Key Tronic Corporation (NASDAQ:KTCC) Q4 2022 Earnings Conference Call August 9, 2022 5:00 PM ET Company Participants Brett Larsen - Chief Financial Officer Craig Gates - President and CEO Conference Call Participants Bill Dezellem - Tieton Capital Sheldon Grodsky - Grodsky Associates George Melas - MKH Management Operator Good day. And welcome to the Fourth Quarter and Year End Fiscal 2022 Key Tronic Corporation Conference Call. Today’s conference is being recorded. At this time, I would like to turn the co ...

PART I. FINANCIAL INFORMATION This section encompasses the unaudited condensed consolidated financial statements and management's discussion and analysis of Key Tronic Corporation's financial performance and condition [Item 1. Financial Statements (Unaudited)](index=3&type=section&id=Item%201.%20Financial%20Statements%20%28Unaudited%29) This section presents the unaudited condensed consolidated financial statements of Key Tronic Corporation and its subsidiaries, including balance sheets, statements of income, comprehensive income, cash flows, and shareholders' equity, along with detailed notes explaining the basis of presentation, significant accounting policies, and specific financial line items [Condensed Consolidated Balance Sheets](index=3&type=section&id=Condensed%20Consolidated%20Balance%20Sheets) This section presents the company's financial position, detailing assets, liabilities, and shareholders' equity at specific reporting dates Consolidated Balance Sheet Highlights (in thousands) | Metric | April 2, 2022 | July 3, 2021 | | :-------------------------------- | :------------ | :----------- | | Total current assets | $344,083 | $299,252 | | Total assets | $411,426 | $361,846 | | Total current liabilities | $164,338 | $126,705 | | Total liabilities | $287,400 | $238,141 | | Total shareholders' equity | $124,026 | $123,705 | [Condensed Consolidated Statements of Income](index=4&type=section&id=Condensed%20Consolidated%20Statements%20of%20Income) This section outlines the company's financial performance over specific periods, reporting net sales, gross profit, operating income, and net income Consolidated Statements of Income Highlights (in thousands, except per share) | Metric | Three Months Ended April 2, 2022 | Three Months Ended April 3, 2021 | Nine Months Ended April 2, 2022 | Nine Months Ended April 3, 2021 | | :----------------- | :------------------------------- | :------------------------------- | :------------------------------ | :------------------------------ | | Net sales | $138,391 | $134,600 | $405,609 | $386,069 | | Gross profit | $11,508 | $11,096 | $31,454 | $31,733 | | Operating income | $2,789 | $2,576 | $6,534 | $8,092 | | Net income | $1,007 | $867 | $2,409 | $4,166 | | Net income per share — Basic | $0.09 | $0.08 | $0.22 | $0.39 | | Net income per share — Diluted | $0.09 | $0.08 | $0.22 | $0.38 | [Condensed Consolidated Statements of Comprehensive Income](index=5&type=section&id=Condensed%20Consolidated%20Statements%20of%20Comprehensive%20Income) This section presents the company's total comprehensive income, including net income and other comprehensive income items like unrealized gains or losses on hedging instruments Consolidated Statements of Comprehensive Income Highlights (in thousands) | Metric | Three Months Ended April 2, 2022 | Three Months Ended April 3, 2021 | Nine Months Ended April 2, 2022 | Nine Months Ended April 3, 2021 | | :--------------------------------------- | :------------------------------- | :------------------------------- | :------------------------------ | :------------------------------ | | Net income | $1,007 | $867 | $2,409 | $4,166 | | Unrealized gain (loss) on hedging instruments, net of tax | $309 | $(632) | $(2,306) | $3,562 | | Comprehensive income | $1,316 | $235 | $103 | $7,728 | [Condensed Consolidated Statements of Cash Flows](index=6&type=section&id=Condensed%20Consolidated%20Statements%20of%20Cash%20Flows) This section details the company's cash inflows and outflows from operating, investing, and financing activities over specific periods Consolidated Statements of Cash Flow Highlights (in thousands) | Activity | Nine Months Ended April 2, 2022 | Nine Months Ended April 3, 2021 | | :------------------------ | :------------------------------ | :------------------------------ | | Cash used in operating activities | $(11,636) | $(17,684) | | Cash used in investing activities | $(4,074) | $(9,655) | | Cash provided by financing activities | $13,959 | $28,067 | | Net (decrease) increase in cash and cash equivalents | $(1,751) | $728 | | Cash and cash equivalents, end of period | $1,722 | $1,281 | [Condensed Consolidated Statements of Shareholders' Equity](index=7&type=section&id=Condensed%20Consolidated%20Statements%20of%20Shareholders%27%20Equity) This section provides a detailed breakdown of changes in the company's shareholders' equity, including common stock, retained earnings, and accumulated other comprehensive income Consolidated Statements of Shareholders' Equity Highlights (in thousands) | Metric | April 2, 2022 (Ending Balance) | April 3, 2021 (Ending Balance) | | :----------------------------------- | :----------------------------- | :----------------------------- | | Total shareholders' equity | $124,026 | $123,460 | | Common stock | $47,399 | $47,121 | | Retained Earnings | $76,861 | $74,277 | | Accumulated other comprehensive income | $(234) | $2,062 | [Notes to Condensed Consolidated Financial Statements](index=8&type=section&id=Notes%20to%20Condensed%20Consolidated%20Financial%20Statements) This section provides detailed explanations and disclosures supporting the condensed consolidated financial statements, covering accounting policies, estimates, and specific financial line items [Note 1. Basis of Presentation](index=8&type=section&id=1.%20Basis%20of%20Presentation) This note describes the basis for preparing the unaudited financial statements, including compliance with SEC rules, management estimates, and the impact of the COVID-19 pandemic - The financial statements are unaudited and prepared in accordance with SEC rules, condensing certain annual disclosures, with management's estimates and assumptions being crucial, and interim results potentially not predicting full-year outcomes[21](index=21&type=chunk) - The Company's fiscal year ends on the Saturday closest to June 30, with the three-month period ended April 2, 2022, being **13 weeks**, compared to **14 weeks** in the prior year's comparable period[22](index=22&type=chunk) - The COVID-19 pandemic has caused significant shifts in demand, supply chain, and logistics risks, potentially impacting future operating results due to closures, costs, labor shortages, and currency fluctuations[23](index=23&type=chunk) [Note 2. Significant Accounting Policies](index=8&type=section&id=2.%20Significant%20Accounting%20Policies) This note outlines the key accounting policies applied in the financial statements, including reclassifications, foreign currency hedging, and the assessment of new accounting standards - Certain prior period reclassifications were made for presentation consistency, with **no impact** on reported income, comprehensive income, cash flows, total assets, or shareholders' equity[24](index=24&type=chunk) - The Company uses foreign currency forward contracts as cash flow hedges to manage variability in Mexican peso-denominated expenses, with gains/losses reported in AOCI and reclassified to earnings[26](index=26&type=chunk)[27](index=27&type=chunk) - The Company is assessing the impact of recently issued accounting standards, including ASU 2021-01 (Reference Rate Reform), ASU 2020-03 (Codification Improvements to Financial Instruments), and ASU 2016-13 (Credit Losses), with plans to adopt them as they become effective[32](index=32&type=chunk)[33](index=33&type=chunk)[34](index=34&type=chunk) [Note 3. Inventories](index=10&type=section&id=3.%20Inventories) This note details the composition and value of the company's inventory, primarily consisting of raw materials Total Inventory (in millions) | Date | Amount | | :------------ | :----------- | | April 2, 2022 | $155.1 | | July 3, 2021 | $137.3 | - Substantially all inventory balances consist of raw materials[35](index=35&type=chunk) [Note 4. Long-Term Debt](index=10&type=section&id=4.%20Long-Term%20Debt) This note provides information on the company's long-term debt, including credit facility amendments, outstanding balances, interest rates, and covenant compliance - The Company amended its loan agreement with Bank of America on September 3, 2021, increasing the credit facility from **$93 million to $120 million**, maturing September 3, 2026[36](index=36&type=chunk) Revolving Credit Facility Outstanding Balance (in millions) | Date | Outstanding Balance | | :------------ | :------------------ | | April 2, 2022 | $99.7 | | July 3, 2021 | $90.9 | - As of April 2, 2022, **$15.8 million** was available for future borrowings under the revolving credit facility[36](index=36&type=chunk) - Interest rates on outstanding debt as of April 2, 2022, range from **3.25% to 5.52%**, consistent with July 3, 2021[42](index=42&type=chunk) - The Company was in compliance with all financial covenants (fixed charge coverage ratio and cash flow leverage ratio) as of April 2, 2022[45](index=45&type=chunk) [Note 5. Income Taxes](index=11&type=section&id=5.%20Income%20Taxes) This note discusses the company's income tax provisions, including expected foreign earnings repatriation, withholding taxes, tax credits, and tax holidays - The Company expects to repatriate approximately **$7.5 million** of foreign earnings in the future, primarily for domestic capital requirements, potential acquisitions, and tax strategies[46](index=46&type=chunk) - Future repatriations from China may incur approximately **$0.8 million** in withholding tax, with no anticipated offsetting foreign tax credits in the U.S[47](index=47&type=chunk) - As of April 2, 2022, the Company has **$7.0 million** in gross federal research and development tax credits, with **$2.7 million** recorded as unrecognized tax benefits[48](index=48&type=chunk) - Vietnam was awarded a tax holiday, resulting in a **zero percent tax rate for four years** starting FY2021, then **five percent for nine years**, and **ten percent for one year**, with a valuation allowance recorded against the Vietnam net operating loss deferred tax asset (**$0.2 million**) in Q3 FY2021[51](index=51&type=chunk) [Note 6. Earnings Per Share](index=11&type=section&id=6.%20Earnings%20Per%20Share) This note reconciles basic and diluted earnings per share, detailing the calculation of weighted average shares outstanding and the impact of dilutive awards EPS Reconciliation (in thousands, except per share) | Metric | Three Months Ended April 2, 2022 | Three Months Ended April 3, 2021 | Nine Months Ended April 2, 2022 | Nine Months Ended April 3, 2021 | | :--------------------------------------- | :------------------------------- | :------------------------------- | :------------------------------ | :------------------------------ | | Net income | $1,007 | $867 | $2,409 | $4,166 | | Weighted average shares outstanding—basic | 10,762 | 10,760 | 10,762 | 10,760 | | Effect of dilutive common stock awards | 300 | 669 | 297 | 280 | | Weighted average shares outstanding—diluted | 11,062 | 11,429 | 11,059 | 11,040 | | Net income per share—basic | $0.09 | $0.08 | $0.22 | $0.39 | | Net income per share—diluted | $0.09 | $0.08 | $0.22 | $0.38 | | Antidilutive SARs not included | 619 | 188 | 619 | 314 | [Note 7. Share-based Compensation](index=12&type=section&id=7.