What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-02-09 compared with 2022-11-09 · 94 added, 57 removed, 335 unchanged (31% of the section changed)

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Executive Summary

For the first quarter of fiscal year 2023, the Company reported total revenue of $137.3 million, up 3.4% from $132.8 million in the same period of fiscal year 2022.

During the first quarter of fiscal year 2023, the Company ramped up new programs from both longstanding and new customers.

While constraints in the global supply chain continued to limit production, the Company saw some gradual improvements with respect to lead times of certain key components.

As new customer programs ramp the concentration of our top three customers’ net sales decreased to 25.4 percent of total sales in the first quarter of fiscal year 2023 from 33.0 percent in the same period of the prior fiscal year.

For the second quarter of fiscal year 2023, the Company reported total revenue of $123.7 million, down (8.0)% from $134.5 million in the same period of fiscal year 2022.

During the second quarter of fiscal year 2023, the Company experienced a six-week delay in starting production for a large program with a leading power equipment company.

This delayed revenue by approximately $20 million from the second quarter of fiscal 2023, but production for this program is currently underway and increasing in the third quarter.

In addition, while constraints in the global supply chain continued to limit production, the Company continues to see gradual improvements with respect to lead times of certain key components.

As new customer programs ramp the concentration of our top three customers’ net sales decreased to 27.7 percent of total sales in the second quarter of fiscal year 2023 from 33.3 percent in the same period of the prior fiscal year.

We expect that concentration to our top three customers will continue to decrease during the fiscal year.

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In addition, our capacity and core competencies for printed circuit board assemblies, precision molding, sheet metal fabrication, tool making, assembly, and engineering can be applied to a wide variety of products.

Gross profit as a percent of net sales was 7.6 percent for the first quarter of fiscal year 2023 as compared to 7.6 percent for the same quarter of the prior fiscal year.

During the first quarter of fiscal year 2023, the results were impacted by storm damage to the Company’s facilities in Arkansas, which reduced revenue and gross profit.

Key Tronic has received initial insurance proceeds to repair the plant and replace equipment, which should be completed by the second half of fiscal year 2023, and these initial coverage amounts, net of equipment book value loss, are included in reported gain on insurance claims during the quarter.

In addition, the global supply chain and transportation issues continued to disrupt production, along with increased costs associated to ramping new programs.

Operating income as a percentage of net sales was 2.4 percent for the first quarter of fiscal year 2023 compared to 1.6 percent of operating income as a percentage of net sales for the first quarter of fiscal year 2022.

Gross profit as a percent of net sales was 7.2 percent for the second quarter of fiscal year 2023 as compared to 7.3 percent for the same quarter of the prior fiscal year.

During the second quarter of fiscal year 2023, the results were adversely impacted by business interruption and other operational losses related to storm damage to our Arkansas facility as well as increased labor costs.

Further, the global supply chain and transportation issues continued to disrupt production, along with increased costs associated to ramping up new programs.

Operating income as a percentage of net sales was 2.9 percent for the second quarter of fiscal year 2023 compared to 1.2 percent of operating income as a percentage of net sales for the second quarter of fiscal year 2022.

The increase in operating income as a percentage of net sales was primarily driven by the reported gain on insurance claim during the quarter.

Net income for the first quarter of fiscal year 2023 was $1.2 million or $0.11 per diluted share, as compared to net income of $0.8 million or $0.07 per diluted share for the first quarter of fiscal year 2022.

Net income for the first quarter of fiscal year 2023 improved based on the increase in operating income generated by the gains on insurance claim of $0.9 million and increased revenue during the quarter when compared to the results to first quarter of fiscal 2022.

During the first quarter of fiscal year 2023, we won new programs involving audio, automation, electric vehicle, and power distribution equipment.

Moving into the second quarter of fiscal 2023, global logistics problems, the war in Europe, and China-US geopolitical tensions continue to drive OEM’s to examine their traditional outsourcing strategies.

We believe we are well positioned to benefit from this growing demand.

We have experienced shortages in electronic components used in our products.

These shortages can result from strong demand for those components or from problems experienced by suppliers, such as shortages of raw materials.

We have also experienced, and expect to continue to experience, such shortages and shutdowns due to the effects of the recent pandemic.

These unanticipated component shortages have resulted and could continue to result in curtailed production or delays in production, which may prevent us from timely satisfying our performance obligations with our customers.

