Key Tronic(KTCC) - 2023 Q2 - Quarterly Report

PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) This section presents Key Tronic Corporation's unaudited condensed consolidated financial statements and accompanying notes Condensed Consolidated Balance Sheets | Metric | December 31, 2022 (in thousands) | July 2, 2022 (in thousands) | | :--------------------------------- | :------------------------------- | :-------------------------- | | Cash and cash equivalents | $810 | $1,707 | | Trade receivables, net | $134,290 | $135,876 | | Inventories | $171,749 | $155,741 | | Total current assets | $361,647 | $340,008 | | Total assets | $430,248 | $406,923 | | Accounts payable | $140,704 | $121,393 | | Total current liabilities | $173,469 | $163,667 | | Total liabilities | $302,937 | $282,045 | | Total shareholders' equity | $127,311 | $124,878 | - Total assets increased by $23.3 million from July 2, 2022, to December 31, 2022, primarily driven by increases in inventories and contract assets[9] - Total liabilities increased by $20.89 million, mainly due to higher accounts payable and revolving loan balances[9] Condensed Consolidated Statements of Income | Metric (in thousands) | Three Months Ended Dec 31, 2022 | Three Months Ended Jan 1, 2022 | Six Months Ended Dec 31, 2022 | Six Months Ended Jan 1, 2022 | | :-------------------- | :------------------------------ | :----------------------------- | :---------------------------- | :--------------------------- | | Net sales | $123,708 | $134,456 | $260,971 | $267,218 | | Gross profit | $8,920 | $9,808 | $19,299 | $19,946 | | Operating income | $3,608 | $1,651 | $6,969 | $3,745 | | Net income | $967 | $587 | $2,119 | $1,402 | | Net income per share—Basic | $0.09 | $0.05 | $0.20 | $0.13 | - Net sales decreased by 8.0% for the three months ended December 31, 2022, compared to the prior year, and by 2.3% for the six months ended December 31, 2022[11] - Operating income significantly increased for both periods, driven by a gain on insurance proceeds[11] Condensed Consolidated Statements of Comprehensive Income | Metric (in thousands) | Three Months Ended Dec 31, 2022 | Three Months Ended Jan 1, 2022 | Six Months Ended Dec 31, 2022 | Six Months Ended Jan 1, 2022 | | :-------------------- | :------------------------------ | :----------------------------- | :---------------------------- | :--------------------------- | | Net income | $967 | $587 | $2,119 | $1,402 | | Unrealized gain (loss) on hedging instruments, net of tax | $59 | $(1,084) | $212 | $(2,615) | | Comprehensive income (loss) | $1,026 | $(497) | $2,331 | $(1,213) | - Comprehensive income improved significantly, moving from a loss of $(497) thousand in the prior year to a gain of $1,026 thousand for the three months ended December 31, 2022, primarily due to an unrealized gain on hedging instruments[14] Condensed Consolidated Statements of Cash Flows | Metric (in thousands) | Six Months Ended Dec 31, 2022 | Six Months Ended Jan 1, 2022 | | :-------------------- | :---------------------------- | :--------------------------- | | Net income | $2,119 | $1,402 | | Cash used in operating activities | $(10,031) | $(10,528) | | Cash used in investing activities | $(359) | $(2,764) | | Cash provided by financing activities | $9,493 | $10,865 | | Net decrease in cash and cash equivalents | $(897) | $(2,427) | | Cash and cash equivalents, end of period | $810 | $1,046 | - Net cash used in operating activities slightly decreased to $10.0 million for the six months ended December 31, 2022, from $10.5 million in the prior year, primarily due to changes in working capital components[18][124] - Cash used in investing activities significantly decreased to $0.4 million, largely due to proceeds from insurance recoveries[18][128] Condensed Consolidated Statements of Shareholders' Equity | Metric (in thousands) | Dec 31, 2022 (6 months) | Jan 1, 2022 (6 months) | | :-------------------- | :---------------------- | :--------------------- | | Total shareholders' equity, beginning balances | $124,878 | $123,705 | | Net income | $2,119 | $1,402 | | Unrealized gain (loss) on hedging instruments, net | $212 | $(2,615) | | Total shareholders' equity, ending balances | $127,311 | $122,635 | - Total shareholders' equity increased to $127.3 million as of December 31, 2022, from $124.9 million at the beginning of the six-month period, driven by net income and an unrealized