Earnings Call Transcript
KEY TRONIC CORP (KTCC)
Earnings Call Transcript - KTCC Q1 2026
Operator, Operator
Good day, and welcome to the Key Tronic First Quarter Fiscal Year '26 Investor Call. Today's conference is being recorded. At this time, I would like to turn the call over to Tony Voorhees. Please go ahead.
Anthony Voorhees, CFO
Good afternoon, everyone. I am Tony Voorhees, Chief Financial Officer of Key Tronic. I would like to thank everyone for joining us today for our investor conference call. Joining me here in our Corinth, Mississippi facility is Brett Larsen, our President and Chief Executive Officer. As always, I would like to remind you that during the course of this call, we might make projections or other forward-looking statements regarding future events or the company's future financial performance. Please remember that such statements are only predictions. Actual events or results may differ materially. For more information, you may review the risk factors outlined in the documents the company has filed with the SEC, specifically our latest 10-K and quarterly 10-Qs. Please note, on this call, we will discuss historical financial and other statistical information regarding our business and operations. Some of this information is included in today's press release. During this call, we will also reference slides that accompany our discussion. The slides can be viewed with the webcast, and the link can be found on our Investor Relations website. In addition, the slides, together with a recorded version of this call will be available on the Investor Relations section of our website. We will also discuss certain non-GAAP financial measures on this call. Additional information about these non-GAAP measures and the reconciliations to the most directly comparable GAAP measures are provided in today's press release, which is posted to the Investor Relations section of our website. For the first quarter of fiscal 2026, we reported total revenue of $98.8 million compared to $131.6 million in the same period of fiscal year 2025. Revenue for the first quarter of fiscal year 2026 was adversely impacted by reductions in demand from one long-standing customer and delays in new program launches as our customers face continued uncertainties in the global economy. In addition, the consigned materials program that was announced last quarter has begun to ramp. As this large program grows, reported revenue is expected to be lower compared to traditional turnkey programs, while our gross margin is projected to improve. Our gross margin was 8.4% in the first quarter of fiscal year 2026 compared to 6.2% in the previous quarter and 10.1% in the same period of fiscal year 2025. The sequential quarterly increase in gross margin was primarily related to operational efficiencies gained from the reductions in workforce. The year-over-year decreases in gross margin in the first quarter of fiscal 2026 largely reflect reduced revenue as well as inventory and accounts receivable reserves of approximately $1.6 million due to a customer bankruptcy. Our operating margin for the first quarter of fiscal year 2026 was a negative 0.6%, down from 3.4% for the same period of fiscal year 2025. As top line growth returns, we expect margins to be strengthened by improvements in our operating efficiencies and the positive impact of our strategic cost savings initiatives. We also believe the recent cost savings initiatives have made us more competitive when quoting new program opportunities. As production volumes increase and our operational adjustments take full effect, we expect to see greater leverage on fixed costs, enhanced productivity and a more streamlined supply chain, all contributing to stronger financial performance. Our net loss was $2.3 million or $0.21 per share for the first quarter of fiscal year 2026 compared to net income of $1.1 million or $0.10 per share for the same period of fiscal year 2025. As mentioned previously, the change in earnings was largely due to the reduction in revenue when compared to last year's results. Our adjusted net loss was $1.1 million or $0.10 per share for the first quarter of fiscal year 2026 compared to adjusted net income of $2.8 million or $0.26 per share for the same period of fiscal year 2025. See non-GAAP financial measures in the earnings release for additional information about adjusted net loss and adjusted net loss per share. Turning to the balance sheet. Our inventory for the first quarter of fiscal 2026 remained largely unchanged from the same time a year ago. Our recent strategic initiatives were designed to better align our inventory with our current revenue. While many of our customers have revamped their forecasting methodologies, we have made significant enhancements to our materials resource planning algorithms. As a result, we are now more prepared to address potential future disruptions in the supply chain and more able to respond effectively to evolving tariff implications as we continue to manage inventory more cost effectively. For the first quarter of fiscal 2026, we reduced our total liabilities by a combined amount of $21.8 million or 9% from a year ago. Our current ratio was 2.4:1 compared to 2.6:1 from a year ago. At the same time, accounts receivable DSOs were at 81 days compared to 92 days a year ago, reflecting stronger collection on receivables. Total cash flow provided by operations for the first quarter of fiscal year 2026 was approximately $7.6 million as compared to $9.9 million for the same period of fiscal year 2025. Our continuing ability to generate cash from operations has allowed us to reduce our debt year-over-year by approximately $12 million. Total capital expenditures in the first quarter of fiscal 2026 are about $3.2 million, and we expect CapEx for the full year to be around $8 million, largely spent on new innovative production equipment and automation. While we're keeping a careful eye on capital expenditures, we plan to continue to invest selectively in our production equipment, SMT equipment and plastic molding capabilities, utilize leasing facilities as well as make efficiency improvements to prepare for growth and add capacity. As we move further into fiscal year 2026, we are pleased to continue to see our new programs gradually ramping and our cost and efficiency improvements from our recent overhead reductions are paying off. We expect to see growth in our U.S. and Vietnam production, have a strong pipeline of potential new business and remain focused on improving our profitability. Over the longer term, we believe that we are increasingly well positioned to win new programs and profitably expand our business. Due to the uncertainty of timing of new products ramping, we are not providing forward-looking guidance in the second quarter of fiscal year 2026. That's it for me. Brett?
