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

Bill Dezellem - Tieton Capital Management Sheldon Grodsky - Grodsky Associates George Melas - MKH Management.

Good day, and welcome to the Key Tronic First Quarter Fiscal 2019 Conference Call. Today's call is being recorded. At this time, I would like to turn the conference over to Mr. Brett Larsen. Please, go ahead sir..

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 that the Company has filed with the SEC, specifically our 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 ended September 29, 2018.

For the first quarter of fiscal 2019, we reported total revenue of $127.5 million up from $117 million in the prior quarter and from $109.2 million in the same period of fiscal year 2018. We adopted the new revenue recognition standard beginning July 1, 2018.

The impact related to the adoption of the standard for the first quarter of fiscal 2019 includes the accelerated recognition of approximately $4.9 million in revenue in the fiscal quarter of 2019 primarily due to the change from point in time to overtime recognition of revenue for certain customers as the standard requires excluding this benefit revenue for the first quarter of fiscal 2019 would have increased 5% from the prior quarter and 12% for the same period of fiscal 2018.

We saw most of our new programs continue to ramp. Once again our overall revenue and productivity was adversely impacted by industry wide shortage in key electronic components. For the first quarter of fiscal year 2019, gross margin was 7.5% and operating margin was 2.0% compared to 7.2% and 1.1% respectively in the same period of fiscal 2018.

Our gross margin was adversely impacted by increased utility rates in Mexico due to recent regulatory changes and the continued component shortages net negatively effecting productivity coupled with the ramp up cost that associated with our new program wins.

We expect to see gradually improving gross margin as shortages and electronic components are mitigated and our new programs move into full production further utilizing existing production capacity.

We plan to further invest in production equipment that will reduce labor and energy cost while preparing for future growth and enhancing our strategic footprint. For example in the next few months we will be reallocating and adding new equipment in Arkansas and we're now leasing additional continuous space for our facility in Minnesota.

Internationally we're also looking possibly augment our global footprint with another manufacturing location in Asia due to current market conditions and tariffs. For the first quarter of fiscal 2019 we had net income of $1.6 million or 15% per share compared to $0.4 million or $0.4 per share for the same period of fiscal 2018.

Turning to the balance sheet, we continue to maintain a strong financial position despite the continued ramp of new programs and delays in shipments due to component shortages we manage to lower our inventory by approximately $10.8 million or 10% from the previous quarter excluding the adjustment due to an arbitration settlement.

We expect to see our net inventory levels gradually come more in line with increasing revenue levels as component delays our addressed and new program ramps continues incoming period. Trade receivables at the end of the first quarter were down 3% from the previous quarter.

We expect our consolidated DSO's to remain around 40 to 45 days in coming quarters. By carefully managing payables during the year, we reduced our total debt by $5.7 million compared to the first quarter of 2018. We hope to accelerate our reduction of debt in coming quarters.

Over the longer term we expect to continue to pay down the term loans and revolving line of credit. We also recently renewed our term loan and revolving line of credit on favorable terms. Total capital expenditures in the first quarter of fiscal 2019 were approximately $1.7 million.

We continue to invest in our production facilities SMT equipment and sheet metal and plastic molding capabilities as well as improvements in our facilities in Arkansas and Minnesota. We plan to have approximately $10 million in capital expenditures in fiscal 2019 to keep up with recent new program wins and invest in future growth.

Moving into the second quarter of fiscal 2019, we expect more of our new customer programs to ramp and move into production taking these factors into consideration. We expect that the second quarter of fiscal 2019 will have revenue in the range of $120 million to $125 million.

For the second quarter of fiscal 2019 we also anticipate earnings in the range of $0.13 to $0.18 per diluted share. This assumes an effective tax rate of 20%. 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're well positioned to win new EMS programs and to continue to profitably expand our business over the longer term. That's it from me. Craig..

Okay, thanks Brett. For the first quarter of fiscal 2019 our new programs continue to ramp despite the continued industry wide supply chain shortages for key components and hampered our growth and increased our cost. We also continue to diversify our customer base, reduce our debt and reduce inventory levels and have return to growth.

During the first quarter we benefited from the continued ramp of SkyBell Technologies a global leader in patented Wi-Fi video doorbell technology that improves home and neighborhood safety. As we discussed last quarter, this important new relationship is projected to expand our customer base and contribute profitable long-term growth.

During the first quarter we also continue to win significant new business both from EMS competitors and existing customers including new programs involving industrial motion control products, power metering and fire protection systems.