gain on hedging instruments[20] Notes to Condensed Consolidated Financial Statements Note 1. Basis of Presentation - The financial statements are unaudited and prepared in accordance with SEC rules, with certain information condensed or omitted compared to annual statements[23] - The Company's fiscal year is 52/53 weeks, ending on the Saturday closest to June 30. The reported periods (three and six months ended December 31, 2022, and January 1, 2022) were both 13-week periods[24] - The COVID-19 pandemic has caused extreme shifts in demand, supply chain, and logistics risks, potentially impacting operating results due to closures, demand fluctuations, freight costs, labor shortages, and currency exchange fluctuations[25] Note 2. Significant Accounting Policies - Certain prior period reclassifications were made for presentation conformity, with no effect on reported income, comprehensive income, cash flows, total assets, or shareholders' equity[26] - The Company uses foreign currency forward contracts as cash flow hedges to manage variability of foreign currency fluctuations for expenses in its Mexico facilities, with no ineffectiveness recorded[28][29] - 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 ASU 2016-13 effective in Q1 FY2024[34][35][36] Note 3. Inventories | Metric | December 31, 2022 (in millions) | July 2, 2022 (in millions) | | :--------- | :------------------------------ | :------------------------- | | Inventories | $171.7 | $155.7 | - Inventories increased by $16.0 million from July 2, 2022, to December 31, 2022, with substantially all balances being raw materials[37] Note 4. Long-Term Debt - As of December 31, 2022, the Company had an outstanding balance of $107.6 million under its $120 million asset-based revolving credit facility with Bank of America, with $1.8 million available for future borrowings[38] - An amendment to the loan agreement on August 26, 2022, removed the cash flow leverage ratio covenant and increased the interest rate by 25 basis points[39] | Debt Type | Interest Rate Range (Dec 31, 2022) | Interest Rate Range (Jul 2, 2022) | | :-------------------- | :--------------------------------- | :-------------------------------- | | Outstanding Debt | 4.85% - 7.44% | 3.25% - 5.52% | Debt Maturities as of December 31, 2022 (in thousands): | Fiscal Years Ending | Amount | | :------------------ | :----- | | 2023 (remaining 6 months) | $1,101 | | 2024 | $2,239 | | 2025 | $2,290 | | 2026 | $1,187 | | 2027 | $110,130 | | Total debt | $116,947 | - The Company was in compliance with all financial covenants, including a fixed charge coverage ratio, as of December 31, 2022[45] Note 5. Income Taxes - The Company expects to repatriate approximately $8.1 million of foreign earnings in the future, which may incur approximately $0.8 million in withholding taxes from China[46][47] - As of December 31, 2022, the Company has $10.8 million in gross federal research and development tax credits, with $3.1 million recorded as unrecognized tax benefits, resulting in a net deferred tax benefit of $7.7 million[48] - The Inflation Reduction Act of 2022 is being evaluated, but the Company does not currently believe it will have a material impact on its financial position, results of operations, or cash flows[49] Note 6. Earnings Per Share EPS Reconciliation (in thousands, except per share): | Metric | Three Months Ended Dec 31, 2022 | Three Months Ended Jan 1, 2022 | Six Months Ended Dec 31, 2022 | Six Months Ended Jan 1, 2022 | | :--------------------------------------- | :------------------------------ | :----------------------------- | :---------------------------- | :--------------------------- | | Net income | $967 | $587 | $2,119 | $1,402 | | Weighted average shares outstanding—basic | 10,762 | 10,762 | 10,762 | 10,762 | | Effect of dilutive common stock awards | 70 | 295 | 70 | 293 | | Weighted average shares outstanding—diluted | 10,832 | 11,057 | 10,832 | 11,055 | | Net income per share—basic | $0.09 | $0.05 | $0.20 | $0.13 | | Net income per share—diluted | $0.09 | $0.05 | $0.20 | $0.13 | | Antidilutive SARs not included | 904 | 629 | 904 | 619 | Note 7. Share-based Compensation - The Company's incentive plan offers various equity and liability awards, including SARs with performance conditions based on Return on Invested Capital (ROIC) goals[54][55] Share-based Compensation Expense (in thousands): | Period | December 