Craig Gates - President and Chief Executive Officer Brett Larsen - Executive Vice President of Administration and Chief Financial Officer.

Andrew Huang - B. Riley & Co., LLC William Dezellem - Tieton Capital Management Vad Yazvinski - The Jordan Company George Melas-Kyriazi - MKH Management Company, LLC.

Good day, everyone, and welcome to the Key Tronic First Quarter Fiscal 2016 Conference. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Mr. Craig Gates, President and Chief Executive Officer. Please go ahead..

extending our Printed Circuit Assembly capabilities to low-volume and prototype business, which gives us an earlier look at new program opportunities; providing a base of proto and low volume PCA business, which leads to some percentage of that business growing to higher volumes and migrating to our operations in China and Juarez; and providing complete product build opportunities, where Ayrshire can only address PCA portion of the business.

Our broader and more diversified customer base significantly lowers the potential risk and impact of a slowdown by any one customer. In the first quarter of fiscal year 2016, our top five customers represented 47% of our total revenue compared to 51% a year ago and 64% two years ago.

Moving into the remainder of fiscal year 2016, we have many new programs in the process of onboarding and several more are nearing the end of the design phase and moving towards production stage. In the second and third quarters, we expect a decline from the same long-standing customer to continue to impact our growth.

By the fourth quarter, we expect lost revenue from this program to be more than offset by new revenue from the continued ramp of new programs. While getting all of this new business up and running does impact our expense line in advance of revenue, we anticipate increased operating efficiencies and profitability in coming periods.

I’d like to turn the call over to Brett to review our financial performance. Then I’ll come back to discuss our strategy going forward.

Brett?.

Thanks, Craig. As always, I would like to remind you that during the course of this call we might make projections or other forward-looking statements regarding future events or the company’s future financial performance. Please remember that such statements are only predictions. Actual events or results may differ materially.

For more information, you may review the risk factors outlined in the documents the company has filed with the SEC, specifically our latest 10-K, quarterly 10-Qs and 8-Ks. Please note that on this call we will discuss historical financial and other statistical information regarding our business and operations.

Some of this information is included in today’s press release and a recorded version of this call will be available on our website. For the quarter ended September 26, 2015 we reported total revenue of $126.2 million, up 46% from $86.3 million in the same period of fiscal year 2015.

Results for the first quarter of fiscal years 2016 and 2015 include approximately $35 million and $11 million respectively in the revenue from the acquisition of Ayrshire.

As Craig has discussed, we had approximately $2 million of unanticipated expenses and erosion of gross margin in the first quarter of 2016, resulting from the decline of a single significant program of a long-standing customer. As a result, gross margin the first quarter of 2016 was only 7.1% compared to 8.6% in the fourth quarter of 2015.

During the first quarter of fiscal year 2015, you will recall that we also had unusually low gross margins as a result of unfavorable product mix, inefficiencies associated with the usually fast ramping production of a new product and costs relating to the Ayrshire acquisition. The result was gross margin a year ago of only 4.9%.

Over the longer-term, we expect our gross margin to gradually improve and to move into the targeted 9% to 10% range. Our total operating expenses were $7.1 million in the first quarter of fiscal 2016 comparable to the prior quarter, but up 20% from the same period last year.

The year-over-year increase primarily reflects the addition of the Ayrshire operations. For the first quarter of fiscal year 2016 our operating margin was 1.4%, down from 2.7% in the prior quarter due to the decrease in the first quarter gross margin.

During the first quarter of 2015 we had an operating loss approximately of negative 2%, which included certain one-time costs related to the Ayrshire acquisition. While the sudden unanticipated impact to our gross margin in the first quarter of fiscal 2016 had a significant impact on our gross margin, we remain profitable.

Net income for the first quarter of - the first quarter of fiscal year 2016 was $0.8 million or $0.07 per share, down from $2.3 million or $0.21 per share last quarter, but up from a net loss of $1.5 million last year or a loss of $0.14 per share for the first quarter of fiscal year 2015.

Turning to the balance sheet, we have continued to maintain a strong financial position. Our inventory did increase by $9.2 million from the previous quarter to $101 million, reflecting the abruptly canceled production of the program previously discussed, along with our preparations for growth in coming periods.

In coming periods, we expect our overall inventory levels to decline. Our trade receivables were $73.8 million at the end of the first quarter, up only $900,000 from previous quarter. Our consolidated DSOs remain steady at about 50 days and we would expect that our DSOs will remain about at this level.

We completed the acquisition of Ayrshire last year using about $5 million from cash on hand, $35 million from a new term loan, and $9 million from our revolving line of credit to fund the purchase price.

During the first quarter of this year, we reduced our total combined borrowings by $750,000, despite the significant use of working capital for inventory. Over the longer-term, we expect to continually - we expect to continue to gradually pay down both the term loan and the revolving line of credit.