%20Share-based%20Compensation) This note describes the company's share-based incentive plans, compensation expense recognition, and unrecognized compensation expense for unvested awards - The Company's incentive plan offers various equity and liability awards to employees and non-employee directors, with compensation cost recognized over the vesting period[55](index=55&type=chunk) - Stock Appreciation Rights (SARs) include a performance condition based on Return on Invested Capital (ROIC) goals relative to a peer group, vesting after three years and expiring in five[56](index=56&type=chunk) Share-based Compensation Expense (in thousands) | Period | Amount | | :--------------------------------------- | :----------- | | Three months ended April 2, 2022 | $75 | | Three months ended April 3, 2021 | $18 | | Nine months ended April 2, 2022 | $218 | | Nine months ended April 3, 2021 | $132 | - As of April 2, 2022, total unrecognized compensation expense for unvested share-based arrangements was approximately **$0.5 million**, expected to be recognized over a weighted average period of **1.98 years**[58](index=58&type=chunk) [Note 8. Commitments and Contingencies](index=13&type=section&id=8.%20Commitments%20and%20Contingencies) This note outlines the company's involvement in legal actions and details warranty reserves, assessing their potential financial impact - The Company is involved in ordinary course lawsuits and claims, but management believes these will not materially adversely affect financial position, results of operations, or cash flow[59](index=59&type=chunk) - Warranty reserves were approximately **$28,000** as of April 2, 2022, and **$25,000** as of July 3, 2021, based on estimates of product return rates and repair/replacement costs[60](index=60&type=chunk) [Note 9. Derivative Financial Instruments](index=13&type=section&id=9.%20Derivative%20Financial%20Instruments) This note describes the company's use of derivative financial instruments, primarily foreign currency forward contracts, for hedging purposes and their fair value - As of April 2, 2022, the Company had **$6.7 million** in outstanding foreign currency forward contracts, maturing through June 2022, with an estimated fair value of **$344,000**[61](index=61&type=chunk)[63](index=63&type=chunk) - For the nine months ended April 2, 2022, the Company entered into **$13.9 million** of foreign currency forward contracts and settled **$17.8 million**[62](index=62&type=chunk) - Previous interest rate swap contracts related to Wells Fargo Bank term loan and line of credit were terminated on August 14, 2020, and their liability positions are being amortized to interest expense[63](index=63&type=chunk)[64](index=64&type=chunk) - The net unrealized gain expected to be reclassified into earnings within the next 12 months is approximately **$267,000** as of April 2, 2022[66](index=66&type=chunk) [Note 10. Fair Value Measurements](index=15&type=section&id=10.%20Fair%20Value%20Measurements) This note explains the fair value measurement of financial instruments, particularly foreign currency forward contracts, using observable market data - Foreign currency forward contracts are measured on a recurring basis using **Level 2 inputs** (observable market data) and qualify for hedge accounting, with unrealized gains or losses reported in AOCI[67](index=67&type=chunk) Fair Value of Financial Assets (in thousands) | Financial Assets | April 2, 2022 (Level 2) | July 3, 2021 (Level 2) | | :-------------------------------- | :---------------------- | :--------------------- | | Foreign currency forward contracts | $344 | $3,614 | - The carrying values of cash, receivables, and current liabilities approximate their fair value, and long-term debt (revolving credit facility, lease liability, equipment loan) also approximates fair value due to variable floating interest rates[68](index=68&type=chunk)[69](index=69&type=chunk) [Note 11. Revenue](index=15&type=section&id=11.%20Revenue) This note details the company's revenue recognition policies, distinguishing between 'over-time' and 'point-in-time' methods and providing a disaggregation of revenue - Revenue recognition primarily involves manufacturing service agreements (MSAs) and customer purchase orders, with transaction prices fixed and no significant variable pricing components[70](index=70&type=chunk) - For most contracts, revenue is recognized 'over-time' using the input cost-to-cost method, as products are customer-specific with no alternative use and the Company has an enforceable right to payment[72](index=72&type=chunk) - For other contracts, revenue is recognized 'point-in-time' upon shipment, while revenue from engineering services is recognized over time as performed[72](index=72&type=chunk) Disaggregation of Revenue (in thousands) | Recognition Method | Three Months Ended April 2, 2022 | Three Months Ended April 3, 2021 | Nine Months Ended April 2, 2022 | Nine Months Ended April 3, 2021 | | :----------------- | :------------------------------- | :------------------------------- | :------------------------------ | :------------------------------ | | Over-Time | $134,980 | $133,124 | $392,587 | $379,494 | | Point-in-Time | $3,411 | $1,476 | $13,022 | $6,575 | | Total | $138,391 | $134,600 | $405,609 | $386,069 | [Note 12. Leases](index=17&type=section&id=12.%20Leases) This note provides information on the company's operating and financing leases, including lease costs, liabilities, right-of-use assets, and weighted-average lease terms - The Company holds operating and financing leases for facilities and equipment, with initial terms ranging from **1 to 10 years**[77](index=77&type=chunk) Total Lease Cost (in thousands) | Lease Type | Three Months Ended April 2, 2022 | Nine Months Ended April 2, 2022 | | :--------------- | :------------------------------- | :------------------------------ | | Operating lease cost | $1,829 | $5,418 | | Financing lease cost | $278 | $1,356 | | Total lease cost | $2,107 | $6,774 | Lease Liabilities and Right-of-Use Assets (in thousands) | Metric | April 2, 2022 | | :----------------------------------- | :------------ | | Operating lease right of use assets | $17,838 | | Operating lease liabilities | $17,796 | | Financing lease right of use assets | $9,698 | | Financing lease liabilities | $8,757 | - Weighted-average remaining lease terms are **5.39 years** for operating leases (**4.0% discount rate**) and **2.69 years** for financing leases (**8.5% discount rate**)[77](index=77&type=chunk) [Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations](index=18&type=section&id=Item%202.%20Management%27s%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) This section provides management's perspective on the Company's financial performance, condition, and future outlook, discussing key operational results, liquidity, and the various risks and uncertainties that could impact the business [Overview](index=18&type=section&id=Overview) This section introduces Key Tronic as a leading contract manufacturer, highlighting its comprehensive services, international capabilities, and mission to deliver superior manufacturing solutions - Key Tronic is a leading contract manufacturer offering design and manufacturing services from facilities in the United States, Mexico, China, and Vietnam[82](index=82&type=chunk) - The Company provides full engineering services, materials management, worldwide manufacturing, assembly, in-house testing, and global distribution[82](index=82&type=chunk) - International production capabilities offer benefits like improved supply-chain management, reduced inventories, lower transportation costs, and faster product fulfillment[83](index=83&type=chunk) - The Company's mission is to deliver superior manufacturing and engineering services at the lowest total cost for high-quality products, fostering long-term relationships through its 'Trust, Commitment, Results' philosophy[84](index=84&type=chunk) [Executive Summary](index=19&type=section&id=Executive%20Summary) This section provides a high-level overview of the company's recent financial performance, key operational highlights, and strategic positioning for future growth Q3 FY22 Financial Highlights (in millions, except per share) | Metric | Q3 FY22 | Q3 FY21 | Change (%) | | :----------------- | :----------- | :----------- | :--------- | | Total Revenue | $138.4 | $134.6 | 2.8% | | Gross Profit % | 8.3% | 8.2% | +0.1 pp | | Operating Income % | 2.0% | 1.9% | +0.1 pp | | Net Income | $1.0 | $0.9 | 11.1% | | Diluted EPS | $0.09 | $0.08 | 12.5% | - Revenue growth was constrained by global supply chain and transportation issues, despite higher customer demand[85](index=85&type=chunk) - Concentration of top three customers' net sales decreased to **34.4%** in Q3 FY22 from **37.9%** in Q3 FY21, as new customer programs ramped[86](index=86&type=chunk) - Net income for Q3 FY22 was impacted by approximately **$0.06 per diluted share** in legal costs related to the SEC's review of a whistleblower complaint[88](index=88&type=chunk) - The Company won new programs in outdoor recreation, RFID, industrial connectivity, and electric mobility products during Q3 FY22, anticipating significant growth in fiscal 2023 and beyond[89](index=89&type=chunk) - Global events like the war in Ukraine and China's COVID lockdowns are driving a favorable trend of contract manufacturing returning to North America, positioning the Company for demand growth[90](index=90&type=chunk) - The Company maintains a strong balance sheet with a current ratio of **2.1** and a debt-to-equity ratio of **0.9** as of April 2, 2022, with **$15.8 million** available on its revolving credit facility[93](index=93&type=chunk) [Critical Accounting Policies and Estimates](index=20&type=section&id=Critical%20Accounting%20Policies%20and%20Estimates) This section discusses the significant estimates and assumptions required for preparing financial statements and outlines the critical accounting policies that impact reported results - The preparation of consolidated financial statements requires significant estimates and assumptions, which are based on historical results and future expectations, and actual results may vary[94](index=94&type=chunk) - Critical accounting policies include Revenue Recognition, Inactive, Obsolete, and Surplus Inventory Reserve, Allowance for Doubtful Accounts, Accrued Warranty, Income Taxes, Share-Based Compensation, Impairment of Long-Lived Assets, Derivatives and Hedging Activity, and Long-Term Incentive Compensation Accrual[97](index=97&type=chunk) [Results of Operations](index=21&type=section&id=Results%20of%20Operations) This section analyzes the company's financial performance over specific periods, detailing changes in net sales, gross profit, operating expenses, and net income [Comparison of the Three Months Ended April 2, 2022 with the Three Months Ended April 3, 2021](index=21&type=section&id=Comparison%20of%20the%20Three%20Months%20Ended%20April%202%2C%202022%20with%20the%20Three%20Months%20Ended%20April%203%2C%202021) This section compares the company's financial performance for the three-month periods, highlighting changes in key revenue and expense metrics Q3 FY22 vs Q3 FY21 Financial Performance (in thousands) | Metric | April 2, 2022 | % of Net Sales | April 3, 2021 | % of Net Sales | $ Change | % Point Change | | :----------------------------------- | :------------ | :------------- | :------------ | :------------- | :------- | :------------- | | Net sales | $138,391 | 100.0% | $134,600 | 100.0% | $3,791 | —% | | Gross profit | $11,508 | 8.3% | $11,096 | 8.2% | $412 | 0.1% | | Research, development and engineering | $2,526 | 1.8% | $2,655 | 2.0% | $(129) | (0.2)% | | Selling, general and administrative | $6,193 | 4.5% | $5,865 | 4.4% | $328 | 0.1% | | Operating income | $2,789 | 2.0% | $2,576 | 1.9% | $213 | 0.1% | | Interest expense, net | $1,551 | 1.1% | $1,020 | 0.8% | $531 | 0.3% | | Income before income taxes | $1,238 | 0.9% | $1,556 | 1.2% | $(318) | (0.3)% | | Income tax provision | $231 | 0.2% | $689 | 0.5% | $(458) | (0.3)% | | Net income | $1,007 | 0.7% | $867 | 0.6% | $140 | 0.1% | - Net sales increased by **2.8%** due to new customer programs and increased demand, but were constrained by global supply chain and logistics issues[100](index=100&type=chunk)[101](index=101&type=chunk) - Gross profit margin improved by **0.1 percentage point to 8.3%**, driven by increased sales, partially offset by supply chain constraints and COVID-19 related expenses[102](index=102&type=chunk) - RD&E expenses decreased by **$0.1 million** due to lower engineering payroll, while SG&A expenses increased by **$0.3 