Key Tronic Corp 10-Q for FY2024 Q1
Key Tronic Corp (KTCC)
10-Q
2023-11-09
For: 2023-09-30
View Original
Added on
April 06, 2026
About this 10-Q
Key Tronic Corp filed this 10-Q on November 9, 2023, covering the quarter ended September 30, 2023 (FY2024 Q1).
Headline figures
Quarter ended September 30, 2023, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $147.76M
- up 7.6% from $137.26M a year earlier
- Net income
- $335K
- down 70.9% from net income of $1.15M a year earlier
- Diluted EPS
- $0.03
- down 72.7% from $0.11 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________________
FORM 10-Q
____________________________________________________________
FOR THE QUARTERLY PERIOD ENDED September 30, 2023
OR
FOR THE PERIOD FROM TO .
Commission File Number 0-11559
____________________________________________________________
(Exact name of registrant as specified in its charter)
____________________________________________________________
| (State or other jurisdiction of Incorporation or organization) | (I.R.S. Employer Identification No.) | ||||
(Address of principal executive offices) (Zip Code)
(509 ) 928-8000
(Registrant’s telephone number, including area code)
N/A
(Former name, former address, and former fiscal year, if changed since last report)
____________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol | Name of each exchange on which registered | ||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements during the past 90 days. Yes ☒ No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulations S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated Filer | ☐ | Accelerated Filer | ☐ | |||||||||||||||||
☒ | Smaller reporting company | |||||||||||||||||||
| Emerging growth company | ||||||||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of November 1, 2023, 10,761,871 shares of common stock, no par value (the only class of common stock), were outstanding.
KEY TRONIC CORPORATION
Index
| Page No. | ||||||||
| PART I. | ||||||||
| Item 1. | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| PART II. | ||||||||
| Item 1. | ||||||||
| Item 1A. | ||||||||
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds* | |||||||
| Item 3. | Defaults upon Senior Securities* | |||||||
| Item 4. | Mine Safety Disclosures* | |||||||
| Item 5. | Other Information* | |||||||
| Item 6. | ||||||||
* Items are not applicable
“We,” “us,” “our,” “Company,” and “Key Tronic,” unless the context otherwise requires, means Key Tronic Corporation and its subsidiaries.
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
KEY TRONIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands; except share data)
| September 30, 2023 | July 1, 2023 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | |||||||||||
Trade receivables, net of allowance for doubtful accounts of $ | |||||||||||
| Contract assets | |||||||||||
| Inventories | |||||||||||
| Other | |||||||||||
| Total current assets | |||||||||||
| Property, plant and equipment, net | |||||||||||
| Operating lease right-of-use assets, net | |||||||||||
| Other assets: | |||||||||||
| Deferred income tax asset | |||||||||||
| Other | |||||||||||
| Total other assets | |||||||||||
| Total assets | |||||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | |||||||||||
| Accrued compensation and vacation | |||||||||||
| Current portion of debt, net | |||||||||||
| Other | |||||||||||
| Total current liabilities | |||||||||||
| Long-term liabilities: | |||||||||||
| Term loans | |||||||||||
| Revolving loan | |||||||||||
| Operating lease liabilities | |||||||||||
| Deferred income tax liability | |||||||||||
| Other long-term obligations | |||||||||||
| Total long-term liabilities | |||||||||||
| Total liabilities | |||||||||||
| Commitments and contingencies (Note 8) | |||||||||||
| Shareholders’ equity: | |||||||||||
Common stock, no par value—shares authorized | |||||||||||
| Retained earnings | |||||||||||
| Accumulated other comprehensive (loss) | ( | ( | |||||||||
| Total shareholders’ equity | |||||||||||
| Total liabilities and shareholders’ equity | |||||||||||
3
See accompanying notes to consolidated financial statements.
4
KEY TRONIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited, in thousands, except share and per share amounts)
| Three Months Ended | |||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | ||||||||||||||||||||||
| Net sales | $ | $ | |||||||||||||||||||||
| Cost of sales | |||||||||||||||||||||||
| Gross profit | |||||||||||||||||||||||
| Research, development and engineering expenses | |||||||||||||||||||||||
| Selling, general and administrative expenses | |||||||||||||||||||||||
| Gain on insurance proceeds, net of losses | ( | ( | |||||||||||||||||||||
| Total operating expenses | |||||||||||||||||||||||
| Operating income | |||||||||||||||||||||||
| Interest expense, net | |||||||||||||||||||||||
| Income before income taxes | |||||||||||||||||||||||
| Income tax provision | ( | ||||||||||||||||||||||
| Net income | $ | $ | |||||||||||||||||||||
| Net income per share — Basic | $ | $ | |||||||||||||||||||||
| Weighted average shares outstanding — Basic | |||||||||||||||||||||||
| Net income per share — Diluted | $ | $ | |||||||||||||||||||||
| Weighted average shares outstanding — Diluted | |||||||||||||||||||||||
See accompanying notes to consolidated financial statements.
5
KEY TRONIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited, in thousands)
| Three Months Ended | |||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | ||||||||||||||||||||||
| Comprehensive income: | |||||||||||||||||||||||
| Net income | $ | $ | |||||||||||||||||||||
| Other comprehensive income (loss): | |||||||||||||||||||||||
| Unrealized gain (loss) on hedging instruments, net of tax | |||||||||||||||||||||||
| Comprehensive income | $ | $ | |||||||||||||||||||||
See accompanying notes to consolidated financial statements.
6
KEY TRONIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited, in thousands)
| Three Months Ended | |||||||||||
| September 30, 2023 | October 1, 2022 | ||||||||||
| Operating activities: | |||||||||||
| Net income | $ | $ | |||||||||
| Adjustments to reconcile net income to cash used in operating activities: | |||||||||||
| Depreciation and amortization | |||||||||||
| Amortization of interest rate swap | |||||||||||
| Amortization of deferred loan costs | |||||||||||
| Noncash Lease Expense | |||||||||||
| Inventory write-down to net realizable value | |||||||||||
| Provision for warranty | |||||||||||
| Provision for doubtful accounts | |||||||||||
| Loss (Gain) on disposal of assets | ( | ||||||||||
| Gain on insurance proceeds, net of losses | ( | ( | |||||||||
| Share-based compensation expense | |||||||||||
| Deferred income taxes | ( | ( | |||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Trade receivables | ( | ||||||||||
| Contract assets | ( | ( | |||||||||
| Inventories | ( | ||||||||||
| Other assets | |||||||||||
| Accounts payable | ( | ||||||||||
| Accrued compensation and vacation | ( | ( | |||||||||
| Other liabilities | ( | ( | |||||||||
| Cash provided by (used in) operating activities | ( | ||||||||||
| Investing activities: | |||||||||||
| Purchase of property and equipment | ( | ( | |||||||||
| Proceeds from insurance | |||||||||||
| Cash provided by (used in) investing activities | ( | ||||||||||
| Financing activities: | |||||||||||
| Payment of financing costs | ( | ||||||||||
| Repayments of long term debt | ( | ( | |||||||||
| Borrowings under revolving credit agreement | |||||||||||
| Repayments of revolving credit agreement | ( | ( | |||||||||
| Principal payments on finance leases | ( | ( | |||||||||
| Cash (used in) provided by financing activities | ( | ||||||||||
| Net (decrease) increase in cash and cash equivalents | ( | ||||||||||
| Cash and cash equivalents, beginning of period | |||||||||||
| Cash and cash equivalents, end of period | $ | $ | |||||||||
| Non-cash investing activities: | |||||||||||
| Supplemental cash flow information: | |||||||||||
| Interest payments | $ | $ | |||||||||
| Income tax payments, net of refunds | $ | $ | |||||||||
| Recognition of operating lease liabilities and right-of-use assets | $ | $ | |||||||||
See accompanying notes to consolidated financial statements.
7
KEY TRONIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited, in thousands; except share data)
| Three Months Ended | ||||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | |||||||||||||||||||||||||
| Total shareholders’ equity, beginning balances | $ | $ | ||||||||||||||||||||||||
| Common stock (shares): | ||||||||||||||||||||||||||
| Beginning balances | ||||||||||||||||||||||||||
| Exercise of stock appreciation rights | ||||||||||||||||||||||||||
| Ending balances | ||||||||||||||||||||||||||
| Common stock: | ||||||||||||||||||||||||||
| Beginning balances | $ | $ | ||||||||||||||||||||||||
| Share-based compensation | $ | |||||||||||||||||||||||||
| Exercise of stock options | $ | |||||||||||||||||||||||||
| Ending balances | $ | |||||||||||||||||||||||||
| Retained Earnings: | ||||||||||||||||||||||||||
| Beginning balances | $ | $ | ||||||||||||||||||||||||
| Net income | $ | |||||||||||||||||||||||||
| Ending balances | $ | |||||||||||||||||||||||||
| Accumulated other comprehensive income (loss): | ||||||||||||||||||||||||||
| Beginning balances | $ | ( | $ | ( | ||||||||||||||||||||||
| Unrealized gain (loss) on hedging instruments, net | $ | |||||||||||||||||||||||||
| Ending balances | $ | ( | ( | |||||||||||||||||||||||
| Total shareholders’ equity, ending balances | $ | $ | ||||||||||||||||||||||||
See accompanying notes to consolidated financial statements.
8
KEY TRONIC CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.Basis of Presentation
The consolidated financial statements included herein have been prepared by Key Tronic Corporation and subsidiaries (the Company) pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted. The year-end condensed consolidated balance sheet information was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The financial statements reflect all normal and recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 2, 2022.
The Company’s reporting period is a 52/53 week fiscal year ending on the Saturday closest to June 30. The three month periods ended September 30, 2023 and October 1, 2022, were both 13 week periods. Fiscal year 2024 will end on June 29, 2024, which is a 52 week year. Fiscal year 2023 which ended on July 1, 2023, was also a 52 week year.
