Key Tronic - Q2 2026

Transcript

Operator (participant)

Day and welcome to the Key Tronic FY 2026 Q2 investor call. Today's conference is being recorded. After the presentation, we will begin the question-and-answer period. At this time, I'd like to turn the call over to Tony Voorhees. Please go ahead.

Tony Voorhees (CFO)

Good afternoon, everyone. I am Tony Voorhees, Chief Financial Officer of Key Tronic. I'd like to thank everyone for joining us today for our investor conference call. Joining me here at our Spokane, Washington headquarters is Brett Larsen, our President and Chief Executive Officer. As always, I would like to remind you that during the course of this call, we might make projections or other forward-looking statements regarding future events or the company's future financial performance. Please remember that such statements are only predictions. Actual events or results may differ materially. For more information, you may review the risk factors outlined in the documents the company has filed with the SEC, specifically our latest 10-K and quarterly 10-Qs. Please note that on this call, we will discuss historical financial and other statistical information regarding our business and operations. Some of this information is included in today's press release.

During this call, we will also reference slides that accompany our discussion. The slides can be viewed with the webcast, and the link can be found on our investor relations website. In addition, the slides, together with the recorded version of this call, will be available on the investor relations section of our website. We will also discuss certain Non-GAAP financial measures on this call. Additional information about these Non-GAAP measures and the reconciliations to the most directly comparable GAAP measures are provided in today's press release, which is posted to the investor relations section of our website. For the second quarter of fiscal year 2026, we reported total revenue of $96.3 million compared to $113.9 million in the same period of fiscal 2025. Revenue for the second quarter of fiscal year 2026 was adversely impacted by reduced demand from a longstanding customer and the transition of an End-of-Life program.

However, this impact was partially offset by new program wins and an increase in demand from other longstanding customers. As in other recent quarters, we believe customers continue to face uncertainties in the global economy and volatile trade policies. In addition, we continued ramping the consigned materials program that was previously announced. For the first six months of fiscal 2026, our total revenue was $195.1 million compared to $245.4 million in the same period of fiscal 2025. In line with our long-term strategic plan, we proactively advanced our nearshoring and tariff mitigation strategies to reduce costs while maintaining the diversity and flexibility of our key locations and operational capabilities. During the second quarter of fiscal 2026, we initiated a wind down of our manufacturing operations at our China-based facility designed to better align organizational structure and resources with our strategic initiatives, including filling the capacity recently created in Vietnam.

We expect to complete this wind down in our fourth quarter, at which point we anticipate saving approximately $1.2 million per quarter. We also continue to further reduce our workforce in Mexico, as we intend to have that facility focus on higher volume manufacturing. Once these reductions are fully implemented during our third quarter, we would expect to save approximately $1.5 million per quarter moving forward. These strategic initiatives resulted in charges for severance, inventory write-offs, and other related expenses of approximately $10.5 million for the quarter, which had a significant adverse impact on our margins. Gross margin was 0.6%, and operating margin was -10.7% in the second quarter of fiscal 2026, compared to 6.8% and -1.0% respectively in the same period of fiscal 2025.

Excluding the charges related to the China closure and the Mexico workforce reductions, the adjusted gross margin was 7.9% for the second quarter of fiscal year 2026. As top-line growth returns, we anticipate margins to be strengthened by improvements in our operating efficiencies and the positive impact of our strategic cost-savings initiatives. We also believe the recent cost-savings initiatives have made us more competitive when quoting new program opportunities. As production volumes increase and our operational adjustments take full effect, we expect to see greater leverage on fixed costs, enhanced productivity, and a more streamlined supply chain, all contributing to stronger financial performance. The winding down of China production, severance charges, and the reduction in revenue had a significant impact on our bottom line.