million** primarily due to higher legal expenses related to an internal investigation[106](index=106&type=chunk)[107](index=107&type=chunk) - Interest expense increased by **$0.5 million** due to a higher average balance on the line of credit and increased interest rates[108](index=108&type=chunk) - The effective tax rate decreased to **18.7%** from **44.3%** primarily due to a valuation allowance against Vietnam's net operating loss deferred tax asset and a true-up of federal R&D tax credits in the prior year[109](index=109&type=chunk) [Comparison of the Nine Months Ended April 2, 2022 with the Nine Months Ended April 3, 2021](index=22&type=section&id=Comparison%20of%20the%20Nine%20Months%20Ended%20April%202%2C%202022%20with%20the%20Nine%20Months%20Ended%20April%203%2C%202021) This section compares the company's financial performance for the nine-month periods, detailing changes in net sales, profitability, and tax rates Nine Months Ended April 2, 2022 vs April 3, 2021 Financial Performance (in thousands) | Metric | April 2, 2022 | % of Net Sales | April 3, 2021 | % of Net Sales | $ Change | % Point Change | | :----------------------------------- | :------------ | :------------- | :------------ | :------------- | :--------- | :------------- | | Net sales | $405,609 | 100.0% | $386,069 | 100.0% | $19,540 | —% | | Gross profit | $31,454 | 7.8% | $31,733 | 8.2% | $(279) | (0.4)% | | Research, development and engineering | $7,473 | 1.8% | $7,292 | 1.9% | $181 | (0.1)% | | Selling, general and administrative | $17,447 | 4.3% | $16,349 | 4.2% | $1,098 | 0.1% | | Operating income | $6,534 | 1.6% | $8,092 | 2.1% | $(1,558) | (0.5)% | | Interest expense, net | $3,638 | 0.9% | $2,549 | 0.7% | $1,089 | 0.2% | | Income before income taxes | $2,896 | 0.7% | $5,543 | 1.4% | $(2,647) | (0.7)% | | Income tax provision | $487 | 0.1% | $1,377 | 0.4% | $(890) | (0.3)% | | Net income | $2,409 | 0.6% | $4,166 | 1.1% | $(1,757) | (0.5)% | | Effective income tax rate | 16.8% | | 24.8% | | | | - Net sales increased by **5.1%** due to new customer programs and increased demand, but were constrained by global supply chain and logistics issues[112](index=112&type=chunk)[113](index=113&type=chunk) - Gross profit margin decreased by **0.4 percentage points to 7.8%**, primarily due to supply chain constraints and COVID-19 related expenses[114](index=114&type=chunk) - RD&E expenses increased by **$0.2 million** due to higher engineering payroll, while SG&A expenses increased by **$1.1 million** primarily due to higher legal expenses related to an internal investigation[116](index=116&type=chunk)[117](index=117&type=chunk) - Interest expense increased by **$1.1 million** due to a higher average balance on the line of credit and increased interest rates[118](index=118&type=chunk) - The effective tax rate decreased to **16.8%** from **24.8%** primarily due to a valuation allowance against Vietnam's net operating loss deferred tax asset and a true-up of federal R&D tax credits in the prior year[119](index=119&type=chunk) [Backlog](index=24&type=section&id=BACKLOG) This section provides an overview of the company's order backlog, explaining its increase due to demand and supply chain issues, and its expected shipment timeframe Order Backlog (in millions) | Date | Amount | | :------------ | :----------- | | April 2, 2022 | $384.1 | | April 3, 2021 | $236.6 | - The significant increase in order backlog is attributed to higher demand and increasing supply chain issues delaying production[120](index=120&type=chunk) - Order backlog consists of purchase orders expected to ship within the next 12 months, but shipment dates are subject to change[120](index=120&type=chunk) [Capital Resources and Liquidity](index=24&type=section&id=CAPITAL%20RESOURCES%20AND%20LIQUIDITY) This section discusses the company's cash flow from operating, investing, and financing activities, its available credit, and its ability to meet future capital requirements Net Cash Flow from Operating Activities (in millions) | Period | Amount | | :----------------------------------- | :----------- | | Nine months ended April 2, 2022 | $(11.6) | | Nine months ended April 3, 2021 | $(17.7) | - Cash used in operating activities for the nine months ended April 2, 2022, was primarily due to increases in accounts receivable (**$27.6 million**) and inventory (**$18.3 million**), partially offset by an increase in accounts payable (**$32.4 million**)[122](index=122&type=chunk) Cash Flow from Investing and Financing Activities (in millions) | Activity | Nine Months Ended April 2, 2022 | Nine Months Ended April 3, 2021 | | :----------------------------------- | :------------------------------ | :------------------------------ | | Cash used in investing activities | $(4.1) | $(9.7) | | Cash provided by financing activities | $14.0 | $28.1 | - Primary investing activity was purchasing equipment for increased production, while financing activities were dominated by borrowings and repayments under the revolving line of credit and term loans[125](index=125&type=chunk)[127](index=127&type=chunk) - As of April 2, 2022, **$15.8 million** was available under the asset-based revolving credit facility[127](index=127&type=chunk) - The Company believes projected cash from operations, revolving credit, and leasing will meet future capital requirements, with approximately **$1.7 million** of cash held by foreign subsidiaries, incurring an estimated **$43,000** in withholding taxes for repatriation[128](index=128&type=chunk) [Off-Balance Sheet Arrangements and Contractual Obligations](index=24&type=section&id=OFF-BALANCE%20SHEET%20ARRANGEMENTS%20AND%20CONTRACTUAL%20OBLIGATIONS) This section confirms that there have been no material changes to the company's contractual obligations or off-balance sheet arrangements since the last annual report - There have been no material changes in contractual obligations outside the ordinary course of business since July 3, 2021[129](index=129&type=chunk) [Risks and Uncertainties that May Affect Future Results](index=25&type=section&id=RISKS%20AND%20UNCERTAINTIES%20THAT%20MAY%20AFFECT%20FUTURE%20RESULTS) This section identifies various risks and uncertainties, including operational, technological, financial, and legal factors, that could materially impact the company's future financial results [RISKS RELATED TO OUR BUSINESS AND STRATEGY](index=25&type=section&id=RISKS%20RELATED%20TO%20OUR%20BUSINESS%20AND%20STRATEGY) This section details risks associated with international operations, market fluctuations, customer and supplier dependency, foreign currency, and new program inefficiencies - Operations in Mexico, China, Vietnam, and the U.S. are subject to risks including political/economic instability, regulatory changes, longer payment cycles, trade barriers, and natural disasters[131](index=131&type=chunk)[136](index=136&type=chunk) - Quarterly results can fluctuate due to macroeconomic conditions, customer demand volatility, new program timing, and pricing changes, with COVID-19 causing extreme demand shifts and supply chain disruptions[133](index=133&type=chunk)[136](index=136&type=chunk) - The Company is highly dependent on a small number of customers; a decline in sales or loss of major customers could materially affect the business[139](index=139&type=chunk)[140](index=140&type=chunk) - Reliance on a limited number of suppliers for critical components exposes the Company to shortages and price increases, which can interrupt operations and delay shipments[141](index=141&type=chunk)[142](index=142&type=chunk) - Fluctuations in foreign currency exchange rates, particularly the Mexican peso and Chinese renminbi, can increase operating costs, though Mexican peso expenses are partially hedged[145](index=145&type=chunk) - Start-up costs and inefficiencies from new or transferred programs can adversely affect operating results, and these costs may not be recoverable if programs are canceled or fail to meet sales volumes[148](index=148&type=chunk) [TECHNOLOGY RISKS](index=28&type=section&id=TECHNOLOGY%20RISKS) This section outlines risks related to cybersecurity threats, information system disruptions, and the necessity of maintaining technological and manufacturing expertise - The Company is exposed to cyberattacks, which could disrupt operations, lead to misappropriation of confidential information, and incur significant mitigation costs[157](index=157&type=chunk)[158](index=158&type=chunk)[159](index=159&type=chunk) - Disruptions to information systems, including data loss or outages due to various events, could adversely affect critical functions like financial reporting and inventory management[160](index=160&type=chunk) - Failure to maintain technological and manufacturing process expertise in a rapidly changing industry could adversely affect the business, as customer success depends on timely new product introductions[161](index=161&type=chunk) [RISKS RELATED TO CAPITAL AND FINANCING](index=29&type=section&id=RISKS%20RELATED%20TO%20CAPITAL%20AND%20FINANCING) This section addresses risks concerning credit arrangements, interest rate fluctuations, stock price volatility, and the management of cash and cash equivalents - Cash and cash equivalents are exposed to credit risk from high-credit quality institutions, with balances potentially exceeding federal depository insurance limits[162](index=162&type=chunk) - The ability to secure and maintain sufficient credit arrangements is crucial; failure to renew agreements or meet financial covenants could lead to immediate debt repayment[163](index=163&type=chunk) - Exposure to interest rate risk on the revolving line of credit and term loan means significant changes in interest rates could adversely affect results, especially with the transition away from LIBOR[164](index=164&type=chunk)[165](index=165&type=chunk) - The Company's stock price is volatile, subject to fluctuations from operating results, earnings estimates, the Audit Committee's internal investigation, and broader market conditions[166](index=166&type=chunk) [RISKS RELATED TO OUR CONTROLS AND PROCEDURES AND THE INTERNAL INVESTIGATION](index=30&type=section&id=RISKS%20RELATED%20TO%20OUR%20CONTROLS%20AND%20PROCEDURES%20AND%20THE%20INTERNAL%20INVESTIGATION) This section discusses risks related to internal control weaknesses, the ongoing internal investigation, potential regulatory inquiries, and the inherent limitations of control systems - A previously identified material weakness in internal control over financial reporting, though remediated as of July 3, 2021, could recur, potentially leading to misstatements or restatements[167](index=167&type=chunk)[168](index=168&type=chunk) - Matters related to the Audit Committee's internal investigation, including legal, accounting, and professional service expenses, regulatory inquiries (e.g., SEC), and potential litigation, could adversely affect the business[169](index=169&type=chunk)[170](index=170&type=chunk)[171](index=171&type=chunk) - Inherent limitations in control systems mean they cannot prevent all errors or fraud, and misstatements may occur and go undetected[172](index=172&type=chunk) [LEGAL AND ACCOUNTING RISKS](index=31&type=section&id=LEGAL%20AND%20ACCOUNTING%20RISKS) This section covers risks arising from legal proceedings, changes in securities laws and regulations, and modifications to financial accounting standards - Involvement in various legal proceedings, even without merit, can result in substantial costs and diversion of resources, potentially affecting financial condition and results of operations[173](index=173&type=chunk) - Changes in securities laws and regulations (e.g., Sarbanes-Oxley, Dodd-Frank) increase compliance costs, legal, financial, and accounting expenses, and the risk of noncompliance[174](index=174&type=chunk) - Changes in financial accounting standards (U.S. GAAP) can significantly affect reported financial condition or results, and increase implementation costs and internal control modifications[175](index=175&type=chunk) [GENERAL RISKS](index=31&type=section&id=GENERAL%20RISKS) This section addresses broader risks such as insufficient insurance coverage and the inherent challenges and potential adverse impacts of acquisitions - Insurance coverage may not be sufficient for all potential damages, claims, or losses, and a significant uninsured claim could negatively impact net income[176](index=176&type=chunk) - Acquisitions involve numerous risks, including potential loss of key employees/customers, internal control deficiencies, liquidity constraints, and unanticipated liabilities, which could harm profitability and operating results[178](index=178&type=chunk)[179](index=179&type=chunk) [Item 3. Quantitative and Qualitative Disclosures about Market Risk](index=32&type=section&id=Item%203.