Management’s Assessment of Liquidity
Historically, we have financed operations and met our capital expenditure requirements primarily through cash flows provided by operations and borrowings under our credit facilities. We generated operating and net income of $3.3 million and $0.3 million respectively, during the 3-month period ended September 30, 2023, and have positive working capital of $194.6 million as of September 30, 2023. Due to the timing between the procurement of raw materials, production cycle and payment from our customers, we have relied on borrowings on our credit facilities and cash from operations to fund operations as the Company increased its revenues and during the first three months of fiscal year 2024. Based on current projections, we anticipate generating cash from operations as revenue is expected to remain flat during the second quarter of fiscal year 2024 and decreasing working capital requirements as existing backlog is manufactured and shipped.
As of September 30, 2023, approximately $9.5 million was available under the asset-based revolving credit facility. We are also in discussions with multiple financial institutions to extend the borrowing capacity on our credit facility. If we are unable to meet projected operating results or extend our borrowing capacity, we may need to delay the purchase of raw materials or require our customers to fund inventory raw material costs ahead of production. Other options to increase our liquidity include factoring receivables or leveraging foreign owned assets for additional borrowing capacity. We believe that projected cash from operations, funds available under our asset-based revolving credit facility and additional financing options will be sufficient to meet our working and fixed capital requirements for at least the next 12 months.
Certain Significant Risks and Uncertainties Related to Outbreak of Coronavirus Disease 2019 (“COVID-19”)
2.Significant Accounting Policies
Earnings Per Common Share
Basic earnings per common share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) by the combination of other potentially dilutive weighted average common shares and the weighted average number of common shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the exercise of stock options were used to repurchase common shares at the average market price during the period. The computation of diluted EPS does
9
Derivative Instruments and Hedging Activities
The Company has previously entered into foreign currency forward contracts and an interest rate swap which are accounted for as cash flow hedges in accordance with ASC 815, Derivatives and Hedging. The effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (AOCI) and is reclassified into earnings in the same period in which the underlying hedged transaction affects earnings. The derivative’s effectiveness represents the change in fair value of the hedge that offsets the change in fair value of the hedged item. As of September 30, 2023, the Company did not have any outstanding foreign currency forward contracts.
The Company occasionally uses derivatives to manage the variability of foreign currency fluctuations of expenses in our Mexico facilities. The foreign currency forward contracts have terms that are matched to the underlying transactions being hedged. As a result, these transactions fully offset the hedged risk and no ineffectiveness has been recorded.
The Company’s foreign currency forward contracts, where applicable, potentially expose the Company to credit risk to the extent the counterparty may be unable to meet the terms of the agreement. The Company minimizes such risk by utilizing a counterparty with a strong credit rating. The Company’s counterparty to the foreign currency forward contracts was a major banking institution. This institution did not require collateral for the contracts, and the Company believes that the risk of the counterparty failing to meet their contractual obligations is remote. The Company does not enter into derivative instruments for trading or speculative purposes.
Income Taxes
We compute our interim income tax provision through the use of an estimated annual effective tax rate (ETR) applied to year-to-date operating results and specific events that are discretely recognized as they occur. In determining the estimated annual ETR, we analyze various factors, including projections of our annual earnings, taxing jurisdictions in which the earnings will be generated, the impact of state and local income taxes, our ability to use tax credits and available tax planning alternatives. Discrete items, including the effect of changes in tax laws, tax rates, and certain circumstances with respect to valuation allowances or other unusual or non-recurring tax adjustments, are reflected in the period in which they occur as an addition to, or reduction from, the income tax provision, rather than included in the estimated annual ETR.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences and benefits attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as tax credit and net operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities for a change in tax rates is recognized in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized.
We utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments based on new assessments and changes in estimates and which may not accurately forecast actual outcomes. Our policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax expense. The tax years 2001 through the present remain open to examination by the major U.S. taxing jurisdictions to which we are subject. Refer to Note 5 for further discussions related to income taxes.
Recently Issued Accounting Standards
In March of 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments, which clarifies specific issues raised by stakeholders. Specifically, the ASU clarifies the following: 1) that all entities are required to provide the fair value option disclosures in ASC 825, Financial Instruments 2) clarifies that the portfolio exception in ASC 820, Fair Value Measurement, applies to nonfinancial items accounted for as derivatives under ASC 815, Derivatives and Hedging; 3) clarifies that for purposes of measuring expected credit losses on a net investment in a lease in accordance with ASC 326, Financial Instruments - Credit Losses, the lease term determined in accordance with ASC 842, Leases, should be used as the contractual term; 4) clarifies that when an entity regains control of financial assets sold, it should recognize an allowance for credit losses in accordance with ASC 326; and 5) aligns the disclosure requirements for debt securities in ASC 320, Investments - Debt Securities, with the corresponding requirements for depository and lending institutions in ASC 942, Financial Services - Depository and Lending. The amendments in the ASU have various effective dates and transition requirements which are
10
dependent on timing of adoption of ASU 2016-13. The Company adopted this amendment as of the effective date of July 2, 2023. This ASU did not have a material impact on our consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13 “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” and also issued subsequent amendments to the initial guidance: ASU 2018-19, ASU 2019-04 and ASU 2019-05, which replaces the existing incurred loss impairment model with an expected credit loss model and requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected. The guidance is effective for the Company beginning in the first quarter of fiscal year 2024 with early adoption permitted. The Company adopted this amendment as of the effective date of July 2, 2023. This ASU did not have a material impact on our consolidated financial statements.
In October 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2021-08 amending Business Combination: (Topic 805), which was necessary due to 2014-09, Revenue from Contracts with Customers (Topic 606). The FASB issued this Update to improve the accounting for acquired revenue contracts with customers in a business combination by addressing diversity in practice and inconsistency related to (1) recognition of an acquired contract liability and (2) payment terms and their effect on subsequent revenue recognized by the acquirer. The Company adopted this amendment as of the effective date of July 2, 2023. These amendments are to be applied prospectively to business combinations occurring on or after the effective date of the amendments. The Company plans to apply the practical expedients as needed for any future acquisitions. The practical expedients cover contracts that were modified prior to acquisition date as well as determining which date an acquirer would have to determine the standalone selling price of each performance obligation in an acquired contract. This ASU did not have a material impact on our consolidated financial statements.
In September 2022, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2022-04, Liabilities—Supplier Finance Programs (Subtopic 405-50). This standard requires disclosure of the key terms of outstanding supplier finance programs and a roll forward of the related obligations. The new standard does not affect the recognition, measurement or financial statement presentation of supplier finance program obligations. The ASU became effective for the Company July 2, 2023, except for the roll forward requirement, which becomes effective July 2, 2024. This ASU, except for the roll forward requirement, was adopted retrospectively as of July 2, 2023 and did not have a material impact on our consolidated financial statements.
3.Inventories
4.Long-Term Debt
On August 14, 2020, the Company entered into a loan agreement with Bank of America. The Loan Agreement replaces the Company’s prior amended and restated credit agreement, as amended, with Wells Fargo Bank. The Loan Agreement provides for a five-year asset-based senior secured revolving credit facility of up to $93 million, maturing on August 14, 2025.
On September 3, 2021, the Company entered into an amendment to the Company’s current loan agreement with Bank of America. The amendment increased the Company’s current credit facility of $93 million to $120 million, subject to the Company’s borrowing base, maturing on September 3, 2026.
On August 26, 2022, the Company entered into a third amendment to the loan agreement with Bank of America. The amendment removed the cash flow leverage ratio covenant and increased the interest rate by 25 basis points.
As of September 30, 2023, the Company had an outstanding balance under the asset-based revolving credit facility of $110.5 million, $0.3 million in outstanding letters of credit and $9.5 million available for future borrowings.
In the third quarter of fiscal year 2023, the Company entered into equipment financing agreements with Ameris Bank dba Balboa Capital ("Balboa Capital") totaling $4.4 million related to the Company’s existing manufacturing equipment that bears an interest rate range of 6 % - 8 % and matures in the third quarter of fiscal 2029. Under these agreements, equal monthly payments of $75,000 commenced in the third quarter of fiscal year 2023 and will continue through the maturity of the equipment financing facility in the third quarter of fiscal 2029. The Company had an outstanding balance $4.0 million as of September 30, 2023.
On August 14, 2020, the Company also entered into a $5.0 million equipment financing facility relating to the Company’s existing U.S. manufacturing equipment that bears interest at 4.85 % and matures on August 14, 2025. Under this loan agreement, equal monthly payments of approximately $94,000 commenced on September 14, 2020 and will continue through the maturity of the equipment financing facility on August 14, 2025. As of September 30, 2023, the Company had an outstanding balance of $2.1 million. As of July 1, 2023, the Company had an outstanding balance of $2.3 million under the Bank of America equipment term loan agreement.
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Generally, the interest rate applicable to loans under the Bank of America loan agreement will be, at the Company’s option: (i)(A) the base rate which is the highest of (a) the Prime Rate for such day, (b) the Federal Funds Rate for such day plus 0.50 %, or (c) Term SOFR for a one month interest period as of such day, plus 1.00 % (provided that in no event shall the base rate be less than zero), plus the applicable interest margin for base rate loans; and (B) SOFR rate for an applicable interest period, plus the applicable interest margin for SOFR rate loans. Depending on average daily excess borrowing availability over applicable periods under the Credit Facility, applicable interest margins on : (x) base rate loans will be 1.50 -2.00 %; and (y) SOFR rate loans will be 2.50 -3.00 %, resetting on a quarterly basis beginning in early 2021. If there is an event of default under the loan agreement, all loans and other obligations will bear interest as a rate of an additional 2.00 % on the otherwise applicable interest rates. In addition to interest charges, the Company is required to pay a fee of 0.25 % per annum on the unused portion of the Credit Facility, monthly in arrears.
On November 24, 2020, the Company entered into a $6.0 million financing facility related to the Company’s existing real estate located in Mexico that bears interest at 5.52 % and matures on April 24, 2026. Under this loan agreement, equal monthly payments of $100,000 commenced on May 24, 2021 and will continue through the maturity of the financing facility on April 24, 2026. As of September 30, 2023, the Company had an outstanding balance of $3.1 million. As of July 1, 2023, the Company had an outstanding balance of $3.4 million.
The interest rates on outstanding debt as of September 30, 2023 range from 4.85 % - 8.43 % compared to 4.85 % - 8.22 % as of July 1, 2023.
