Good day and welcome to the Key Tronic Q4 Fiscal 2020 Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to 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 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.

Prior to getting into the details of the results of the most recent quarter, I would like to give Craig some time to address this past fiscal year and the series of unanticipated events that impacted Key Tronic in its fiscal year 2020..

Okay. Thanks, Brett. 2020 was a year of significant and unusual challenges and rewards for Key Tronic.

The dedication and courage of our employers – employees, the support of our customers both near and long term, and the strategic decisions we made both recently and years ago enabled our promising exit of fiscal 2020 and encourages us for the coming year. We began the year with a trade war between U.S.

and China, which was layered on top of a persistent worldwide supply pinch for electronic components. Due to the long hours and extreme effort of our materials groups on both sides of the ocean, we worked our way through most of the supply issues albeit with painfully high levels of component inventory and some missed revenue opportunities.

While the trade-war-related supply issues hurt us in the short term, they put the risk associated with an overly China-centric supply chain in clear focus for many of our current and prospective customers. As those customers began to assess their options, the benefits of our strategic focus on Juarez and U.S. production became clear to many of them.

New business wins were the result. Over the years preceding 2020, our concerns surrounding China-centric strategies had led us to evaluate many other regions and prepared plans for diversification. As a result of this earlier work, we were able to launch and commission a new facility in Vietnam, which was up and running in about 7 months.

This unprecedented ramp put us in an excellent position to address the needs of customers looking for an agile solution to China-centric sourcing. The ramp of our Da Nang facility continues with new business and new customers. Just as we gained some control over the trade war supply issues, COVID-19 hit, our employees were suddenly at risk.

Scientifically proven safety measures were up for debate. Our Juarez facility, along with many other Juarez facilities, was closed for essentially 2 weeks. And supply chain issues, which were bad already, were enormously magnified. Our gaming customer demand went to 0.

We implemented every safety measure we could in our facilities with overprotection as our goal. COVID-19 so far is a net positive to our business. Our focus on medical products over the past years resulted in a net gain in revenue as the virus drove demand, more than offsetting the decline in other COVID-affected businesses.

China-centric potential customers who were concerned but on the fence during the trade war were pushed off the fence by the virus and pushed in our direction. Our sites in Juarez, the U.S. and Vietnam served as a powerful risk mitigator for these customers, with several choosing to write new business in 2 or more of our locations.

We enter 2021 with a forecast for growth and increased profits, that is due to the courage, hard work and strategic foresight of our employees, the support and trust of our new and established customers, and the support of our shareholders. For that, I am profoundly grateful.

Brett?.

Thanks, Craig. Today, we released our results for the quarter ended June 27, 2020. For the fourth quarter of fiscal 2020, we reported total revenue of $116 million, up 10% from $105.6 million in the same period of fiscal year 2019.

During the fourth quarter, our revenue was constrained as a result of the temporary shutdown of our facilities in Juarez by the Mexican government due to COVID-19 pandemic and associated delays in restarting production. Our Mexico operations were completely shut down for roughly 2 weeks.

However, recruiting efforts to fill positions on temporary leave due to potential vulnerabilities, ramping production back up, improving physical distancing and other COVID-related disruptions continued throughout the quarter.

For the full year of fiscal 2020, total revenue was $449.5 million compared to $464 million in the same period of fiscal 2019.

Throughout much of the year, our revenue was adversely impacted by disruptions to supply chains in China caused by trade tensions and then by the COVID-19 crisis, which delayed the arrival of key components and caused production delays.

We’ve seen most of our China suppliers come fully back online for production in the fourth quarter but continue to see some backlog and long lead times in certain custom microchips as demand has outpaced capacities.

For the fourth quarter of fiscal year 2020, net income was $1.5 million or roughly $0.14 per share compared to $800,000 or $0.08 per share for the same period of fiscal year 2019.

Earnings for the fourth quarter of fiscal year 2020 included a tax benefit from releasing a portion of the company’s allowance on research and development credits taken in previous years of $1.3 million or $0.12 per share.