%20Quantitative%20and%20Qualitative%20Disclosures%20about%20Market%20Risk) This section details the Company's exposure to market risks, specifically interest rate risk on its secured debt and foreign currency exchange risk from international operations, and the strategies employed to manage these risks - The Company is exposed to fluctuating interest rates on its secured debt, including a **$99.7 million** asset-based senior secured revolving credit facility and **$8.4 million** in equipment financing facilities, which fluctuate with LIBOR rates[180](index=180&type=chunk) - Foreign currency exchange risk arises from operations in foreign locations, with transactions in currencies other than the U.S. dollar, and the Company uses Mexican peso forward contracts to hedge a portion of its Mexican peso-denominated expenses[181](index=181&type=chunk) - As of April 2, 2022, **$6.7 million** of foreign currency forward contracts were outstanding with a fair value of **$344,000**[181](index=181&type=chunk) [Item 4. Controls and Procedures](index=32&type=section&id=Item%204.%20Controls%20and%20Procedures) This section confirms management's evaluation of the effectiveness of the Company's disclosure controls and procedures and reports on any significant changes in internal control over financial reporting - Management, under the supervision of the CEO and CFO, evaluated the effectiveness of disclosure controls and procedures and concluded they were effective as of April 2, 2022[182](index=182&type=chunk)[183](index=183&type=chunk) - There have been no significant changes in internal controls over financial reporting during the three months ended April 2, 2022, that materially affected or are reasonably likely to materially affect them[184](index=184&type=chunk) PART II. OTHER INFORMATION This section includes additional information not covered in the financial statements, such as legal proceedings, risk factors, exhibits, and official signatures [Item 1. Legal Proceedings](index=33&type=section&id=Item%201.%20Legal%20Proceedings) This section addresses the Company's involvement in legal actions, stating management's opinion on their potential impact - The Company is involved in various legal actions arising in the ordinary course of business[185](index=185&type=chunk) - Management believes the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position, results of operations, or cash flows[185](index=185&type=chunk) [Item 1A. Risk Factors](index=33&type=section&id=Item%201A.%20Risk%20Factors) This section refers to the comprehensive discussion of risk factors detailed elsewhere in the report - Information regarding risk factors is provided in Item 2, 'Management's Discussion and Analysis of Financial Condition and Results of Operations' and Item 3, 'Quantitative and Qualitative Disclosures about Market Risk' of this Form 10-Q[186](index=186&type=chunk) - There are no material changes to the risk factors set forth in Part I Item 1A in the Company's Annual Report on Form 10-K for the year ended July 3, 2021[186](index=186&type=chunk) [Item 6. Exhibits](index=33&type=section&id=Item%206.%20Exhibits) This section lists all exhibits filed as part of the Form 10-Q, including corporate documents, certifications, and XBRL-related files - The exhibits include Articles of Incorporation, Bylaws, Certifications of Chief Executive Officer and Chief Financial Officer (pursuant to Exchange Act Rules and 18 U.S.C. 1350), and various Inline XBRL documents[187](index=187&type=chunk) [Signatures](index=34&type=section&id=Signatures) This section contains the official signatures of the registrant's authorized officers, affirming the due submission of the report - The report is duly signed on behalf of Key Tronic Corporation by Craig D. Gates, President and Chief Executive Officer, and Brett R. Larsen, Executive Vice President of Administration, Chief Financial Officer and Treasurer, on May 11, 2022[189](index=189&type=chunk)[191](index=191&type=chunk)

Key Tronic Corporation (NASDAQ:KTCC) Q3 2022 Earnings Conference Call May 5, 2022 5:00 PM ET Company Participants Brett Larsen – Chief Financial Officer Craig Gates – President & Chief Executive Officer Conference Call Participants Bill Dezellem – Tieton Capital Sheldon Grodsky – Grodsky & Associates George Melas – MKH Management Bill Dezellem – Tieton Capital Operator Good day and welcome to the Q3 Fiscal 2022 Key Tronic Corporation Conference Call. Today's conference is being recorded. At this time, I'd l ...

PART I. FINANCIAL INFORMATION [Item 1. Financial Statements (Unaudited)](index=3&type=section&id=Item%201.%20Financial%20Statements%20(Unaudited)) The unaudited statements show increased assets and liabilities, with higher sales but lower net income and a cash use from operations [Condensed Consolidated Balance Sheets](index=3&type=section&id=Condensed%20Consolidated%20Balance%20Sheets) Total assets and liabilities grew, driven by higher inventories and accounts payable, while shareholders' equity slightly decreased Condensed Consolidated Balance Sheet Highlights (in thousands) | Account | January 1, 2022 | July 3, 2021 | | :--- | :--- | :--- | | **Total current assets** | $343,551 | $299,252 | | Inventories, net | $157,750 | $137,329 | | **Total assets** | **$410,507** | **$361,846** | | **Total current liabilities** | $167,128 | $126,705 | | Accounts payable | $131,842 | $92,823 | | Revolving loan | $96,435 | $90,362 | | **Total liabilities** | **$287,872** | **$238,141** | | **Total shareholders' equity** | **$122,635** | **$123,705** | [Condensed Consolidated Statements of Income](index=4&type=section&id=Condensed%20Consolidated%20Statements%20of%20Income) Quarterly and six-month net sales increased, but higher costs led to a significant decline in net income Consolidated Income Statement Summary (in thousands, except per share data) | Metric | Three Months Ended Jan 1, 2022 | Three Months Ended Dec 26, 2020 | Six Months Ended Jan 1, 2022 | Six Months Ended Dec 26, 2020 | | :--- | :--- | :--- | :--- | :--- | | Net sales | $134,456 | $128,262 | $267,218 | $251,469 | | Gross profit | $9,808 | $10,622 | $19,946 | $20,637 | | Operating income | $1,651 | $2,720 | $3,745 | $5,516 | | Net income | $587 | $1,580 | $1,402 | $3,299 | | Net income per share — Diluted | $0.05 | $0.14 | $0.13 | $0.30 | [Condensed Consolidated Statements of Cash Flows](index=6&type=section&id=Condensed%20Consolidated%20Statements%20of%20Cash%20Flows) Cash used in operations improved, while financing activities provided cash, resulting in a net decrease in cash equivalents Consolidated Cash Flow Summary (in thousands) | Activity | Six Months Ended Jan 1, 2022 | Six Months Ended Dec 26, 2020 | | :--- | :--- | :--- | | Cash used in operating activities | $(10,528) | $(16,823) | | Cash used in investing activities | $(2,764) | $(6,963) | | Cash provided by financing activities | $10,865 | $28,240 | | **Net (decrease) increase in cash** | **$(2,427)** | **$4,454** | | **Cash and cash equivalents, end of period** | **$1,046** | **$5,007** | [Notes to Condensed Consolidated Financial Statements](index=8&type=section&id=Notes%20to%20Condensed%20Consolidated%20Financial%20Statements) Key notes detail COVID-19 impacts, an expanded credit facility, revenue recognition policies, and a tax holiday in Vietnam - The company has seen extreme shifts in demand, supply chain risks, and increased costs due to the **COVID-19 pandemic**, which can materially impact operating results[23](index=23&type=chunk) - On September 3, 2021, the company amended its loan agreement with Bank of America, **increasing its credit facility from $93 million to $120 million**, maturing in September 2026[36](index=36&type=chunk) - The company received a tax holiday in Vietnam for its principal product line, resulting in a **zero percent tax rate for four years** starting in fiscal 2021, followed by reduced rates for subsequent years[51](index=51&type=chunk) - The majority of revenue is **recognized 'over-time'** using a cost-to-cost input method, as products are customer-specific with no alternative use and the company has an enforceable right to payment[70](index=70&type=chunk) [Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations](index=18&type=section&id=Item%202.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) Management discusses revenue growth offset by declining profitability due to supply chain issues, alongside a rising order backlog [Results of Operations](index=21&type=section&id=Results%20of%20Operations) Net sales rose due to customer reimbursements, but gross margin and operating income fell due to supply chain and legal costs Financial Performance Comparison - Three Months Ended | Metric | Q2 FY2022 | Q2 FY2021 | $ Change | % Point Change (Margin) | | :--- | :--- | :--- | :--- | :--- | | Net sales | $134.5M | $128.3M | +$6.2M | N/A | | Gross profit | $9.8M | $10.6M | -$0.8M | -1.0% | | Gross Margin | 7.3% | 8.3% | N/A | -1.0% | | Operating income | $1.7M | $2.7M | -$1.0M | -0.9% | | Net income | $0.6M | $1.6M | -$1.0M | -0.8% | Financial Performance Comparison - Six Months Ended | Metric | H1 FY2022 | H1 FY2021 | $ Change | % Point Change (Margin) | | :--- | :--- | :--- | :--- | :--- | | Net sales | $267.2M | $251.5M | +$15.7M | N/A | | Gross profit | $19.9M | $20.6M | -$0.7M | -0.7% | | Gross Margin | 7.5% | 8.2% | N/A | -0.7% | | Operating income | $3.7M | $5.5M | -$1.8M | -0.8% | | Net income | $1.4M | $3.3M | -$1.9M | -0.8% | - Legal costs related to the SEC's review of a whistleblower complaint totaled approximately **$0.7 million during the second quarter**, impacting net income[86](index=86&type=chunk)[88](index=88&type=chunk) [Capital Resources and Liquidity](index=24&type=section&id=Capital%20Resources%20and%20Liquidity) Operating cash flow was negative due to working capital changes, but the company maintains sufficient liquidity via its credit facility - **Net cash used in operating activities** for the six months ended January 1, 2022 was **$10.5 million**, compared to $16.8 million used in the prior year period[120](index=120&type=chunk) - The company had an **order backlog of approximately $333.1 million** on January 1, 2022, a significant increase from $218.7 million a year prior, attributed to higher demand and supply chain delays[119](index=119&type=chunk) - As of January 1, 2022, the company had **$97.0 million in borrowings** on its revolving credit facility, with **$17.3 million remaining available**[93](index=93&type=chunk)[127](index=127&type=chunk) [Risks and Uncertainties that May Affect Future Results](index=25&type=section&id=Risks%20and%20Uncertainties%20that%20May%20Affect%20Future%20Results) The company faces significant risks from customer concentration, supply chain disruptions, foreign operations, and cybersecurity threats - Business risks include **dependency on a concentrated customer base**, potential fluctuations in quarterly results, and operational challenges in foreign manufacturing facilities[131](index=131&type=chunk)[133](index=133&type=chunk)[139](index=139&type=chunk) - The company is **dependent on a limited number of suppliers** for critical components and has experienced shortages, which can curtail or delay production[141](index=141&type=chunk) - Technology risks include **cybersecurity incidents** that could disrupt operations or misappropriate confidential data, and disruptions to information systems[156](index=156&type=chunk)[159](index=159&type=chunk) - The company has incurred and may continue to **incur significant expenses related to the Audit Committee's internal investigation** and is cooperating with the SEC, which could lead to further costs, penalties, or litigation[169](index=169&type=chunk)[170](index=170&type=chunk) [Item 3. Quantitative and Qualitative Disclosures about Market Risk](index=32&type=section&id=Item%203.