Debt maturities as of September 30, 2023 for the next five years and thereafter are as follows (in thousands):
| Fiscal Years Ending | Amount | ||||
2024 (1) | $ | ||||
| 2025 | $ | ||||
| 2026 | $ | ||||
| 2027 | $ | ||||
| 2028 - Thereafter | $ | ||||
| Total debt | |||||
| Unamortized debt issuance costs | ( | ||||
| Long-term debt, net of debt issuance costs | $ | ||||
(1) Represents scheduled payments for the remaining nine-month period ending June 29, 2024.
The Company must comply with certain financial covenants, including a fixed charge coverage ratio. The credit agreement requires the Company to grant certain inspection rights to Bank of America, limit or restrict the Company’s cash management; limit or restrict the ability of the Company to incur additional liens, make acquisitions or investments, incur additional indebtedness, engage in mergers, consolidations, liquidations, dissolutions, or dispositions, pay dividends or other restricted payments, prepay certain indebtedness, engage in transactions with affiliates, and use proceeds. Management believes the Company was in compliance with all financial covenants as of September 30, 2023.
5.Income Taxes
The Company expects to repatriate a portion of its foreign earnings based on increased net sales growth driving additional capital requirements domestically, cash requirements for potential acquisitions and to implement certain tax strategies. The Company currently expects to repatriate approximately $7.8 million of foreign earnings in the future. All other unremitted foreign earnings are expected to remain permanently reinvested for planned fixed assets purchases and improvements in foreign locations.
Repatriations of cash will generally be tax-free in the U.S. However, withholding taxes in China may still apply to any such future repatriations. Management has not changed its indefinite investment assertions with regard to the portion of accumulated earnings and profits in China that may be repatriated in the future. Accordingly, management estimates that future repatriations of cash from China may result in approximately $0.8 million of withholding tax. We do not anticipate there would be any offsetting foreign tax credits in the U.S. and as such, this potential liability is a direct cost associated with actual repatriations. Withholding taxes would not apply to future repatriations from Mexico or Vietnam.
The Company has available approximately $10.0 million of gross federal research and development tax credits as of September 30, 2023. ASC 740 requires the Company to recognize in its financial statements uncertainties in tax positions taken that may not be sustained upon examination by the taxing authorities. Accordingly, as of September 30, 2023, the Company has recorded $3.0 million of unrecognized tax benefits associated with these federal tax credits, resulting in a net deferred tax benefit of approximately $7.0 million.
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6.Earnings Per Share
The following table presents a reconciliation of the denominator in the basic and diluted EPS calculation and the number of antidilutive common share awards that were not included in the diluted earnings per share calculation. These antidilutive securities occur when equity awards outstanding have an option price greater than the average market price for the period.
| Three Months Ended | |||||||||||
| (in thousands, except share and per share information) | |||||||||||
| September 30, 2023 | October 1, 2022 | ||||||||||
| Net income | $ | $ | |||||||||
| Weighted average shares outstanding—basic | |||||||||||
| Effect of dilutive common stock awards | |||||||||||
| Weighted average shares outstanding—diluted | |||||||||||
| Net income per share—basic | $ | $ | |||||||||
| Net income per share—diluted | $ | $ | |||||||||
| Antidilutive SARs not included in diluted earnings per share | |||||||||||
7. Share-based Compensation
The Company’s incentive plan provides for equity and liability awards to employees and non-employee directors in the form of stock options, stock appreciation rights (SARs), restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock-based or cash-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service period, which is generally the vesting period, and is recorded as employee compensation expense in cost of goods sold, research, development and engineering, and selling, general and administrative expenses. Share-based compensation is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on historical experience and future expectations.
In addition to service conditions, SARs contain a performance condition. The additional performance condition is based upon the achievement of Return on Invested Capital (ROIC) goals relative to a peer group. All awards with performance conditions are evaluated quarterly to determine the likelihood that performance metrics will be achieved during the performance period. These awards are charged to compensation expense over the requisite service period based on the number of shares expected to vest. The SARs cliff vest after a three-year period from date of grant and expire five years from date of grant.
The grant date fair value for the awards granted below were estimated using the Black-Scholes option valuation method:
| July 29, 2022 | |||||
| SARs Granted | |||||
| Strike Price | $ | ||||
| Fair Value | $ | ||||
Total share-based compensation expense recognized during the three months ended September 30, 2023 and October 1, 2022 was approximately $59,000 and $40,000 , respectively.
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8.Commitments and Contingencies
Litigation and Other Matters
The Company is party to certain lawsuits or claims in the ordinary course of business. The Company does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the financial position, results of operations, or cash flow of the Company.
Warranties
The Company provides warranties on certain product sales. Allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. If actual return rates and/or repair and replacement costs differ significantly from management’s estimates, adjustments to recognize additional cost of sales may be required in future periods. The Company’s warranty reserve was approximately $113,000 as of September 30, 2023 and $29,000 as of July 1, 2023, respectively.
Gain from Insurance Recoveries, Net of Losses
9.Derivative Financial Instruments
As of September 30, 2023, the Company did not have any outstanding foreign currency forward contracts. For the three months ended September 30, 2023, the Company did not enter into or settle any foreign currency forward contracts. During the same period of the previous year, the Company did not enter into or settle any foreign currency forward contracts.
On November 6, 2019, the Company entered into an interest rate swap contract with an effective date of November 6, 2019 and a termination date of September 30, 2022, related to the borrowings outstanding under the term loan with Wells Fargo Bank. This interest rate swap contract was terminated on August 14, 2020 when the Company entered into a loan and security agreement with Bank of America. On the date of termination this interest rate swap was in a liability position of $148,400 , which will be amortized to interest expense over the original term of the swap.
On November 6, 2019, the Company entered into an interest rate swap contract with an effective date of November 6, 2019 and a termination date of November 1, 2023, related to the borrowings outstanding under the line of credit with Wells Fargo Bank. This interest rate swap contract was terminated on August 14, 2020 when the Company entered into a loan and security agreement with Bank of America. On the date of termination this interest rate swap was in a liability position of $776,500 , which will be amortized to interest expense over the original term of the swap.
14
The following tables summarize the gain (loss) on derivative instruments, net of tax, on the Consolidated Statements of Income for the three months ended September 30, 2023 and October 1, 2022, respectively (in thousands):
| Derivatives Designated as Hedging Instruments | Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) | AOCI Balance as of July 1, 2023 | Effective Portion Recorded In AOCI | Effective Portion Reclassified From AOCI Into Income | AOCI Balance as of September 30, 2023 | ||||||||||||||||||||||||
| Forward contracts | Cost of sales | $ | |||||||||||||||||||||||||||
| Interest rate swap | Interest expense | ( | ( | ||||||||||||||||||||||||||
| Total | $ | ( | $ | $ | $ | ( | |||||||||||||||||||||||
| Derivatives Designated as Hedging Instruments | Classification of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) | AOCI Balance as of July 2, 2022 | Effective Portion Recorded In AOCI | Effective Portion Reclassified From AOCI Into Income | AOCI Balance as of October 1, 2022 | ||||||||||||||||||||||||
| Forward contracts | Cost of sales | ( | |||||||||||||||||||||||||||
| Interest rate swap | Interest expense | ( | ( | ||||||||||||||||||||||||||
| Total | $ | ( | $ | $ | $ | ( | |||||||||||||||||||||||
As of September 30, 2023, the Company does not have any foreign exchange contracts with credit-risk-related contingent features. The Company is subject to the risk of fluctuating interest rates from our line of credit and foreign currency risk resulting from our China operations. The Company does not currently manage these risk exposures by using derivative instruments.
10.Revenue
Revenue Recognition
The Company specializes in services ranging from product manufacturing to engineering and tooling services. The first step in its process for revenue recognition is to identify the contract with a customer. A contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. A contract can be written, oral, or implied. The Company generally enters into manufacturing service agreements (“MSA”) with its customers that outline the terms of the business relationship between the customer and the Company. This includes matters such as warranty, indemnification, transfer of title and risk of loss, liability for excess and obsolete inventory, pricing, payment terms, etc. The Company will also bid on a program-by-program basis for customers in which an executed MSA may not be in place. In these instances, as well as when we have an MSA in place, we receive customer purchase orders for specific quantities and timing of products. As a result, the Company considers its contract with a customer to be the combination of the MSA and the purchase order. The transaction price is fixed and set forth in each purchase order. In the Company's normal course of business, there are no variable pricing components, or material amounts refunded to customers in the form of refunds or rebates.
15
The Company assesses whether control of the product or services promised under the contract is transferred to the customer at a point in time (shipment) or over time (as we manufacture the product). The Company is first required to evaluate whether its contracts meet the criteria for 'over-time' or 'point-in-time' recognition. The Company has determined that for the majority of its contracts the Company is manufacturing products for which there is no alternative use due to the unique nature of the customer-specific product, IP and other contract restrictions. The Company has an enforceable right to payment including a reasonable profit for performance completed to date with respect to these contracts. As a result, revenue is recognized under these contracts 'over-time' based on the input cost-to-cost method as it better depicts the transfer of control. This input method is based on the ratio of costs incurred to date as compared to the total estimated costs at completion of the performance obligation. For all other contracts that do not meet these criteria, such as manufacturing contracts for which the terms do not provide an enforceable right to payment for performance completed to date, the Company recognizes revenue when it has transferred control of the related manufactured products which generally occurs upon shipment to the customer. Revenue from engineering services is recognized over time as the services are performed.
The Company’s sales arrangements do not contain any significant financing component for its customers.
The Company generally provides a warranty for workmanship on its manufacturing contracts. Although we offer warranties on our products, our warranties are considered to be assurance-type in nature and do not cover anything beyond ensuring that the product is functioning as intended. Based on the guidance in ASC 606, assurance-type warranties do not represent separate performance obligations; therefore, the primary performance obligation in the majority of our contracts is the delivery of a specific good through the purchase order submitted by our customer.
The Company elected to not disclose information about remaining performance obligations as they are part of contracts that have expected durations of one year or less.
The Company has elected to expense costs to obtain contracts as incurred as these costs are immaterial to the financial statements.