For the full year of fiscal 2020, net income was $4.8 million or $0.44 per share compared to a net loss of $8 million or a loss of $0.74 per share for the fiscal year 2019.

Excluding the goodwill and intangibles write-down that occurred in fiscal 2019, the company would have reported net income of $4.5 million or $0.42 per share for the fiscal year 2019.

During the fourth quarter of fiscal 2020, we incurred a variety of additional costs caused by the COVID-19 crisis, totaling approximately $2.2 million or $0.16 per share.

These expenses are related to the temporary shutdown and restart of the Juarez facility as well as preventative measures and equipment for employees across all of our facilities in the U.S., Mexico, China and Vietnam.

These included providing personal protective equipment to all of our employees, restructuring the production lines to provide for social distancing and other measures.

We currently expect to incur about $1 million or $0.07 per share of similar expenses during the first quarter of fiscal year 2021, but of course, this is an estimate based on today’s information and the assumption that the virus doesn’t force future closures and that current labor constraints do not worsen.

Further, the pandemic’s adverse impact on revenue and expenses dampened our margins. For the fourth quarter of fiscal 2020, gross margin was 7.4% and operating margin was 0.9% compared to gross margin of 7.9% and an operating margin of 1.3% in the same period of fiscal 2019.

Without the impact of the disruptions from the pandemic, our gross margins would have been closer to 9%. Turning to the balance sheet, we continue to maintain a strong financial position.

As a result of production delays in the fourth quarter and the continued ramp in transfers of new programs, our inventory remained roughly flat with the prior quarter. In future quarters, we expect to see our net inventory turns increase to be more in line with expected revenue.

Although we have a healthy balance sheet as well as flexibility in available bank debt, we feel it is prudent to preserve cash where possible should the pandemic again disrupt operations for an extended period. In this light, we are expecting to increase our total credit facility to give us more flexibility to ramp up production in the coming months.

At the end of the fourth quarter, trade receivables were up $6.1 million from the prior quarter, reflecting the increased revenue levels and the timing of shipments late in the quarter. Our DSOs remained at about 60 days. Total capital expenditures in the fourth quarter of fiscal 2020 were approximately $2.7 million and $8.3 million for the year.

While this is less than we had originally planned to spend during fiscal 2020, we will continue to invest in our production facilities, SMT equipment and sheet metal and plastic molding capabilities as well as improvements in our facilities as we move into fiscal 2021 and prepare for growth.

For the first quarter of fiscal 2021, we currently expect to report revenue of between $118 million to $125 million and earnings of approximately $0.18 to $0.25 per diluted share. With that said, a lot of uncertainty remains in those estimates.

We’re working closely with our customers, key suppliers and employees to minimize effects of delays attributable to the continued global pandemic.

While the company’s facilities in the U.S., Mexico, China and Vietnam are currently operating and rigorously following current health guidelines, uncertainty as to the possibility of future temporary closures, customer demands and costs and future supply chain disruptions during the rapidly changing COVID-19 environment could significantly impact operations in coming periods.

Due to the heightened risks associated with the pandemic, we may issue updated guidance during the upcoming quarter. In summary, while the COVID-19 crisis continues to cause disruptions in the fourth quarter and remains a risk in future periods, we are encouraged by our prospects for future growth.

The overall financial health of the company is strong, and we believe that we are increasingly well positioned to win new EMS programs and to continue to profitably expand our business over the longer term. That’s it for me.

Craig?.

Okay. Thanks, Brett. 2020 was a year of both powerful global headwinds and tailwinds. Through much of the year, we confronted component shortages and trade disputes related to suppliers in China.

For the close of the year, we faced COVID crisis directly, which temporarily halted production in Mexico as well as disrupted production and added costs across all of our facilities. These are unprecedented and challenging times, and this pandemic affects all of us.