Brett Larsen, CEO
Thanks, Tony. Moving into fiscal 2026, the uncertainty surrounding global tariffs and the macroeconomic outlook continued to delay new program ramps for many of our customers. To provide our customers with options to manage these uncertainties and to remain cost competitive, we have continued to build up new production capacity in the U.S. and Vietnam and have rightsized our Mexico facility. Demand from certain long-standing customers has reduced total revenues when compared to last year's first quarter results. Moreover, the continued market uncertainty and shifts of tariffs have unfortunately impacted new program launches across all of our facilities. We're doing our best to work with suppliers and with our customers on options for manufacturing their products from different locations in mitigating the impact of tariffs. Our changes made to our manufacturing footprint and cost reductions enable us to offer improved mitigation options, particularly when our customers consider the varying implications of current and future potential tariffs. We're moving full speed ahead with adding capacity in key regions. During the first quarter of fiscal 2026, we opened our new technology and research and development location in Arkansas. We're delighted to be enhancing our operations in a region where we have maintained a long-standing presence and a strong team and can benefit from a business-friendly environment. Our U.S.-based production provides customers with outstanding flexibility, engineering support, and ease of communications. We expect double-digit growth in our facility in Arkansas during the latter half of this fiscal year. In Vietnam, we have doubled our manufacturing capacity in Vietnam and now have the capability to support anticipated future medical device manufacturing. Our Vietnam-based production offers the high-quality, low-cost choice that was associated with China in the past. In coming years, we expect our Vietnam facility to play a major role in our growth. We anticipate that these new facilities in the U.S. and Vietnam will enable us to benefit from customer demand for rebalancing their contract manufacturing and to mitigate the impact and uncertainty surrounding tariffs on goods and critical components. By the end of fiscal 2026, we expect approximately half of our manufacturing to take place in our U.S. and Vietnam facilities. These initiatives reflect both the long-standing customer trends to nearshore as well as derisk the potential adverse impact of tariff increases and geopolitical tensions. Our Mexico facility offers a unique solution for tariff mitigation under the existing USMCA tariff agreement. Given the sustained trend of continued wage increases in Mexico, we have streamlined our operations, increased efficiencies, and invested in automation in order to be more cost-competitive in the market. Our improved cost structure in Mexico is anticipated to lead to new programs and growth over the longer term. During the first quarter of fiscal 2026, we won new programs in medical technology and industrial equipment. In addition, we got underway with the recently announced manufacturing services contract with a data processing OEM that will consign its materials to our Corinth, Mississippi manufacturing facility. As we discussed, the consigned materials model is new for us at this scale, and if successful, will considerably improve our profitability in coming quarters. It has the potential to ramp significantly during fiscal year 2026 and is estimated to grow to over $20 million in annual revenue. Despite the many uncertainties and disruptions in our global markets, our strong pipeline of potential new business underscores the continued trend towards onshoring and the dual source of contract manufacturing. We expect that global tariff wars and geopolitical tensions will continue to drive OEMs to reexamine their traditional outsourcing strategies. Over time, the decision to onshore production is becoming more widely accepted as a smart long-term strategy. We believe our manufacturing footprint and cost competitiveness will allow us to take advantage of these opportunities. The combination of our flexible global footprint and our expansive design capabilities continues to be extremely effective in capturing new business. Many of our new manufacturing program wins are predicated upon Key Tronic's deep and broad design services. And once we have completed the design and ramped it into production, we believe our knowledge of the program-specific design challenges makes that business extremely sticky. We anticipate a continued increase in the number and capability of our design engineers in coming quarters. We also continue to invest in vertical integration and manufacturing process knowledge, including a wide range of plastic molding, injection molding, multi-shot as well as PCB assembly, metal forming, painting and coating, complex high-volume automated assembly and the design, construction and operation of complicated test equipment. We believe this expertise will increasingly set us apart from our competitors of a similar size. While the global market uncertainties have created some delays to new product launches for us, our suppliers and our customers, we believe geopolitical tensions and heightened concerns about tariffs and supply chains will continue to drive the favorable trend of contract manufacturing returning to North America as well to our expanding Vietnam facilities. We are expecting revenue growth in the coming quarters from new programs launching in the U.S., Mexico and Vietnam. We move forward with a strong pipeline of potential new business, and we're seeing significant improvements in our operating efficiencies. Over the long term, we remain very encouraged by our cost reductions made over the past 2 years to become more market competitive, our increasing cash flow generated from operations, enhanced global manufacturing footprint, and the innovations from our design engineering. All of these initiatives have increased our potential for profitable growth. This concludes the formal portion of our presentation. Tony and I will now be pleased to answer your questions.