During the first three months of fiscal year 2024, no revenues were recognized from performance obligations satisfied or partially satisfied in previous periods.
Contract Balances
A contract asset is recognized when the Company has recognized revenue, but has not issued an invoice for payment. Contract assets are classified separately on the condensed consolidated balance sheet and transferred to receivables when the right to payment becomes unconditional. The following table summarizes the activity in the Company’s contract assets during the three months ended September 30, 2023 (in thousands):
| Contract Assets | |||||
Beginning balance, July 1, 2023 | $ | ||||
| Revenue recognized | $ | ||||
| Amounts collected or invoiced | $ | ( | |||
Ending balance, September 30, 2023 | $ | ||||
Disaggregation of Revenue
The following table presents the Company’s revenue disaggregated for the three months ended September 30, 2023 and October 1, 2022 (in thousands):
| Revenue | ||||||||||||||||||||||||||
| Recognition | Three Months Ended | |||||||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | |||||||||||||||||||||||||
| Over-Time | $ | $ | ||||||||||||||||||||||||
| Point-in-Time | ||||||||||||||||||||||||||
| Total | $ | $ | ||||||||||||||||||||||||
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11.Leases
The Company has several commitments under operating and financing leases for warehouses, manufacturing facilities, office buildings, and equipment with initial terms that expire at various dates during the next 1 year to 10 years.
The Company has some leases that include an extension clause. Management has considered the likelihood of exercising each extension option included and estimated the duration of the extension option, for those leases management determined to be reasonably certain, in calculating the lease term for measurement of the right of use asset and liability.
For operating leases, management assumed a discount rate of 4.2 %. The weighted average discount rate is disclosed in the tables below.
17
The components of lease cost for the three months ended September 30, 2023 and October 1, 2022 were (in thousands):
| Lease cost | Classification | September 30, 2023 | October 1, 2022 | |||||||||||||||||
| Operating lease cost | Cost of sales | $ | $ | |||||||||||||||||
| Operating lease cost | Selling, general and administrative expenses | $ | $ | |||||||||||||||||
| Financing lease cost | Cost of sales | $ | $ | |||||||||||||||||
| Financing lease cost | Selling, general and administrative expenses | $ | $ | |||||||||||||||||
| Total lease cost | $ | $ | ||||||||||||||||||
| Fixed lease cost | $ | $ | ||||||||||||||||||
| Short-term lease cost | $ | $ | ||||||||||||||||||
| Total lease cost | $ | $ | ||||||||||||||||||
Amounts reported in the Consolidated Balance Sheet as of September 30, 2023 were (in thousands, except weighted average lease term and discount rate):
| September 30, 2023 | ||||||||
| Operating Leases: | ||||||||
| Operating lease right of use assets | $ | |||||||
Operating lease liabilities (1) | $ | |||||||
| Weighted-average remaining lease term (in years) | ||||||||
| Operating leases | ||||||||
| Weighted-average discount rate | ||||||||
| Operating leases | ||||||||
Financing Leases (2): | ||||||||
| Financing lease right of use assets | $ | |||||||
| Financing lease liabilities | $ | |||||||
| Weighted-average remaining lease term (in years) | ||||||||
| Financing leases | ||||||||
| Weighted-average discount rate | ||||||||
| Financing leases | ||||||||
(1) The current portion of the total operating lease liabilities of $5.0 million is classified under , resulting in $10.9 million classified under in the Long-term Liabilities section of the condensed consolidated balance sheet.
(2) The total finance lease right of use assets of $6.0 million is classified under . The current portion of the total finance lease liabilities of $3.3 million is classified under , resulting in $1.2 million classified in section of the condensed consolidated balance sheet.
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Other information related to leases was as follows (in thousands):
| Three Months Ended | ||||||||||||||||||||
| September 30, 2023 | October 1, 2022 | |||||||||||||||||||
| Cash paid for amounts included in the measurement of lease liabilities: | ||||||||||||||||||||
| Operating cash flows from operating leases | $ | $ | ||||||||||||||||||
| Financing cash flows used in financing leases | $ | $ | ||||||||||||||||||
Future lease payments under non-cancellable leases as of September 30, 2023 are as follows (in thousands):
| Fiscal Years Ending | Operating Leases | Finance Leases | ||||||||||||
2024 (1) | $ | $ | ||||||||||||
| 2025 | $ | $ | ||||||||||||
| 2026 | $ | $ | ||||||||||||
| 2027 | $ | $ | ||||||||||||
| 2028 | $ | $ | ||||||||||||
| Thereafter | $ | $ | ||||||||||||
| Total undiscounted lease payments | $ | $ | ||||||||||||
| Less: present value discount | $ | ( | $ | ( | ||||||||||
| Total lease liabilities | $ | $ | ||||||||||||
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
References in this report to “the Company,” “Key Tronic,” “we,” “our,” or “us” mean Key Tronic Corporation together with its subsidiaries, except where the context otherwise requires.
This Quarterly Report contains forward-looking statements in addition to historical information. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risks and Uncertainties that May Affect Future Results.” Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management’s opinions only as of the date hereof. The Company undertakes no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaims any obligation to do so. Readers should carefully review the risk factors described in this report and other periodic reports the Company files from time to time with the Securities and Exchange Commission, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K.
Overview
Key Tronic is a leading contract manufacturer offering value-added design and manufacturing services from its facilities in the United States, Mexico, China, and Vietnam. The Company provides its customers full engineering services, materials management, worldwide manufacturing facilities, assembly services, in-house testing, and worldwide distribution. Our customers include some of the world’s leading original equipment manufacturers. Our combined capabilities and vertical integration are proving to be a desirable offering to our expanded customer base.
Our international production capability provides our customers with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. We continue to make investments in all of our operating facilities to give us the production capacity, capabilities, and logistical advantages to continue to win new business. The following information should be read in conjunction with the consolidated financial statements included herein and with Part II Item 1A, Risk Factors included as part of this filing.
Our mission is to provide our customers with superior manufacturing and engineering services at the lowest total cost for the highest quality products, and create long-term mutually beneficial business relationships by employing our “Trust, Commitment, Results” philosophy.
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Executive Summary
For the first quarter of fiscal year 2024, the Company reported total revenue of $147.8 million, up 8% from $137.3 million in the same period of fiscal year 2023. During the first quarter of fiscal year 2024, the Company ramped up new programs produced in the Company’s U.S. facilities and remained profitable, despite a softening of customer demand in the Company’s Mexico-based facilities. As previously announced, the large program with a leading power equipment company is now expected to resume materially in fiscal 2025 rather than 2024, with a redesigned product.
As new customer programs ramp, the concentration of our top three customers’ net sales increased to 29.9 percent of total sales in the first quarter of fiscal year 2024 from 25.4 percent in the same period of the prior fiscal year. We expect that concentration to our top three customers will decrease during the fiscal year.
Net sales to our largest customers may vary significantly from quarter to quarter depending on the size and timing of customer program commencement, forecasts, delays, and design modifications. We remain dependent on continued net sales to our significant customers and most contracts with customers are not firm long-term purchase commitments. We seek to maintain flexibility in production capacity by employing skilled temporary and short-term labor and by utilizing short-term leases on equipment and manufacturing facilities. In addition, our capacity and core competencies for printed circuit board assemblies, precision molding, sheet metal fabrication, tool making, assembly, and engineering can be applied to a wide variety of products.
Gross profit as a percent of net sales was 7.4 percent for the first quarter of fiscal year 2024 as compared to 7.6 percent for the same quarter of the prior fiscal year. During the first quarter of fiscal year 2024, the results were impacted by unanticipated severance costs of $0.6 million, as the Company reduced its workforce by over 100 employees in Mexico and the U.S. which adversely impacted gross profit. Gross margin was also adversely impacted by the strength of the Mexican Peso, although the Mexican Peso has weakened during the second quarter.
Operating income as a percentage of net sales was 2.2 percent for the first quarter of fiscal year 2024 compared to 2.4 percent of operating income as a percentage of net sales for the first quarter of fiscal year 2023. The decrease in operating income as a percentage of net sales was primarily driven by unanticipated severance costs and the strength of the Mexican Peso.
Net income for the first quarter of fiscal year 2024 was $0.3 million or $0.03 per diluted share, as compared to net income of $1.2 million or $0.11 per diluted share for the first quarter of fiscal year 2023. The year-over-year decline in earnings was primarily a result of a $1.1 million increase in interest expense on higher interest rates. Earnings were also adversely impacted by an unanticipated severance costs of $0.6 million, or approximately $0.04 to $0.05 per diluted share. The workforce reduction reflects softening demand for a number of different programs and is expected to reduce operating expenses by more than $5 million annually.
During the first quarter of fiscal year 2024, we won new programs involving security equipment, sporting and outdoor products, environmental solutions, and industrial control systems.
Moving into the second quarter of fiscal year 2024, global logistics problems, the war in Europe, and China-US geopolitical tensions continue to drive OEM’s to examine their traditional outsourcing strategies. We believe these customers increasingly realize they have become overly dependent on their China-based contract manufacturers not only for products, but also for design and logistics services. The decision to onshore or near shore production appears to be becoming more widely accepted as a smart long-term strategy. As a result, we see opportunities for continued growth. In addition, the headwinds from the global supply chain continue to present uncertainty and multiple business challenges but do show some signs of gradually abating, particularly with respect to the recent price stabilization for some commodity components. At the same time, these price reductions are offset by increasing wages at our North American facilities. In our second quarter of fiscal 2024, the Company is beginning to see the Peso weaken to the US dollar which may translate into improving conditions moving forward.
We maintain a strong balance sheet with a current ratio of 2.5 and a debt-to-equity ratio of 0.9 as of September 30, 2023. Total cash provided by operating activities as defined on our cash flow statement was $5.6 million for the three months ended September 30, 2023, the Company focuses on inventory reductions and other working capital improvements. We believe we maintain sufficient liquidity for our expected future operations and had $110.5 million in borrowings on our revolving credit facility and $9.5 million remained available at September 30, 2023.
20
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. These estimates and assumptions are based on historical results as well as future expectations. Actual results could vary from our estimates and assumptions.