Our capital expenditures for the first quarter of fiscal 2016 were approximately $3.5 million as we continue to expand our electrical assembly, plastic injection molding and sheet metal fabrication capacity and capabilities. For the full fiscal year, we expect CapEx will be around $8 million.

Moving into the second quarter of fiscal 2016, we expect more of our new customer programs to be moving into production and ramping. At the same time, we expect revenue from the long-standing customer to continue to decline.

Taking these into consideration, we anticipate that the second quarter of fiscal 2016, we will have revenue in the range of $115 million $220 million. We expect the overall gross margin percentage will rebound during the second quarter, but on less total revenue. We expect earnings in the range of $0.08 to $0.13 per share for the second quarter.

This expected earnings range assumes an effective tax of 35%. In summary, we expect to see earnings growth in the second quarter and sequential revenue growth resuming in coming periods as our new programs continue to ramp.

Overall, the financial health of the company is excellent, and we believe that we are well-positioned to continue to profitably expand our business over the longer-term. That’s it for me.

Craig?.

Thanks, Brett. We continue to believe our fundamental strategy remains sound. From our perspective, slowdowns by the single long-standing customer have continued to mask the positive impact of production ramps with several new customers. If there is any good news in this situation, it is this. Two years ago, this was one of our largest customers.

While today, it is not in the top five. We have managed to mitigate most of that customer’s sizable drop by adding new business and in a couple of quarters we anticipate that all of that business decline will be replaced with new customers’ business.

Moreover, once we replaced this customer’s revenue, we are very encouraged by the potential our many new programs that we’re onboarding and the positive impact of our recent acquisitions. Entering the second quarter, we continue to win new business. As we’ve discussed before, we have three long-term major competitive advantages.

First, the increasing costs in China are driving demand for more localized production, Mexico for North American end-users and China for Asian end-users. Among EMS providers, we stand alone in the excellence and breadth of our Mexican operations.

As more previously outsourced manufacturing business moves back from China, we stand and continue to benefit. Second, our unique organizational structure, honed over years of experience running geographically-diverse operations.

Beyond the level of cost and service we can provide from our Mexico and China-based facilities, we offer US-based engineering and prototyping with an exceptional level of offshore experience.

Our growing portfolio of customers increasingly want offshore cost savings, but without the risk of managing offshore relationship-schedules, inventory uncertainty, or IP loss. Third, we offer a broader range of capabilities and manufacturing footprint than competitors our size.

We are not aware of EMS providers of our size offering offshore regional and low-volume manufacturing, mechanical and electrical engineering, plastic molding, sheet metal fabrication, US-based program management and test equipment development, and optimized global logistics and purchasing.

In order to get our comprehensive level of capabilities, the next size CM option for a customer in our sweet-spot is a multibillion dollar contract manufacturer. Choosing that options means that customer’s program commands a very small portion of the CM provider’s total revenue and attention.

Our size and capabilities mix makes our customer relationships much more sticky. As we work with our customers in transferring existing product to our factories or in designing, prototyping and ramping new product for them, multiple functions within the customer organization discover the breadth of our capabilities.

As a result, our company has become deeply and profoundly entwined. In many cases, we become the virtual VP of Operations for the customer. Over the longer-term, the EMS market is expected to see steady growth.

While periodic fluctuations in customer demand, mix-changes in our program portfolio and costs associated with onboarding new programs will continue to be part of our business, we believe our sustained focus on controlling costs, augmenting production processes and enhancing our capabilities will result in increasing competitive advantages.

We see more of our new customer programs moving into production and ramping up. And our pipeline of new business opportunities looks increasingly robust. We believe Key Tronic is increasingly well-positioned to grow profitably, capture market share and capitalize on emerging opportunities. This concludes the formal portion of our presentation.

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

Thank you. [Operator Instructions] And we’ll go first to Andrew Huang with B. Riley..

Thanks for taking my question. And thank you for continuing to break up the contribution from the Ayrshire acquisition. So I believe the problematic customer that you’ve been talking about is part of your organic business and not Ayrshire.

Is that correct?.

Yes..

So then, I guess, what I’m getting at is that even with that downwards pressure from that customer, you’re actually still growing pretty nicely your organic business year-over-year..

That’s correct..

Okay. And then, if you look at the Ayrshire revenue. It’s been trending downwards.

Do you have any concerns with those numbers or trends?.

I don’t think that we have any serious concerns. We’re never happy to see something going down rather than up, but I don’t think there is any systemic issues there. And part of it is the way we’re accounting for where revenue is resident. So I’ll give you an example without a customer name.

But one of our customers, that was a large part of one of the Ayrshire facilities, ended up doing exactly what we discussed in generalities during the narrative. And that customer got higher volumes, higher revenues. And as result, they, I guess, earned is the right word to say, earned a place in our Juarez facility. And so we moved them down there.