Operator, Operator
We will take our first question from Bill Dezellem with Tieton Capital.
William Dezellem, Analyst
Let's just start with the 2 wins this quarter. What was the size of each of those, please?
Brett Larsen, CEO
Sure, Bill. Just to clarify, there was actually 1 medical and 2 industrial. The medical was roughly about $5 million in size. And the 2 industrial combined is probably around $6 million.
William Dezellem, Analyst
All right. And you referenced in your opening remarks the medical capabilities, medical production capabilities in Vietnam. Does this particular product belong in Vietnam? Or will it be produced somewhere else?
Brett Larsen, CEO
So our intent is that later this fiscal year to be actually up in production for some medical device over in Vietnam. We've recently received certification to do that, and our customer actually visited the site just last week and has given us the go ahead.
William Dezellem, Analyst
And this specific customer or one another medical customer?
Brett Larsen, CEO
This specific customer. And I think with the introduction of one, our anticipation is that, that facility will continue to show well, and we're expecting continued interest from others.
William Dezellem, Analyst
That's helpful. You mentioned the manufacturing services contract. Let's start with the revenue level you experienced this quarter. You indicated it was the first quarter where you had some revenue from that.
Brett Larsen, CEO
Yes. It had just started. So I'm assuming you're talking about the consigned program that we referenced.
William Dezellem, Analyst
That's right.
Brett Larsen, CEO
Yes. The consigned program down here in Corinth, and Tony and I are actually down in Corinth today visiting and checking in on that program and seeing it launch and ramp. And in our first quarter, there was roughly just over $1 million of actual revenue. That will grow sequentially over the next few quarters and our expectation it could exceed $20 million on an annual basis.
William Dezellem, Analyst
Great. That's helpful. And then as you referenced in your opening remarks, if it's successful, the $20 million or more, what are the swing factors that will make that contract more successful or less successful?
Brett Larsen, CEO
I think from our perspective, Bill, a consigned program, it takes a special customer that has its own supply chain capabilities and has the ability to provide the components on a timely basis and has the capital to do so. In this specific instance, all of those are true. And I think with the consigned model, the amount of margin will increase because you're not including the cost of the materials. So on 2 fronts, both our reported margin percent is expected to go up. And then also the amount of working capital required for that revenue is minimal other than local ancillary supplies and, of course, labor.
William Dezellem, Analyst
Great. So essentially, you are really billing for use of the facility, labor and your profit and not for the inventory component, which historically is a very large portion of your revenue?
Brett Larsen, CEO
It is. It is.
William Dezellem, Analyst
Okay. That's helpful. And so ultimately, this model's success or failure is a function of your customers' ability to manage the inventory. It's really on their shoulders rather than anything tied to Key Tronic and your activities other than what would be normal for any other manufacturing contract?
Brett Larsen, CEO
Yes. This one is a bit different in that respect. And of course, there's communication and correspondence between us and them of specific components that are required, but ultimate delivery of that will be dependent on their supply chain rather than our own group going out and buying from specific suppliers.
William Dezellem, Analyst
Right. Okay. And thinking out loud, do I remember correctly that 80% of the bill of materials ends up being inventory as opposed to labor or overhead expense?