%20Quantitative%20and%20Qualitative%20Disclosures%20about%20Market%20Risk) The company is exposed to market risks from variable interest rates on its debt and foreign currency fluctuations in Mexico and China - The company is subject to **interest rate risk on its $97.0 million outstanding borrowings** under its asset-based revolving credit facility, as rates fluctuate with LIBOR[180](index=180&type=chunk) - The company faces foreign currency exchange risk from its operations in Mexico and China and **hedges a portion of its Mexican peso exposure with forward contracts**, with a notional value of $13.9 million outstanding as of January 1, 2022[181](index=181&type=chunk) [Item 4. Controls and Procedures](index=32&type=section&id=Item%204.%20Controls%20and%20Procedures) Management concluded that disclosure controls and procedures were effective, with no material changes to internal controls - Based on an evaluation as of the end of the period, management concluded that the company's **disclosure controls and procedures were effective**[183](index=183&type=chunk) - **No significant changes were made to internal controls** over financial reporting during the second quarter of fiscal 2022[184](index=184&type=chunk) PART II. OTHER INFORMATION [Item 1. Legal Proceedings](index=33&type=section&id=Item%201.%20Legal%20Proceedings) Ongoing legal actions are not expected to have a material adverse effect on the company's financial condition - The company is involved in various legal actions arising in the ordinary course of business, which management **does not expect to have a material adverse effect** on its financial condition[185](index=185&type=chunk) [Item 1A. Risk Factors](index=33&type=section&id=Item%201A.%20Risk%20Factors) No material changes have been made to the risk factors disclosed in the company's most recent Annual Report on Form 10-K - There are **no material changes to the risk factors** set forth in the Company's Annual Report on Form 10-K for the year ended July 3, 2021[186](index=186&type=chunk) [Item 6. Exhibits](index=33&type=section&id=Item%206.%20Exhibits) This section lists filed exhibits, including required CEO/CFO certifications and interactive data files - **Exhibits filed include certifications from the CEO and CFO**, as well as Inline XBRL data files[187](index=187&type=chunk) [Signatures](index=34&type=section&id=Signatures)

Financial Data and Key Metrics Changes - For Q2 fiscal 2022, total revenue was $134.5 million, an increase from $128.3 million in the same period of fiscal 2021, representing a growth of approximately 1.7% [6] - Net income for Q2 fiscal 2022 was $0.6 million or $0.05 per share, down from $1.6 million or $0.14 per share in Q2 fiscal 2021 [10] - Gross margin decreased to 7.3% from 8.3% year-over-year, and operating margin fell to 1.2% from 2.1% [9] Business Line Data and Key Metrics Changes - Revenue related to customer reimbursements for tooling and equipment increased by approximately $10 million compared to the previous year [7] - The company experienced a decrease in inventory turns due to supply chain-related production delays [11] Market Data and Key Metrics Changes - The company faced ongoing global supply chain disruptions, including parts supply issues and increased transportation costs, which have significantly impacted production [8][22] - Labor costs and shortages of production staff were also noted as challenges affecting operations [22] Company Strategy and Development Direction - The company plans to invest selectively in production equipment and efficiency improvements to prepare for growth [15] - Key Tronic aims to capitalize on the increasing demand for North American production as companies seek to diversify their supply chains away from Asia [26][27] Management's Comments on Operating Environment and Future Outlook - Management expressed optimism about future growth prospects, citing a growing backlog and increased customer demand [18][19] - However, they acknowledged that supply chain disruptions and pandemic-related challenges continue to pose risks [18][29] Other Important Information - Legal costs related to the SEC's review of a whistleblower complaint totaled approximately $0.7 million during the quarter [9] - The company expects Q3 fiscal 2022 revenue to be between $130 million and $140 million, with earnings of approximately $0.05 to $0.10 per diluted share [16] Q&A Session Summary Question: Can you characterize the size of the new programs won? - The new programs range from $5 million to $15 million per year, with one significant program expected to contribute approximately $80 million in annual revenue [34][36] Question: How has the supply chain situation changed over the last quarter? - The supply chain situation has stabilized, but lead times remain long, and there are still surprises regarding shipment delays [39] Question: What is the anticipated revenue growth from U.S. facilities? - U.S. facilities are expected to see a 35% increase in annual revenue due to new business wins and increased production [25][50] Question: What is the expected CapEx for the fiscal year? - The company expects total capital expenditures to be around $6 million for the fiscal year, down from previous forecasts [14][100] Question: How are customer reimbursements for tooling and equipment viewed? - Customer reimbursements are seen as a favorable indicator of future production, as they indicate serious commitment from customers [69][72]

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ____________________________________________________________ FORM 10-Q ____________________________________________________________ ☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED OCTOBER 2, 2021 OR ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD FROM TO . Commission File Number 0-11559 _____________________ ...

Key Tronic Corporation (NASDAQ:KTCC) Q1 2022 Earnings Conference Call November 2, 2021 5:00 PM ET Company Participants Brett Larsen - Chief Financial Officer Craig Gates - President & Chief Executive Officer Conference Call Participants Bill Dezellem - Tieton Capital Sheldon Grodsky - Grodsky Associates George Melas - MKH Management Operator Good day and welcome to the Key Tronic Corporation First Quarter Fiscal 2022 Conference Call. Today's conference is being recorded. At this time, I would like to turn t ...

UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ____________________________________________________________ FORM 10-K ____________________________________________________________ ☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JULY 3, 2021 OR ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD FROM TO Commission File Number 0-11559 __________________________________ ...

Financial Data and Key Metrics Changes - For Q4 FY2021, the company reported revenue of approximately $132.6 million, up 14% from $116 million in the same period of FY2020 [4] - Total revenue for FY2021 was $518.7 million, the highest annual revenue in the company's history, up 15% from $449.5 million in FY2020 [4] - Net income for Q4 FY2021 was $200,000 or approximately $0.02 per share, compared to $1.5 million or $0.14 per share in Q4 FY2020 [5] - For FY2021, net income was $4.3 million or $0.39 per share, compared to $4.8 million or $0.44 per share in FY2020 [10] - Gross margin improved to 8.1% and operating margin to 1.8% for FY2021, up from 7.8% and 1.5% respectively in FY2020 [9] Business Line Data and Key Metrics Changes - The company faced significant revenue constraints due to worldwide supply chain issues, impacting both new and existing customer demand [5] - Operating income for FY2021 was $9.5 million, a 40% increase from the prior year [10] - The company incurred additional costs due to supply chain issues, including factory downtime and overtime expenses [6] Market Data and Key Metrics Changes - Trade receivables decreased by $2.6 million from the prior quarter, with days sales outstanding (DSOs) increasing to about 76 days [12] - The company maintained total working capital of $172 million and a current ratio of 2.4:1 [13] Company Strategy and Development Direction - The company plans to increase its credit facility to $120 million to enhance liquidity and manage potential risks [13] - Capital expenditures for FY2021 were about $10.6 million, with plans to invest in production equipment and efficiency improvements [14] - The company is focusing on winning new EMS programs and expanding its business, particularly in North America, due to increasing demand and supply chain challenges [21][23] Management's Comments on Operating Environment and Future Outlook - Management expressed optimism about future growth despite ongoing supply chain disruptions and the COVID-19 crisis [17] - The company expects to report revenue of approximately $125 million to $135 million for Q1 FY2022, with significant uncertainty surrounding these estimates [15] - Management noted that demand remains strong, with potential revenue exceeding $160 million if all parts were available [55] Other Important Information - The company is cooperating with the SEC regarding an internal investigation, which has resulted in additional expenses [9] - The internal investigation cost the company in excess of $1.5 million for the year [65] Q&A Session Summary Question: Can you discuss the new program won in Q3 that led to adding square footage in Juarez? - The program involves moving business from China and is based on customer response time [34][35] Question: What is the revenue potential of the new program? - The Q3 program is expected to generate between $20 million and $50 million annually, while Q4 wins are between $5 million and $15 million [38] Question: What caused the change in revenue guidance for Q4? - The change was primarily due to component availability and new program ramps [42] Question: Is there a demand issue? - The company is experiencing the highest demand in its history, with no demand issues reported [54] Question: How much did the internal investigation cost? - The cost exceeded $1.5 million for the year [65] Question: How much of the $700 million demand was related to COVID products? - It is estimated that the demand would drop to around $600 million without COVID-related products [75] Question: What is the expected gross margin target? - The long-term goal is to achieve a gross margin above 9% [90]

