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

Paul Carter - Adaptable Capital Management Inc. William Dezellem - Tieton Capital Management Buzz Heidtke - Heidtke & Company.

Good day and welcome to the Key Tronic Fiscal Q4 2017 Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. 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 fourth quarter and full-year ended July 1, 2017.

For the fourth quarter of the fiscal year 2017, we reported total revenue of $118.5 million compared to $123.9 million in the same period of fiscal year 2016. For the fiscal year 2017, total revenue was $467.8 million compared to $485 million for the fiscal year 2016.

During fiscal 2017, as anticipated our revenue and margins were impacted by declining demand from some longstanding customers, which was not yet fully offset by the continued ramp of revenue from our new programs.

For the fourth quarter of fiscal year 2017, gross margin was 8.3% and operating margin was 2%, compared to 8.7% and 2.8%, respectively, in the same period of fiscal 2016. While the year-over-year decline in margins primarily reflects lower revenue levels.

The results for the fourth quarter of fiscal 2017 also include approximately $3.2 million in revenue for shipped excess inventory for a prior customer at cost, which had no contributions to margins.

Throughout the year, our gross margins was adversely impacted by the ramp up costs associated with our new program wins, some of which involve transferring ongoing production from a competitor's facility to our own.

We expect to see gradually improving gross margins as these new programs move into full production, further utilizing existing production capacity. Net income for the fourth quarter of fiscal 2017 was $1.3 million or $0.12 per share compared to $2.1 million or $0.20 per share for the same period of fiscal year 2016.

For the full fiscal year 2017, net income was $5.6 million or $0.51 per share compared to $6.5 million or $0.58 per share for the fiscal year 2016. Turning to the balance sheet. We continue to maintain a strong financial position. As a result of ramping programs, our inventory increased about 3% from the previous quarter.

In coming periods, we expect to see our net inventory levels gradually decline. Our trade receivables were $65.2 million at the end of the fourth quarter, up $2.9 million from the previous quarter, which approximates the increase in sales reported during the fourth quarter.

Our consolidated DSOs were around 43 days and we expect that our DSOs will remain under 50 days in coming quarters. During the fourth quarter, we reduced our total debt by $1.5 million when compared to the prior quarter. Over the longer-term, we expect to continue to pay down the term loans and the revolving line of credit at a more accelerated rate.

Total capital expenditures for the fourth quarter of fiscal 2017 were approximately $1.7 million and were $9.3 million for the full-year, as we continue to invest in our SMT, sheet metal and plastic molding capabilities. Fiscal year 2018 capital expenditures are expected to be around $7 million.

Moving into the first quarter of fiscal 2018, we expect more of our new customer programs to ramp and to move into production. At the same time, we expect continued softness among a few of our longstanding customers.

Taking these factors into consideration, we anticipate that the first quarter of fiscal 2018 will look much like the fourth quarter of fiscal 2017, with revenue in the range of $110 million to $115 million.

It is expect in an overall gross margin percentage will also remain essentially flat in the first quarter, but will gradually improve as new customer programs ramp and further contribute additional revenue over the longer-term.

Taking these factors mentioned into consideration, we anticipate earnings in the range of $0.10 to $0.15 per share for the first quarter. This expected earnings range assumes an effective tax rate of 25%. In summary, we're 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 are well-positioned to continue to profitably expand our business over the longer-term. That's it for me.

Craig?.

Okay. Thanks, Brett. As we've discussed in prior calls, we saw decrease demand among some of our longstanding customers throughout the year. We're also seeing a more competitive EMS marketplace, the latest reports of U.S. known EMS companies indicate decreases in year-over-year sales and decreasing sales sequentially in recent quarters.

The slowdown in growth in the EMS market maybe related to current geopolitical uncertainties in the market delaying outsourcing or manufacturing. That said, most of our new customers appear to be moving forward with their new programs with us, though at a slower pace than we've historically seen.

We expect new programs we have one to contribute to higher revenue later in fiscal 2018 as we expect these new programs, sales to outpace weakness in longstanding customers. We continue to see strong results this past fiscal year from Key Tronic East, which you will recall was acquired just over two years ago.

After closing our Kentucky facility and trimming non-profitable programs during the year, we are now seeing strong growth and revenue from these facilities. We believe that this reflects a growing appetite for U.S. build products.

At the same time, we continue to capture significant new business from other EMS competitors at all of our global locations, including established programs that will begin generating revenue in fiscal 2018. We recently won two new programs involving gaming and seismic monitoring devices.

Moving into fiscal 2018, we continue to see a strong pipeline of potential new business opportunities. While it is perhaps an overreach to draw global conclusions from our window into the market, we believe our experience does point in a consistent direction. Up to the election and the aftermath, we saw slowdown in the award and transfer programs.