Brett Larsen, CEO
That's a bit high. I would say it's closer to about 60% to 70%, Bill, is material on a typical turnkey program.
William Dezellem, Analyst
Appreciate that. Over the last several quarters, you have discussed a utility product program. It's designed for customers who will be selling to a utility. What’s the update on the success of that product with their customers and the growth of that business?
Brett Larsen, CEO
Sure. That's a good question, Bill. In our first quarter, we had anticipated to have some production revenue from that particular customer. It was delayed by about 1.5 months, but fortunately, we're seeing that ramp nicely in our second quarter.
William Dezellem, Analyst
You mentioned a consumer product where your customer faced some difficulties. This program had the potential to be significant if they had succeeded with the retailers involved. Can you provide an update on that?
Brett Larsen, CEO
No update at this point. We are seeing some softness in some of our long-standing customers, in particular, consumer products. I can't recall the specific one you're mentioning, but we are seeing some reductions in demand from some consumer products that we are building today.
William Dezellem, Analyst
So the one I'm specifically referring to, I believe you all made an announcement about it. It could have been that large.
Brett Larsen, CEO
Okay.
William Dezellem, Analyst
That's not resonating what that one might be.
Brett Larsen, CEO
No, I'm sorry, Bill.
William Dezellem, Analyst
Okay. No problem. And then relative to one additional question here, and then I'll turn it over. Relative to Mexico, you have been rightsizing that for some period of time. Where are you at in that process?
Brett Larsen, CEO
We will continue to monitor that. We have excess capacity in Mexico, but we also have a very strong sales pipeline that we're expecting to drop in, in the latter half of this fiscal year into Mexico. If that doesn't transpire, we'll need to make some additional cost reductions, but I don't anticipate in our second quarter to make any big severance or headcount reductions in Mexico. We do have capacity. I feel like we are now market competitive in our cost structure, and we're seeing the benefits from that in an increased amount of activity and interest down in that site.
William Dezellem, Analyst
So essentially, you believe that the excess capacity you currently have will begin to be utilized significantly in the second half of this fiscal year. If that doesn't occur, you may need to consider alternative options.
Brett Larsen, CEO
Absolutely. Yes, well said.
William Dezellem, Analyst
And if it does happen and you are able to use that capacity, then would I be mistaken to think that, that will have a meaningfully favorable benefit to net income and should be something that we shareholders are quite enthusiastic about?
Brett Larsen, CEO
Yes. If that comes to fruition, as we've discussed before, there's an earnings multiple once your fixed costs are covered. And yes, that would be a meaningful improvement in the overall profitability.
Operator, Operator
And we will take our next question from Sheldon Grodsky with Grodsky Associates.
Sheldon Grodsky, Analyst
Let me ask a couple of questions here. First of all, is your facility in Vietnam primarily to serve the North American market or to serve the Asian market?
Brett Larsen, CEO
It's both.
Sheldon Grodsky, Analyst
Any sense as to how much is going to Asia and how much to the U.S.?
Brett Larsen, CEO
Broad brush, I would say 2/3 Asia, 1/3 North America at this point.
Sheldon Grodsky, Analyst
Okay. And what kind of tariffs are you facing on your Vietnam imports?
Brett Larsen, CEO
It's what is it, Tony? Twenty percent or thirty percent?
Anthony Voorhees, CFO
Yes.
Brett Larsen, CEO
Sheldon, our customers will be responsible for paying that to import it into the U.S. We will be selling it to them in Vietnam.
Sheldon Grodsky, Analyst
What is the current tariff situation in Mexico? There have been many changes, and I feel uncertain about the topic and suspect there may be a lot of misinformation out there. Are most of your products exempt from NAFTA, or are you facing significant tariffs there? What can you tell us about that?
Brett Larsen, CEO
Yes, you raise an important point, Sheldon. Our facility in Juarez, Mexico helps to reduce tariffs. If there are significant changes in products or shifts in tariffs, we can often leverage the USMCA to manufacture products without incurring tariffs. However, there are complexities involved, especially regarding foreign metal sources, and I don’t claim to know all the details. Overall, we are generally able to lower most tariffs by assembling in Mexico.
Sheldon Grodsky, Analyst
Okay. So I've been trying to figure out where it's bad and where it isn't, but your customers seem to be put off completely anyway. It seems like we're going into a manufacturing depression with the tariffs that were supposed to give us a manufacturing new beginning here. So.