I’ve been humbled by the stalwart dedication of Key Tronic employees as they work to manage through this crisis. Our primary focus continues to be to ensure as best we can that our employees and their families stay safe.

Within the constraints of our efforts to keep everybody in the Key Tronic family healthy, we’re doing our best to maintain production in all of our facilities. We have been taking and we’ll continue to take precautionary measures to limit the risks.

Our most vulnerable staff and many of our non-manufacturing employees now work from home, and travel is very tightly restricted. We’ve implemented all recommended safety measures in our manufacturing facilities.

This includes full-time wearing of face masks and face shields, workstation arrangements to provide for social distancing, temperature monitoring, enhanced work site disinfection, spacing in cafeterias and break areas, contact management and more.

Some of our suppliers have experienced temporary closures resulting from government lockdown and shelter-in-place orders. So far, we’ve either been able to work around these temporary disruptions or closures have been resolved.

We’re also managing transportation complexities and disruptions to our supply chain via alternate sourcing, airfreight, product redesigns and alternate component qualifications. We’re closely monitoring inventories and we’ll use safety stock as much as possible to ensure minimum interruption.

At this point in time, we have been able to find solutions for most of these challenges. In spite of the many challenges we faced, fiscal 2020 generated strong and encouraging tailwinds for our business. Uncertainty over tariffs and trade tension between U.S.

and China, combined with disruptions caused by the pandemic, have further intensified a growing consensus among many of our customers and potential customers.

They see more clearly that the total cost and risks of over-reliance on manufacturing in China are actually higher than for a balanced, more shared mix of supply out of China and localized supply chains. Shortened supply chains, supported by localized vertical integration, are becoming more widely understood and highly desirable.

Moreover, our customers and potential customers increasingly want their IP maintained in the U.S., where there is more enforceable ownership and maintenance of their IP. As we’ve discussed before, Key Tronic is ideally situated to benefit from these global trends of moving away from over-reliance on China manufacturing.

A growing number of existing and new customers are transitioning from China facilities to our expanding facilities in Mexico, Vietnam and the U.S. Facilitated by our centralized command and control we can drastically reduce the risk and time associated with such a transfer.

At the very least, diversifying the geographies of our customers’ manufacturing sources allows some leeway to respond to the rapidly changing political and health landscape.

The year was a whipsaw experience between the upside of these favorable geopolitical trends and the downside of COVID-19 impact on our component supply chains and its effects on our operations and workforce. By the end of the year, the upside had overcome the downside.

Demand from many of our customers remained strong in the fourth quarter, and some customers significantly increased their demand, particularly programs for health care and home-oriented consumer products and exercise equipment.

While our marketplace remains very competitive, we continue to win significant new business both from EMS competitors and existing customers.

During the year, we won new programs involving consumer products, electric vehicle charging infrastructure, LED lighting, flight controls for aircraft, personal safety, WiFi-enabled signage, temperature control devices, home exercise, sanitizer dispensing, automotive controllers, oil and gas drilling, wireless security, and consumer health care equipment.

A large program that we announced in the third quarter, which when fully ramped, is anticipated to contribute $100 million in annual revenue. That’s underway in the fourth quarter and is expected to contribute to revenue in fiscal 2021.

Last but certainly not least, we now manufacture face masks by the millions in our Corinth, Mississippi facility and high-end respirators in our Oakdale, Minnesota facility. Our broader and more diversified customer base lowers the potential future impact of a slowdown of any one customer.

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 size.

As OEMs face a pandemic layered on top of an increasingly uncertain geopolitical landscape, we are uniquely equipped to offer risk mitigation with our vertical integration and manufacturing facilities located in Mexico, Vietnam, China and the U.S. While we are carefully managing our expenses, we’ve been preparing for growth in coming periods.

During fiscal 2020, we continued to invest in our facilities, including the expansion of SMT, sheet metal and plastic molding capabilities in Mexico and the U.S. With respect to integrated electronics and sheet-metal-centric programs, we see very strong growth and very few real competitors of our size in North America.