Our broader and more diversified customer base significantly lowers the potential future impact and the slow down by any one customer. At the same time, our productivity continued to be adversely impacted by industry wide shortage and key components resulting in delays and delivery, inventory pressure and increased costs.

Moreover the tariff situation as it exist today and as it is anticipate to evolve, as complex ramification for KTCC. Certainly for our customers in our Shanghai site the tariffs are a huge problem for any product imported back into the USA.

But for those current customers a transition of their business out of our Shanghai site to our [indiscernible] USA site is facilitated by our centralized command and control.

This dramatically reduces the risk and time associated with the move back to our North America sites and thus allows these customers some leeway to respond to the rapidly changing tariff landscape.

Meanwhile for companies with business at our China-centric CM competitors KTCC's North American sites become extremely competitive for USA bound products subject to the new tariffs. This has resulted in a storm of inquires and request for quotes from perspective customers.

But there's certainly wait and see aspect to these customers interest in Key Tronic as many hope the tariffs will be revealed soon. On balance, we're increasingly well positioned for the returning tide of North American based customers as they correctly analyze the total cost for overseas production, pushing production into both Mexico and the US.

As we discussed on our recent calls, we see continue strong results from our domestic facilities. We believe that this reflects a growing appetite for US built products and the significant value of having [indiscernible] efficient domestic production facilities.

While we're carefully managing our expenses we're making investments in our facilities SMT sheet metal and plastic molding capabilities in both Mexico and the US. With respect to sheet metal centric programs, we see very strong growth and few real competitors in North America.

We're also deploying innovative new manufacturing equipment in each of our facilities which make our production less labor intensive and more efficient. These investments are expected to enable planned future growth with lower cost and more efficient production of existing business.

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 comparison to other EMS competitors of our sites. As OEM space in increasingly uncertain geopolitical landscape.

Key Tronic is uniquely equipped to offer risk mitigation with our vertical integration manufacturing facilities located in China, Mexico and the US. Moving further into fiscal year 2019, although we continue to face industry supply chain shortages. We expect growth in revenue and earnings.

In preparation throughout fiscal 2019, we plan to investment new equipment in processes to be more productive in our Mexico facilities and or expanding enhancing our highly profitable US facilities. We're optimistic about our opportunities for growth in fiscal 2019 and beyond. This concludes the formal portion of our presentation.

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

[Operator Instructions] we'll take our first question from Bill Dezellem with Tieton Capital Management..

As usual I have a group of questions. The first one is the same standard question size of your new wins this quarter please..

Five to 10 each..

And anything special to mention about any one of them that is either unique or may lead to something more meaningful in the future?.

I don't think so, these are pretty much our standard average wins..

Okay, great. Thank you. And then relative to SkyBell, talk a little bit around the issue of component shortages there and the degree to which they are settling down or improving or getting orders.

What are you seeing on that front please and how is that matching with demand that you're seeing for their product?.

The component shortages and long lead times have severely limited our production we've been probably half of the demand is where we've been producing for the last two or three months. We see a number of components in that family of products that have 40-week to 50-week lead times as we have been working our way through those products.

We've been able to increase output from the factory but we're still nowhere near what the market would like us to be shipping.

We see I guess hope it's not wishful thinking, but see the slight improvement in supply over the last couple three months certainly nothing where everybody can stand up and celebrate, but I think I am sure that it has ceased to continue to get worse every day..

Given the pace that you currently see or trajectory as you're on when would you anticipate that component availability would match demand and please don't say, 1,000 years..

Well, the problem is there's two variables here. One is the increase in demand from the market and the other is the improvement in supply from the supply chain. So I don't really have the ability to tell you when those two variables are going to cross.

I can't tell you that over the next three to four months, we see our output continuing to improve nicely. But our demand also continues to improve which is a great problem to have but nonetheless a problem..

Thank you, that's appreciated. So thank you. In all seriousness putting the joking aside.

Is the increase in your supply of SkyBell products on the market leading more prospective customers to be aware of the product and therefore that's pushing demand or is there something else that is driving that?.

I think it's safer to say, we haven't even reached that stage yet. Right now the increase in demand is from current customers who are gaining confidence and our ability to supply and our turning lose their sales team to do a little promoting and take some orders.

So I would say that we haven't begun to tap the new customer demand, new channels and all we're doing is filing up some of the demand from existing customers and convincing them that our performance is convincing them that it's safer to let their sales guys be a little bit more aggressive in selling this product..