Brett Larsen, CEO
What we're finding is there's a lot of hesitation. There's a lot of intent and discussion about transferring manufacturing, but the uncertainty and changing nature of duties and tariffs have caused many of those plans to be put on hold.
Sheldon Grodsky, Analyst
Okay. You mentioned also in the presentation that you had a customer bankruptcy that cost you some money. Is this a big customer, long-standing customer? Or someone who came briefly and managed to go belly up?
Brett Larsen, CEO
It was about a 3- or 4-year customer relationship. We did get stuck with some inventory and receivables, unfortunately. But yes, that was not a significant customer by any means, but it did stay in writing off the $1.6 million this quarter.
Operator, Operator
And we will take our next question from George Melas with MKH Management.
George Melas, Analyst
A follow-up on the last question. You had gross margins of $8.4 million this quarter. And in dollar terms, it was $8.3 million. If we add back the $1.6 million, which was the reserve that you took, you also had some severance of $1.2 million in the quarter. How did those flow through the P&L?
Brett Larsen, CEO
Yes. So the severance definitely goes through COGS. So that would have an impact to your gross margin. The $1.6 million write-off for the bankruptcy was segregated into 2 amounts. $600,000 of that went through cost of goods to write off the inventory and roughly $1 million went through SG&A as writing off the receivable.
George Melas, Analyst
Got it. Okay. So let me just quickly adjust this in my model. So I would say your adjusted gross margin was roughly 10.2%. It goes from 8.4% to 10.2% if you add back the $1.6 million and the $600,000 for the inventory write-off.
Brett Larsen, CEO
Yes.
George Melas, Analyst
So trying to find some good things in the release, that's a pretty good gross margin for you guys, especially at that revenue level and especially given that the consignment material model hasn't really sort of contributed much. As you said, it was just roughly $1 million in revenue. So help us understand why that margin is as robust as it is.
Brett Larsen, CEO
I think there are two key points here, George. First, we are continuing to reduce our overall costs, and this is evident in our performance. If you compare the gross margin from Q4 to Q1, it has improved. In Q1, we also saw a significant amount of NRE revenue, which is revenue we collect from customers upfront for tooling, line setup, and engineering services, and this was notably high. I believe this has contributed to the increase in gross margin for the first quarter. To achieve a consistent gross margin of 10% moving forward, we will need to increase revenue.
George Melas, Analyst
Okay. I understand that for tooling revenue, line set up, and engineering services, we can charge more than the average gross margin. We apply the same approach for tooling and line set up as well.
Brett Larsen, CEO
We do. We do. It just so happens with a couple of large programs we're ramping, we were able to book the profits associated with that during our first quarter.
George Melas, Analyst
Okay. Can you give us roughly in the order of magnitude of how much that was?
Brett Larsen, CEO
An estimate, I think, between $1 million and $1.5 million.
George Melas, Analyst
Of revenue?
Brett Larsen, CEO
Of profit.
George Melas, Analyst
Of gross profit. Okay. So it was meaningful. The consignment materials program, if it ramps up to $20 million and with the math that you gave, Bill, it's sort of equivalent to a $60 million program for one of your regular programs, right?
Brett Larsen, CEO
That is correct.
George Melas, Analyst
Okay. So that would make it probably your largest customer or one of your top 3 customers?
Brett Larsen, CEO
Yes, it would.
George Melas, Analyst
Okay. And what is your assessment so far of how the program is ramping up?
Brett Larsen, CEO
We are actually down in Corinth real time and watching that ramp and excited to see where it's headed. We are definitely not on a $20 million run rate yet, but that's our goal to get there by the end of the fiscal year, and we are busily trying to add some additional capacity down here in order to achieve that.
George Melas, Analyst
Okay. So as you see the program ramp as you expected, the entire program production would be in Mississippi?
Brett Larsen, CEO
At this point, yes, there is some possibility of some dual sharing of that program across a couple of sites. But at this point, we're expecting that to be in our Mississippi.
Operator, Operator
And at this time, we have no further questions. I'd now like to turn the call back to Mr. Larsen for any additional or closing remarks.
Brett Larsen, CEO
We'd like to thank you for attending or listening today's conference. Tony and I look forward to talking with you in next quarter.
Operator, Operator
Thank you. And this does conclude today's call. Thank you for your participation. You may now disconnect.