We also deployed innovative new manufacturing equipment in each of our facilities, which has improved efficiencies and has made our production less labor-intensive. The result of this effort has been decreasing manufacturing and operating expenses while making us increasingly well positioned for the returning tide in North American-based customers.

Additionally, we are continuing to ramp production in our new, 86,000-square-foot manufacturing facility in Vietnam to augment our Asian footprint and reduce production costs as well as providing additional hedge against uncertainty with respect to COVID-19-related disruptions to China production as well as the lingering or future trade wars with China.

As we enter fiscal 2021, considerable uncertainty remains around the continuing impact of COVID-19 and potential future disruptions to our workforce and operations. There is also the related risk of a deeper economic downturn. Nevertheless, we entered the fiscal year with a positive momentum.

We continue to invest in new capacity and remain optimistic about our long-term opportunities for growth. In closing, I want to thank all of our great employees for their hard work and dedication during these challenging times and for adhering to our strict guidelines for precautions during the pandemic.

Let me assure you that we will continue to make protecting the health of our employees our highest priority. I also want to wish you and your families’ good health and safe passage during the pandemic. This concludes the formal portion of the presentation. Brett and I will now be pleased to answer your questions.

Operator, can you open the line for questions?.

Thank you [Operator Instructions] Our first question will come from Bill Dezellem with Tieton..

Thank you.

I would like to start with a normal question of, each of the 5 new programs that you won, what’s the size of those?.

Let’s call all between 5 and 20..

Okay, thank you very much. And then you called out in the press release, the $2.2 million or $0.16 of COVID costs. And then on the – your prepared remarks, I think it was a reference to $0.07 cost anticipated in the first quarter.

How much of that $0.16 is a recurring cost? And same with the $0.07, how much is recurring versus onetime in nature?.

Well, I think the $0.07, if things keep going the way they are going, is probably recurring. The rest of it is one-time..

And the $0.16, would that imply that $0.07 of those $0.16 would be under the recurring cost?.

Correct..

Great. And then if I go back to the transcript from last quarter, the $100 million new customer that you mentioned last quarter, you said that, that was in the home exercise equipment arena. I mean once again, congratulations that that’s ramping.

But is that customer in what I would think of as a legacy exercise equipment or in a new area, like start-up or something of that nature?.

Let’s call it something other than legacy..

So as I think about the newer companies, I can only think of two that would be large enough to be $100 million of business. That’s Mirror and Peloton.

Are you working with one of those or, I guess, both of them for that matter or is it somebody different that I am just not even thinking of?.

No comment..

Okay. Let me switch a bit then. So of the $100 million run rate, annual run rate, that would be $25 million in a quarter when you are fully ramped. But you did say you began in the June quarter.

How much revenue did you have from that customer? Or how far along in that ramp process are you?.

In Q4, we only – did not a whole lot, maybe $1 million, maybe $2 million..

Yes..

And how....

We just started last month in Q4..

Okay.

And so how quickly are you anticipating that to move up to its full $25 million per quarter run rate?.

We are hoping to be there in Q1 – for our fiscal Q1, which is the January, February, March quarter. That’s it, fiscal, not calendar, sorry..

Yes, calendar Q1, Bill..

Calendar Q1..

So not until our third quarter..

Right.

So the next two quarters, we will see – is it somewhat of a linear ramp if you are successful or are there certain step function increases that you are anticipating?.

This ramp right now is controlled by component availability. So whether it’s step functions or sawtooth, I don’t know, but it’s jerky. The – we are ahead of the availability of components right now, and I expect us to stay that way..

And when you say you are ahead of availability, does that mean that demand is exceeding component supply? Or are you trying to communicate something else?.

Demand is exceeding component supply, and the factory is building fast enough that we have chewed through all the components we get our hands on..

Understood. So if you can find more components, you will build more basically..

Yes..

And presumably, you have a line of sight on future component availability that leads to that $25 million quarterly run rate out a couple of quarters?.

