Craig Gates - President and CEO Brett Larsen - CFO, EVP of Administration.

Zach Cummins - B. Riley & Co. Bill Dezellem - Tieton Capital Management.

Good day and welcome to the Key Tronic Q1 Fiscal Year 2017 Conference Call. Today's conference is being recorded. At this time I'd like to turn the conference over to Brett Larsen. Please go ahead..

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

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

For more information, you may review the risk factors outlined in the documents the Company has filed with the SEC, specifically our latest 10-K, quarterly 10-Qs, and 8-Ks. 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. Today we released our results for the first quarter of fiscal year 2017.

For the quarter ended October 1, 2016, we reported total revenue of $117.1 million, compared to $123.9 million in the previous quarter and $126.2 million in the same period of fiscal year 2016. We saw a slight slowdown in demand from several customers in the first quarter of fiscal 2017.

As expected, we continued to replace this revenue from the longstanding customer that adversely impacted our business throughout fiscal 2016. New programs continue to ramp and we continue to diversify our customer base. In coming periods, we anticipate sequential revenue growth.

For the first quarter of fiscal 2017, gross margin was 8.3% and operating margin was 2.4%, compared to 7.1% and 1.4%, respectively, in the same period of fiscal 2016. Year-over-year improvements in margin were a direct result of new programs and increasing production efficiencies.

During the first quarter of fiscal 2017, our margins were impacted by the costs associated with the planned consolidation of our U.S.-based operations in Kentucky, which should result in improved operating efficiencies in future quarters.

Net income for the first quarter of fiscal 2017 was $1.8 million or $0.16 per share, up $0.8 million or $0.07 per share for the first quarter of fiscal 2016. We expect margins and our profitability to continue to gradually improve over the coming quarters. Turning to the balance sheet, we continue to maintain a strong financial position.

As you will recall, inventory [lows][ph] have been abnormally high in recent quarters. We're pleased to see the results of efforts to reduce our inventory as inventory decreased approximately $7 million in the first quarter from the previous quarter.

In the coming periods we expect to see inventory continue to gradually decrease, returning to levels more in line with revenue. Our trade receivables were $64.8 million at the end of the first quarter, up $3.1 million from the previous quarter due to a lower utilization of our account purchase agreement.

Our consolidated DSOs increased to closer to 50 days and we expect our DSOs will remain at about this level in coming quarters.

During the first quarter we had an increase of approximately $4 million on our debt facilities as we sold fewer accounts receivable under our account purchase agreement, which will lower our interest expense in coming periods. Over the longer term we expect to continue to gradually pay down both the term loan and revolving line of credit.

Total capital expenditures for the first quarter of fiscal 2017 were approximately $3 million, and we expect to be about $9 million for the full year as we continue to expand our SMT, sheet metal and plastic molding capabilities.

Moving into the second quarter of fiscal 2017, we expect more of our new customer programs to ramp and to move into production.

At the same time, we expect to see a modest decline in our revenue due to the closure of our Harrodsburg, Kentucky facility which saw a decrease in revenue as we disengaged with -- as we disengaged with less profitable programs and finished transitioning remaining programs to our Mississippi and Minnesota facilities.

Taking these factors into consideration, we anticipate that the second quarter of fiscal 2017 will have revenue in the range of $115 million to $120 million. We anticipate improvements in margin during coming quarters as the remaining Harrodsburg programs are transferred to other facilities and we begin to realize cost savings from the closure.

Over the longer term we expect to realize annual savings of approximately $0.08 diluted earnings per share as a result of the Harrodsburg facility closure. We expect that our overall gross margin percentage will continue to gradually improve.

Taking the factors just mentioned into consideration, we anticipate earnings in the range of $0.13 to $0.18 per share for the second quarter. This expected earnings range assumes an effective tax rate of 25%. In summary, we're pleased with our strong financial position and encouraged by the prospects for future growth in revenue and earnings.

The overall financial health of the Company is strong and we believe that we're well-positioned to continue to profitably expand our business over the longer term. That's it for me.

Craig?.

All right. Thanks, Brett. As you will recall, a major portion of our business was concentrated with a large customer who encountered a sharp decline in demand over the past 15 months.

We have now fully exited that customer relationship as its business had become increasingly risky, and we continue to replace the high risk revenue that was associated with that customer. Over the past 15 months, we've replaced approximately $50 million in revenue from that single customer by winning and ramping smaller new programs and customers.

Going forward, our broader and more diversified customer base significantly lowers the potential risk and impact of a slowdown by any one customer. Moreover, the tide of North American based customers correctly analyzing the total costs for overseas production continues to help our production in both Mexico and the U.S.

As a result, we're continuing to see a robust pipeline of potential new business for our Mexico and USA facilities. During the first quarter of fiscal 2017, we won new programs involving transportation logistics, medical and personal safety products.

Our steady pipeline of new business continues to be boosted by the Ayrshire acquisition, our level of vertical integration, our multi-country footprint, and the excellence of our manufacturing sites. In particular we have seen significant increases and opportunities for our U.S. facilities over the past six months.

We think this is a chain reaction, work coming back from China goes into Mexico and pushes some work from Mexico to the U.S. Our U.S. facilities, coupled with legacy Key Tronic proficiencies offer a much better menu of skills and resources than many of our regional competitors.

So our thesis for acquiring Ayrshire to create one plus one equals three opportunities is working in multiple ways. To make this formula work, however, has required a much higher concentration of PCA business at the front end.

In fact, most of the new programs generating revenue are PCA intensive, which makes sense as many new opportunities tend to start as PCB and then foster a broader range of services. We now have 13 SMT lines in Juarez, up from 6 a year ago. This has forced significant capital expenditure, training expense and management retention in recent periods.

As a result of our high capital investment in PCA automation equipment, we are seeing more high-value opportunities for full product manufacturing.

In coming periods, we plan to continue to invest in expanding our SMT, sheet metal and plastic molding capabilities in anticipation of increasing demand while continuing to decrease our inventory levels to be more in line with revenues.

As we move further into fiscal 2017, we expect to see many of our new programs continue to ramp up, and continued onboarding of several new customers, and a robust pipeline of potential new business.

Over the long term we anticipate our new programs and customers will continue to grow far beyond the revenue levels today and we'll continue to invest in increasing our capacity and improving our operations to accommodate a more diversified customer base.

Overall we feel increasingly encouraged by our growth opportunities and our competitive strengths. This concludes the formal portion of our presentation. Brett and I will now be pleased to answer your questions..

[Operator Instructions] And we'll take our first question from Herve Francois with B. Riley & Co..

Hi, good afternoon. This is actually Zach Cummins on for Herve today. But I guess we'll just start off with the closure of your Kentucky facility. It seems like you've run into a few headwinds as you're transferring business to your other facilities in Minnesota and Mississippi.

Do you have a timeline as to when you think you'll be fully transitioned into those other plants?.

Yeah, we're about there, so we'll be done with it this quarter..

Okay. Okay, good.

And I think, so with it being done immediately this quarter, should we, I don't know, be modeling or expecting a meaningful improvement in gross margin and operating margin this quarter?.

Well, we baked it into our forecast, so the numbers you're seeing are including us finishing up this effort this quarter..

Okay, great. And I think on prior -- I think on the last quarter call you had like a long-term gross margin goal somewhere between 9% to 11%.

Do you think it's possible to reach that 9% level towards the end of this year?.

Towards the end of this year, yes..

Okay, great.

And then for some of your new program wins this quarter, could you talk about more of kind of what businesses those were in and kind of the approximate value of those program wins when fully ramped?.

Well, we try to keep those ranges pretty broad because we're never sure whether or not the customer's dreams are actually going to become reality. But the three that we talked about were between $5 million and $20 million in annual revenue. And they're in transportation, medical and personal safety stuff.

I wouldn't try to draw any trends from the last set of programs we win because we're really all over the map in terms of what we're looking at, what we're quoting on..

Okay, great. That was helpful. I'll go ahead and go back in queue for now..

Okay..

Thank you. Our next question comes from Bill Dezellem with Tieton Capital Management..

Thank you. So I'm not sure if this is a question that you're comfortable answering, but hoping you'll give us some insights here.

The longstanding customer that you've referenced that has now gone away, would you be able to tell us what the revenue level was that you had with them in the September quarter of last year, the June quarter of this year, and then this quarter?.

Well, I'd say roughly around $15 million to $20 million in those two quarters. And then it's almost zero now, for all intents and purposes, is zero..

So in the June quarter it was still up at the $15 million, $20 million mark?.

No, that was a year ago, Bill..

Okay --.

I'm sorry I didn't understand your question.

You mean a year ago?.

Year over year, 15 down to about nil..

Yeah..

Yeah, all right.

And then how about the June quarter?.

That was about six, five to six, if I remember right..

Four million, Bill..

Excellent. All right, I appreciate that.

So you have been winning new business over the course of, well, of the history of the Company, but of the recent new business that you won, and when I say recent, I really mean year, year and a half, are you finding that those programs are just rolling out smoothly or is there some level of call it pent-up backlog, and I don't mean backlog in an accounting sense, but pent-up business that's being created just because of one-off reasons for ramps? And if that is the case, is that leading to some period in the future where you may get more than preponderance of a revenue ramp?.

Wow. So if I think back at all the programs we've won and tried to ramp over the last 18 months, the drivers for either the slow average or quick ramps are so varied that I don't think you can draw a general conclusion from what goes on out there.

I think it's more random and it can range from a management team getting taken out, replaced by another one that has a much more aggressive view of how [inaudible] to Key Tronic, all the way to a technical issue with a new design that has to get solved before we can move the product from the current supplier to us.

And I can think of at least four different reasons for stuff going in different directions just off the top of my head beyond those two..

So, given the puts and takes that you've described there, does that lead you to have a thought that in a future quarter that you're going to see a larger-than-normal bump-up or pretty much the puts and takes start to offset themselves and there's a smoothing factor that takes place..

Well, we've got a chart we look at that says this quarter's revenue from all the new customers, the expected annual run rate at full ramp, and divided by four, and then we look out two quarters and look at what it's going to be out there. We started doing that about a year ago, trying to track all these new ones.

And if you believe that, which I'm not sure I do yet because we just started doing all this modeling, but if you believe it, it says that the rate of new business onboarding, turning it into significant revenue, should be increasing over the next year.

Whether or not that's going to happen, I don't know, but that's what this chunk of data we're trying to put into some kind of a forecasting tool tells us right now..

That's helpful, thank you. And then I do have a couple of questions relative to the Kentucky facility.

What was the gross margin impact in this quarter?.

That's a tough one to define, Bill. I would say that, you know, you go back to what we stated already as there's a longer term, once we're completely exited out of Harrodsburg starting in Q3 of $0.08 per earning -- $0.08 of EPS saving..

And so, would it be --.

Per year. That's per year..

That's per year. And so that's the go-forward savings from a normal run rate. But this quarter you actually were below the normal run rate, if I'm understanding correctly, as a result of the cost of closing the facility..

Yeah. There have been some drag on earnings as we have had to keep folks on even though they didn't have the revenue to justify it to clean things up. I would not call that a substantial drag..

All right, that's helpful.

And then that facility is going to be finished in terms of the closure process this quarter or is it already done at this point in the quarter?.

It's very close to already done..

You just need to lock the door and turn off the lights?.

Pretty close to that..

Pretty close to that..

Yeah..

Yeah. Okay. Great. Thank you both..

You bet..

You bet..

Thank you. [Operator Instructions] And we'll return to Herve Francoise with B. Riley & Co..

Hi again. So I think I remember from the last quarter's earnings call you said about $6 million in revenues from this Kentucky facility would be transferred out to your -- would be transferred out to your other plants.

Is it still about that amount of level? And then, do you have like an allocation plan between what type of revenues will go to your Minnesota facility versus your Mississippi facility?.

Yeah, it's already there..

Yeah. And there have been no changes to that $6 million..

Okay, no changes to that. And then just kind of looking at your SG&A as a percentage of sales over the, I don't know, past five or six quarters, it stays right around that 4% to 4.5% range.

Is that should be expected going forward or could we see some improvements with the closure of your Kentucky facility?.

Nothing significant with the closure of Kentucky. Most of those were just production cost savings..

Okay. And then I guess one final question, I believe the Kentucky facility had around 80-soemthing employees.

Are you retaining all of those employees or just retaining partial of them or anything along those lines?.

Actually just a couple of them..

Okay. Great. Well, thank you for answering my questions..

You bet..

Thanks, Zach..

Thank you. [Operator Instructions] It appears there are no further questions at this time. Mr. Gates, I'd like to turn the conference back to you for any additional or closing remarks..

Okay. Thank you everyone for participating in today's conference call. Brett and I look forward to speaking with you next quarter. Thanks and have a good day..

Thank you. This does conclude today's presentation. We thank you for your participation..