31, 2022 | January 1, 2022 | | :-------------------- | :---------------- | :-------------- | | Three Months Ended | $62 | $75 | | Six Months Ended | $102 | $143 | - As of December 31, 2022, total unrecognized compensation expense related to unvested share-based compensation was approximately $0.5 million, expected to be recognized over a weighted average period of 1.96 years[57] Note 8. Commitments and Contingencies - The Company is involved in ordinary course lawsuits and claims, which management believes will not have a material adverse effect on financial position, results of operations, or cash flow[58] Warranty Reserve (in thousands): | Date | Amount | | :---------------- | :----- | | December 31, 2022 | $83 | | July 2, 2022 | $31 | - The Company recorded a gain from insurance recoveries, net of losses, of $2.7 million and $3.6 million for the three and six months ended December 31, 2022, respectively, due to storm damage at its Arkansas facility[61] Note 9. Derivative Financial Instruments - As of December 31, 2022, the Company had no outstanding foreign currency forward contracts and did not enter into or settle any during the three and six months ended December 31, 2022[63][64] - Previous interest rate swap contracts related to Wells Fargo Bank borrowings were terminated in August 2020 and their liability positions are being amortized to interest expense[65][66] Gain (Loss) on Derivative Instruments, Net of Tax (in thousands): | Period | Unrealized gain (loss) on hedging instruments, net | | :-------------------- | :----------------------------------------------- | | Three Months Ended Dec 31, 2022 | $59 | | Six Months Ended Dec 31, 2022 | $212 | Note 10. Revenue - For the majority of contracts, revenue is recognized 'over-time' using the input cost-to-cost method due to the unique nature of customer-specific products and enforceable right to payment[70] Contract Assets Activity (in thousands) for Six Months Ended December 31, 2022: | Metric | Amount | | :-------------------------- | :----- | | Beginning balance, July 2, 2022 | $21,974 | | Revenue recognized | $254,207 | | Amounts collected or invoiced | $(247,852) | | Ending balance, December 31, 2022 | $28,329 | Disaggregation of Revenue (in thousands): | Recognition Method | Three Months Ended Dec 31, 2022 | Three Months Ended Jan 1, 2022 | Six Months Ended Dec 31, 2022 | Six Months Ended Jan 1, 2022 | | :----------------- | :------------------------------ | :----------------------------- | :---------------------------- | :--------------------------- | | Over-Time | $119,649 | $128,126 | $254,207 | $257,607 | | Point-in-Time | $4,059 | $6,330 | $6,764 | $9,611 | | Total | $123,708 | $134,456 | $260,971 | $267,218 | Note 11. Leases Total Lease Cost (in thousands): | Period | December 31, 2022 | January 1, 2022 | | :-------------------- | :---------------- | :-------------- | | Three Months Ended | $4,744 | $2,482 | | Six Months Ended | $7,200 | $4,667 | Lease Balances as of December 31, 2022 (in thousands): | Metric | Operating Leases | Financing Leases | | :-------------------------------- | :--------------- | :--------------- | | Right of Use Assets | $18,652 | $10,258 | | Lease Liabilities | $18,652 | $9,006 | | Weighted-average remaining lease term (years) | 4.84 | 2.08 | | Weighted-average discount rate | 4.0% | 8.8% | Future Undiscounted Lease Payments as of December 31, 2022 (in thousands): | Fiscal Years Ending | Operating Leases | Finance Leases | | :------------------ | :--------------- | :------------- | | 2023 (remaining 6 months) | $2,877 | $2,607 | | 2024 | $5,048 | $3,960 | | 2025 | $3,987 | $2,539 | | 2026 | $3,365 | $107 | | 2027 | $2,464 | $71 | | Thereafter | $3,240 | — | | Total undiscounted lease payments | $20,981 | $9,284 | Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the Company's financial performance, condition, and operations, including policies and risks Overview - Key Tronic is a leading contract manufacturer offering design and manufacturing services from facilities in the United States, Mexico, China, and Vietnam[84] - The Company provides full engineering services, materials management, worldwide manufacturing, assembly, in-house testing, and global distribution[84] - The mission is to provide superior manufacturing and engineering services at the lowest total cost for the highest quality products, fostering long-term mutually beneficial business