We have a line of sight, but our VP of Materials’ office is 2 over from mine. And every day I walk by, he is in there eating TUMS and looking pale. So I don’t know what’s going to happen..

Excellent. Well, as long as he keeps working. Okay, thank you, both of you. I will sit back in line..

Thank you..

We will take our next question from Orin Hirschman with AIG Investment Partners..

Hi, how are you?.

Good..

In terms of actually seeing the macro trend of real programs shifting away from China and like countries, when do you really think that begins to make an impact in a meaningful way on the numbers?.

Well, it has already started because some of those programs, which have already begun to ramp, are offsetting the decreases that we have seen from the gaming industry and a couple of other industries that are being really hammered by COVID.

So the kind of the top line impact has already been very positive from that, and we continue to see that improving. So it’s already begun..

And in terms of medical as a percent of total sales this quarter – I am not sure if you mentioned the actual number, what was it up to?.

So that was probably....

It’s probably around 15%..

Yes a little bit better than that, yes..

15%, 16%, 17%..

Yes..

That’s on the medical side?.

Yes..

Yes..

And finally, obviously, it’s a big swing if you are able to hit your target range for next Q.

Besides component availability, what would you say is the biggest issue? Or is that just the overwhelming issue here in terms of next – this quarter?.

So the issue is the availability of labor in Mexico is probably as or more impactful than component supply. But I hesitate to give you a percentage because, like I said, at any moment, as you see, the market – suddenly that you can no longer get one part, and that kills a big chunk of revenue.

So, both of those things are at the forefront of our mind right now as risk..

Is there upside, if any, if components for Mexico loosens cost?.

Yes. There is quite a bit. We are offering a pretty wide range this quarter, and we are telling you that we may have to come out with an update as we get through the quarter because it’s a big range..

Okay, great. Okay, thank you very much..

Yes. Thanks, Orin..

We will take our next question from Sheldon Grodsky with Grodsky Associates..

Okay. Let me first start off with respirators and masks. That’s, shall we say, a hot area right now.

Where are these being made and where are these being sold?.

They are being made – the masks are being made in Corinth. And the respirators, it’s actually the electronic part of our respirators being made in our Minnesota factory..

Where did you say the masks will be made?.

The masks are being made in Corinth, Mississippi..

Okay.

And the respirators in, you said, Minnesota?.

Yes..

Okay.

Are these significant lines of business at the moment?.

No. I wouldn’t say – we have to announce them if we are going to follow the rules of significant, but we think every piece is significant. So I don’t know..

Have you had any coronavirus patients among your employees?.

Yes. We have got over 5,500 employees. So it would be a miracle if we had not. If you walk into our factories in Juarez, you would be confused and think you walked into a medical operating arena. I am not joking. It’s amazing what we have done to keep our people safe. We are running far below the city of Juarez as average in terms of new cases.

I think it’s been 4 weeks since we have had a new case. We have had a smattering of cases in the U.S. sites, none in China, none in Vietnam. So we think we are – we actually think our people are safer at work than they are at home. Certainly, they are safer at work than they are in a bar or in a 4th of July party..

What about a Labor Day party? I am kidding. Go ahead..

Don’t go..

I will say, I am done for now. Thank you..

Thank you..

We will take our next question from Mike Hughes with SGF Capital..

Good afternoon. A couple of questions for you.

First, do you have an operating cash flow number for the fourth quarter?.

You have to give me just a second here. I am sorry, Mike. I have got it for the year. I don’t have it for the quarter..

Okay.

What’s the number for the year?.

We used $30 million in operating activities..

Okay. So just looking at the AR, and I think you look at AR and contract assets, if you combine those in the June quarter at about $110 million and you did the same level of revenue in the December quarter and they were $87 million, so there’s – the business is really consuming a lot of cash.

So just thinking about it on a go-forward basis, what does the operating cash flow look like and is there more intense focus on the AR and the inventory?.