Our inability to satisfy these performance obligations could cause us to experience a reduction in sales, increase in inventory levels and costs, and could adversely affect our operating results.

We are carefully monitoring potential supply chain disruptions due to ongoing tightness in the overall component environment and are working to mitigate supply chain constraint risks.

We maintain a strong balance sheet with a current ratio of 2.1 and a debt to equity ratio of 0.9 as of October 1, 2022.

Total cash used in operating activities as defined on our cash flow statement was $5.8 million for the three months ended October 1, 2022.

We maintain sufficient liquidity for our expected future operations and had $105.4 million in borrowings on our revolving credit facility and $10.6 million remained available at October 1, 2022.

Net income for the second quarter of fiscal year 2023 was $1.0 million or $0.09 per diluted share, as compared to net income of $0.6 million or $0.05 per diluted share for the second quarter of fiscal year 2022.

Net income for the second quarter of fiscal year 2023 improved based on the increase in operating income generated by the gains on insurance claim of $2.7 million, or approximately $0.19 per share.

During the second quarter of fiscal year 2023, we won new programs involving outdoor power equipment, battery management, automated sprinklers, and biometric sensor technology.

Moving into the third quarter of fiscal 2023, global logistics problems, the war in Europe, and China-US geopolitical tensions continue to drive OEMs to examine their traditional outsourcing strategies.

We believe these customers increasingly realize they had become overly dependent on their China-based contract manufacturers for not only product, but also for design and logistics services.

Over time, the decision to onshore or near shore production is becoming more widely accepted as a smart long-term strategy.

As a result, we see opportunities for continued growth.

In addition, the headwinds from the global supply chain continue to present uncertainty and multiple business challenges but do show some signs of gradually abating, particularly with respect to the recent price stabilization for some commodity components.

At the same time, these price reductions are offset by increasing wages at our North American facilities.

We maintain 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.

Total cash used in operating activities as defined on our cash flow statement was $10.0 million for the six months ended December 31, 2022.

We maintain sufficient liquidity for our expected future operations and had $107.6 million in borrowings on our revolving credit facility and $1.8 million remained available at December 31, 2022.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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• Allowance for Doubtful Accounts

• Accrued Warranty

• Income Taxes

• Share-Based Compensation

• Long-Term Incentive Compensation Accrual

Please refer to the discussion of critical accounting policies in our most recent Annual Report on Form 10-K for the fiscal year ended July 2, 2022, for further details.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended October 1, 2022 with the Three Months Ended October 2, 2021

Comparison of the Three Months Ended December 31, 2022 with the Three Months Ended January 1, 2022

The financial information and discussion below should be read in conjunction with the Consolidated Financial Statements and Notes.

The following table sets forth certain information regarding the components of our condensed consolidated statements of income for the three months ended October 1, 2022 as compared to the three months ended October 2, 2021.

The following table sets forth certain information regarding the components of our condensed consolidated statements of income for the three months ended December 31, 2022 as compared to the three months ended January 1, 2022.

It is provided to assist in assessing differences in our overall performance (in thousands):

Three Months Ended

October 1, 2022 % of

net sales October 2, 2021 % of

December 31, 2022 % of

net sales January 1, 2022 % of

net sales $ change % point

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Net income $ 967 0.8 % $ 587 0.4 % $ 380 0.4 %

Net sales of $137.3 million for the first quarter of fiscal year 2023 increased by 3.4 percent as compared to net sales of $132.8 million for the first quarter of fiscal year 2022.

The $4.5 million increase in net sales from the prior year period was primarily due to the successful ramp of new customer programs for new and legacy customers.

The Company’s revenue continued to be constrained by tightening worldwide supply chain and transportation and logistics issues, but these problems do show signs of gradually abating.

Gross profit as a percentage of net sales for the three months ended October 1, 2022 was 7.6 percent compared to 7.6 percent for the three months ended October 2, 2021.

Gross profits percentages were flat as a result of the loss of production related to storm damage in Arkansas and increasing costs associated to new program ramps offset by the efficiencies gained in additional revenue.

Net sales of $123.7 million for the second quarter of fiscal year 2023 decreased by 8.0 percent as compared to net sales of $134.5 million for the second quarter of fiscal year 2022.

The $10.7 million decrease in net sales from the prior year period was primarily due to a six-week delay in starting production for a large program with a leading power equipment company.