relationships[86] Executive Summary Q2 Fiscal Year 2023 Financial Highlights (in millions, except EPS): | Metric | Q2 FY23 | Q2 FY22 | Change (%) | | :-------------------- | :------ | :------ | :--------- | | Total Revenue | $123.7 | $134.5 | (8.0)% | | Gross Profit % | 7.2% | 7.3% | (0.1) pp | | Operating Income % | 2.9% | 1.2% | 1.7 pp | | Net Income | $1.0 | $0.6 | 66.7% | | Diluted EPS | $0.09 | $0.05 | 80.0% | - Revenue was delayed by approximately $20 million in Q2 FY23 due to a six-week delay in starting production for a large power equipment program, though production is now increasing in Q3[87][104] - The concentration of net sales from the top three customers decreased to 27.7% in Q2 FY23 from 33.3% in the prior year, with expectations for further decrease[88] - Operating income and net income improved significantly, primarily driven by a $2.7 million gain on insurance claims related to storm damage[91][92] - New programs were won in outdoor power equipment, battery management, automated sprinklers, and biometric sensor technology[93] - 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 December 31, 2022, with sufficient liquidity[95] Critical Accounting Policies and Estimates - Preparation of financial statements requires significant estimates and assumptions that affect reported amounts[97] - Revenue Recognition - Inactive, Obsolete, and Surplus Inventory Valuation - Allowance for Doubtful Accounts - Income Taxes Results of Operations Comparison of the Three Months Ended December 31, 2022 with the Three Months Ended January 1, 2022 Three Months Ended Financial Performance (in thousands): | Metric | Dec 31, 2022 | Jan 1, 2022 | $ Change | % Point Change | | :-------------------------------- | :----------- | :---------- | :------- | :------------- | | Net sales | $123,708 | $134,456 | $(10,748) | — % | | Gross profit | $8,920 | $9,808 | $(888) | (0.1)% | | Research, development and engineering | $2,287 | $2,498 | $(211) | (0.1)% | | Selling, general and administrative | $5,735 | $5,659 | $76 | 0.4 % | | Gain on insurance proceeds, net of losses | $(2,710) | — | $(2,710) | (2.2)% | | Operating income | $3,608 | $1,651 | $1,957 | 1.7 % | | Interest expense, net | $2,507 | $1,095 | $1,412 | 1.2 % | | Income before income taxes | $1,101 | $556 | $545 | 0.5 % | | Income tax provision | $134 | $(31) | $165 | 0.1 % | | Net income | $967 | $587 | $380 | 0.4 % | - Net sales decreased by $10.7 million (8.0%) primarily due to a six-week delay in a large power equipment program, which delayed approximately $20 million in revenue[103][104] - Gross profit percentage slightly decreased from 7.3% to 7.2% due to business interruption from storm damage, preparations for sales growth, and increased labor costs[105] - Operating income increased by $1.96 million, largely driven by a $2.7 million gain on insurance proceeds[102][108] - Interest expense increased by $1.4 million due to higher interest rates and an increased average balance on the line of credit[110] Comparison of the Six Months Ended December 31, 2022 with the Six Months Ended January 1, 2022 Six Months Ended Financial Performance (in thousands): | Metric | Dec 31, 2022 | Jan 1, 2022 | $ Change | % Point Change | | :-------------------------------- | :----------- | :---------- | :------- | :------------- | | Net sales | $260,971 | $267,218 | $(6,247) | — % | | Cost of sales | $241,672 | $247,272 | $(5,600) | 0.1 % | | Gross profit | $19,299 | $19,946 | $(647) | (0.1)% | | Research, development and engineering | $4,583 | $4,947 | $(364) | (0.1)% | | Selling, general and administrative | $11,391 | $11,254 | $137 | 0.2 % | | Gain on insurance proceeds, net of losses | $(3,644) | — | $(3,644) | (1.4)% | | Operating income | $6,969 | $3,745 | $3,224 | 1.3 % | | Interest expense, net | $4,394 | $2,087 | $2,307 | 0.9 % | | Income before income taxes | $2,575 | $1,658 | $917 | 0.4 % | | Income tax provision | $456 | $256 | $200 | 0.1 % | | Net income | $2,119 | $1,402 | $717 | 0.3 % | - Net sales decreased by $6.2 million (2.3%) due to the delayed power equipment program, partially offset by successful ramp-up of new customer programs in Q1 FY23[114][115] - Gross profit percentage slightly decreased from 7.5% to 7.4% due to storm damage, preparations for sales growth, and increased labor costs[116] - Operating income increased by $3.2 million, significantly influenced by a $3.6 million