Craig if I may interpret that, are you saying that up till recently that SkyBell's customers just didn't have confidence they were going to be able to get them product. Now the Key Tronic is manufacturing for them, they are - they now have that confidence and so that's what leading them to sell.

Actually go out and sell whereas as they really had that [indiscernible] basically turned off before..

That would sound like tuning our own horn a little bit, but basically yes I would say that's the case. And we're still a long way from having their current customers believe that they could go completely waltz on the wall and sell as much as they could get orders for.

But it certainly has improved their confidence in what they can do and what we're going to be able to do in the near future..

So when you had originally shared with the investment community this new relationship. Are you gaining confidence in the end product demand more so than you originally had? If I remembered right, you thought the potential was pretty great to begin with..

Yes so we continue to believe that the potential is great and as we produce product and it gets basically snapped up as soon as we can get it into the warehouse and El Paso we're gaining confidence that the continuation of the demand is there..

Great. Thank you. I've additional questions, but I'll step back in and re-queue up and let others ask..

[Operator Instructions] we'll take our next question from Sheldon Grodsky with Grodsky and Associates..

Nice to double-digit earnings per share. I'd like to see higher double-digit soon, I just wanted to check on one of the numbers that you actually mentioned in the presentation. I wasn't sure if I quoted right, well what are your capital expenditures expected to be for the current year..

$10 million..

$10 million? Okay that's sizable..

$10 million..

I heard, okay. Thank you..

Thank you. We'll take our next question from Hans [indiscernible] with [indiscernible]..

I had one on the arbitration and the settlement.

Did the company already receive the settlement payment and if not, when do you expect to receive this amount?.

We did receive the payment already..

And was it already up in the Q3 numbers or I mean on the balance sheet or is it after, was it received after Q3..

It was received prior to our first quarter ended in September so it's included in the balance sheet..

Yes all right. Thanks..

That is included in the results. Yes..

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

Can you provide a little bit more color on the utility and the labor cost increases? I sort of calculate in a very back of the envelope we're at 50 bps decline in gross margin is roughly $600,000 to $700,000.

Can you sort of - some color on that?.

Sure I can take that one Craig. Definitely the utilities themselves were approximately about $400,000 increase in cost quarter-over-quarter. In addition there was some additional labor cost we were bit inefficient the first part of the quarter predominantly in some of our US locations.

So you're half of percentage of estimated cost increases during the quarter is accurate based on those two events..

Okay, great. Brett next one is for you too. There's a new item on your balance sheet on tracked assets of roughly $16.8 million.

That looks like it's a reclassification, what is it?.

So what that is, new general accounting principles require that Key Tronic and other contract manufacturers recognize revenue overtime. So as we build product, we actually recognize the revenue upon completing that production and not upon shipment.

So what that is, it's a change in revenue recognition so that's $16.7 million is really inventory and work in process and its associated margin that have been recorded through the income statement..

Well that sounds complicated..

It is, I mean in reality it's a one-time adjustment it's kind of a lean forward of your revenue and the impact as we disclosed in the first quarter was roughly $4.9 million of additional revenue. We don't anticipate future material impact due to this revenue recognition standard, but included in Q1 is about $4.9 million of extra revenue..

Okay and did that, that I imagined did not have much of an impact on gross margin on a percentage gross margin.

Did it have an impact on OpEx?.

No. not materially no..

Okay and then quick other question. Your SG&A came down quite a bit and maybe that's because of a decline in legal cost. OpEx now roughly 5.5% of revenue and that now we're sort of modeling at 6%, what would be a good number to use or a dollar number I'm not sure how you think about it..

I think as a percentage I think 5% between 5.5% to 6% is a good estimate. As you mentioned we spent far less in legal cost now that the arbitration is behind us with an increase in revenue I would hope to keep that closer to the 5.5% than 6%, but yes that's a reasonable estimate within that range..

Okay great and then Craig, is there way you didn't have any constraints in the supply chain and shortages of what would be the additional revenue that you would be able to produce and recognize?.

A really crude number would be probably another $10 million to $15 million in the last quarter..

And that I imagine, this would come then with some improved gross margin because you wouldn't delays the scheduling issues and that kind of stuff right..

Yes there would actually the effect of a two-fold, one is as you just pointed out SGA& as a number rather than a percent even though it's easier to use a percent.

So every little bit we add the revenue helps and on top of that, we've got a bunch of people in Juarez who have to sit around at the beginning of the week while we wait for components to show up and then we have to build as quick as we can, so we can ship parts out and meet our customers' expectation.