This delayed revenue by approximately $20 million from the second quarter of fiscal 2023, but production for this program is currently underway and increasing in the third quarter.

Gross profit as a percentage of net sales for the three months ended December 31, 2022 was 7.2 percent compared to 7.3 percent for the three months ended January 1, 2022.

Gross profits percentages slightly decreased as a result of the business interruption and other operational losses related to storm damage to our Arkansas facility, as well as by preparations for expected sales growth in the second quarter and increased labor costs in both the US and Mexico.

The level of gross margin is impacted by facility utilization, product mix, timing, severity and steepness of new program ramps, pricing within the electronics industry and material costs, which can fluctuate significantly from quarter to quarter.

Included in gross profit are charges related to reductions in the carrying value of our inventory due to obsolescence.

We recorded a provision of approximately $175,000 and $138,000 for obsolete inventory during the three months ended October 1, 2022 and October 2, 2021, respectively.

We recorded an impairment of approximately $175,000 and $138,000 for obsolete inventory during the three months ended December 31, 2022 and January 1, 2022, respectively.

We adjust the carrying value for estimated obsolescence as necessary in an amount equal to the difference between the cost of inventory and its net realizable value based on assumptions as to future demand and market conditions.

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Operating Expenses

There were no significant changes to operating expenses during the presented quarters, other than the gain on insurance proceeds of $934,000 recorded in the first quarter of fiscal 2023.

Total research, development, and engineering (RD&E) expenses were $2.3 million during the three months ended October 1, 2022 and $2.4 million during the three months ended October 2, 2021, respectively.

Total RD&E expenses as a percent of net sales were 1.7 percent during the three months ended October 1, 2022 and 1.8 percent during the three months ended October 2, 2021.

Total selling, general and administrative (SG&A) expenses were $5.7 million during the three months ended October 1, 2022 compared to $5.6 million for the three months ended October 2, 2021.

Total SG&A expenses as a percentage of net sales were 4.1 percent for the three months ended October 1, 2022 and 4.2 percent for the three months ended October 2, 2021.

Interest expense was $1.9 million during the three months ended October 1, 2022 and $1.0 million during the three months ended October 2, 2021.

There were no significant changes to operating expenses during the presented quarters, other than the gain on insurance proceeds of $2.7 million recorded in the second quarter of fiscal 2023.

Total research, development, and engineering (RD&E) expenses were $2.3 million during the three months ended December 31, 2022 and $2.5 million during the three months ended January 1, 2022, respectively.

Total RD&E expenses as a percent of net sales were 1.8 percent during the three months ended December 31, 2022 and 1.9 percent during the three months ended January 1, 2022.

Total selling, general and administrative (SG&A) expenses were $5.7 million during the three months ended December 31, 2022 compared to $5.7 million for the three months ended January 1, 2022.

Total SG&A expenses as a percentage of net sales were 4.6 percent for the three months ended December 31, 2022 and 4.2 percent for the three months ended January 1, 2022.

Interest expense was $2.5 million during the three months ended December 31, 2022 and $1.1 million during the three months ended January 1, 2022.

The increase in interest expense is primarily related to increased interest rates and an increase in the average balance outstanding on our line of credit.

The effective tax rate for the three months ended October 1, 2022 was 21.8 percent compared to 26.0 percent for the three months ended October 2, 2021.

The decrease was primarily due to increased federal research and development tax credits expected during the fiscal year 2023.

The effective tax rate for the three months ended December 31, 2022 was 12.2 percent compared to (5.6) percent for the three months ended January 1, 2022.

The increase was primarily due to federal research and development tax credits constituting a lower percentage of income before taxes and the impact of fluctuations in foreign exchange rates.

For further information on taxes see Note 5 of the “Notes to Consolidated Financial Statements.”

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If assumptions and estimates change in the future the deferred tax assets and liability will be adjusted accordingly and any increase or decrease will result in an additional deferred income tax expense or benefit in subsequent periods.

On October 1, 2022, we had an order backlog of approximately $380.0 million.

This compares with a backlog of approximately $320.9 million on October 2, 2021.

Comparison of the Six Months Ended December 31, 2022 with the Six Months Ended January 1, 2022

The financial information and discussion below should be read in conjunction with the Consolidated Financial Statements and Notes.

The following table sets forth certain information regarding the components of our condensed consolidated statements of income for the six months ended December 31, 2022 as compared to the six months ended January 1, 2022.