gain on insurance proceeds[113] - Interest expense increased by $2.3 million due to higher interest rates and an increased average balance on the line of credit[121] Backlog Order Backlog (in millions): | Date | Amount | | :---------------- | :----- | | December 31, 2022 | $404.0 | | January 1, 2022 | $333.1 | - The increase in order backlog is attributed to increased demand and ongoing supply chain issues causing production delays[123] - Order backlog consists of purchase orders expected to ship within 12 months but is not an accurate measure of future net sales due to potential changes in shipment dates[123] Capital Resources and Liquidity Net Cash Flow (in millions): | Activity | Six Months Ended Dec 31, 2022 | Six Months Ended Jan 1, 2022 | | :-------------------- | :---------------------------- | :--------------------------- | | Operating activities | $(10.0) | $(10.5) | | Investing activities | $(0.4) | $(2.8) | | Financing activities | $9.5 | $10.9 | - Cash used in operating activities was primarily driven by increases in inventory and accounts receivable, partially offset by increases in accounts payable and other liabilities[125] - Cash used in investing activities decreased due to proceeds from insurance, while financing activities were mainly borrowings and repayments under the revolving line of credit[128][130] - The Company believes projected cash from operations, available revolving credit, and leasing capabilities will meet future working and fixed capital requirements, despite anticipated slowdowns in collections and increasing inventory[132] - Approximately $1.3 million of cash was held by foreign subsidiaries as of December 31, 2022, with potential withholding taxes of $32,000 for repatriation[133] Off-Balance Sheet Arrangements and Contractual Obligations - There have been no material changes in contractual obligations outside the ordinary course of business since July 2, 2022[134] Risks and Uncertainties That May Affect Future Results Risks Related to Our Business and Strategy - International operations in Mexico, China, and Vietnam are subject to risks including political/economic instability, regulatory changes, longer payment cycles, trade barriers, and natural disasters - Loss of tax incentives in foreign locations or restrictions on cash transfers could increase taxes or incur penalties - Quarterly operating results may fluctuate due to macroeconomic conditions, customer demand volatility, new program timing, and changes in pricing or material costs - Dependence on a small number of customers means a decline in sales from any major customer could materially affect the business - Reliance on a limited number of suppliers for critical components exposes the Company to supply shortages and price increases, potentially disrupting operations - The highly competitive contract manufacturing industry could lead to price reductions, reduced margins, and loss of market share - Fluctuations in foreign currency exchange rates, particularly the Mexican peso and Chinese renminbi, could increase operating costs, with current hedging only for Mexican peso expenses Technology Risks - Operations are subject to cyberattacks, which could lead to data breaches, operational disruptions, and increased costs - Disruptions to information systems, including outages or data loss, could adversely affect operations - Failure to maintain technological and manufacturing process expertise in a rapidly changing industry could harm the business Risks Related to Capital and Financing - Cash and cash equivalents are exposed to concentrations of credit risk with high credit quality institutions - Ability to secure and maintain sufficient credit arrangements is crucial; failure to renew or meet covenants could lead to immediate debt repayment - Adverse changes in interest rates for borrowings, particularly the revolving line of credit and term loan, could negatively affect financial condition, especially with the transition away from LIBOR - The Company's stock price is volatile and subject to wide fluctuations due to various factors, including operating results, market conditions, and internal investigations Risks Related to Our Controls and Procedures and the Internal Investigation - A previously identified material weakness in internal control over financial reporting, though remediated, poses a risk if future deficiencies arise, potentially leading