So we're running inefficiently right now in order to try to fulfil market demand yet deal with parts that don't show up on time or at all..

Thank you we'll take our next question. [Operator Instructions] we'll take our next question from Hanz [indiscernible] with [indiscernible]..

Thanks guys for taking one more question. I was just looking at the working capital and the balance sheet a little bit and it looks like, if I'm looking correctly the payment that you received for the settlement didn't really go into reducing the debt.

Can you perhaps give some color on where that those funds went?.

Sure I can take that.

so the roughly $6.7 million that we received is part of the arbitration did in fact help us get back to paying payables early allowing us to again initiate early pay discounts and as well helped us increase in the amount of inventory that's available for some of these ramping new customers, would have liked to have seen in some additional decreases in debt, but hope to see those in the near future as we continue to work down the inventory..

Very good and the other line from current assets, saw that's increasing a little bit from the Q4 of last fiscal year is that anything specific it's now $17 million, I think..

I would need to look into that, but I believe what that is, is the foreign currency contracts many of them are in an asset position rather than a liability within the next 12 months..

Okay, yes. Thank you very much.

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

In the opening remarks, I believe that there was some reference to fiscal 2019 growth and your confidence that you would be growing this year.

Would you dive into that and provide some more commentary about how you were thinking about fiscal 2019 unfolding please?.

Okay, we've been winning business over the last coupled three years as we recovered from the decline of that one large customer who we also had to sue in arbitration to get paid from.

So we are at I think we are not at, we're little bit past the tip point where we've replaced them and now what's been going on under the top line should start to stack on top of the top line. So the cadence of the wins continues and in fact has speeded up and we're no longer trying to fill a hole now we're packing on top.

So that's where we think it's going to come from, companies like SkyBell and other that we've mentioned are going in production and that's basically where it's going to come from. We're not counting on [indiscernible] of an acquisition to key to growth that we foresee..

And so do you kind of have a conceptual or qualitative view about the March and June quarters and just how that trajectory looks. I mean you continue at a modest rate of growth, are you seeing some increasing in that trajectory.

What are you currently thinking there please?.

We're thinking that we're not going to put any kind of numbers to that. As per our..

[Indiscernible] something think about at night..

Me too..

So let me jump on one of your answers to prior question or $10 million to $15 million of additional revenues that you believe that you could be shipping if you had the components.

If we just simply assume the low end of that $10 million and an incremental gross margin of roughly 20% with 20% tax rate, that gives us an additional $0.15 a share and so is there anything flawed with my thinking that if you didn't have these component shortages, the business could be running at $0.30 a quarter of earnings or roughly about 20 annualized run rate..

The only flaw on that thinking would be, if that was a one-time or if it repeated every quarter. So it's hard to say if that would be a one-time bump and then the ones we filled all the shortages, if the fulfilled POs would then be filled in from behind with more demand, hard to figure that out.

But certainly there's a chunk of unfulfilled demand out there today that we can't ship..

Right. Okay that is helpful. And then lastly for now, in the opening remarks there was a reference to an evaluation of new Asian facility location.

Would you talk to that please?.

Yes, so about five or six years ago we took a look and decided that we had lot in our plates so we're going to hold off, but if the tariff situation continues as it is, our China facility is not going to be very attractive to people, when it's shipped into the states.

So we're going to have to come up with another spot for those folks who don't want to be in Mexico or don't want to be in the states but still want to ship into the states.

The nice thing about that is since we're centralized it's pretty easy for us to step and repeat in new facility as you may or may not remember we've had facilities in France, in Ireland, outside of Budapest and we don't see a really big challenge to picking one up and say India or Vietnam or Thailand or whoever that it is, that we decided that we want to go, so we're pretty far down the road.

We had done some Greenfield studies a while back and looking at costs and doing pro forma “for products out of facilities”. Since that time they mature, I mean the supply chain was in those target countries has matured and I think it's not going to be that hard to make move if we decided to do it.

We're kind of like the customers we talked about, is we've got a little bit of wait and see because we don't know what's going to happen with all the tariffs, even without the tariffs it's interesting to come up with another Asian site and so that's why we mentioned it..

Great. Thank you for the time..

[Operator Instructions] that concludes our questions for today. I'll turn it back to Craig Gates for closing remarks..

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

Thank you ladies and gentlemen, this concludes today's conference. You may now disconnect..