It is provided to assist in assessing differences in our overall performance (in thousands):

Six Months Ended

December 31, 2022 % of

net sales January 1, 2022 % of

net sales $ change % point

Net sales $ 260,971 100.0 % $ 267,218 100.0 % $ (6,247) — %

Cost of sales 241,672 92.6 % 247,272 92.5 % (5,600) 0.1 %

Gross profit 19,299 7.4 % 19,946 7.5 % (647) (0.1) %

Research, development and engineering 4,583 1.8 % 4,947 1.9 % (364) (0.1) %

Selling, general and administrative 11,391 4.4 % 11,254 4.2 % 137 0.2 %

Gain on insurance proceeds, net of losses (3,644) (1.4) % — — % (3,644) (1.4) %

Total operating expenses 12,330 4.8 % 16,201 6.1 % (3,871) (1.3) %

Operating income 6,969 2.7 % 3,745 1.4 % 3,224 1.3 %

Interest expense, net 4,394 1.7 % 2,087 0.8 % 2,307 0.9 %

Income before income taxes 2,575 1.0 % 1,658 0.6 % 917 0.4 %

Income tax provision 456 0.2 % 256 0.1 % 200 0.1 %

Net income $ 2,119 0.8 % $ 1,402 0.5 % $ 717 0.3 %

Net sales of $261.0 million for the six months ended December 31, 2022 decreased by (2.3) percent as compared to net sales of $267.2 million for the six months ended January 1, 2022.

The $(6.2) million decrease in net sales from the prior year period was primarily due to a six-week delay in starting production for a large program with a leading power equipment company.

This delayed revenue by approximately $20 million from the second quarter of fiscal 2023, but was offset by the successful ramp up of new customer programs for new and legacy customers during Q1 of fiscal 2023.

Gross profit as a percentage of net sales for the six months ended December 31, 2022 was 7.4 percent compared to 7.5 percent for the six months ended January 1, 2022.

Included in gross profit are charges related to reductions in the carrying value of our inventory due to obsolescence.

We recorded an impairment of approximately $355,000 and $365,000 for obsolete inventory during the six months ended December 31, 2022 and January 1, 2022, respectively.

The provisions are established for inventory that we have determined customers are not contractually responsible for and for inventory that we believe customers will be unable to purchase.

Operating Expenses

Total research, development, and engineering (RD&E) expenses were $4.6 million during the six months ended December 31, 2022 and $4.9 million during the six months ended January 1, 2022, respectively.

Total RD&E expenses as a percent of net sales were 1.8 percent during the six months ended December 31, 2022 and 1.9 percent during the six months ended January 1, 2022.

Total selling, general and administrative (SG&A) expenses were $11.4 million during the six months ended December 31, 2022 compared to $11.3 million for the six months ended January 1, 2022.

Total SG&A expenses as a percentage of net sales were 4.4 percent for the six months ended December 31, 2022 and 4.2 percent for the six months ended December 31, 2022.

Interest expense was $4.4 million during the six months ended December 31, 2022 and $2.1 million during the six months ended January 1, 2022.

The increase in interest expense is primarily related to increased interest rates and an increase in the average balance outstanding on our line of credit.

The effective tax rate for the six months ended December 31, 2022 was 17.7 percent compared to 15.4 percent for the six months ended January 1, 2022.

The increase was primarily due to the impact of fluctuations in foreign exchange rates.

For further information on taxes see Note 5 of the “Notes to Consolidated Financial Statements.”

Our judgments regarding deferred tax assets and liabilities may change due to changes in market conditions, changes in estimates, changes in tax laws or other factors.

On December 31, 2022, we had an order backlog of approximately $404.0 million.

This compares with a backlog of approximately $333.1 million on January 1, 2022.

The increase in order backlog is related to increases in demand and continuing supply chain issues that have delayed production.

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Operating Cash Flow

Net cash used in operating activities for the three months ended October 1, 2022 was $5.8 million, compared to $14.6 million during the same period of the prior fiscal year.

The $5.8 million of net cash used in operating activities for the three months ended October 1, 2022 is primarily related to $0.2 million in net income for the period adjusted for $2.4 million of depreciation and amortization, a $1.8 million increase in accounts receivable, a $13.5 million increase in inventory, a $2.8 million decrease in accrued compensation and vacation, a $3.6 million increase in other assets, partially offset by a $12.7 million increase in accounts payable, a $2.2 million increase in other liabilities and a $4.4 million decrease in contract assets.