And the question is do you count that as Ayrshire or the old Key Tronic revenue. So that’s part of what you’re seeing is the migration of different customers in different directions..

Also in other words, revenue from that customer that was Ayrshire is now being reclassified as Key Tronic revenue just because it went into Juarez?.

Yes..

A portion of it..

Yes, not all of it, but the portion that moved..

Yes..

Got it. Okay.

And then, if you had to kind of look at the next fiscal year, fiscal 2016, do you think that, assuming you’re in a full year of Ayrshire in fiscal 2015 that Ayrshire would be growing on a year-over-year basis?.

I think, as it stands today, they would be growing on a year-over-year basis. They had a couple of peaky quarters in there. But on annualized basis, compared to what they were running when we bought them to what they’re running now, they have grown..

Okay. And then, I was wondering, if you could give me a little bit of color on the gross margin and the operating expenses for the December quarter. You said you expected some improvement. I think, you used the word rebound in gross margin for the December quarter.

Are you talking about like a number, was that eight in front of it or nine in front of it or just a little bit of color would be helpful?.

Sure. Andrew, as we mentioned, there is anticipated rebound of our gross margin percentage, meaning that we will be higher than our first quarter of 2016. Don’t want to quantify it, but over the longer-term, yes, we expect to get back up to 9% to 10%..

Okay.

And then, if you’re going to kind of talk about 9% to 10% gross margins, maybe if you’d give us some help us to like at what of level of revenue that would, so that you would need to get there?.

Yes, again, we don’t want to make any specific revenue projections that far out. But over the longer-term, as we see these new programs ramp; as we’ve mentioned previously, our expectation is that we’ll get back to that target range of 9% to 10%..

Okay. Okay. I’ll kind of jump back in the queue. Thank you..

Thanks..

Thank you. We’ll take our next question from Bill Dezellem with Tieton Capital Management..

Thank you. I have a group of questions. But following up on the last question, I’ve got a couple to start there.

Without Ayrshire, I was just doing the calculation of taking off the $35 million this year and $11 million last year, and assuming that you had $91.2 million of revenues on top of $75.3 million or about 21% growth, is that correct in terms of the organic growth or is there some movement of revenue, given what you said that by one customer, for example, now we’re in the place in Juarez and so my math is not correct?.

Your math is pretty close and the movement is obviously lot more significant to the decline by percentage of Ayrshire, than it is to the increase of the old Key Tronic. But your math is very directionally correct..

Yes..

Okay. So you, on an organic basis you were growing roughly 20% this quarter..

Yes..

Yes..

Year-over-year, yes..

Great. And, that would be, I guess, for the old Key Tronic, if we may call it that. And you did say that Ayrshire was growing.

At roughly what rate is the, if I can call it the old Ayrshire, growing?.

I don’t have that number ready for you, Bill..

That’s all right. I’ve got a plenty of other questions to take up sometime.

How about that?.

Okay..

That was off the top of my head. Sorry..

No, that’s - there is no problem. I would like to first hit kind of my normal question. What’s the size of these two new program wins that you discussed in your press release? And can you talk about whether they’re new customers or just new programs from existing customers? And any characterization of them will be helpful..

They’re new customers. One is over five. One is close to twenty..

Thank you. And then, you referenced the top five customers, both in your opening remarks and in the press release.

How many of your top five customers today were top five customers one year ago and two years ago?.

Okay. Give me a minute. We got to do some figuring..

That’s quite alright. I will shift for a moment.

The customers that gave - kind of did the quick start and quick halt on you, were they a higher-margin customer or a lower-margin customer?.

I guess I’m not going to want to answer that, since they are probably listening to this call..

Fair enough.

Relative to revenues, and if you don’t want to - it would be great if you would be able to characterize how many dollars they represented this quarter, last quarter and year-ago quarter, but is that something that you’re not inclined to do? Somehow scale it for us, so we can understand maybe how significant they were a year ago and then what sort of a decline we’ve seen since then and this sort of decline we saw sequentially..

Okay. Let me give you the answer to your previous question and just going to continue the answer to this question too. So if I look back at fiscal year 2014, fiscal year 2015 and 2016 so far, out of the top five, three have remained the same and two have moved out. So looking at our problem customer, they were near the top in 2014 and 2015.

And by the time we get into Q2, their revenue will have declined from the peak by about 80%. So they’re only 20% of what they were a couple of years ago..

Bill, you can take a look at our sequential revenue. Our revenue range is now $115 million to $120 million, whereas it was $126 million in quarter one. That also will give you order of magnitude..

And so, Brett, that decline, that is - would it be fair to say, all of this one customer plus more, because you have other customers that are increasing in the December quarter versus September quarter?.