We believe uncertainty drove our market toward status as our company is waiting to see, how new rules, regulations, public pressure, and international gaming shift would impact sourcing decisions.

In our experience, companies continue to quote new suppliers and in fact, program the new suppliers, but they moved very slowly to transfer meaningful revenue from supplier to supplier. We have several new customers that have moved business to us in this mode.

As a result during the last year we incurred most of the expense of quoting, winning and transferring new business into our facilities while enjoying very little of the margin that will come as the customers complete transition to us. In other cases, customers have made decisions based on uncertainty.

This has involved moving product from one of our sites to another along with all the costs associated with that process. We believe this unrest is beginning to subside. In fact we are in the midst of one unwinding some of those moves from our customers and in other cases making changes to minimize the effects of those decisions.

Going forward, our broader and more diversified customer base significantly lowers the potential risk and impact of any slowdown by any one customer.

Moreover, Key Tronic is well positioned for the returning tide of North American-based customers correctly analyzing the total cost for overseas production and pushing production in the both Mexico and the U.S.

Our steady pipeline of new business opportunities continues to be boosted by our unmatched level of vertical integration, our multi-country footprint and the excellence of our manufacturing sites in comparisons to other EMS competitors of our size.

As OEMs face an increasing uncertain geopolitical landscape, Key Tronic is uniquely equipped to offer risk mitigation with our manufacturing facilities located in China, Mexico and U.S.

To continue to capitalize on our diversity of locations, however, has required significant capital expenditure, training expense and management attention in recent periods. During the past few years, we have made significant investments in expanding our SMT, sheet metal and plastic molding capabilities in anticipation of increasing demand.

Throughout fiscal 2017, we also made significant investments in improving our customer support organization. We expect to see utilization of this new capacity in coming periods which will enable us to grow with lower levels of capital expenditures in coming years.

Moving into fiscal 2018, we expect to see many of our new programs continue to ramp up, the continued onboarding, and several new customers and a strong pipeline of potential new business. By the second half of fiscal 2018, we anticipate a return to growth and revenue and improving margins.

Over the long-term, we believe our new programs and customers will continue to grow far beyond their revenue levels today with our increased capacity and stronger operations potential to accommodate a more diversified customer base. Overall, we remain optimistic about our growth opportunities and our competitive strengths.

I want to take this opportunity to express my gratitude to our employees for their dedication and hard work during this past year for valued customers who continue to honor us with their trust and to our shareholders for your continuing support. This concludes the formal portion of our presentation.

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

Thank you. [Operator Instructions] We will take our first question from Paul Carter with Adaptable Capital Management. .

Good afternoon. Thanks for taking my questions. So your SG&A as a percent of revenue was about 5%, again this quarter if you adjust for the $3.2 million of zero margin revenue. Last quarter, I think it was elevated because of legal expenses.

Was that the same situation this quarter?.

Yes..

So how much will be sort of non-recurring or unusual sort of legal fees this quarter?.

I don’t know the exact amount, it’s going to be somewhere between $200,000 and $300,000..

Okay.

And then what was the impact this quarter to your cost of goods sold of realized foreign exchange contracts?.

Similar to what it was in the third quarter of fiscal 2017..

Okay. And then in your third quarter 10-Q, you said that the expected net amount of FX losses to hit earnings for the next 12 months was like $3.5 million or about $900,000 per quarter on average.

Do you expect that – what do you expect that to be now?.

I expect that to continue for the next approximately three quarters..

Okay, great.

And then your effective tax rate in the last couple of years where I think 22.5% and 20% a year-ago, why do you think it'll increase to 25% going forward? Or you expecting your proportion of profits to shift away from Mexico somewhat this year?.

No, it’s actually the fact that we are paying a few more taxes within Mexico. So the tax by jurisdictions is slightly different than it has been in the past. I'm expecting it still to be somewhere around 25%. That's a good estimate..

Okay. Great. And just final question, so in the past, I think about a year ago or so in our presentation, you articulated your financial targets sort of 9% to 11% gross margins and I think 4% to 7% operating margins.

Are these still your targets and do you expect to get to these levels and sort of stay there within the foreseeable future? Or are they more sort of like everything would have to go right in order for you to hit them?.

I don't think everything would have to go right; probably about half of everything would have to go right. We're not expecting as we’ve shown. That is going to happen this quarter, but we certainly still have quite a bit of optimism that it will..

Okay.

So that’s still your longer term sort of objective?.

Yes..

Okay. Great. Well, that's it for me. Thank you very much for taking the questions..

Thank you..