The accounting policies and estimates listed below are those that we believe are the most critical to our consolidated financial condition and results of operations. They are also the accounting policies that typically require our most difficult, subjective and complex judgments and estimates, often for matters that are inherently uncertain.
•Revenue Recognition
•Inactive, Obsolete, and Surplus Inventory Valuation
•Allowance for Doubtful Accounts
•Income Taxes
Please refer to the discussion of critical accounting policies in our most recent Annual Report on Form 10-K for the fiscal year ended July 1, 2023, for further details.
21
RESULTS OF OPERATIONS
Comparison of the Three Months Ended September 30, 2023 with the Three Months Ended October 1, 2022
The financial information and discussion below should be read in conjunction with the Consolidated Financial Statements and Notes.
The following table sets forth certain information regarding the components of our condensed consolidated statements of income for the three months ended September 30, 2023 as compared to the three months ended October 1, 2022. It is provided to assist in assessing differences in our overall performance (in thousands):
| Three Months Ended | |||||||||||||||||||||||||||||||||||
| September 30, 2023 | % of net sales | October 1, 2022 | % of net sales | $ change | % point change | ||||||||||||||||||||||||||||||
| Net sales | $ | 147,763 | 100.0 | % | $ | 137,263 | 100.0 | % | $ | 10,500 | 7.6 | % | |||||||||||||||||||||||
| Cost of sales | 136,901 | 92.6 | % | 126,884 | 92.4 | % | 10,017 | 0.2 | % | ||||||||||||||||||||||||||
| Gross profit | 10,862 | 7.4 | % | 10,379 | 7.6 | % | 483 | (0.2) | % | ||||||||||||||||||||||||||
| Research, development and engineering | 2,241 | 1.5 | % | 2,296 | 1.7 | % | (55) | (0.2) | % | ||||||||||||||||||||||||||
| Selling, general and administrative | 5,784 | 3.9 | % | 5,656 | 4.1 | % | 128 | (0.2) | % | ||||||||||||||||||||||||||
| Gain on insurance proceeds, net of losses | (431) | (0.3) | % | (934) | (0.7) | % | 503 | 0.4 | % | ||||||||||||||||||||||||||
| Total operating expenses | 7,594 | 5.1 | % | 7,018 | 5.1 | % | 576 | — | % | ||||||||||||||||||||||||||
| Operating income | 3,268 | 2.2 | % | 3,361 | 2.4 | % | (93) | (0.2) | % | ||||||||||||||||||||||||||
| Interest expense, net | 3,011 | 2.0 | % | 1,887 | 1.4 | % | 1,124 | 0.6 | % | ||||||||||||||||||||||||||
| Income before income taxes | 257 | 0.2 | % | 1,474 | 1.1 | % | (1,217) | (0.9) | % | ||||||||||||||||||||||||||
| Income tax provision | (78) | (0.1) | % | 322 | 0.2 | % | (400) | (0.3) | % | ||||||||||||||||||||||||||
| Net income | $ | 335 | 0.2 | % | $ | 1,152 | 0.8 | % | $ | (817) | (0.6) | % | |||||||||||||||||||||||
Net Sales
Net sales of $147.8 million for the first quarter of fiscal year 2024 increased by 7.6 percent as compared to net sales of $137.3 million for the first quarter of fiscal year 2024.
The $10.5 million increase in net sales from the prior year period was primarily due to the successful ramp of new customer programs and increased component sales for a large customer. However, the Company’s revenue was constrained by tightening worldwide supply chain and transportation and logistics issues.
Gross Profit
Gross profit as a percentage of net sales for the three months ended September 30, 2023 was 7.4 percent compared to 7.6 percent for the three months ended October 1, 2022. This 0.2 percentage point decrease was primarily a result of unanticipated severance costs related to a reduction of the Company’s workforce in Mexico and the United States.
The level of gross margin is impacted by facility utilization, product mix, timing, severity and steepness of new program ramps, pricing within the electronics industry and material costs, which can fluctuate significantly from quarter to quarter.
Included in gross profit are charges related to reductions in the carrying value of our inventory due to obsolescence. We recorded an impairment of approximately $265,000 and $175,000 for obsolete inventory during the three months ended September 30, 2023 and October 1, 2022, respectively. We adjust the carrying value for estimated obsolescence as necessary in an amount equal to the difference between the cost of inventory and its net realizable value based on assumptions as to future demand and market conditions. The provisions are established for inventory that we have determined customers are not contractually responsible for and for inventory that we believe customers will be unable to purchase.
Operating Expenses
There were no significant changes to operating expenses during the presented quarters, other than the gain on insurance proceeds of $0.4 million recorded in the first quarter of fiscal year 2024. Total research, development, and engineering (RD&E) expenses were $2.2 million during the three months ended September 30, 2023 and $2.3 million during the three months ended October 1, 2022, respectively. Total RD&E expenses as a percent of net sales were 1.5 percent during the three months ended September 30, 2023 and 1.7 percent during the three months ended October 1, 2022.
Total selling, general, and administrative (SG&A) expenses were $5.8 million during the three months ended September 30, 2023 compared to $5.7 million for the three months ended October 1, 2022. Total SG&A expenses as a percentage of net sales were 3.9 percent for the three months ended September 30, 2023 and 4.1 percent for the three months ended October 1, 2022.
22
Interest
Interest expense was $3.0 million during the three months ended September 30, 2023 and $1.9 million during the three months ended October 1, 2022. The increase in interest expense is primarily related to increased interest rates and an increase in the average balance outstanding on our line of credit.
Income Taxes
The effective tax rate for the three months ended September 30, 2023 was (30.4) percent compared to 21.8 percent for the three months ended October 1, 2022. The decrease is primarily due to the impact of discrete foreign exchange benefits and the relatively low amount of income before income taxes for the three months ended September 30, 2023.
Our judgments regarding deferred tax assets and liabilities may change due to changes in market conditions, changes in estimates, changes in tax laws or other factors. If assumptions and estimates change in the future the deferred tax assets and liability will be adjusted accordingly and any increase or decrease will result in an additional deferred income tax expense or benefit in subsequent periods.
BACKLOG
On September 30, 2023, we had an order backlog of approximately $319.8 million. This compares with a backlog of approximately $380.0 million on October 1, 2022. The decrease in order backlog is related to some softening on demand for a number of our Mexico-based programs, partially offset by an increase in demand for our U.S. based facilities. Order backlog consists of purchase orders received for products expected to be shipped within the next 12 months, although shipment dates are subject to change due to design modifications or changes in other customer requirements. Order backlog should not be considered an accurate measure of future net sales.
CAPITAL RESOURCES AND LIQUIDITY
Operating Cash Flow
Net cash provided by operating activities for the three months ended September 30, 2023 was $5.6 million, compared to net cash used in operating activities of $5.8 million during the same period of the prior fiscal year.
The $5.6 million of net cash provided by operating activities for the three months ended September 30, 2023 is primarily related to $0.3 million in net income adjust for 2.8 million of depreciation and amortization, a $9.2 million decrease in accounts receivable, a $10.9 million decrease in inventory, partially off set by a $1.5 million decrease in accrued compensation and vacation, a $14.3 million decrease in accounts payable, a $1.0 million decrease in other liabilities and a $3.0 million increase in contract assets.
The $5.8 million of net cash used in operating activities for the three months ended October 1, 2022 is primarily related to $1.2 million in net income for the period adjusted for $2.4 million of depreciation and amortization, a $4.4 million increase in contract assets, a $1.8 million increase in accounts receivable, a $13.7 million increase in inventory, a $2.8 million decrease in accrued compensation and vacation partially offset by a $12.7 million increase in accounts payable.
Accounts receivable fluctuates based on the timing of shipments, terms offered and collections that occurred during the quarter. While overall net sales are not typically seasonal in nature, we ship the majority of our product during the latter half of the quarter. We purchase inventory based on customer forecasts and orders, and when those forecasts and orders change, the amount of inventory may also fluctuate. Accounts payable fluctuates with changes in inventory levels, volume of inventory purchases, negotiated supplier terms and taking advantage of early pay discounts.
Investing Cash Flow
Cash provided by investing activities was $1.7 million during the three months ended September 30, 2023 as compared to cash used in investing activities of $2.5 million during the three months ended October 1, 2022. Our primary investing activity during the three months ended September 30, 2023 and October 1, 2022, was purchasing equipment to support increased production levels for new programs. The Company also received $2.2 million related to insurance proceeds as a result of previously disclosed storm damage to the Company’s Arkansas facility.
Leases are often utilized when potential technical obsolescence and funding requirement advantages outweigh the benefits of equipment ownership. Total capital expenditures are expected to be $8.0 million during the fiscal year, a significant portion of which may be funded through finance leases. Capital expenditures and periodic lease payments are expected to be financed with internally generated funds as well as our revolving line of credit facility and equipment term loan.
23
Financing Cash Flow
Cash used in financing activities was $7.4 million during the three months ended September 30, 2023 as compared to cash provided by financing activities of $8.8 million in the same period of the previous fiscal year. Our primary financing activities during the three months ended September 30, 2023 and October 1, 2022, were borrowings and repayments under our revolving line of credit facility and term loans.
As of September 30, 2023, approximately $9.5 million was available under the asset-based revolving credit facility.
Our cash requirements are affected by the level of current operations and new programs. We believe that projected cash from operations, funds available under the revolving credit facility and leasing capabilities will be sufficient to meet our working and fixed capital requirements for the foreseeable future. The Company further notes projected cash from operations from increased demand from certain customers will be partially offset by an anticipated slowdown in collections from other customers and increasing inventory levels in efforts to mitigate supply chain constraint risks. As of September 30, 2023, we had approximately $3.6 million of cash held by foreign subsidiaries. If cash is to be repatriated in the future from these foreign subsidiaries, the Company would be subject to certain withholding taxes in the foreign jurisdictions. The total amount of tax payments required for the amount of foreign subsidiary cash on hand as of September 30, 2023 would approximate $56,000. We have accrued withholding taxes for expected future repatriation of foreign earnings as discussed in Note 6 of the “Notes to Consolidated Financial Statements.”
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
We have included a summary of our Contractual Obligations in our annual report on Form 10-K for the fiscal year ended July 1, 2023. There have been no material changes in contractual obligations outside the ordinary course of business since July 1, 2023.