[Explanatory Note](index=3&type=section&id=Explanatory%20Note) The Company filed this Quarterly Report late due to an internal investigation by the Audit Committee, which found inventory and cost of goods sold were improperly recorded, but no restatement was required - The Company filed this Quarterly Report on Form 10-Q late due to an internal investigation by the Audit Committee, which concluded that inventory and cost of goods sold were improperly recorded at its Oakdale, MN facility during Q4 FY2020 and H1 FY2021, resulting from deficiencies in internal control over financial reporting[8](index=8&type=chunk) - These errors did not lead to a restatement of previously issued financial statements[8](index=8&type=chunk) PART I. FINANCIAL INFORMATION [Item 1. Financial Statements (Unaudited)](index=4&type=section&id=Item%201.%20Financial%20Statements%20(Unaudited)) This section presents the unaudited condensed consolidated financial statements, including balance sheets, income statements, comprehensive income, cash flows, and shareholders' equity, along with detailed notes [Condensed Consolidated Balance Sheets](index=4&type=section&id=Condensed%20Consolidated%20Balance%20Sheets) This section provides a snapshot of the Company's financial position, detailing assets, liabilities, and shareholders' equity at specific points in time **Condensed Consolidated Balance Sheet Highlights (in thousands):** | Metric | Dec 26, 2020 | Jun 27, 2020 | Change ($) | Change (%) | | :-------------------------------- | :----------- | :----------- | :--------- | :--------- | | Cash and cash equivalents | $5,007 | $553 | $4,454 | 805.4% | | Trade receivables, net | $100,105 | $86,123 | $13,982 | 16.2% | | Inventories, net | $119,439 | $115,020 | $4,419 | 3.8% | | Total current assets | $267,147 | $242,764 | $24,383 | 10.0% | | Total assets | $330,522 | $304,861 | $25,661 | 8.4% | | Accounts payable | $69,937 | $80,204 | $(10,267) | -12.8% | | Total current liabilities | $93,755 | $112,219 | $(18,464) | -16.4% | | Revolving loan | $89,357 | $60,094 | $29,263 | 48.7% | | Total liabilities | $207,358 | $189,304 | $18,054 | 9.5% | | Total shareholders' equity | $123,164 | $115,557 | $7,607 | 6.6% | [Condensed Consolidated Statements of Income](index=5&type=section&id=Condensed%20Consolidated%20Statements%20of%20Income) This section details the Company's financial performance over specific periods, showing net sales, gross profit, operating income, and net income **Condensed Consolidated Statements of Income Highlights (in thousands, except per share):** | Metric | Three Months Ended Dec 26, 2020 | Three Months Ended Dec 28, 2019 | Change ($) | Change (%) | | :-------------------------------- | :------------------------------ | :------------------------------ | :--------- | :--------- | | Net sales | $128,262 | $116,722 | $11,540 | 9.9% | | Gross profit | $10,622 | $8,122 | $2,500 | 30.8% | | Gross profit % | 8.3% | 7.0% | 1.3 ppt | - | | Operating income | $2,720 | $1,498 | $1,222 | 81.6% | | Operating income % | 2.1% | 1.3% | 0.8 ppt | - | | Net income | $1,580 | $824 | $756 | 91.7% | | Net income per share — Diluted | $0.14 | $0.08 | $0.06 | 75.0% | | Metric | Six Months Ended Dec 26, 2020 | Six Months Ended Dec 28, 2019 | Change ($) | Change (%) | | :-------------------------------- | :---------------------------- | :---------------------------- | :--------- | :--------- | | Net sales | $251,469 | $222,007 | $29,462 | 13.3% | | Gross profit | $20,637 | $17,395 | $3,242 | 18.6% | | Gross profit % | 8.2% | 7.8% | 0.4 ppt | - | | Operating income | $5,516 | $4,037 | $1,479 | 36.6% | | Operating income % | 2.2% | 1.8% | 0.4 ppt | - | | Net income | $3,299 | $2,376 | $923 | 38.8% | | Net income per share — Diluted | $0.30 | $0.22 | $0.08 | 36.4% | [Condensed Consolidated Statements of Comprehensive Income](index=6&type=section&id=Condensed%20Consolidated%20Statements%20of%20Comprehensive%20Income) This section presents the Company's comprehensive income, including net income and other comprehensive income items like unrealized gains or losses on hedging instruments **Condensed Consolidated Statements of Comprehensive Income Highlights (in thousands):** | Metric | Three Months Ended Dec 26, 2020 | Three Months Ended Dec 28, 2019 | Change ($) | | :-------------------------------- | :------------------------------ | :------------------------------ | :--------- | | Net income | $1,580 | $824 | $756 | | Unrealized gain (loss) on hedging instruments, net of tax | $2,926 | $778 | $2,148 | | Comprehensive income | $4,506 | $1,602 | $2,904 | | Metric | Six Months Ended Dec 26, 2020 | Six Months Ended Dec 28, 2019 | Change ($) | | :-------------------------------- | :---------------------------- | :---------------------------- | :--------- | | Net income | $3,299 | $2,376 | $923 | | Unrealized gain (loss) on hedging instruments, net of tax | $4,194 | $(169) | $4,363 | | Comprehensive income | $7,493 | $2,207 | $5,286 | [Condensed Consolidated Statements of Cash Flows](index=7&type=section&id=Condensed%20Consolidated%20Statements%20of%20Cash%20Flows) This section outlines the Company's cash inflows and outflows from operating, investing, and financing activities over specific periods **Condensed Consolidated Statements of Cash Flow Highlights (Six Months Ended, in thousands):** | Activity | Dec 26, 2020 | Dec 28, 2019 | Change ($) | | :-------------------------------- | :----------- | :----------- | :--------- | | Net cash used in operating activities | $(16,823) | $(8,438) | $(8,385) | | Net cash used in investing activities | $(6,963) | $(1,969) | $(4,994) | | Net cash provided by financing activities | $28,240 | $10,305 | $17,935 | | Net increase (decrease) in cash and cash equivalents | $4,454 | $(102) | $4,556 | | Cash and cash equivalents, end of period | $5,007 | $499 | $4,508 | [Condensed Consolidated Statements of Shareholders' Equity](index=8&type=section&id=Condensed%20Consolidated%20Statements%20of%20Shareholders'%20Equity) This section details changes in the Company's shareholders' equity, including net income and other comprehensive income, over specific periods **Condensed Consolidated Statements of Shareholders' Equity Highlights (Six Months Ended, in thousands):** | Metric | Dec 26, 2020 | Dec 28, 2019 | Change ($) | | :-------------------------------- | :----------- | :----------- | :--------- | | Total shareholders' equity, beginning balances | $115,557 | $114,459 | $1,098 | | Net income | $3,299 | $2,376 | $923 | | Unrealized gain (loss) on hedging instruments, net | $4,194 | $(169) | $4,363 | | Total shareholders' equity, ending balances | $123,164 | $116,807 | $6,357 | [Notes to Condensed Consolidated Financial Statements](index=9&type=section&id=Notes%20to%20Condensed%20Consolidated%20Financial%20Statements) This section provides detailed explanations and additional information supporting the condensed consolidated financial statements [1. Basis of Presentation](index=9&type=section&id=1.%20Basis%20of%20Presentation) This note describes the framework and principles used to prepare the unaudited interim financial statements, including compliance with SEC rules and the impact of management estimates - The financial statements are unaudited and prepared in accordance with SEC rules, condensing certain annual disclosures, with management's estimates and assumptions used, and interim results not necessarily indicative of the full year[23](index=23&type=chunk)[24](index=24&type=chunk) - The Company's fiscal year is 52/53 weeks, ending on the Saturday closest to June 30, with the periods ended December 26, 2020, and December 28, 2019, being 13 and 26 weeks, respectively[24](index=24&type=chunk) - The COVID-19 pandemic has caused extreme shifts in customer demand, supply chain, and logistics risks, potentially impacting operating results due to closures, cost fluctuations, and labor shortages[25](index=25&type=chunk) - An immaterial disclosure error regarding inventory classification (raw materials vs. finished goods/work-in-process) was corrected, with no change to the total inventory balance[26](index=26&type=chunk) [2. Significant Accounting Policies](index=9&type=section&id=2.%20Significant%20Accounting%20Policies) This note outlines the key accounting principles and methods applied in preparing the financial statements, including revenue recognition, inventory valuation, and tax accounting - The Company computes basic and diluted EPS, uses foreign currency forward contracts as cash flow hedges to manage Mexican peso expense variability, and accounts for income taxes using the asset and liability method with an estimated annual effective tax rate[27](index=27&type=chunk)[28](index=28&type=chunk)[31](index=31&type=chunk) - Recently issued accounting standards (ASU 2021-01, ASU 2020-03, ASU 2019-12, ASU 2016-13) are being assessed for their impact, with ASU 2019-12 not expected to have a material impact and ASU 2016-13 effective in FY2024[34](index=34&type=chunk)[35](index=35&type=chunk)[36](index=36&type=chunk)[37](index=37&type=chunk) [3. Inventories](index=11&type=section&id=3.%20Inventories) This note provides details on the composition and valuation of the Company's inventory balances, including reserves and customer payments **Inventory Balances (in millions):** | Metric | Dec 26, 2020 | Jun 27, 2020 | | :-------------------------------- | :----------- | :----------- | | Total inventory, net | $119.4 | $115.0 | | Reserves, customer payments, and customer deposits | $13.6 | $17.3 | Substantially all inventory balances are raw materials [4. Long-Term Debt](index=11&type=section&id=4.%20Long-Term%20Debt) This note describes the Company's long-term debt arrangements, including credit facilities, equipment financing, and debt maturities - On August 14, 2020, the Company replaced its Wells Fargo credit agreement with a new five-year, **$93 million asset-based senior secured revolving credit facility** with Bank of America, maturing August 14, 2025, with **$89.9 million outstanding** and **$3.1 million available** as of December 26, 2020[39](index=39&type=chunk) - The Company also entered into two equipment financing facilities: a **$5.0 million facility** (August 14, 2020, 4.85% interest, maturing August 14, 2025) with **$4.7 million outstanding**, and a **$6.0 million facility** (November 24, 2020, 5.52% interest, maturing April 24, 2026) with **$6.0 million outstanding**[41](index=41&type=chunk)[44](index=44&type=chunk) **Debt Maturities (in thousands):** | Fiscal Years Ending | Amount | | :------------------ | :----- | | 2021 (remaining 6 months) | $654 | | 2022 | $2,143 | | 2023 | $2,190 | | 2024 | $2,239 | | 2025 | $2,290 | | Thereafter | $91,073 | | Total debt | $100,589 | | Unamortized debt issuance costs | $(529) | | Long-term debt, net | $100,060 | The Company was in compliance with all financial covenants as of December 26, 2020 [5. Trade Accounts Receivable Purchase Programs](index=12&type=section&id=5.%20Trade%20Accounts%20Receivable%20Purchase%20Programs) This note provides information on the Company's participation in trade accounts receivable purchase programs, including sales activity - The Company did not sell any accounts receivables during the six months ended December 26, 2020, in contrast to approximately **$35.0 million of accounts receivables sold** during the six months ended December 28, 2019[50](index=50&type=chunk) [6. Income Taxes](index=12&type=section&id=6.%20Income%20Taxes) This note details the Company's income tax provisions, including expected repatriation of foreign earnings, tax credits, and the impact of recent tax legislation - The Company expects to repatriate approximately **$8.0 million of foreign earnings**, primarily from China, which may incur approximately **$0.8 million in withholding taxes**, while other unremitted foreign earnings are expected to remain permanently reinvested[51](index=51&type=chunk)[52](index=52&type=chunk) - As of December 26, 2020, the Company has **$8.6 million in gross federal R&D tax credits**, with **$3.0 million recognized as uncertain tax benefits**, resulting in a net deferred tax benefit of **$5.6 million**[53](index=53&type=chunk) - The CARES Act provisions, including NOL carryovers and increased business interest deduction limits, are not expected to have a material impact on the Company's financial position, results of operations, or cash flows, and the Company elected to claim 100% of AMT credits for the 2018 tax year in Q4 FY2020[54](index=54&type=chunk)[96](index=96&type=chunk) [7. Earnings Per Share](index=13&type=section&id=7.%20Earnings%20Per%20Share) This note provides a reconciliation of basic and diluted earnings per share, detailing the impact of common stock awards **Earnings Per Share Reconciliation (in thousands, except per share):** | Metric | Three Months Ended Dec 26, 2020 | Three Months Ended Dec 28, 2019 | | :-------------------------------- | :------------------------------ | :------------------------------ | | Net income | $1,580 | $824 | | Weighted average shares outstanding—basic | 10,760 | 10,760 | | Effect of dilutive common stock awards | 625 | 117 | | Weighted average shares outstanding—diluted | 11,385 | 10,877 | | Net income per share—basic | $0.15 | $0.08 | | Net income per share—diluted | $0.14 | $0.08 | | Antidilutive SARs not included | — | 725 | | Metric | Six Months Ended Dec 26, 2020 | Six Months Ended Dec 28, 2019 | | :-------------------------------- | :---------------------------- | :---------------------------- | | Net income | $3,299 | $2,376 | | Weighted average shares outstanding—basic | 10,760 | 10,760 | | Effect of dilutive common stock awards | 280 | 51 | | Weighted average shares outstanding—diluted | 11,040 | 10,811 | | Net income per share—basic | $0.31 | $0.22 | | Net income per share—diluted | $0.30 | $0.22 | | Antidilutive SARs not included | 324 | 725 | [8. Share-based Compensation](index=14&type=section&id=8.