Sure. Let me take that into two sections. One, contract assets, I would really consider more to be a finished good that’s unbilled revenue. That’s the stage that it’s in. But regardless, the company is utilizing quite a bit of capital. One nuance from the comparison that you make is that we are no longer factoring a portion of our receivables.

So that also is one of the reasons why there’s such a large increase in that. We are expecting our accounts receivables to continue around 60 days, DSO of about 60 days. As mentioned in the narrative, we are hoping to close on an increased credit facility very soon, which will allow us some additional liquidity to support the expected growth..

And is the current credit facility backed by AR and inventory? Is that how it works?.

It’s a cash flow deal..

Okay.

And it’s $65 million right now?.

It is, plus the $10 million term debt..

Okay, okay.

And then was there any bad debt expense in the fourth quarter that was unusual above trend?.

No, there was not..

Okay.

And then the facility in Vietnam, can you just talk about the level of revenue there and kind of how that ramps for the – over the next few quarters?.

We are expecting revenue from Vietnam to be roughly about $5 million in this quarter, in our first quarter. We are expecting that to grow slowly during the fiscal year..

And how is the labor situation of Vietnam at this point?.

Good..

Very good..

Okay, that’s all I had. Thank you very much..

Thank you..

You bet..

We will take our next question from Bill Dezellem with Tieton..

Thank you. I do have a few follow-up questions. First of all, when you gave your original guidance for the June quarter before COVID started to ravage things, you were thinking you could do a pretty big revenue number.

How much, when you look back with hindsight, was revenue constrained in the June quarter?.

I would say anywhere between $5 million and $12 million..

And in response to another question, you said that revenue in the Q1, the September quarter here that you expected it will be constrained again.

How much are you thinking if you didn’t have the COVID issues that you could be producing out of this quarter?.

I don’t really know how to answer that..

Can you talk about the – go ahead Craig. Go ahead..

There’s just – there’s too many factors to call it COVID versus trade war versus – I don’t know. It’s – there’s – I don’t know how to answer it..

But you actually just started to go down the path that I was thinking maybe we could explore, which is, what are the factors that are the impacts? And could you quantify each of them? And then we can decide if they are COVID or something different..

Well, you’ve got the lack of employees in Juarez. You have the turnover of the employees in Juarez. You have the inability to get one or two components that may impact some big chunk of revenue. You have customers who are – we have one – well, actually, there’s more than one.

We’ve had a number of customers who, at the beginning of the COVID crisis, shut us down entirely and thought that they would get no orders.

And then as, I guess, the socioeconomic trends began to make themselves clear, these same customers not only turned us back on again, they went into full panic mode because people were doing things that they had never done before and they needed to buy product to enable those things.

So we’ve got a number of customers who are right now – 2 months ago had a shutdown and are right now trying to double their forecast to us. So our ability to expedite parts in the midst of all this is unknown and changes every day. It’s almost impossible to find an airfreight route from Asia to here.

Many of the suppliers in China are raising their prices or demanding cash, half upfront or whatever or the kind of madness you can think of. But that right there is enough for me to just get confused and say, I don’t know if there is upside, but I don’t know how to kind of give you a number..

That’s fair. I am equally confused. So that’s good enough. Let’s talk about a couple of things. First of all, you had the announcement here a while ago that you were the Manufacturing Technology Insight – one of the top 10 that Insight Magazine – so you’re one of the top 10 CMS suppliers.

What are the implications of that? And to what degree do headlines or awards like that influence existing and/or prospective customers to either work with you or call you and put you on a list?.

I think the most that does is get somebody notice who’s in the market – suddenly in the market for a new contract manufacturer. I think it’s just one more way for us to get in front of a VP of purchasing from one of our prospective customers..

Is it when you are talking with a prospective customer and they – kind of their first introduction to you? Does it add any credibility to the beginning of the relationship or do they pretty much go through their checklist irrespective once they found out who you are, none of the rest of it matters?.