Our net loss was $8.6 million or $0.79 per share for the second quarter of fiscal 2026, compared to a net loss of $4.9 million or $0.46 per share for the same period of fiscal 2025. For the first six months of fiscal 2026, the net loss was $10.9 million or $1 per share, compared to $3.8 million or $0.35 per share for the same period of fiscal 2025. Our adjusted net income was break-even or $0 per share for the second quarter of fiscal 2026, compared to adjusted net loss of $4.1 million or $0.38 per share for the same period of fiscal 2025. For the first six months of fiscal 2026, the adjusted net loss was $1.1 million or $0.10 per share, compared to an adjusted net loss of $1.3 million or $0.12 per share for the same period of fiscal 2025.

Turning to the balance sheet, our inventory for the second quarter of fiscal 2026 is down $12.3 million or by 12% from a year ago. Our current ratio was 2.0 to 1, compared to 2.8 to 1 from a year ago. At the same time, accounts receivable DSOs were at 77 days, compared to 99 days a year ago, reflecting stronger collection on receivables. Total cash flow provided by operations for the second quarter of fiscal 2026 was approximately $6.3 million as compared to $1.3 million in the same period of fiscal 2025. Our continuing ability to generate cash from operations has allowed us to reduce our debt year-over-year by approximately $13.4 million. In the second quarter, capital expenditures were approximately $3.3 million, bringing year-to-date total capital expenditures through the second quarter to approximately $6.5 million.

We expect CapEx for the full year to be around $8-$10 million, largely spent on new innovative production equipment and automation. While we're keeping a careful eye on capital expenditures, we plan to continue to invest selectively in our production equipment, SMT equipment, and plastic molding capabilities, utilize leasing facilities, and make efficiency improvements to prepare for growth and add capacity. As we move further into fiscal 2026, we continue to face a lot of global economic uncertainties and volatile trade policies. Nevertheless, we are pleased to continue to see our new programs gradually ramping and our cost and efficiency improvements from our recent overhead reductions taking hold. We also expect to see growth in our U.S. and Vietnam production, have a strong pipeline of potential new business, and remain focused on improving our profitability.

Over the longer term, we believe that we are increasingly well-positioned to win new programs and profitably expand our business. Due to the uncertainty of timing of new products ramps in light of the continued macroeconomic uncertainty, we are not providing forward-looking guidance in the third quarter of fiscal 2026. That's it for me, Brett.

Brett Larsen (President and CEO)

Thanks, Tony. During the second quarter of fiscal 2026, we continue to provide our customers with options to better manage macroeconomic uncertainties and enhance our potential for profitable long-term growth. We are excited about the significant investments made to our U.S. and Vietnam locations. During the quarter, we witnessed the increasing number of customer program starts in Springdale, Arkansas, started a new production line in Corinth, Mississippi, in support of a growing consignment customer, and we shipped our first batch of medical products from Da Nang, Vietnam.

Due to ongoing geopolitical tensions and tariff uncertainties, we began to execute our long-term strategy to wind down manufacturing operations at our China facility and continue to right-size our Mexico facility. Demand from specific longstanding customers has declined in recent periods, but we believe that recently won programs more than offset the loss in revenue in future quarters. Moreover, the continued market uncertainty and shifts of tariffs have unfortunately impacted the timing and launch of new programs, but those programs continue to slowly proceed. We are doing our best to work with suppliers and with our customers on options for manufacturing their products from different locations and mitigating the impact of tariffs. Our changes made to our manufacturing footprint and cost reductions have enabled us to offer improved mitigation options, particularly when our customers consider the varying implications of current and future potential tariffs.

As part of our long-term strategy and in recognition of the continuing geopolitical tensions, tariff uncertainties, and increasing costs associated with China-based productions, we have begun winding down our facilities there and transferring several programs to Vietnam. As part of our global sourcing strategy, we will continue to operate in China with a small team focused on sourcing critical components locally. Over the past 18 months, we have also reduced our total headcount by approximately 40% in Mexico and have begun transferring some of the programs from Mexico to the U.S. and Vietnam. Our Mexico facility continues to offer a unique solution for tariff mitigation under the existing USMCA tariff agreement. Given the sustained trend of continued wage increases in Mexico, we have streamlined our operations, increased efficiencies, and invested in automation in order to be more cost-competitive in the market.