%20Share-based%20Compensation) This note details the Company's share-based compensation plans, including the types of awards, vesting conditions, and related expenses - The Company's incentive plan offers various equity and liability awards, with SARs including a performance condition based on Return on Invested Capital (ROIC) goals relative to a peer group, vesting after three years and expiring after five years[59](index=59&type=chunk)[60](index=60&type=chunk) **Share-based Compensation Expense (in thousands):** | Period | Dec 26, 2020 | Dec 28, 2019 | | :-------------------------------- | :----------- | :----------- | | Three Months Ended | $51 | $67 | | Six Months Ended | $114 | $141 | As of December 26, 2020, total unrecognized compensation expense was approximately **$0.4 million**, expected to be recognized over a weighted average period of 2.14 years [9. Commitments and Contingencies](index=14&type=section&id=9.%20Commitments%20and%20Contingencies) This note outlines the Company's legal proceedings, claims, and warranty reserves, assessing their potential financial impact - The Company is involved in ordinary course litigation and claims, which management believes will not have a material adverse effect on financial position, results of operations, or cash flow[63](index=63&type=chunk) - Warranty reserves were **$11,000** as of December 26, 2020, down from **$15,000** as of June 27, 2020[64](index=64&type=chunk) [10. Derivative Financial Instruments](index=14&type=section&id=10.%20Derivative%20Financial%20Instruments) This note describes the Company's use of derivative financial instruments, such as foreign currency forward contracts and interest rate swaps, for hedging purposes - As of December 26, 2020, the Company had **$23.8 million in outstanding foreign currency forward contracts**, maturing through December 2021, to hedge Mexican peso denominated expenses[65](index=65&type=chunk) - No new contracts were entered into during the three or six months ended December 26, 2020, while **$6.3 million and $13.0 million of contracts were settled**, respectively[66](index=66&type=chunk) - Two interest rate swap contracts with Wells Fargo Bank, entered into on November 6, 2019, were terminated on August 14, 2020, due to the new loan agreement with Bank of America[67](index=67&type=chunk) - The liabilities from these terminations (**$148,400 and $776,500**) will be amortized to interest expense over their original terms[68](index=68&type=chunk) **Fair Value of Derivative Instruments (in thousands):** | Derivative Type | Balance Sheet Location | Dec 26, 2020 Fair Value | Jun 27, 2020 Fair Value | | :-------------------------------- | :--------------------- | :---------------------- | :---------------------- | | Foreign currency forward contracts | Other current assets | $4,613 | — | | Foreign currency forward contracts | Other long-term assets | — | $1,097 | | Foreign currency forward contracts | Other current liabilities | — | $(1,960) | | Foreign currency forward contracts | Other long-term liabilities | — | $(17) | | Interest rate swap | Other current liabilities | — | $(347) | | Interest rate swap | Other long-term liabilities | — | $(610) | As of December 26, 2020, the net unrealized gain expected to be reclassified into earnings within the next 12 months is approximately **$3.6 million** [11. Fair Value Measurements](index=17&type=section&id=11.%20Fair%20Value%20Measurements) This note explains how the Company measures the fair value of its financial instruments, categorizing them by input levels (Level 1, 2, or 3) - The Company's foreign currency forward contracts are measured on a recurring basis using Level 2 inputs (observable market data) and are reported as accumulated other comprehensive gain (loss) in shareholders' equity[71](index=71&type=chunk) - The carrying values of cash, receivables, and current liabilities approximate their fair value[72](index=72&type=chunk) **Fair Value of Financial Assets (in thousands):** | Asset Type | Level 1 | Level 2 | Level 3 | Total Fair Value | | :-------------------------------- | :------ | :------ | :------ | :--------------- | | Foreign currency forward contracts (Dec 26, 2020) | — | $4,613 | — | $4,613 | | Foreign currency forward contracts (Jun 27, 2020) | — | $1,097 | — | $1,097 | **Fair Value of Financial Liabilities (in thousands):** | Liability Type | Level 1 | Level 2 | Level 3 | Total Fair Value | | :-------------------------------- | :------ | :------ | :------ | :--------------- | | Interest rate swap (Jun 27, 2020) | — | $(957) | — | $(957) | | Foreign currency forward contracts (Jun 27, 2020) | — | $(1,977) | — | $(1,977) | [12. Revenue](index=17&type=section&id=12.%20Revenue) This note details the Company's revenue recognition policies, including methods for recognizing revenue over time or at a point in time, and disaggregation of revenue by recognition method - The Company recognizes revenue primarily from manufacturing services, with the majority recognized 'over-time' using the input cost-to-cost method for customer-specific products with no alternative use and an enforceable right to payment[74](index=74&type=chunk) - Other contracts recognize revenue 'point-in-time' upon shipment, and engineering services revenue is recognized over time as performed[75](index=75&type=chunk) **Disaggregation of Revenue (in thousands):** | Recognition Method | Three Months Ended Dec 26, 2020 | Three Months Ended Dec 28, 2019 | Six Months Ended Dec 26, 2020 | Six Months Ended Dec 28, 2019 | | :----------------- | :------------------------------ | :------------------------------ | :---------------------------- | :---------------------------- | | Over-Time | $125,534 | $115,118 | $246,370 | $219,144 | | Point-in-Time | $2,728 | $1,604 | $5,099 | $2,863 | | Total | $128,262 | $116,722 | $251,469 | $222,007 | Contract assets decreased from **$23,753 thousand to $22,635 thousand** during the six months ended December 26, 2020[78](index=78&type=chunk)[79](index=79&type=chunk) [13. Leases](index=19&type=section&id=13.%20Leases) This note provides information on the Company's lease arrangements, including lease costs, right-of-use assets, and lease liabilities **Lease Cost (in thousands):** | Lease Cost Type | Three Months Ended Dec 26, 2020 | Six Months Ended Dec 26, 2020 | | :-------------------------------- | :------------------------------ | :---------------------------- | | Operating lease cost (Cost of sales) | $1,137 | $2,301 | | Operating lease cost (SG&A) | $333 | $671 | | Total lease cost | $1,470 | $2,972 | **Operating Lease Balances (Dec 26, 2020, in thousands):** | Metric | Amount | | :-------------------------------- | :----- | | Operating lease right of use assets | $17,672 | | Operating lease liabilities | $17,428 | | Weighted-average remaining lease term | 6.30 years | | Weighted-average discount rate | 4.06% | Future undiscounted lease payments total **$20,071 thousand** [Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations](index=20&type=section&id=Item%202.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) This section provides management's perspective on the Company's financial performance, condition, and future outlook, covering business overview, executive summary, critical accounting policies, and risk analysis [Overview](index=20&type=section&id=Overview) This section introduces Key Tronic as a leading contract manufacturer offering comprehensive design and manufacturing services globally - Key Tronic is a leading contract manufacturer offering design and manufacturing services from facilities in the United States, Mexico, China, and Vietnam, providing full engineering services, materials management, worldwide manufacturing, assembly, in-house testing, and global distribution[84](index=84&type=chunk) - The Company's mission is to deliver superior manufacturing and engineering services at the lowest total cost for high-quality products, fostering long-term relationships through its 'Trust, Commitment, Results' philosophy[86](index=86&type=chunk) [Executive Summary](index=20&type=section&id=Executive%20Summary) This section provides a high-level summary of the Company's recent financial performance, key operational highlights, and significant events **Q2 FY2021 Financial Performance (vs. Q2 FY2020, in millions, except per share):** | Metric | Q2 FY2021 | Q2 FY2020 | Change ($) | Change (%) | | :-------------------------------- | :-------- | :-------- | :--------- | :--------- | | Total Revenue | $128.3 | $116.7 | $11.6 | 9.9% | | Gross Profit % | 8.3% | 7.0% | 1.3 ppt | - | | Operating Income % | 2.1% | 1.3% | 0.8 ppt | - | | Net Income | $1.6 | $0.8 | $0.8 | 100.0% | | Diluted EPS | $0.14 | $0.08 | $0.06 | 75.0% | - Revenue growth was driven by new customer programs and increased demand from existing customers, despite constraints from COVID-19 related shutdowns and labor shortages in Juarez[87](index=87&type=chunk) - The concentration of top three customers' net sales slightly decreased to **35.9%** from **37.0%**[88](index=88&type=chunk) - The Company incurred approximately **$1.8 million in additional COVID-19 related costs** in Q2 FY2021[90](index=90&type=chunk) - An internal investigation concluded improper recording of inventory and cost of goods sold at the Oakdale, MN facility, identifying accounting errors and internal control deficiencies, but no restatement was required, with investigation costs of **$0.7 million** incurred in Q3 FY2021[97](index=97&type=chunk) - The Company maintains a strong balance sheet with a **current ratio of 2.8** and a **debt-to-equity ratio of 0.8** as of December 26, 2020[98](index=98&type=chunk) - Net cash used in operating activities for the six months ended December 26, 2020, was **$16.8 million**, with **$3.1 million available** on the revolving credit facility[98](index=98&type=chunk) [Critical Accounting Policies and Estimates](index=22&type=section&id=Critical%20Accounting%20Policies%20and%20Estimates) This section highlights the accounting policies and estimates that require significant judgment and can materially impact the financial statements - The preparation of financial statements requires significant estimates and assumptions, including revenue recognition, inventory reserves, allowance for doubtful accounts, accrued warranty, income taxes, share-based compensation, impairment of long-lived assets, derivatives and hedging activity, and long-term incentive compensation accrual[100](index=100&type=chunk)[101](index=101&type=chunk)[103](index=103&type=chunk) [Results of Operations (Three Months Ended December 26, 2020 with the Three Months Ended December 28, 2019)](index=23&type=section&id=Results%20of%20Operations%20(Three%20Months%20Ended%20December%2026,%202020%20with%20the%20Three%20Months%20Ended%20December%2028,%202019)) This section analyzes the Company's financial performance for the three months ended December 26, 2020, compared to the same period in the prior year **Q2 FY2021 vs. Q2 FY2020 Performance (in thousands):** | Metric | Dec 26, 2020 | Dec 28, 2019 | Change ($) | Change (%) | | :-------------------------------- | :----------- | :----------- | :--------- | :--------- | | Net sales | $128,262 | $116,722 | $11,540 | 9.9% | | Gross profit | $10,622 | $8,122 | $2,500 | 30.8% | | Gross profit % | 8.3% | 7.0% | 1.3 ppt | - | | RD&E expenses | $2,392 | $1,720 | $672 | 39.1% | | SG&A expenses | $5,510 | $4,904 | $606 | 12.4% | | Operating income | $2,720 | $1,498 | $1,222 | 81.6% | | Interest expense, net | $848 | $524 | $324 | 61.8% | | Net income | $1,580 | $824 | $756 | 91.7% | | Effective income tax rate | 15.6% | 15.4% | 0.2 ppt | - | - Net sales increased due to new program wins and demand, partially offset by