to misstatements or restatements - Matters related to the Audit Committee's internal investigation, including expenses, diversion of resources, regulatory investigations (SEC), and potential litigation, could adversely affect the business and financial condition - Inherent limitations in control systems mean there is no absolute assurance against errors, theft, or fraud, or timely reporting of all material information Legal and Accounting Risks - Involvement in various legal proceedings could result in substantial costs and diversion of resources, even for claims without merit - Changes in securities laws and regulations (e.g., Sarbanes-Oxley, Dodd-Frank) increase compliance costs and the risk of noncompliance - Changes in financial accounting standards (U.S. GAAP, FASB, SEC) may affect reported financial condition or results of operations and increase implementation costs General Risks - Insurance coverage levels may be insufficient for potential damages, claims, or losses, potentially negatively impacting net income - Complications with acquisitions, including financing, integration difficulties, loss of key personnel/customers, and exposure to unanticipated liabilities, could harm the business Item 3. Quantitative and Qualitative Disclosures About Market Risk This section details the Company's exposure to and management of market risks, including interest rate and foreign currency exchange risks - The Company is exposed to interest rate risk on its secured debt, including a $107.6 million asset-based senior secured revolving credit facility and $7.8 million in equipment financing facilities, which fluctuate with LIBOR rates[185] - Foreign currency exchange risk arises from operations in Mexico and China, where transactions occur in currencies other than the U.S. dollar. The Company uses Mexican peso forward contracts to hedge a portion of Mexican peso denominated expenses but had no outstanding contracts as of December 31, 2022[186] Item 4. Controls and Procedures This section reports on the evaluation of disclosure controls and procedures and internal control changes - Management, under the supervision of the CEO and CFO, evaluated the effectiveness of disclosure controls and procedures and concluded they were effective as of December 31, 2022[187][188] - There have been no significant changes in internal controls over financial reporting during the three months ended December 31, 2022, that materially affected or are reasonably likely to materially affect them[189] PART II. OTHER INFORMATION Item 1. Legal Proceedings This section addresses the Company's involvement in legal actions arising in the ordinary course of business - The Company is involved in various legal actions in the ordinary course of business, which management believes will not have a material adverse effect on its consolidated financial position, results of operations, or cash flows[190] Item 1A. Risk Factors This section refers to risk factors that could affect the Company's future results, as detailed elsewhere in the report - Information regarding risk factors is presented 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[191] - 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 2, 2022[191] Item 6. Exhibits This section lists all exhibits filed as part of the Form 10-Q, including corporate documents, certifications, and XBRL data - 3.1 Articles of Incorporation - 3.2 Bylaws, as amended - 31.1 Certification of Chief Executive Officer - 31.2 Certification of Chief Financial Officer - 32.1 Certification of Chief Executive Officer (18 U.S.C. 1350) - 32.2 Certification of Chief Financial Officer (18 U.S.C. 1350) - 101.INS Inline XBRL Instance Document - 101.SCH Inline XBRL Taxonomy Extension Schema Document - 101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase Document - 101.DEF Inline XBRL Taxonomy Extension Definition Linkbase Document - 101.LAB Inline XBRL Taxonomy Extension Label Linkbase Document - 101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase Document - 104 Cover Page Interactive Data File Signatures This section contains the official signatures of the Company's authorized executive officers, certifying the report filing - The report is duly signed by Craig D. Gates, President and Chief Executive Officer, and Brett R. Larsen, Executive Vice President of Administration, Chief Financial Officer and Treasurer, on February 9, 2023[195][197]