Due to the successful cost reductions and streamlining production processes, we have recently seen an increase in the quoting volume and probability of landing new programs manufactured within our Mexico facilities. We've also seen an influx of new customer visits and audits of our Juarez campus as of late that demonstrates we are competitive for a growing variety of quoting opportunities. Our improved cost structure in Mexico is anticipated to lead to new programs and growth over the longer term. We are very excited about the recent investments made in the U.S. and Vietnam to build out capacity and new capabilities to meet evolving customer demand. You will recall that we opened our new technology and research and development location in Arkansas during the first quarter of fiscal 2026. Our U.S. based production provides customers with outstanding flexibility, engineering support, and ease of communication.

We expect double-digit growth in our facility in Arkansas during the latter half of this fiscal year. You also recall that we have recently doubled our manufacturing capacity in Vietnam that now has the capability to support medical device manufacturing. Our Vietnam-based production offers the high-quality, low-cost choice that had been associated with China in the past. In coming years, we expect our Vietnam facility to play a major role in our growth. We anticipate these new facilities in the U.S. and Vietnam will enable us to benefit from customer demand for rebalancing contract manufacturing and mitigate the severe impact and uncertainties surrounding the tariffs on goods and critical components. By the end of fiscal 2026, we expect approximately half of our manufacturing to take place in our U.S. and Vietnam facilities.

These initiatives reflect both the longstanding customer trend to nearshoring as well as de-risk the potential adverse impact of tariff increase and geopolitical tensions. During the second quarter of fiscal 2026, we won new programs in automotive technology, pest control, and industrial equipment. As already noted, we continue to ramp our recently announced manufacturing services contract with a data processing OEM that consigns its materials to our Corinth, Mississippi manufacturing facility. As we discussed, the consigned material model is new for us at this scale, and if successful, will considerably improve our profitability in coming quarters. It has the potential to grow to over $25 million in annual revenue, roughly the equivalent of a $100 million turnkey program. Despite the many uncertainties and disruptions in global markets, our strong pipeline of potential new business underscores the continued trend towards onshoring and the dual sourcing of contract manufacturing.

We expect that global tariff wars and geopolitical tensions will continue to drive OEMs to reexamine their traditional outsource strategies. Over time, the decision to onshore production is becoming more widely accepted as a smart long-term strategy. We believe our manufacturing footprint and cost-competitiveness will allow us to take advantage of these opportunities. The combination of our flexible global footprint and our expansive design capabilities continues to be extremely effective in capturing new business. Many of our manufacturing program wins are predicated upon Key Tronic's deep and broad design services. And once we have completed a design and ramped it into production, we believe our knowledge of a program's specific design challenges makes that business extremely sticky. We anticipate a continued increase in the number and capability of our design engineers in coming quarters.

We also continue to invest in vertical integration and manufacturing process knowledge, including a wide range of plastic molding, injection, blow, gas assist, multi-shot, as well as PCB assembly, metal forming, painting, and coating, complex high-volume automated assembly, and the design, construction, and operation of complicated test equipment. We believe that this expertise will increasingly set us apart from our competitors of a similar size. While the global market uncertainties have created some delays to new product launches for us, our suppliers, and our customers, we believe geopolitical tensions and heightened concerns about tariffs and supply chains will continue to drive the favorable trend of contract manufacturing returning to North America as well to our expanding Vietnam facilities. We are expecting revenue growth in the coming quarters from new programs launching in the U.S., Mexico, and Vietnam.

We move forward with a strong pipeline of potential new business, and we are anticipating significant improvements in our operating efficiencies. Over the long term, we remain very encouraged by our cost reductions made over the past two years to become more price competitive. Our increasing cash flow generated from operations enhances global manufacturing footprint and the innovations from our design engineering. All of these initiatives have increased our potential for profitable growth. This concludes the formal portion of our presentation. Tony and I will now be pleased to answer your questions.