The $14.6 million of net cash used in operating activities for the three months ended October 2, 2021 is primarily related to $0.8 million in net income for the period adjusted for $1.3 million of depreciation and amortization, a $16.2 million increase in accounts receivable, a $5.8 million increase in inventory, a $3.0 million decrease in accrued compensation and vacation partially offset by a $18.8 million increase in accounts payable, and a $1.1 million decrease in contract assets.

Net cash used in operating activities for the six months ended December 31, 2022 was $10.0 million, compared to $10.5 million during the same period of the prior fiscal year.

The $10.0 million of net cash used in operating activities for the six months ended December 31, 2022 is primarily related to $2.1 million in net income for the period adjusted for $4.7 million of depreciation and amortization, a $1.6 million increase in accounts receivable, a $16.0 million increase in inventory, a $4.0 million decrease in accrued compensation and vacation, a $2.5 million increase in other assets, partially offset by a $19.3 million increase in accounts payable, a $10.5 million increase in other liabilities and a $6.4 million decrease in contract assets.

The $10.5 million of net cash used in operating activities for the six months ended January 1, 2022 is primarily related to $1.4 million in net income for the period adjusted for $2.6 million of depreciation and amortization, a $13.1 million increase in accounts receivable, a $20.4 million increase in inventory, a $4.1 million decrease in accrued compensation and vacation, a $13.5 million increase in other assets, partially offset by a $39.0 million increase in accounts payable, and a $1.2 million increase in contract assets.

Accounts receivable fluctuates based on the timing of shipments, terms offered and collections that occurred during the quarter.

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Investing Cash Flow

Cash used in investing activities was $2.5 million during the three months ended October 1, 2022 as compared to $1.8 million during the three months ended October 2, 2021.

Our primary investing activity during the three months ended October 1, 2022 and October 2, 2021, was purchasing equipment to support increased production levels for new programs.

Cash used in investing activities was $0.4 million during the six months ended December 31, 2022 as compared to $2.8 million during the six months ended January 1, 2022.

Our primary investing activity during the six months ended December 31, 2022 and January 1, 2022, was purchasing equipment to support increased production levels for new programs.

Leases are often utilized when potential technical obsolescence and funding requirement advantages outweigh the benefits of equipment ownership.

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Financing Cash Flow

Cash provided by financing activities was $8.8 million during the three months ended October 1, 2022 as compared to $14.5 million in the same period of the previous fiscal year.

Our primary financing activities during the three months ended October 1, 2022 and three months ended October 2, 2021, were borrowings and repayments under our revolving line of credit facility and term loans.

As of October 1, 2022, approximately $10.6 million was available under the asset-based revolving credit facility.

Cash provided by financing activities was $9.5 million during the six months ended December 31, 2022 as compared to $10.9 million in the same period of the previous fiscal year.

Our primary financing activities during the six months ended December 31, 2022 and six months ended January 1, 2022, were borrowings and repayments under our revolving line of credit facility and term loans.

As of December 31, 2022, approximately $1.8 million was available under the asset-based revolving credit facility.

Our cash requirements are affected by the level of current operations and new programs.

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The Company further notes projected cash from operations from increased demand from certain customers will be partially offset by an anticipated slowdown in collections from other customers and increasing inventory levels in efforts to mitigate supply chain constraint risks.

As of October 1, 2022, we had approximately $2.1 million of cash held by foreign subsidiaries.

As of December 31, 2022, we had approximately $1.3 million of cash held by foreign subsidiaries.

If cash is to be repatriated in the future from these foreign subsidiaries, the Company would be subject to certain withholding taxes in the foreign jurisdictions.

The total amount of tax payments required for the amount of foreign subsidiary cash on hand as of October 1, 2022 would approximate $12,000.

The total amount of tax payments required for the amount of foreign subsidiary cash on hand as of December 31, 2022 would approximate $32,000.

We have accrued withholding taxes for expected future repatriation of foreign earnings as discussed in Note 5 of the “Notes to Consolidated Financial Statements.”

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Increased energy prices could cause an increase to our raw material costs and transportation costs.

increased transportation costs related to certain suppliers and customers could be passed along to us.

In addition, increased transportation costs related to certain suppliers and customers could be passed along to us.

We may not be able to increase our product prices enough to offset these increased costs.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis