumably, you were putting that equipment in for business that you had. Did that delay the ramp of business that that equipment was going towards? And if so when do we -- what's the time line now for moving forward?
Craig Gates: It did indeed delay a ramp and that's why we're projecting a higher quarter this quarter than last quarter.
Bill Dezellem: Understood. Thank you both.
Craig Gates: Yes.
Operator: And our next question will come from Scott Bundy with Moors & Cabot.
Scott Bundy: Gentlemen, just one question if I may. Have you had to add additional square footage in your Mexican facilities to accommodate some of this new business that you have coming your way?
Craig Gates: Yes.
Scott Bundy: Can you give us an idea of how much square footage you had to add?
Brett Larsen: I think, it's about 100,000 square feet. So we are currently in a five-year lease of that facility. We've done some tenant improvements, which are including CapEx, but that is what we've invested in today.
Scott Bundy: And I'm -- I made that I apologize what is that as a percentage of what is currently available in Mexico.
Brett Larsen: That's about a 10% increase.
Scott Bundy: That is significant. Thanks guys. Appreciate your time.
Brett Larsen: Thank you.
Craig Gates: Yes.
Operator: Thank you. And that does conclude the question-and-answer session. I'll now turn the conference back over to you for any additional or closing remarks.
Craig Gates: Okay. Thank you all again for participating in today's conference call. I hope all of you and your families stay healthy and safe. And that I look forward to speaking with you again next quarter.
Operator: Thank you. And that does conclude today's conference call. We do thank you for your participation and have an excellent day.