Operator (participant)

Thank you. If you would like to signal with questions, please press star one on your touch tone telephone. If you're joining us today using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, that is star one if you would like to signal with questions, star one. And our first question will come from Matt Dane with Titan Capital Management.

Matt Dane (Equity Research Analyst)

Great. Thank you. I was hoping to delve a little bit more. You referenced earlier in the call that. Can you hear me?

Brett Larsen (President and CEO)

Yes, we can, Matt.

Matt Dane (Equity Research Analyst)

Okay. I'm sorry. I thought maybe someone was saying they could not hear me. So, want to circle back around, like I was saying, the increased demand from existing customers. I was hoping to get a little bit more color. How significant that is? Is it across a wide variety of customers? And what do you sense is driving that increased demand?

Brett Larsen (President and CEO)

Yeah. I would say that the large part, it's predominantly two specific longstanding customers. One is product maturation, just the fact that there's a need for a refresh of this particular design. That had a rough order of magnitude, probably about a $20 million hit to our overall quarter revenue. I think the next was essentially an end-of-life program. They're looking at replacing it down the road, but that one too, roughly about a $7 million reduction from last year's fiscal. Of course, offsetting that, those large decreases in revenue are some of the ramping new programs.

Matt Dane (Equity Research Analyst)

Okay. So you're not really seeing a ramp from existing customers, that the ramp is really coming from new programs then? Am I hearing you correct then?

Brett Larsen (President and CEO)

Yeah, Matt. We do have a few customers that we're seeing some increased demand on. I would say it's around 6 that are kind of impacting that increase from longstanding customers.

Matt Dane (Equity Research Analyst)

Okay. Okay. No, that's helpful. And then you also in the press release referenced the three new programs that you won. I was just hoping to get a rough size estimate of each and the timing of the ramp and then also where you're going to be manufacturing each of those?

Brett Larsen (President and CEO)

Sure. I think the first, we'll start with the automotive. That one will be manufactured down in Mexico. That rough order could be up to $5 million when fully ramped. I think the pest control, I think that one's actually in our U.S. facility in Vietnam, and that could be up to $2 million. And then the industrial equipment is also in our U.S. location, $2-$5 million.

Matt Dane (Equity Research Analyst)

Okay. No, that's helpful. And then final question I'd like to ask. You folks have referenced in the past and again on this call today that you have a number of tariff mitigation strategies. I don't think I've ever actually delved in and tried to better understand when you say that, what are you actually doing behind the scenes and what can you do to help us understand better what you're doing there?

Brett Larsen (President and CEO)

Yeah. I mean, that really gets to the core of our long-term strategy to essentially have a lower-cost Asian facility that could eventually replace our China facility. One of the biggest reasons we're winding down China is now that we've ramped Vietnam. We feel confident in the new technology and the new production equipment that we now have online. It really is ready now to essentially resolve the China to U.S. tariff situation and then also some of the geopolitical tension that we have. That's one piece. The other piece is that we offer either a U.S. made opportunity for those that would require that, but we also still offer the production down in Mexico.

Currently, you still can take advantage of the USMCA agreement that allows you to build things down in Mexico and bring it back up into the U.S. and even consume it in the U.S. under that agreement and avoid certain tariffs as well. It's a complex algorithm that really we help our customers with coming up with the best solution.

A lot of that is dependent on how much labor is required, where the components are currently being supplied, where could they be supplied from, possibly using some more North American-centric suppliers that we have, and then basically coming up with various price points of a total cost to our customer and saying, "Here's where we think it's advantageous to build your product." We feel confident based on our locations and footprint that we can offer a suite of different answers to our customers that really could mitigate tariffs regardless of where they end up.

Matt Dane (Equity Research Analyst)

Okay. Okay. And so whenever a prospective customer is coming to you looking to have you quote a new product or program, do you usually go back to them? And if they're really agnostic where it comes from, do you go back to them and offer them pricing? If we were to build it in Vietnam, this would be your price, U.S. price, and then a Mexico price? Do they really have the full choice and spectrum? And is that really how you approach it oftentimes?