Yes, you are correct..

And so, this customer must be getting very close to, I mean, to near zero.

And is that fair, and if so, I guess, that means we really don’t have to worry about them causing us a negative downdraft after the December quarter?.

Yes, that’s kind of the bittersweet thing about this, is that that they become so small, that anymore forecasting problems on their part are going to become a lot less of an issue to us..

That’s helpful. Thank you. I’ll step back into the queue now..

Okay..

Thank you. [Operator Instructions] We’ll go next to Vad Yazvinski with The Jordan Company..

Good afternoon, gentlemen..

Hi..

I got a few questions. So one is obviously the customer that you referred to, obviously, it’s - I guess, it’s not really a secret. I mean, they’ve got it two days before you guys got it down. As of the - I mean, you don’t have to confirm it or deny it, obviously. But we all know who they are.

You referenced that you have some inventory increase related to that customer.

How much balance should you basically have related to them?.

We’re not going to talk about that number, because I think it’s something that’s their businesses as much as ours, but it’s a sizable amount obviously..

But it’s - okay. And then, obviously, the second question is more strategic and I think already addressed it. But Brett told in a few weeks ago. You guys have, over the last several years and we a large shareholder, we know that there are a lot of other large shareholders on the phone.

And obviously, right about a year ago, we have went through a similar situation to where things are going okay and then all of a sudden there is an unexpected slowdown or errors in forecasts and whatever you want to call it, and all of a sudden the problem….

Same customer..

Yes, well - I understand. And this is where it takes me to the next - I’ll get to the next, the second part of the question. So, here is the truth, I mean your competitors, obviously, some of them go through that kind of issues once in a while, but they are lot - most of them are a lot larger so the impact is a lot smaller.

For you guys, at what point does the board, and you guys as a management team go out there and starts to kind of realize and respect the fact that there - due to lumpiness of the business and the concentration of the customer, which obviously is kind of loss them a lot less so.

But nevertheless, were you guys are going - go out there and actually potentially, do some kind of review of strategic alternatives? Just barely a year ago, you guys spent $47 million on buying a company. And now your market cap is not - is $80 million and obviously the business is a lot more stable, it’s probably a lot more valuable.

You want them - you have terrific facilities that are state-of-the-art and a very valuable. The asset value is becoming more and more disconnected from the - call it, structural performance of being a public company and the pressures on the - over the lumpiness of the business and giving guidance.

At what point do you guys just do something and say, okay, this is - for us, considering our customer base and our asset base, we’re clearly being misrecognized. Then I’m quite certain, since I know the business of contract manufacturing fairly well, you guys would be worth a lot more in the private sector today than you are being a public company.

But that does miss guidance seem to be pretty regularly..

Well, we think, we look at that all the time. It’s part of the board and our responsibilities to look at it and talk about it and think about it. Since we haven’t done what you talked about, it’s pretty clear that we’ve decided that it doesn’t make sense at this time to take that kind of a step.

We have been trying to portray and we believe that the decline in this one customer has been more or less the root of the problems that have masked the rest of the business. And we’ve tried to explain that again.

When somebody who was that big, I remember, one of our investors talked to me three years ago and said, oh geez, they’re going to come on and they’re going to be as big as you say, can’t you somehow throttle them so that they come on at a steady-state and don’t confuse the markets when they go up and then when they inevitably drop.

And our answer was, well, you can’t do that. You can’t tell a customer, we don’t want all your business. And so, we understand that. We’re playing a game that could result in some fluctuations in our market cap as it goes good or it doesn’t go good with this customer.

But we took them, because they were able to fund the acquisition, not at the time, but they were able to build our war-chest and then fund the acquisition of Ayrshire. So, yes, the long question, that’s already a long answer.

To shorten up, when we look at what’s happening with our current customer base, when we look at what’s happening with the new business we’re adding, when we look at the way this one customer’s decline, precipitous decline, has masked the underlying health of the company, we don’t think it’s time now to look at trying to take the company private or do something else.

We think it’s time to get through the next couple of quarters and see if what we think is going to happen does happen, because if you look at it, we’ve grown $12 million, $16 million organically just in the last year, if you take away what happened with this one customer. So hope that answers your question..

It does to some degree. But to be honest, I mean, as I’ve said, I mean, for me as an investor, I remember it, you guys are - this is a public company, so I guess, it’s all - the board and I’m sure you guys as a management team, everybody looks at different options. But we all understand.

Two or three quarters ago, it seems like you guys were on their - on the cusp of adding basically $0.04 or $0.05 to the EPS each quarter and everything was growing. And you guys were on page probably from most - the most expectations were you guys going to get up $1 a share of earnings base.

And that’s all - at that point you might get some recognition and kind of perform maybe Sparton has performed or some of the other peers that have multiplied in the last three or four years. But, then, the reality of it is, you’re still in the tangible [ph] book.