RISKS AND UNCERTAINTIES THAT MAY AFFECT FUTURE RESULTS
The following risks and uncertainties could affect our actual results and could cause results to differ materially from past results or those contemplated by our forward-looking statements. When used herein, the words “expects,” “believes,” “anticipates” and other similar expressions are intended to identify forward-looking statements.
RISKS RELATED TO OUR BUSINESS AND STRATEGY
Our operations may be subject to certain risks.
We manufacture product in facilities located in Mexico, China, Vietnam and the United States. These operations may be subject to a number of risks, including:
•difficulties in staffing, turnover and managing onshore and offshore operations;
•political and economic instability (including acts of terrorism, pandemics, civil unrest, forms of violence and outbreaks of war), which could impact our ability to ship, manufacture, and/or receive product;
•unexpected changes in regulatory requirements and laws, including those related to climate change;
•longer customer payment cycles and difficulty collecting accounts receivable;
•cash liquidity, the ability to acquire new debt capacity, and capital constraints;
•export duties, import controls and trade barriers (including quotas);
•governmental restrictions on the transfer of funds;
•burdens of complying with a wide variety of foreign laws and labor practices; subject to trade wars and tariffs;
•our locations are subject to physical and operational risks from natural disasters, severe weather events, and climate change; and
•our locations may also be impacted by future temporary closures and labor constraints as a result of local mandates for medical, climate, and unforeseen emergencies.
Our operations in certain foreign locations receive favorable income tax treatment in the form of tax credits or other incentives. In the event that such tax incentives are not extended, are repealed, or we no longer qualify for such programs, our taxes may increase, which would reduce our net income.
Additionally, certain foreign jurisdictions restrict the amount of cash that can be transferred to the U.S or impose taxes and penalties on such transfers of cash. To the extent we have excess cash in foreign locations that could be used in, or is needed by, our operations in the United States, we may incur significant penalties and/or taxes to repatriate these funds.
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We may experience fluctuations in quarterly results of operations.
Our quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including adverse changes in the U.S. and global macroeconomic environment, volatility in overall demand for our customers’ products, success of customers’ programs, timing of new programs, new product introductions or technological advances by us, our customers and our competitors, and changes in pricing policies by us, our customers, our suppliers, and our competitors. Our customer base is diverse in the markets they serve, however, decreases in demand, particularly from customers in certain industries could affect future quarterly results. Additionally, our customers could be adversely impacted by illiquidity in the credit markets which could directly impact our operating results.
Component procurement, production schedules, personnel and other resource requirements are based on estimates of customer requirements. Occasionally, our customers may request accelerated production that can stress resources and reduce operating margins. Conversely, our customers may abruptly lower or cancel production which may lead to a sudden, unexpected increase in inventory or accounts receivable for which we may not be reimbursed even when under contract with customers. In addition, because many of our operating expenses are relatively fixed, a reduction in customer demand can harm our gross profit and operating results. The products which we manufacture for our customers have relatively short product lifecycles. Therefore, our business, operating results, and financial condition are dependent in a significant way on our ability to obtain orders from new customers and new product programs from existing customers.
Operating results can also fluctuate if changes are made to significant estimates and assumptions. Significant estimates and assumptions include the allowance for doubtful receivables, net realizable inventory, the valuation allowance on deferred tax assets.
Due to the COVID-19 pandemic, we have seen extreme shifts in demand from our customer base. The possibility of future temporary closures and labor constraints, as well as the inability to predict customer demand, costs, and future supply chain disruptions during the rapidly changing COVID-19 environment can materially impact operating results.
We are exposed to general economic conditions, which could have a material adverse impact on our business, operating results and financial condition.
Adverse economic conditions and uncertainty in the global economy such as unstable global financial and credit markets, inflation, and recession can negatively impact our business. Unfavorable economic conditions could affect the demand for our customers’ products by triggering a reduction in orders as well as a decline in forecasts which could adversely affect our sales in future periods. Additionally, the financial strength of our customers and suppliers and their ability to obtain and rely on credit financing may affect their ability to fulfill their obligations to us and have an adverse effect on our financial results.
Adverse macroeconomic conditions, such as those that were a result of COVID-19 have and may continue to affect our business. The conditions affect the Company’s ability to predict and plan for future supply chain disruptions, fluctuations in customer demand and costs, and the ability to operate as there is uncertainty over future temporary closures. Inflation has also risen globally to historically high levels. If the inflation rate continues to increase, the costs of labor and other expenses could also increase. We may not be able to increase our product prices enough to offset these increased costs. In addition, any increase in our product prices may reduce our future customer orders and profitability. Inflation may further exacerbate other risk factors discussed in this Quarterly Report on Form 10-Q, including disruptions to international operations.
The majority of our sales come from a small number of customers and a decline in sales to any of these customers could adversely affect our business.
At present, our customer base is concentrated and could become more or less concentrated. There can be no assurance that our principal customers will continue to purchase products from us at current levels. Moreover, we typically do not enter into long-term volume purchase contracts with our customers, and our customers have certain rights to extend or delay the shipment of their orders. We, however, typically require that our customers contractually agree to buy back inventory purchased within specified lead times to build their products if not used.
The loss of one or more of our major customers, or the reduction, delay or cancellation of orders from such customers, due to economic conditions or other forces, could materially and adversely affect our business, operating results and financial condition. The contraction in demand from certain industries could impact our customer orders and have a negative impact on our operations over the foreseeable future. Additionally, if one or more of our customers were to become insolvent or otherwise unable to pay for the manufacturing services provided by us, our operating results and financial condition would be adversely affected.
We depend on a limited number of suppliers for certain components that are critical to our manufacturing processes. A shortage of these components or an increase in their price could interrupt our operations and result in a significant change in our results of operations.
We are dependent on many suppliers, including sole source suppliers, to provide key components and raw materials used in manufacturing customers’ products. We have seen supply shortages in certain electronic components. In addition, our suppliers' facilities may also experience earthquakes, tsunamis, and other natural disasters which may cause a shortage of components. This can result in longer lead times and the inability to meet our customers request for flexible production and extended
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shipment dates. If demand for components outpaces supply, capacity delays could affect future operations. Delays in deliveries from suppliers or the inability to obtain sufficient quantities of components and raw materials have and may continue to cause delays or reductions in shipment of products to our customers which could adversely affect our operating results and damage customer relationships.
Key Tronic continues to work closely with its employees and key suppliers to ascertain delays attributable to the COVID-19 pandemic. Delays in production and extended transit times of critical parts have and may continue to cause a shortage of components.
We operate in a highly competitive industry; if we are not able to compete effectively in the contract manufacturing industry, our business could be adversely affected.
Competitors may offer customers lower prices on certain high volume programs. This could result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect our business, operating results, and financial condition. If we were unable to provide comparable or better manufacturing services at a lower cost than our competitors, it could cause sales to decline. In addition, competitors can copy our non-proprietary designs and processes after we have invested in development of products for customers, thereby enabling such competitors to offer lower prices on such products due to savings in development costs.
Fluctuations in foreign currency exchange rates could increase our operating costs.
We have manufacturing operations located in Mexico and China. A significant portion of our operations are denominated in the Mexican Peso and the Chinese currency, the Renminbi ("RMB"). Currency exchange rates fluctuate daily as a result of a number of factors, including changes in a country's political and economic policies. Volatility in the currencies of our entities and the United States dollar, as well as inflationary costs, could seriously harm our business, operating results and financial condition. The primary impact of currency exchange fluctuations is on the cash, receivables, payables and expenses of our operating entities. As part of our hedging strategy, we may use Mexican peso forward contracts to hedge future foreign currency fluctuations for a portion of our Mexican peso denominated expenses. We currently do not hedge expenses denominated in RMB. Unexpected losses could occur from increases in the value of these currencies relative to the United States dollar.
Global economic and political events, including as a result of COVID-19, can lead to significant currency exchange fluctuations can occur causing unexpected losses. Future temporary closures of production facilities in Mexico could also cause significant changes in our ability to qualify for hedge accounting treatment of our forward contracts to hedge foreign currency fluctuations. However, given the unprecedented nature of the pandemic the FASB staff believes that an entity may apply the exception in paragraph 815-30-40-4 for rare cases caused by extenuating circumstances that are related to the nature of the forecasted transaction and are outside the control or influence of an entity to delays in the timing of the forecasted transactions if those delays are related to the effects of the COVID-19 pandemic and are considered probable to still occur. In addition, the FASB staff believes that it would be acceptable for an entity to determine that missed forecasts related to the effects of the COVID-19 pandemic need not be considered when determining whether it has exhibited a pattern of missing forecasts that would call into question its ability to accurately predict forecasted transactions and the propriety of using cash flow hedge accounting in the future for similar transactions.
Our success will continue to depend to a significant extent on our key personnel.
Our future success depends in large part on the continued service of our key technical, marketing and management personnel and on our ability to continue to attract and retain qualified production employees. There can be no assurance that we will be successful in attracting and retaining such personnel, particularly in our manufacturing locales that may be experiencing high demand for similar key personnel. The loss of key employees could have a material adverse effect on our business, operating results and financial condition.
Start-up costs and inefficiencies related to new or transferred programs can adversely affect our operating results and such costs may not be recoverable if such new programs or transferred programs are canceled or don’t meet expected sales volumes.
Start-up costs, the management of labor and equipment resources in connection with the establishment of new programs and new customer relationships, and the need to obtain required resources in advance can adversely affect our gross margins and operating results. These factors are particularly evident in the ramping stages of new programs. These factors also affect our ability to efficiently use labor and equipment. We are currently managing a number of new programs. Consequently, our exposure to these factors has increased. In addition, if any of these new programs or new customer relationships were terminated, our operating results could be harmed, particularly in the short term. We may not be able to recoup these start-up costs or replace anticipated new program revenues.
Customers may change production timing and demand schedules which makes it difficult for us to schedule production and capital expenditures and to maximize the efficiency of our manufacturing capacity.