I would say the latter, not the former..

Okay. That’s fair. And then lastly, you have – 1 of your 5 new customer wins this quarter was in wireless security.

And given that you have previously announced that you are working with SkyBell, what can you tell us about this wireless security customer? And is there any spillover benefit from the SkyBell – kind of link or don’t link those together for us, if you would, please..

That one is a perfect example of a customer with a China-centric supply chain who was already experiencing some difficulties before the trade war came along. Once the trade war got going, they got really concerned about being completely China-centric and, as they got to know us, decided to completely move to Key Tronic.

So that’s – and that was – I don’t know when all this started. But anyway, that’s been ramping for a quarter. And there may be a link at some point with them, including a SkyBell product in their offering.

Right now, the only advantage that we received with this new customer from being a supplier to SkyBell was the fact that we are in that market and understand its vagaries. And that actually carries a lot of weight with customers.

If you’re in their market, it gives them a pretty high degree of confidence you understand what they are going to go through..

Alright. I am going to have a little fun here with you then. Given that, I think just this week that ADT announced that Google was investing $450 million or something into their business.

So is there something happening here in this market that we should all be thinking about that’s really, really relevant to you all? And where does ADT and/or Google fit into the Key Tronic ecosystem?.

Well, let’s see. I think the first part of that question is part of the overall, I guess, unanticipated, unexpected changes being driven by both COVID and the maturing of the IoT, Internet of Things, space. 15, 20 years ago, everybody was talking about the smart home, blah, blah, blah. Nothing really happened.

And now it’s becoming more and more possible to have a smart home without running a bunch of wires. So in general, I see, as apparently Google does – they’re a lot smarter than we are. So maybe they see something else.

But I see that the smart home, Internet of Things, the marriage of what you can do once you are in the home is becoming a lot clearer to a lot more people.

So the folks that are on the – that are already penetrating into the home, like ADC or dot-com, other people, they’re a lot more interesting than they used to be because there’s a lot of money being spent on virtually wiring up of homes. So I think that’s the overall trend.

I think it’s being accelerated by the fact that people are stuck in their homes quite a bit more than they used to be. So they want them to be cooler and work better, whereas before it was – you can live with the inconvenience. Now you’re there 24/7 and something that was just stupid before, now it really bugs you.

So you’re willing to spend some money to fix it but....

And….

Go ahead..

No. Please, after you..

So that’s the first part of the question. And the second part was how does ADT and Google fit into our Key Tronic space a little bit right now. I don’t know much in the future..

And so because you have these customers that you are already now working with and you said that you have a lot of credibility when you’re already in a space, does this imply that this is potentially a future – I guess someone else used this term on the call, but a future hot area for you or a soon-to-be hot area for you? Or do you not see this becoming a much larger piece of your overall revenues?.

I don’t know. We’ll see. For sure, every time we get a little bit better at something, we get a little bit more penetration into the market. Business follows business. So we’ll see. Certainly, the people in that industry know who we are now..

Well congratulations and thank you for taking all the questions..

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

Hi, guys. Good afternoon. A question on the gross margin, I think that Brett, if I understand right, you said that without the disruption related to COVID-19, your gross margin was close to 9%.

So that means that the $2.2 million is it maybe $1.8 million or close to that is – was related to the cost of goods sold, is that how you think about it?.

Yes. George, the bulk of that is cost of goods. When I mentioned 9%, it was just a round number..

A round number, okay.

Is there a way you can tell us exactly how much of the $2.2 million you would attribute to cost of goods?.

$2 million of the $2.2 million..

$2 million. Okay, great. So that puts you in a gross margin – at a gross margin level that you haven’t been in quite a while.

And can you sort of – Craig, can you maybe help us understand how gross margin has gone back to 9%? And can it stay at that level? Is that a new level? Is that related to the investment you did over the last few years?.

Yes..

Craig, that’s a long question with a short answer. I like it better the other way around..

Yes. I know. So – but that is the answer. We spent 2 or 3 years, as we say just about every quarter, investing in automation. We have continued to drive the integration of the east into the west. The site in Vietnam is coming online nicely. We are becoming more efficient in Juarez. We were helped by the exchange rate. We were hurt by the death of gaming.

So it’s all these things mixed together, but in the end, it’s the result of a long pole of working to make this better.

I can’t tell you what’s going to happen going forward, but it sure seems to me like all the bets we placed in the last 10 years on not China-centric, on vertical integration, on engineering services, on streamlining our facilities, on capital equipment in our facilities, on building out our sales channels.

All these things are working a lot better, as they should over time, when you apply consistent pressure and effort to them. And you get lucky or you have foresight and people wake up and realize that they shouldn’t have every one of their eggs in one basket..

Right, okay. Let me try to ask about new programs.

So if you look at recently won new programs, let’s say, in the last 12 months, what is your expectation of gross margin contribution from these programs? What may – is the gross margin sort of – did it improve on – because of your automation on all programs or is that really applied primarily to sort of new programs?.

The gross margin on most of those new programs is around 8% to 9%. So we are able to win programs now at a slightly better gross margin than we were in the past. This is – if you look back over the year – I haven’t actually gone back and checked. I should.

But I’m almost positive this is, by far, the biggest number of programs we’ve won and for sure, this is the most revenue, when you add it all together, that we won in any year since I’ve been here..

Okay. And now maybe just one last question. If you look at the program – imagine you won a program today and you expect it to have an 8% or 9% gross margin.

In 5 years, do you expect that gross margin to remain the same, to decline, to improve? And what impacts that?.

Well, that’s a pretty big question. So you can shut me off when you get tired of the answer. But what typically happens in contract manufacturing is you are forced to drive a pretty hard deal in order to win the business.

And you hope that over time, you can drive your efficiencies and you can put pressure on the suppliers over time or the components and get your margin back up to the target that you would like it to be. So that side of the equation says that if you’re taking in at 7%, you’re hoping you can drive it up to 9%.

At the same time, a lot of it depends upon the age of the product that you take on.

So if you win some product that’s mature, that has a lot of through-hole components on it, a lot of the components are going obsolete and the customer doesn’t want to spend money to redesign it, then you’ve got the opposite pressure going on because you’re trying to buy parts in a seller’s market and you can’t really put a lot of pressure on the component suppliers in order to drive the parts down.

So the answer to your question depends on how hard we had to compete in the first place to win it. It depends on the age and maturity of the product that we won, depends on the psychological or cultural makeup of the customer. Some customers believe that a partnership is the best way to overall make the most amount of money.

And so we may make a little bit more margin but overall save them more money. Other customers take the old-school purchasing approach and think that they should go into an e-bid process and bid the thing out every 6 months. So all those things coming together make it impossible for me to give you a simple answer to your simple question..

I think that’s been a recurring pattern over many years when you explain the details of your answer..

If it was easier – if it was easy....

Yes, if it was easier..

Go ahead, yes..

If you win programs at 8% to 9%, and it seems like quite a few of those programs are not mature programs or not sort of aged program, let’s say, the hope is that this 8% to 9% moves up a little bit over the next couple of years or 3 years?.

Yes. Of course, that’s the hope. That’s always the hope..

Okay. But hope is based on possibility. So there is the possibility of that. It’s a realistic hope..

It is a realistic hope. I will grant you that..

Great. Good. I’m glad to end on a good hope. Well done, guys..

Yes. See you, George..

[Operator Instructions] We’ll take our next question from Sheldon Grodsky with Grodsky Associates..

My question was covered by one of the other questions..

Great..

Thanks, Sheldon..

At this time, we have no further questions. I will hand it back to our speakers for any additional comments..

Okay. Thank you again for participating in today’s conference call. I hope all of you and your families stay healthy and safe. Brett and I look forward to speaking with you again. Thanks, and have a good day..

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may now disconnect..