Brett Larsen (President and CEO)

It really is. And I think that's one of the unique things that we can offer as Key Tronic is we can easily quote from all three of those locations that you provided and offer our customer, "This is what the lead time that would be required. Here's what your price is. Here's what the pros and cons from building in each of those locations," and really offer that to our customer to ultimately make that decision of where they want the product built.

Matt Dane (Equity Research Analyst)

Okay. Great. That's helpful. Appreciate the answers, guys.

Brett Larsen (President and CEO)

You bet.

Operator (participant)

As a reminder, if you would like to signal with questions, please press star one. Again, that is star one. Our next question will come from George Melas with MKH Management.

George Melas (President and Portfolio Manager)

Great. Thank you. Let me just pick up the phone. How are you guys?

Brett Larsen (President and CEO)

Doing well, George. Thank you.

George Melas (President and Portfolio Manager)

Good. Great. Just want to review a little bit the Gross Margin. On an adjusted basis, it's 7.9%, which is better than a year ago, but it's down a bit sequentially. I'm just trying to see if there's anything unusual in the quarter in the Gross Margin, something positive like the high level of tooling or engineering services, or maybe something negative like some disruptions and the transition of the end-of-life program or other things like that.

Brett Larsen (President and CEO)

Yeah. Just to mention a few, and I'm sure Tony will fill in as well, but I think some of the negative, some of the headwind we had during the quarter was we still are transferring programs from Mississippi up into Arkansas, the new facility. And of course, with that comes some additional costs. I'd also mention that in our second quarter, as always, we really lose out on a week of production just due to the holidays. In particular, our Mexican facility was closed for a full week. And then, of course, our domestic sites are closed for at least a half a week over Christmas. So you lose some production time, but that helps explain some of the sequential drop in the adjusted gross margin. We really need volume.

Looking forward prospectively, in order to really increase our gross margin prospectively, we need to drive sales volume and utilize some of the excess capacity that we have in each of our sites. Tony, anything you'd add?

Tony Voorhees (CFO)

There was just to add to that, there were some slight mix changes that negatively impacted gross margin quarter-over-quarter as well, essentially.

George Melas (President and Portfolio Manager)

Mixed changes, Tony, do you mean different programs or different locations?

Tony Voorhees (CFO)

Primarily just different programs, yeah.

George Melas (President and Portfolio Manager)

Okay. Great. Okay. Maybe another question, so do you guys are heading in the expectation to be net income breakeven in the June quarter, so just 2 quarters away? And with interest expense sort of remaining, let's say, at $2.3 million or in that range, you need, and if we think of normalized OpEx at roughly $7.4 million, you need a roughly $10.7 million in my basic calculation of gross profits. And that implies both revenue growth and margin expansion, I think. Some of the margin expansion will come from the consigned program in Mississippi. But can you comment on that and how you think that you're able to both grow revenue and margin?

Brett Larsen (President and CEO)

Yeah. I think we would stick with that same expectation. We still anticipate achieving somewhere break-even by the end of the fiscal year. We mentioned a bit about that consignment program. That continues to ramp nicely. It's definitely not to the level of revenue that we expect it to be exiting this quarter or even in their fourth quarter. There's more growth there that is required. But as we mentioned earlier, I think with that consigned program, as large as it is, you will also see some uptick in the gross margin percentage. So you'll see both our expectation is some additional revenue, but then also improvement in the gross margin percentage.

George Melas (President and Portfolio Manager)

Okay. Just to follow up on that, Brett, any particular reason for the program sort of ramping up maybe slower than you expected? Because it seems like it's a very important program for you guys.