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Changes in demand for customer products reduce our ability to accurately estimate the future requirements of our customers. This makes it difficult to schedule production and maximize utilization of our manufacturing capacity. We must determine the levels of business that we will seek and accept from customers, set production schedules, commit to procuring inventory, and allocate personnel and resources, based on our estimates of our customers' requirements. Customers can require sudden increases and decreases in production which can put added stress on resources and reduce margins. Sudden decreases in production can lead to excess inventory on hand which may or may not be reimbursed by our customers even when under contract.
Continued growth could further lead to capacity constraints. We may need to transfer production to other facilities, acquire new facilities, or outsource production which could negatively impact gross margin. The Company has been able to manage the arrival of components in an effort to control inventory levels of customers that have seen sharp decreases in demand, as a result of COVID-19.
Compliance or the failure to comply with current and future environmental and health laws or regulations could cause us significant expense.
We are subject to a variety of domestic and foreign environmental regulations relating to the use, storage, and disposal of materials used in our manufacturing processes. In addition, increasing governmental focus on climate change may result in new environmental regulations that may negatively affect us, our vendors, or our customers. As a result, we may incur additional costs or obligations in complying with any new environmental and reporting requirements, as well as increased indirect costs resulting from our vendors or customers that get passed on to us.
If we fail to comply with any present or future regulations, we could be subject to future liabilities or the suspension of current manufacturing operations. In addition, such regulations could restrict our ability to expand our operations or could require us to acquire costly equipment, substitute materials, or incur other significant expenses to comply with government regulations.
If our manufacturing processes and services do not comply with applicable statutory and regulatory requirements, or if we manufacture products containing design or manufacturing defects, demand for our services may decline and we may be subject to liability claims.
We manufacture and design products to our customers’ specifications, and, in some cases, our manufacturing processes and facilities may need to comply with applicable statutory and regulatory requirements. For example, medical devices that we manufacture or design, as well as the facilities and manufacturing processes that we use to produce them, are regulated by the Food and Drug Administration and non-U.S. counterparts of this agency. In addition, our customers’ products and the manufacturing processes that we use to produce them often are highly complex. As a result, products that we manufacture may at times contain manufacturing or design defects, and our manufacturing processes may be subject to errors or not be in compliance with applicable statutory and regulatory requirements. Defects in the products we manufacture or design, whether caused by a design, manufacturing or component failure or error, or deficiencies in our manufacturing processes, may result in delayed shipments to customers or reduced or canceled customer orders. If these defects or deficiencies are significant, our business reputation may also be damaged. The failure of the products that we manufacture or our manufacturing processes and facilities to comply with applicable statutory and regulatory requirements may subject us to legal fines or penalties and, in some cases, require us to shut down or incur considerable expense to correct a manufacturing process or facility. Our customers are required to indemnify us against liability associated with designing products to meet their specifications. However, if our customers are responsible for the defects, they may not, or may not have resources to, assume responsibility for any costs or liabilities arising from these defects, which could expose us to additional liability claims.
If we do not manage our growth effectively, our profitability could decline.
Our business is experiencing growth which can place considerable additional demands upon our management team and our operational, financial and management information systems. Our ability to manage growth effectively requires us to continue to implement and improve these systems; avoid cost overruns; maintain customer, supplier and other favorable business relationships during possible transition periods; continue to develop the management skills of our managers and supervisors; and continue to train, motivate and manage our employees. Our failure to effectively manage growth could have a material adverse effect on our results of operations.
Energy price increases may negatively impact our results of operations.
Certain components that we use in our manufacturing process are petroleum-based. In addition, we, along with our suppliers and customers, rely on various energy sources in our transportation activities. While significant uncertainty currently exists about the future levels of energy prices, a significant increase, such as the increased fuel prices experienced in fiscal year 2023, is possible. Increased energy prices could cause an increase to our raw material costs and transportation costs. In addition, increased transportation costs related to certain suppliers and customers could be passed along to us. We may not be able to increase our product prices enough to offset these increased costs. In addition, any increase in our product prices may reduce our future customer orders and profitability.
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TECHNOLOGY RISKS
Our operations are subject to cyberattacks that could have a material adverse effect on our business.
We are increasingly dependent on digital technologies and services to conduct our operations. We use these technologies for internal purposes, including data storage, processing and transmissions, as well as in our interactions with vendors and customers. Digital technologies and services are subject to the risk of cybersecurity incidents and some incidents can remain undetected for a period of time.
We routinely monitor our systems for cyber threats and have processes in place to detect and remediate vulnerabilities. Nevertheless, we have experienced attempted security breaches, such as phishing emails and other targeted attacks. We expect that our operations will continue to be subject to cyber threats, and any future cybersecurity incident could significantly disrupt our operations.
Cybersecurity incidents could also result in the misappropriation of proprietary or confidential information of the Company or that of its customers, employees, vendors or customers. We expect to incur costs in the future to mitigate against cybersecurity incidents as threats are expected to continue to become more persistent and sophisticated. If our systems for protecting against cybersecurity incidents prove not to be sufficient, we could be adversely affected by, among other things, loss of or damage to intellectual property, proprietary or confidential information, or employee, vendor or customer data; interruption of our business operations; and increased costs to prevent, respond to or mitigate cybersecurity incidents. These risks could harm our reputation and our relationships with employees, vendors, and customers and may result in claims or enforcement actions and investigations against us.
Disruptions to our information systems, including losses of data or outages, could adversely affect our operations.
We rely on information technology networks and systems to process, transmit and store electronic information. In particular, we depend on our information technology infrastructure for a variety of functions, including worldwide financial reporting, inventory management, procurement, invoicing and email communications. Any of these systems may be susceptible to outages due to fire, floods, power loss, telecommunications failures, terrorist attacks and similar events. If we or our vendors are unable to prevent such outages, our operations could be disrupted.
If we are unable to maintain our technological and manufacturing process expertise, our business could be adversely affected.
The markets for our customers’ products are characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and short product life cycles. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. Our success will depend upon our customers’ ability to enhance existing products and to develop and introduce, on a timely and cost-effective basis, new products that keep pace with technological developments and emerging industry standards and address evolving and increasingly sophisticated customer requirements. Failure of our customers to do so could substantially harm our customers’ competitive positions. There can be no assurance that our customers will be successful in identifying, developing and marketing products that respond to technological change, emerging industry standards or evolving customer requirements.
RISKS RELATED TO CAPITAL AND FINANCING
Cash and cash equivalents are exposed to concentrations of credit risk.
We place our cash with high credit quality institutions. At times, such balances may be in excess of the federal depository insurance limit or may be on deposit at institutions which are not covered by insurance. If such institutions were to become insolvent during which time it held our cash and cash equivalents in excess of the insurance limit, it could be necessary to obtain other credit financing to operate our facilities.
Our ability to secure and maintain sufficient credit arrangements is key to our continued operations.
There is no assurance that we will be able to retain or renew our credit agreements in the future. In the event the business grows rapidly or there is uncertainty in the macroeconomic climate, additional financing resources could be necessary in the current or future fiscal years. There is no assurance that we will be able to obtain equity or debt financing at acceptable terms, or at all in the future. In addition, we have restrictive covenants with our financial institution which could impact how we manage our business. If we cannot meet our financial covenants, our borrowings could become immediately payable which could have a material adverse impact on our financial statements. For a summary of our banking arrangements, see Note 4 Long-Term Debt of the “Notes to Consolidated Financial Statements.”
An adverse change in the interest rates for our borrowings could adversely affect our financial condition.
We are exposed to interest rate risk under our revolving line of credit and term loan. We have not historically hedged the interest rate on our credit facility; therefore, unless we do so, significant changes in interest rates could adversely affect our
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results of operations. For a summary of our debt obligations, see Footnote “Long-Term Debt” of the “Notes to Consolidated Financial Statements.”
In addition, the U.K.’s Financial Conduct Authority, which regulates LIBOR, has confirmed that LIBOR-indexed rates will cease after June 30, 2023, with the remaining IBOR-indexed rates ceasing on December 31, 2021. The Federal Reserve Board and the Federal Reserve Bank of New York identified Secured Overnight Financing Rate (“SOFR”) as its preferred alternative rate for LIBOR for debt and derivative financial instruments.
Our stock price is volatile.
Our stock price has and may continue to be subject to wide fluctuations and possible rapid increases or declines over a short time period. These fluctuations may be due to factors specific to us such as our stock's thinly traded nature, variations in quarterly operating results, changes in earnings estimates, or the Audit Committee's internal investigation, or to factors relating to the contract manufacturing industry or to the securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have been unrelated to the operating performance of the specific companies whose stocks are traded. In addition, holders of our common stock will suffer immediate dilution to the extent outstanding equity awards are exercised to purchase common stock.
RISKS RELATED TO OUR CONTROLS AND PROCEDURES
If we fail to properly remediate any future deficiencies or material weaknesses or to maintain proper and effective internal controls, our business and financial condition could be materially adversely impacted.
If deficiencies in our internal control over financial reporting are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results and incur the additional costs and expenses associated therewith. Moreover, because of the inherent limitations of any control system, material misstatements due to error or fraud may not be prevented or detected on a timely basis, or at all. If we are unable to provide reliable and timely financial reports in the future, our business and reputation may be further harmed. Restated financial statements and failures in internal controls may also cause us to fail to meet additional reporting obligations, negatively affect investor confidence in our management and the accuracy of our financial statements and disclosures, or result in adverse publicity and concerns from investors, any of which could have a negative effect on the price of our common stock, subject us to regulatory investigations and penalties or stockholder litigation, and materially adversely impact our business, financial condition, results of operations and cash flows.
Matters relating to or arising from the subject of the Audit Committee’s internal investigation, including expenses and diversion of personnel and resources, regulatory investigations, and proceedings and litigation matters, could have an adverse effect on our business, results of operations and financial condition.
We have incurred, and may continue to incur, significant expenses related to legal, accounting and other professional services in connection with matters relating to or arising from the subject of the Audit Committee’s internal investigation. As a result of the internal investigation, we have taken and continue to take a number of steps in order to remediate identified deficiencies in our internal control over financial reporting and attempt to reduce the risk of future recurrence. The validation of the efficacy of these remedial steps have resulted in us incurring additional near term expenses, and to the extent these steps are not successful, we may incur significant additional time and expense.