All right, thank you..

We'll take our next question from Bill Dezellem with Tieton Capital..

Thank you and good afternoon. A couple questions to begin with here.

So my standard one, two new customers, what's the range of size for those customers?.

The first one is probably 6% to 10% and the second one is 10% to 15%..

And you haven't said which one is the seismic, but I'm presuming given how weak the seismic industry is today that your estimate whatever it is for that customer is based on current level of activity.

And so if activity levels pick up as they historically have for energy then that could be significantly larger or are you already taking that to rebound into account?.

The number I quoted you – which is one of the two numbers I quoted you was based on the current level of oil and gas..

Great. Thank you..

There would be – yes, if that would have takeoff there would be significant upside from that customer..

And given the volatility of that seismic has even relative to the energy industry, I mean literally it could have three to four times of the magnitude of what you’ve listed here, is that correct?.

Three..

That's helpful. Thanks. And then you did mentioned in the press release that that you made investments in SMT metal and plastics.

Would you talk in some detail about what you did in each of those three areas and what you are trying to accomplish with those investments?.

In the SMT area, we were buying some of the latest equipment because the advances in speed have made the capital equation versus cost reduction equation worthwhile. We’ve also added some automatic inspection equipment, which allows us to produce much finer pitch components with a higher quality level.

In plastics, we've been migrating away from hydraulically operated presses to electrically operated processes, which up to about 450,000 tons have a lot better degree of controllability in terms of shaft size and shaft speed and lot lower maintenance costs and better power dropped too.

And then in metals, we've added some pretty high-end inner gas blanketing technology into the laser cutters. So that we can dramatically increase the speed at which the lasers can cut and the thickness of the steel that they can cut, so it also reduces our costs and therefore makes our ability to quote aggressively a lot stronger..

And where any of the items that you described specific for new customers that you had one?.

Yes, and one of the SMT lines was specific to a customer. The others I would say are more in general..

Great, thanks.

And then in your – I think in your comments you made reference to customers that are moved product to other facilities of your own to accommodate the political environment and then some of that's actually being unwound slowly now, would you talk in some more detail about what you saw there and how it is the customer seem to be thinking at this moment in time?.

I think there was some panic during the election and after the election about what might happen to duties coming out of Mexico, coming out of China and availability of products coming out of the two locations.

So people were making moves in where we were going to build their product based more on panic than they were on some financial analysis of shipping costs and expedite costs. And the costs of getting new engineers to the site and need to.

So as the noise out of DC has turned into more noise in less panic people started to rethink some of those decisions in running the numbers again in driving a bit more logically rather than fear what you're doing..

Are you sensing that fear is still a part of the process and the back of some of these buying decisions or is it really putting pen to paper and it’s really a financial decision now?.

I think serious still a big part of what everybody is doing, but it fact moving in zone eventually become a little bit number of the bombs, and you still done buy milk in the market. So I don't really know. All I know is it's the worst I've ever seen..

And then let me switch to couple of question. Brett I wouldn't want you to feel left out.

The gross margin increased sequentially, what caused that and is there anything that we can read into that improving margin and again small, but directionally the right way?.

Yes, directionally a couple of things that helped us this quarter. One was we were able to take advantage of some material savings, which we profited from, also the results of Key Tronic East where the acquired Ayrshire also was up in profits.

Our expectation is that as we continue to grow the revenue line, we will see incremental improvement in that gross margin, we had capacity..

Great. And the margin improvement that would not have fallen under the noise category that really was an indication of – like you said material cost and things improving in East..

Well, that’s correct..

Thanks.

And then the last thing, you’ve mentioned that you were anticipating that you would pay debt down at a faster rate, would you talk about how you plan on doing that?.

Yes. In the last three years we've spent a lot in capital expenditures as Craig mentioned in the three vertical manufacturing arenas. Our anticipation is that based on our forecasted revenue that we most likely will not have to spend at the same rate we have been.

We feel confident in the capabilities and the capacity of our current equipments that allow us to not spend as much annually in CapEx. And the other is coupled with the expectation of increased profitability with no revenue..

Great. We look forward to that last part in particular. Thank you both..

[Operator Instructions] And we have a question from Buzz Heidtke with Heidtke & Company..

Yes. My question is on R&D spending. I’ll spend a quite a bit on R&D spending.

Are you continuing to spend about the same amount in relation to your revenue?.

Yes..

Okay. That’s the only question I had. Thank you..

Thank you, Buzz. End of Q&A.

[Operator Instructions] And with no further questions at this time, actually we will turn the call back over to the management team for any additional or closing remarks..

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

And that does conclude today's conference. Thank you for your participation and you may now disconnect..