COVID-19 related shutdowns and labor shortages in Juarez[107](index=107&type=chunk) - Gross profit percentage improved due to increased revenue and streamlining efforts in the Juarez facility[108](index=108&type=chunk) - RD&E and SG&A expenses increased primarily due to higher payroll, with SG&A partially offset by reduced travel[111](index=111&type=chunk)[112](index=112&type=chunk) - Interest expense rose due to increased debt[113](index=113&type=chunk) - The effective tax rate increased slightly due to foreign currency transactions[114](index=114&type=chunk) [Results of Operations (Six Months Ended December 26, 2020 with the Six Months Ended December 28, 2019)](index=24&type=section&id=Results%20of%20Operations%20(Six%20Months%20Ended%20December%2026,%202020%20with%20the%20Six%20Months%20Ended%20December%2028,%202019)) This section analyzes the Company's financial performance for the six months ended December 26, 2020, compared to the same period in the prior year **H1 FY2021 vs. H1 FY2020 Performance (in thousands):** | Metric | Dec 26, 2020 | Dec 28, 2019 | Change ($) | Change (%) | | :-------------------------------- | :----------- | :----------- | :--------- | :--------- | | Net sales | $251,469 | $222,007 | $29,462 | 13.3% | | Gross profit | $20,637 | $17,395 | $3,242 | 18.6% | | Gross profit % | 8.2% | 7.8% | 0.4 ppt | - | | RD&E expenses | $4,637 | $3,380 | $1,257 | 37.2% | | SG&A expenses | $10,484 | $9,978 | $506 | 5.1% | | Operating income | $5,516 | $4,037 | $1,479 | 36.6% | | Interest expense, net | $1,529 | $1,234 | $295 | 23.9% | | Net income | $3,299 | $2,376 | $923 | 38.8% | | Effective income tax rate | 17.3% | 15.2% | 2.1 ppt | - | - Net sales increased due to successful ramp of new customer programs and increased demand, despite COVID-19 related constraints[118](index=118&type=chunk) - Gross profit percentage improved primarily due to streamlining efforts in Juarez facilities[119](index=119&type=chunk) - Provision for obsolete inventory increased significantly to **$446,000** from **$41,000**[120](index=120&type=chunk) - RD&E expenses increased due to engineering payroll[121](index=121&type=chunk) - SG&A expenses increased due to employee-related costs, partially offset by reduced travel[122](index=122&type=chunk) - Interest expense increased due to a higher average balance on the line of credit[123](index=123&type=chunk) - The effective tax rate increased due to foreign currency transactions[124](index=124&type=chunk) [BACKLOG](index=25&type=section&id=BACKLOG) This section provides information on the Company's order backlog, including its value and the factors influencing its changes **Order Backlog (in millions):** | Date | Amount | | :---------------- | :----- | | Dec 26, 2020 | $218.7 | | Dec 28, 2019 | $145.5 | The increase in backlog was primarily due to increased demand for home-consumer products, healthcare, and home exercise equipment, influenced by the COVID-19 pandemic. Backlog consists of purchase orders expected to ship within 12 months but is not an accurate measure of future net sales [CAPITAL RESOURCES AND LIQUIDITY](index=26&type=section&id=CAPITAL%20RESOURCES%20AND%20LIQUIDITY) This section discusses the Company's sources of capital and its ability to meet short-term and long-term financial obligations **Cash Flow Summary (Six Months Ended, in millions):** | Activity | Dec 26, 2020 | Dec 28, 2019 | Change ($) | | :-------------------------------- | :----------- | :----------- | :--------- | | Net cash used in operating activities | $(16.8) | $(8.4) | $(8.4) | | Net cash used in investing activities | $(7.0) | $(2.0) | $(5.0) | | Net cash provided by financing activities | $28.2 | $10.3 | $17.9 | Operating cash flow usage increased due to higher accounts receivable (no factoring in H1 FY2021 vs. **$35.0 million factored** in H1 FY2020), increased inventory, and decreased accounts payable[127](index=127&type=chunk)[128](index=128&type=chunk)[129](index=129&type=chunk) - Cash used in investing activities increased due to equipment purchases for new programs[130](index=130&type=chunk) - Cash provided by financing activities increased due to higher borrowings under the revolving line of credit and term loans[132](index=132&type=chunk) - As of December 26, 2020, **$3.1 million was available** under the revolving credit facility, down from **$22.6 million** in the prior year[133](index=133&type=chunk) - The Company believes projected cash from operations, revolving credit, and leasing will meet future capital requirements[134](index=134&type=chunk) - Repatriation of **$1.3 million cash** held by foreign subsidiaries as of December 26, 2020, would incur approximately **$83,000 in withholding taxes**[134](index=134&type=chunk) [Off-Balance Sheet Arrangements and Contractual Obligations](index=27&type=section&id=Off-Balance%20Sheet%20Arrangements%20and%20Contractual%20Obligations) This section discloses any material off-balance sheet arrangements and changes to contractual obligations since the last annual report - There have been no material changes in contractual obligations outside the ordinary course of business since June 27, 2020[135](index=135&type=chunk) - A summary of contractual obligations was included in the annual report on Form 10-K for fiscal year ended June 27, 2020[135](index=135&type=chunk) [Risks and Uncertainties That May Affect Future Results](index=27&type=section&id=Risks%20and%20Uncertainties%20That%20May%20Affect%20Future%20Results) This section identifies various factors that could adversely impact the Company's financial performance and operations - Operations in Mexico, China, and Vietnam are subject to risks including staffing difficulties, political/economic instability, regulatory changes, longer payment cycles, trade barriers, governmental fund transfer restrictions, natural disasters, and potential COVID-19 related closures/labor constraints[137](index=137&type=chunk)[141](index=141&type=chunk) - Quarterly results can fluctuate due to macroeconomic conditions, customer demand volatility, new program timing, pricing, and material costs[139](index=139&type=chunk) - Dependence on a small number of customers and limited suppliers for critical components poses significant risks, including order reductions, cancellations, and supply shortages, exacerbated by COVID-19[145](index=145&type=chunk)[147](index=147&type=chunk)[148](index=148&type=chunk) - Other risks include intense industry competition, credit risk concentration, ability to secure/maintain credit arrangements, foreign currency exchange rate fluctuations (especially with COVID-19 impacts on hedging), reliance on key personnel, maintaining technological expertise, start-up costs for new programs, interest rate changes, environmental compliance, stock price volatility, and potential disruptions to information systems[149](index=149&type=chunk)[150](index=150&type=chunk)[151](index=151&type=chunk)[152](index=152&type=chunk)[153](index=153&type=chunk)[154](index=154&type=chunk)[155](index=155&type=chunk)[157](index=157&type=chunk)[160](index=160&type=chunk)[161](index=161&type=chunk)[162](index=162&type=chunk)[174](index=174&type=chunk) [Item 3. Quantitative and Qualitative Disclosures about Market Risk](index=34&type=section&id=Item%203.%20Quantitative%20and%20Qualitative%20Disclosures%20about%20Market%20Risk) This section details the Company's exposure to market risks, primarily focusing on interest rate risk and foreign currency exchange risk, and how these risks are managed - The Company is exposed to interest rate risk from its asset-based senior secured revolving credit facility and equipment financing facilities, which have fluctuating LIBOR-based interest rates[183](index=183&type=chunk) - As of December 26, 2020, **$89.9 million was outstanding** on the revolving credit facility and **$10.7 million** on equipment financing[183](index=183&type=chunk) - Foreign currency exchange risk arises from operations in Mexico, China, and Vietnam, with the Company using Mexican peso forward contracts to hedge a portion of its Mexican peso denominated expenses[184](index=184&type=chunk) - As of December 26, 2020, **$23.8 million in foreign currency forward contracts** were outstanding with a fair value of **$4.6 million**[184](index=184&type=chunk) [Item 4. Controls and Procedures](index=34&type=section&id=Item%204.%20Controls%20and%20Procedures) This section addresses the effectiveness of the Company's disclosure controls and internal control over financial reporting, identifying a material weakness related to inventory accounting and outlining remedial actions - Management concluded that the Company's disclosure controls and procedures were not effective as of December 26, 2020, due to a material weakness in internal control over financial reporting[186](index=186&type=chunk) - This weakness stemmed from improperly recorded inventory and cost of goods sold at the Oakdale, MN facility, resulting from accounting errors and deficiencies in controls over inventory accounting and monitoring activities[188](index=188&type=chunk) - Despite the material weakness, management asserts that the condensed consolidated financial statements in this Form 10-Q fairly present the Company's financial position, results of operations, and cash flows in conformity with U.S. GAAP[186](index=186&type=chunk) - Remedial actions include implementing additional review levels for significant balance sheet accounts, analyzing inventory balances and revenue, reviewing manual journal entries, system upgrades for inventory cost determination, changes in finance/accounting reporting structures, and enhanced training and monitoring controls for inventory accounting at domestic facilities[190](index=190&type=chunk) PART II. OTHER INFORMATION [Item 1. Legal Proceedings](index=36&type=section&id=Item%201.%20Legal%20Proceedings) This section states that the Company is involved in various legal actions in the ordinary course of business, which management believes will not materially impact its financial position, results of operations, or cash flows - The Company is party to certain lawsuits or claims in the ordinary course of business, which management does not believe will have a material adverse effect on its consolidated financial position, results of operations, or cash flows[194](index=194&type=chunk) [Item 1A. Risk Factors](index=36&type=section&id=Item%201A.%20Risk%20Factors) This section refers to the risk factors discussed in Item 2 (MD&A) and Item 3 (Market Risk) of this Form 10-Q, and highlights two new material risk factors identified since the last annual report - Information regarding risk factors is primarily found in Item 2, 'Management's Discussion and Analysis of Financial Condition and Results of Operations' and Item 3, 'Quantitative and Qualitative Disclosures about Market Risk' of this Form 10-Q[195](index=195&type=chunk) - Two new risk factors have been added: (1) the identified material weakness in internal control over financial reporting and the potential adverse impact if not remediated, and (2) risks associated with the Audit Committee's internal investigation, including expenses, diversion of resources, regulatory investigations, and litigation[196](index=196&type=chunk) [Item 6. Exhibits](index=36&type=section&id=Item%206.%20Exhibits) This section lists the exhibits filed with the Form 10-Q, including certifications from the CEO and CFO, and Inline XBRL documents - Exhibits include certifications of the Chief Executive Officer and Chief Financial Officer (pursuant to Exchange Act Rules 13(a)-14, 15(d)-14, and 18 U.S.C. 1350), and various Inline XBRL taxonomy extension documents[196](index=196&type=chunk) [Signatures](index=37&type=section&id=Signatures) This section contains the official signatures of the Company's authorized officers, confirming the submission of the report - The report is signed by Craig D. Gates, President and Chief Executive Officer (Principal Executive Officer), and Brett R. Larsen, Executive Vice President of Administration, Chief Financial Officer and Treasurer (Principal Financial Officer), both dated July 6, 2021[200](index=200&type=chunk)