In addition, we are cooperating with the SEC regarding matters related to the internal investigation. The completion of the internal investigation will not automatically resolve the SEC’s inquiries. If the SEC or any other regulator were to commence legal action against us, we could be required to pay significant additional legal fees, as well as penalties and become subject to injunctions, cease and desist orders or other remedies. We can provide no assurances as to the outcome of any governmental inquiry or investigation. Further, we, our officers and members of our board of directors could be named as defendants in lawsuits asserting claims arising out of the subject matter of the Audit Committee’s internal investigation. As a result of any legal proceedings and any related indemnification requirements to our officers and directors, we could be required to pay additional legal fees and/or monetary damages that may be in excess of our insurance coverage or may have additional penalties or other remedies imposed against us or our officers and directors.
All of these expenses, the delay in timely filing our periodic reports and the diversion of the attention of management and other personnel that has occurred and is expected to continue, could adversely affect our business, financial condition, results of operations and cash flows.
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Due to inherent limitations, there can be no assurance that our system of disclosure and internal controls and procedures will be successful in preventing all errors, theft and fraud, or in informing management of all material information in a timely manner.
Management does not expect that our disclosure controls and procedures and internal controls over financial reporting will prevent all errors or fraud. A control system is designed to give reasonable, but not absolute, assurance that the objectives of the control system are met. In addition, any control system reflects resource constraints and the benefits of controls must be considered relative to their costs. Inherent limitations of a control system may include: judgments in decision making may be faulty, breakdowns can occur simply because of error or mistake and controls can be circumvented by collusion or management override. Due to the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.
LEGAL AND ACCOUNTING RISKS
We are involved in various legal proceedings.
In the past, we have been notified of claims relating to various matters including contractual matters, intellectual property rights or other issues arising in the ordinary course of business. In the event of such a claim, we may be required to spend a significant amount of money to defend or otherwise address the claim. Any litigation or dispute resolution, even where a claim is without merit, could result in substantial costs and diversion of resources. Accordingly, the resolution or adjudication of such disputes, even those encountered in the ordinary course of business, could have a material effect on our business, consolidated financial conditions and results of operations.
Changes in securities laws and regulations will increase our costs and risk of noncompliance.
We are subject to additional requirements contained in the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act) and more recently the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act). The Sarbanes-Oxley and Dodd-Frank Acts required or will require changes in some of our corporate governance, securities disclosure and compliance practices. In response to the requirements of the Sarbanes-Oxley and Dodd-Frank Acts, the SEC and NASDAQ promulgated new rules and additional rulemaking is expected in the future. Compliance with these new rules and future rules has increased and may increase further our legal, financial and accounting costs as well as a potential risk of noncompliance. Absent significant changes in related rules, which we cannot assure, we anticipate some level of increased costs related to these new regulations to continue indefinitely. We also expect these developments to make it more difficult and more expensive to obtain director and officer liability insurance, and we may be forced to accept reduced coverage or incur substantially higher costs to obtain coverage. Likewise, these developments may make it more difficult for us to attract and retain qualified members of our Board of Directors or qualified management personnel. Further, the costs associated with the compliance with and implementation of procedures under these and future laws and related rules could have a material impact on our results of operations. In addition, the costs associated with noncompliance with additional securities laws and regulations could also impact our business.
Changes in financial accounting standards may affect our reported financial condition or results of operations as well increase costs related to implementation of new standards and modifications to internal controls.
Our consolidated financial statements are prepared in conformity with accounting standards generally accepted in the United States, or U.S. GAAP. These principles are subject to amendments made primarily by the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC). A change in those policies can have a significant effect on our reported results and may affect our reporting of transactions which are completed before a change is announced. Changes to accounting rules or challenges to our interpretation or application of the rules by regulators may have a material adverse effect on our reported financial results or on the way we conduct business.
GENERAL RISKS
Our levels of insurance coverage may not be sufficient for potential damages, claims or losses.
We have various forms of business and liability insurance which we believe are appropriate based on the needs of companies in our industry. As a result, not all of our potential business risks or potential losses would be covered by our insurance policies. If we sustain a significant claim or loss which is not covered by insurance, our net income could be negatively impacted.
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We may encounter complications with acquisitions, which could potentially harm our business.
Any current or future acquisitions may require additional equity financing, which could be dilutive to our existing shareholders, or additional debt financing, which could potentially affect our credit ratings. Any downgrades in our credit ratings associated with an acquisition could adversely affect our ability to borrow by resulting in more restrictive borrowing terms. To integrate acquired businesses, we must implement our management information systems, operating systems and internal controls, and assimilate and manage the personnel of the acquired operations. The integration of acquired businesses may be further complicated by difficulties managing operations in geographically dispersed locations. The integration of acquired businesses may not be successful and could result in disruption by diverting management’s attention from the core business. In addition, the integration of acquired businesses may require that we incur significant restructuring charges or other increases in our expenses and working capital requirements, which reduce our return on invested capital.
Acquisitions may involve numerous other risks and challenges including but not limited to: potential loss of key employees and customers of the acquired companies; the potential for deficiencies in internal controls at acquired companies; lack of experience operating in the geographic market or industry sector of the acquired business; constraints on available liquidity, and exposure to unanticipated liabilities of acquired companies. These and other factors could harm our ability to achieve anticipated levels of profitability at acquired operations or realize other anticipated benefits of an acquisition, and could adversely affect our consolidated business and operating results.
Item 3.Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We are subject to the risk of fluctuating interest rates in the normal course of business. Our major market risk relates to our secured debt. Our asset-based senior secured revolving credit facility and equipment financing facility are secured by substantially all of our assets. The interest rates applicable to our asset-based senior secured revolving credit facility fluctuate with LIBOR rates. There was outstanding $110.5 million in borrowings under our asset-based senior secured revolving credit facility and $6.1 million outstanding on our equipment financing facilities as of September 30, 2023. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources and Liquidity” and Note 4 – “Long-Term Debt” to the Consolidated Financial Statements for additional information regarding our revolving credit facility and term loans.
Foreign Currency Exchange Risk
A significant portion of our operations are in foreign locations. As a result, transactions occur in currencies other than the U.S. dollar. Exchange rate fluctuations among other currencies used by us would directly or indirectly affect our financial results. From time to time, we use Mexican peso forward contracts to hedge foreign currency fluctuations for a portion of our Mexican peso denominated expenses. As of September 30, 2023, the Company did not have any outstanding foreign currency forward contracts. For the three months ended September 30, 2023, the Company did not enter into or settle any foreign currency forward contracts.
Item 4.Controls and Procedures
Evaluation of Disclosure Controls and Procedures
It is the responsibility of our management to establish, maintain, and monitor disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our company’s Chief Executive Officer and Chief Financial Officer, allowing for timely decisions regarding required disclosures.
As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b).
Based on our assessment, we believe that as of September 30, 2023, the Company’s disclosure controls and procedures are effective based on those criteria.
Changes in Internal Control over Financial Reporting
There have been no significant changes in our internal controls over financial reporting during the three months ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)).
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PART II. OTHER INFORMATION:
Item 1.Legal Proceedings
We are involved in various legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Item 1A.Risk Factors
Information regarding risk factors appear in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 3, “Quantitative and Qualitative Disclosures about Market Risk” of this Form 10-Q.
There are no material changes to the risk factors set forth in Part I Item 1A in the Company’s Annual Report on Form 10-K for the year ended July 1, 2023.
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| 101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document | |||||||||||||
| 101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document | |||||||||||||
| 101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document | |||||||||||||
| 104 | Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101.INS, 101.SCH, 101.CAL, 101.DEF, 101.LAB and 101.PRE) | |||||||||||||
32
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
| KEY TRONIC CORPORATION | |||||||||||
/s/ CRAIG D. GATES | |||||||||||
| Craig D. Gates | Date: | November 9, 2023 | |||||||||
| President and Chief Executive Officer | |||||||||||
| (Principal Executive Officer) | |||||||||||
| /s/ BRETT R. LARSEN | |||||||||||
| Brett R. Larsen | Date: | November 9, 2023 | |||||||||
| Executive Vice President of Administration, Chief Financial Officer and Treasurer | |||||||||||
| (Principal Financial Officer) | |||||||||||
33
Exhibit 31.1
CERTIFICATION
I, Craig D. Gates, certify that:
1.I have reviewed this quarterly report on Form 10-Q of Key Tronic Corporation;
2.Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a – 15(e) and 15d – 15(e)), and internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)) for the registrant and have:
a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles,
c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions);
a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting
| Dated: | November 9, 2023 | |||||||
| /s/ Craig D. Gates | ||||||||
| Craig D. Gates | ||||||||
| President and Chief Executive Officer | ||||||||
Exhibit 31.2
CERTIFICATION
I, Brett R. Larsen, certify that:
1.I have reviewed this quarterly report on Form 10-Q of Key Tronic Corporation;
2.Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a – 15(e) and 15d – 15(e)), and internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)) for the registrant and have:
a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles,
c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions);
a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting
| Dated: | November 9, 2023 | |||||||
| /s/ Brett R. Larsen | ||||||||
| Brett R. Larsen | ||||||||
| Executive Vice President of Administration, Chief Financial Officer and Treasurer | ||||||||
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Key Tronic Corporation (the “Company”) on Form 10-Q for the period ended September 30, 2023 as filed with the Securities and Exchange Commission on the date hereof (the “Form 10-Q”), I, Craig D. Gates, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:
1.The Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
2.The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.
| Dated: | November 9, 2023 | |||||||
| /s/ Craig D. Gates | ||||||||
| Craig D. Gates | ||||||||
| President and Chief Executive Officer | ||||||||
Exhibit 32.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Key Tronic Corporation (the “Company”) on Form 10-Q for the period ended September 30, 2023 as filed with the Securities and Exchange Commission on the date hereof (the “Form 10-Q”), I, Brett R. Larsen, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that:
1.The Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
2.The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.
| Dated: | November 9, 2023 | |||||||
| /s/ Brett R. Larsen | ||||||||
| Brett R. Larsen | ||||||||
| Executive Vice President of Administration, Chief Financial Officer and Treasurer | ||||||||