Brett Larsen (President and CEO)

No. We expected that it would be a slow growth. Some of that required some additional equipment. We were able to procure that. It had some lead time to it. We actually ended up installing some of that over the Christmas holiday. And then, unfortunately, down in Mississippi this quarter, they got hit with a bad ice storm. So we are recovering from that. I think that'll have a slight impact into our third quarter but won't disrupt the momentum of growing that consignment model. It just may delay it by a week or two as we get through this ice storm. But we fully anticipated that that would be a slow roll to get to its peak.

Matt Dane (Equity Research Analyst)

Okay. Okay. And then just to try to understand, you expect growth in Mexico going forward. So does that mean that Mexico has hit sort of a bottom and that you've restructured Mexico into, let's say, a lower service but full capability but maybe slightly lower service but low-cost operation? How would you characterize that?

Brett Larsen (President and CEO)

George, I think I would kind of like what we mentioned is that we have found that we were not market competitive. We needed to increase our efficiency. We needed to invest in some automation. We really needed to be far more competitive in our pricing down in Mexico. I hope that we're at a bottom. I don't have a crystal ball, but my expectation based off of just the recent history, just the recent visits that we've had down in Mexico and some of the quoting opportunities that we've been down selected to take it to the next round, I feel like we're more competitive in Mexico than we were. So yeah, over the longer term, we're still expecting Mexico to grow. We don't have anticipated additional reductions in headcount other than those that we've already accrued for in our second quarter. But as you know, things change.

We are looking forward to the review of the USMCA that is to occur mid-year this year and hoping that most, if not all, of that continues as part of a trilateral agreement between us, Mexico, and Canada. But things do change. But for now, yes, based on the volume of quotes and the recent visits by potential customers, our expectation is that Mexico will grow.

George Melas (President and Portfolio Manager)

Okay. Great. And then just one quick final question for Tony. You mentioned the $1.2 million savings per quarter once the rampdown or the winddown of the China manufacturing operation is completed. That $1.2 million, is that the impact on cost of sales? Is it the impact on the EBIT line? How does that $1.2 million flow through the P&L?

Tony Voorhees (CFO)

Well, yeah, good question, George. So that $1.2 million really is kind of taking into consideration the entire wind-down of the manufacturing portion of our China operations. So it's across the board. It's up in COGS as well as certain SG&A as well and OpEx. So as we see and we expect to have that done by our fiscal year-end, so at which point is when we'd see that $1.2 million begin to take full effect in our results?

Brett Larsen (President and CEO)

I would say the bulk of it is in cost of goods, but to Tony's point, there is also some OpEx that will be reduced based off of that wind down.

George Melas (President and Portfolio Manager)

Okay. That $1.2 million in savings, what would be the impact on the EBIT line?

Brett Larsen (President and CEO)

I would take the $1.2 million.

George Melas (President and Portfolio Manager)

But if you have some COGS, wouldn't there be some revenue attached to the COGS that the $1.2 is a net number, basically?

Brett Larsen (President and CEO)

It is. Sorry. Yes, it is a net number.

George Melas (President and Portfolio Manager)

Okay. Okay.

Brett Larsen (President and CEO)

Sorry. Yes, I know. We know now what you're asking. Sorry about that, George. Yes. It's a net number.

George Melas (President and Portfolio Manager)

I just had to ask three times because I couldn't find a way to do it. I'm not surprised by that.

Brett Larsen (President and CEO)

No, thank you, George.

George Melas (President and Portfolio Manager)

Okay. Great. Okay. Great. Thanks for your hard work. It seems like you're really doing a lot of stuff to make the operation better. So thank you very much.

Brett Larsen (President and CEO)

Thank you.

Operator (participant)

Once again, if you would like to signal with questions, please press star one. Again, that is star one. If you would like to ask questions, we'll pause for a moment. That does conclude the question-and-answer session. I'll now turn the conference back over to Brett Larsen for closing remarks.

Brett Larsen (President and CEO)

Thank you again for participating in today's conference call. Tony and I look forward to speaking to you again next quarter. Thank you.

Operator (participant)

Thank you. That does conclude today's conference. We do thank you for your participation. Have an excellent day.