And there as a shareholder I don’t see how somebody who looks at you guys as a potential acquisition target does not see what you are already referring to.

Obviously, I mean, me as a shareholder now looking back, when you guys spent $47 million, if you just gave everybody $4 or $3 a share dividend, right now I wouldn’t be sitting in the $8 share a stock.

But it’s probably would be worth lot more potentially, because your Mexican excellence and your Mexican capabilities alone have worked a lot more than the market cap.

But I just think, honestly, and this is - and I hope the board of directors and everybody else is listening, because I believe that you guys, everybody had been patient for a very long time, and I was hoping mile-for-close, [ph] and I complement you guys on doing a good job. But, to be honest, that story is getting a little tiresome for a lot of us.

And for us, a shareholder sitting on something for four years, but has not really moved in either direction, and we have not gotten the dividend, we have not gotten really a buyback, or - it’s just feels like, we all deserve a little bit of our - or as shareholders, we deserve some kind of reward.

And I cheer you, and I understand but [indiscernible] you guys have great organic growth outside of SMT, maybe a few others. But a buyer or acquirer would recognize that as much as we do..

Well, I guess, I don’t know what to say, I don’t know that’s a question or statement? I would like to point out to you that I’m a pretty sizable shareholder myself and I’m as frustrated as you are, but I don’t think it’s time to do, you are suggesting, but you’re certainly entitled to your opinion and it’s noted..

Thank you. We’ll take our next question from Andrew Huang with B. Riley..

Thanks very much. I just want to follow-up on a question that was asked earlier. I think you mentioned that there were two new program wins.

And the numbers you gave where those expected annual revenue from those two programs?.

Yes..

Can you just repeat those numbers again?.

It was more than $5 million, once about $20 million for a year..

And can you say like what end markets these two new programs are in?.

In telecommunications and security equipment..

So does that mean that one is in telecom and one is in security?.

Yes, correct. That’s what it means, yes..

Yes. Okay, got it.

And then, how long will it take for you to kind of get to the full - like on a quarterly basis the full run rate for those programs?.

The first one if I get there to buy nine months, second one will take a couple of years..

Okay. Got it.

And then, next on your CapEx commentary, I think you said, you spent $3.5 million in the quarter?.

That’s correct..

And some of that was for electrical, some of that was for plastic injection molding, some of that was for sheet metal.

I mean, are you - is your utilization in all three of those kind of functionalities just too high, or you have to spend that much?.

Yes. As we grow, we found that our customers’ ability to forecast is not all that good, I guess, I should it put a qualitative speed on it, but they have a hard time getting better than plus or minus 10%, 15%.

And so we found that we have to run it about 65% to 70% capacity at any given time in order to handle the upsides and come along and expecting from our customers. So all of those expenditures were to increase capacity to get us back up into the 65% range, particularly in SMT, we’ve allowed to get up into the 95% range, and that’s way too tight..

Great.

But then conversely, like if they surprise on the downside, then you kind of hit with unabsorbed or higher overhead and kind of higher fixed cost, correct?.

Yes. That’s why, we try to do it with very judiciously..

Okay.

So far SMT, you’re saying above 95%?.

We’re not anymore, but we were..

Okay. And for, are you like in the 80% range now or are you still [indiscernible]..

No. We’ve got to back down below 80% or down probably 70% now..

Okay.

And how about the plastics?.

Plastics were probably still up a little bit higher than we’d like to be, I would guess, were around 80%..

Yes.

And on the sheet metal?.

Sheet metal is a different story, because the machines are so not custom, but it’s kind of one machine is required for one job. And then other machine is required for another job. They’re not as general as is the plastic molding. So in the sheet metal group I really hesitate to give you an overall capacity number, because it’s so specific related..

Got it.

But can those sheet metal, like what’s the program is done, can that sheet metal machine be retooled to meet the needs for another customer?.

Yes. We’re not buying customer equipment, it just that you have a 400 ton stamping press and it will be 100% consumed by one customer’s business. And we’ve only got one 400 ton press. So do you had one or not, how far close to led the customer get the full capacity before you go add one, those are questions we struggle with every day..

Okay.

And then for fiscal 2016 for the full year, but you said your CapEx, but it was $8 million?.

That’s correct..

Okay.

So, yes, I guess, let’s just hope that you need all that CapEx?.

At this point, it looks like we’re going to..

Thanks very much..

Yes. You’re welcome..

Thank you. We’ll take our next question from George Melas with MKH Management..

Hey, guys..

Hi, George..

I have a question, I’m trying to understand the guidance that you had given the $0.18 to $0.24. So if you add back to $2 million tax, keep the same OpEx, and tax it at 35%, you would have done $0.18. So within the range but that sort of the low-end of the guidance range.

If you look at the $0.24 and you keep the same OpEx and the think same tax rate, I would have implied the gross margin of 9.4%.

So I’m just trying to understand, how with that have been possible?.

There it was beyond the program that we talked about, there it is another significant ramp that we thought was going to be running smoothly by Q1, and enabling the nice 9% range of gross margin, instead that ramp got very messy for almost all three months, in fact, all three months of the quarter.

So that sucked quite a bit of gross margin off of the bottom line and we spent it in getting this program to run at the yields it’s running at today. So today the program is running at 99.6% yield and during almost all of Q1, it was running at about 85% yield..

So is that’s the big delta?.

That is the big delta..

Okay. So trying to if you look at the project that ramp, give you most of the production issues and the yield issues related to programs that are in the ramping stage, right? Once you ramp them and you sort of stabilize and got into certain yield, there is fairly little variation in the yield of the results.

Is that right?.

That’s correct. And so if you look at Q1, Q1 was probably the worst quarterly over had in the factory. We had the big customer that tried to ramp was really hard on a new product that was not mature, so we are driving the factory nuts with retesting, reworking, troubleshooting, over time yield issues, moreover time.

And at the same time in another department in the factory, we had a product that was running at full speed, because our customers’ orders were fantastic.

And yet we were yielding in the 80s, and so try to keep track of all those parts it needed to be reworked and trying to do all the experiments that we were doing, to try to figure out what the yield problem was a real mess in trying to keep the factory in line and in control.

And this is very unusual situation for us, because this was a product the one product with the yield issues we had design, and we hadn’t intended for - the customer didn’t expect the massive demand that they enjoyed, and we enjoyed. It’s rough to say we enjoyed, because it wasn’t very enjoyable.

So this was just really a unique quarter, and in one case all the yield issues have gone away, because we’re no longer producing or trying to produce that new product. And in the other case, the yield issues have gone away, because we figured it out.

So this quarter compared to last quarter earlier, I think, Andrew asked a question about how much revenue do you need in order to achieve the 9% or 8% or whatever, and we didn’t give them a good answer because it’s as much product yield and factory efficiency, and product mix based as it is just pure revenue based.

So it’s a long answer, but that’s exactly what happened..

Okay. So just try to understand, I’m a little puzzled by the decline in the revenue in the guidance, the extent of it.

I mean, if you look at the midpoint of the guidance, it’s like $9 million sequential decline?.

Yes..

Is that mean that this one large customer had basically had become had fallen behind below the 10% mark in fiscal 2015.

But then, in this quarter with that new program basically had a significant growth in revenue, at least in the first part of the quarter, until they pull the plugged on the program?.

You’re doing a pretty good job of figuring that off, George. You’re exactly right..

Okay. And now, the capacity that you had devoted to that program, which must have been pretty significant, so you probably have one line devoted to that program.

Are you able to repurpose that line, and are you able to use it, or is it just sort of ideal, and sort of you just hoping to - not hoping but targeting new customers to fill that line?.

So when you think of a line it’s - that’s wrong for what we do, and that’s what’s unique about us, as we don’t have a line. We’ve got fab departments that make the steel or that fabricate the molded plastics or that fabricate the PCBs.

And then those parts which other than die-casting or about all you can fabricate those parts are shipped into another department across the factory, where there assembled into finished goods. So when we have a customer like this one who cranks us up and then cranks us down.

The fab departments are just producing products that can be manufactured off of a standard mold equipment or standard SMT equipment or standard stamping equipment. So the only line sort to speak of is the assembly line, where the parts are made it together.

In most of the cases for our customers, the assembly line is so custom, that they buy all of the equipment, the significant equipment they goes on that line, and that is indeed the case for this product. So our customer owns all of the things, all of the equipment that sitting out there being unused right now.

And it’s not hard for us to bundle it all up and shove it in a quarter and repurpose that space so that makes sense..

Yes. It makes sense..

Right. Okay..

Is there a way to understand the organic growth, the sequential growth or the organic - the year-over-year growth in the second quarter, excluding that customer.

Is there declining in the growth, is there - in the way the growth this quarter was partly the result of that one sort of the ill-fated program that died in the middle of the quarter, right?.

Yes. So that’s why we say that were $16 million better in organic growth should try to cancel out the effects of those the explosion, and then implosion and say that $16 million of it is new business..

George, we did mention that the decline of this longstanding customer will be replaced by completely new business by the end of our fourth quarter, and as we anticipate that..

By the end of the fourth quarter?.

Yes..

Does that mean, and then are you saying sort of the end of the fourth quarter should be at a run rate, which is $126 million, I’m not sure how to interpret that?.

Well, we don’t want you to interpret, because we don’t want to give you any forecast a quarter up. As the previous caller said, people are frustrated, when we get a forecast wrong, so what are going to do that. But….

Okay. Let me ask a different question. This quarter you have any big complex programs that are ramping up, any other way it’s good and bad, but I’m just it’s good, because it good at the revenue, it’s scary because it always a risk, when you have big programs ramping up it.

Tell us a little bit about what’s ramping up this quarter and maybe next quarter that you have visibility on?.

I’ll do even one better than that, I’ll go out through Q4..

Okay..

So from now through Q4, I don’t see any programs that are ramping, that have the potential to screw us up in terms of yield or gross margin in any way or shape or form close to what we’ve been through in the last 2.5 quarters..

Okay..

So everything will ramp - go ahead..

Sorry. Go ahead, Craig. I’ll ask, go ahead….

No. You go ahead. Go ahead..

So how many programs are we talking about into Q4?.

I can’t even tell you, somewhere in excess of 10 new programs..

Okay..

So I’m glad you’d asked all these because it give us a chance to explain what was so weird and painful about Q4 and Q1, and why that was something different in our norm, and I don’t anticipate it happening again..

Okay.

The Q4 that one program that had these yield issues that was also in Q4 in part, then?.

Yes..

In Q4, and in the first three quarters, or in the three quarters of Q1?.

Three months..

Three months of Q1..

Three month of Q1, yes, one missing, yes, okay.

And then, at that level at which you will be at the end of the fourth quarter, do you anticipate the gross margin that starts with a nine?.

Over the long term, we have to hit that target..

I know that, Brett. Do you think it comes that, do you think it comes - do you think we can anticipate that by then or if you do - maybe I’m sorry, I’m pushing - go ahead, Craig..

Let’s you answer that one, Craig?.

I have no comment..

Okay. Very good. Thank you very much guys..

Yes, bye..

Thanks, George..

Thank you. We’ll go next to Bill Dezellem with Tieton Capital Management..

Bill, you got us on mute?.

Apparently, I did my apology..

Here we go..

Thank you. So I’m going to follow-up on the last two questioners with a couple of questions for clarification. Did we just hear you say that the inefficiencies that you experienced this quarter also impacted the prior quarter? I thought I heard you say the last couple of quarters..

Yes..

So even though the June quarter was a respectable quarter from margin standpoint, it was still impacted by some ramp challenges?.

Yes. By the ramp challenge..

Great. That is helpful.

And then, did we also hear that this is one customers that, hit the gas and then hit the break, that they were the problem customer, we may call them that a year ago?.

Yes. They’ve been the problem for the past two..

And they are now as of the December quarter, around in here that a fair description?.

Pretty close..

Yes. They’re outside of the top five..

Great. Thank you. And then, I did actually want to talk a little bit about the top five in any of the two that are new to the top five now.

Did they come from the Ayrshire side of the business?.

One of them did, and one of them is some nice longstanding organic growth out of customers been with us for six years. They’ve made a couple of acquisitions and the business that came with that acquisition is coming our way..

Congratulations. And then, lastly early in the call, you all referenced new program pipeline that you are feeling good about. And I’m thinking it would be nice to hear a little more detail around that, please..

Okay. We’ve got the eastern guys and the western guys that’s how we’ve ended up saying it rather than the old Key Tronic and the old Ayrshire. So that two sales teams that we had to merge that took us. I’d say a quarter-and-a-half. So the coordination between the sales teams is working a lot better.

Our whole process, again, the combination of the two companies is working quite a bit better. And the overall number of leads that are coming at us as both the word is out on the street and the sales guys have a better idea of what it is exactly they’re selling, we’re getting us lot more times up at bat.

And so, that combination is leading to the best funnel I’ve seen so far..

Best funnel you’ve seen ever?.

Yes..

Great. Thank you. That’s probably a nice spot to close..

Okay..

Thank you. We do have a follow-up from Andrew Huang with B. Riley..

Thanks. So apart from this customer that’s been causing you all these problems with the ramp and then the cancellation, you mentioned that there was a customer where yields in the quarter are in the 80% range, and I think exiting the quarter the yields were at 99%.

Is that right?.

Actually, it was the first week of this quarter. I kneeled down and cried in the parking lot, because we had 99.6%..

So my question is, a year ago would you have anticipated having the 85% yield problem with this customer?.

We would have anticipated having it, but we would have thought - it was going to be during a nice low-volume ramp, where we had a chance to do all the experiments and the troubleshooting and the tweaking that you normally have to do to a very complex product. Unfortunately/fortunately, the product hit the market and everybody loved it.

And so, we had to - we had no choice. You don’t tell a customer that, hey, this is great, sorry, I’m going to work on my profitability, I’m not going to ship your product. You just got to buckle under and make it for them, while you figure out what the hell is the matter with it. So that’s what happened..

Okay.

Can you say whether this program involved the use of FMT, plastics and sheet-metal, or all three or…?.

It involves - it uses all three, all three..

So that means there was a full box build program then?.

Yes, indeed..

Yes..

Well, that’s pretty. Okay.

And, just to be clear, for the December quarter, is this customer going to continue the super strong volume ramp or is it going to moderate somewhat for the December quarter?.

December quarter, we’re running at max capacity. Right now, they’re forecasting that it’s going to slow down a little bit in the next quarter..

When you say the next quarter, you mean the March quarter?.

Yes, the March quarter..

Okay. Thanks very much..

You bet..

Thank you. Next, we’ll take a follow-up from George Melas with MKH Management..

Thank you very much. I want to try to ask a sort of 100,000 foot question.

If we - if you look at the business over a long period of time, how much business usually turns over annually? So if you start with $100 in sales, how much do you expect that $100 to be a year from now? Do you lose 5% of the business, because sort of program sort of come off or was it 10% of the business?.

Well, if you’re looking at 10,000 feet, go back to six years ago we’re about a $170 million, right. Before we bought Ayrshire we were running $325 million, somewhere in there. We don’t see that we lose much revenue. There’s not a lot of churn in our customer list. Our fortunes kind of go up and down with customers as their markets are impacted.

For example, the gaming industry got hit pretty hard and was coming back a little bit. But a point of pride for us and part of our marketing pitch is to tell our prospective customer, cover your eyes with your hand and stick a pin in this customer list. And you can do two things.

One is you can call anybody to stick a pin in, and they’ll tell you that we’re an effective, moral, trustworthy and efficient company. And two, you’ll see that that customer has been with us probably for either a long time or has no intentions of leaving. We haven’t been fired by very many customers.

I can count on one hand the number of customers who have fired us in the last 15 years. We have fired a few, but our churn rate is very, very low compared to many of our competitors..

Right, and there is no - is there a way to determine sort of the churn by - so for example, if you start with a $100 and you have no wins, right? You add nothing to the bucket..

Yes..

I understand that you fluctuate based on the health of the industries that you serve. And gaming has ups and down. And clearly, the education technology market has been up and down.

So is there any way to think about that as a model for you or for the industry or is it just this waste of time?.

I’ve tried. We look at, although we don’t give them out. We have forecasted rolling out 12 months and you can look at them. And you can look at them in detail so the only you can make any sense of our business that I found is look at it customer-by-customer.

And that’s what’s unfortunate about these conference calls is I can’t talk to you about it customer-by-customer. Each customer is different. Each customer’s position in their market is different. The age of the program we have with that customer is different. The success of the program that customer is enjoying in its market is different..

The maturity of the….

It’s just….

Yes..

[indiscernible]..

It’s very, very specific. So I can’t come up with a way to give you an average burnout real-life….

Right..

I can’t tell you that we wouldn’t….

Is there a metric that would be - is there a metric that would be helpful for us to say, 90% of the revenue this quarter came from customers that we’ve had for more than one year or from programs we had for more than one year. I don’t know. That the metrics you give us have to mean something to you.

Otherwise it’s just stuff we put in ours models and then has no meaning. But I’m just wondering how you guys look at that and say, because if you look at your sales, you have new customers every quarter. It would be interesting to see how much do those guys really add to the business..

Yes, so, one thing I can tell you that we look at is, if we’re looking out at Q4, because the next quarter no one after that.

In this business, anything that’s good is going to happen to you isn’t going to have any effect from a new customer, new program basis for at least two quarters, right? So there’s no reason to look at the first, the nearest two quarters other than to go through this exercise with you guys in the phone.

So when we look at what’s happening, we’re looking out three quarters, four quarters, five quarters. And we look at where do we stand in terms of new business that’s ramped versus new businesses that ramping and new business run-rate.

So one metric I can tell you is that when we look at Q4 with one business today, we look at Q4 in the quarter, that will be about $8 million of business that’s running in Q4 versus about $33 million of business that is one that is still being ramped. So that’s the kind of thing we look at to see how are we doing and what’s the future going to hold..

Let me just see if I understand that. So in Q4 there would be $8 million in new business that you don’t have now, but that will - on which you will be able to recognize revenue, and there is another $33 million that you’re not recognizing because it’s being ramped.

Is that what you’re saying?.

Yes..

Yes..

Okay. And….

So, the question?.

Yes, the $8 million sort of makes up the decline of the one big problem customer?.

Yes..

Okay. That’s helpful. I appreciate that. Good luck..

You bet. Thanks..

Thanks..

Thank you. And with that, we have no further time for questions. I’d like to turn the call back over to Mr. Craig Gates for any additional or closing comments..

No. Other than thanks to everybody for participating in today’s call, Brett and I look forward to speaking to you again. Thanks and have a good day..

That does conclude today’s call. Thank you for your participation..