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KEY TRONIC CORP - Quarter Report: 2001 December (Form 10-Q)

Prepared by R.R. Donnelley Financial -- FORM 10-Q FOR QUARTER ENDED DECEMBER 29, 2001
Table of Contents

 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10–Q
 
QUARTERLY REPORT UNDER SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For Quarter Ended December 29, 2001
 
Commission File Number
Number 0–11559
Key Tronic Corporation
Washington
 
91–0849125
(State of Incorporation)
 
(I.R.S. Employer
Identification No.)
 

 
North 4424 Sullivan
Spokane, Washington 99216
(509) 928–8000
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes  x     No  ¨.
 
At February 8, 2002, 9,672,580 shares of Common Stock, no par value (the only class of common stock), were outstanding.
 


Table of Contents
 
KEY TRONIC CORPORATION
 
Index
 
 
 
PART I.
 
FINANCIAL INFORMATION:
  
Page
No.

Item 1.
 
Financial Statements:
    
      
3-4
      
          5
      
6
      
7
      
8-10
Item 2.
    
10-14
PART II.
 
OTHER INFORMATION:
    
Item 1.
    
15
Item 4.
    
15
Item 5.
    
15
Item 6.
    
15

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KEY TRONIC CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
(in thousands)
    
December 29, 2001

  
June 30, 2001

    
(Unaudited)
    
ASSETS
             
Current assets:
             
Cash and cash equivalents
  
$
1,736
  
$
2,137
Trade receivables, less allowance for doubtful accounts of $369 and $633
  
 
30,091
  
 
21,674
Inventories
  
 
22,399
  
 
20,601
Real estate held for sale
  
 
1,624
  
 
1,697
Deferred income tax asset, net
  
 
0
  
 
771
Other
  
 
4,806
  
 
5,670
    

  

Total current assets
  
 
60,656
  
 
52,550
 
Property, plant and equipment—at cost
  
 
85,543
  
 
99,228
Less accumulated depreciation
  
 
72,375
  
 
82,559
    

  

Total property, plant and equipment
  
 
13,168
  
 
16,669
    

  

Other assets:
             
Non-current deferred income tax asset
  
 
0
  
 
3,746
Other (net of accumulated amortization of $1,520 and $1,326)
  
 
1,140
  
 
513
Goodwill (net of accumulated amortization of $971 and $907)
  
 
829
  
 
893
    

  

    
$
75,793
  
$
74,371
    

  

 
See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
(in thousands)
    
December 29, 2001

    
June 30, 2001

 
    
(Unaudited)
        
LIABILITIES AND SHAREHOLDERS’ EQUITY
                 
Current liabilities:
                 
Current portion of long-term obligations
  
$
150
 
  
$
150
 
Accounts payable
  
 
22,140
 
  
 
21,385
 
Deferred sales proceeds
  
 
78
 
  
 
2,894
 
Accrued compensation and vacation
  
 
2,910
 
  
 
2,615
 
Accrued taxes other than income taxes
  
 
1,007
 
  
 
973
 
Interest payable
  
 
94
 
  
 
69
 
Revolver
  
 
16,340
 
  
 
0
 
Litigation reserve
  
 
17,000
 
  
 
0
 
Other
  
 
2,377
 
  
 
1,578
 
    


  


Total current liabilities
  
 
62,096
 
  
 
29,664
 
    


  


Long-term obligations, less current portion
  
 
1,201
 
  
 
9,389
 
    


  


Commitments and contingencies (Notes 2, 3 and 7)
                 
Shareholders’ equity:
                 
Common stock, no par value, authorized 25,000 shares; issued and outstanding
9,673 and 9,673 shares
  
 
38,393
 
  
 
38,393
 
Accumulated deficit
  
 
(25,897
)
  
 
(3,320
)
Accumulated other comprehensive income
  
 
0
 
  
 
245
 
    


  


Total shareholders’ equity
  
 
12,496
 
  
 
35,318
 
    


  


    
$
75,793
 
  
$
74,371
 
    


  


 
See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
    
Second Quarters Ended

 
    
December 29,
2001

      
December 30,
2000

 
    
(in thousands, except per share amounts)
 
Net sales
  
$
50,516
 
    
$
52,586
 
Cost of sales
  
 
45,639
 
    
 
48,100
 
    


    


Gross profit
  
 
4,877
 
    
 
4,486
 
Operating expenses:
                   
Research, development and engineering
  
 
689
 
    
 
566
 
Selling
  
 
747
 
    
 
1,208
 
General and administrative
  
 
2,449
 
    
 
2,514
 
    


    


Operating income
  
 
992
 
    
 
198
 
Interest expense
  
 
359
 
    
 
674
 
Litigation reserve
  
 
17,000
 
    
 
0
 
Other income, net
  
 
(227
)
    
 
(657
)
    


    


Income (loss) before income tax provision
  
 
(16,140
)
    
 
181
 
Income tax provision
  
 
5,455
 
    
 
178
 
    


    


Net income (loss)
  
$
(21,595
)
    
$
3
 
    


    


Earnings (loss) per share:
                   
Earnings (loss) per common share—basic and diluted
  
$
(2.23
)
    
$
.00
 
 
 
 
See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
    
Two Quarters Ended

 
    
 
 
December 29,
2001
 
 
  
 
 
December 30,
2000
 
 
    


  


    
(in thousands, except per share amounts)
 
Net sales
  
$
85,142
 
  
$
103,800
 
Cost of sales
  
 
78,134
 
  
 
94,010
 
    


  


Gross profit
  
 
7,008
 
  
 
9,790
 
 
Operating expenses:
                 
Research, development and engineering
  
 
1,247
 
  
 
1,380
 
Selling
  
 
1,468
 
  
 
2,742
 
General and administrative
  
 
4,194
 
  
 
4,649
 
    


  


Operating income
  
 
99
 
  
 
1,019
 
 
Interest expense
  
 
694
 
  
 
1,232
 
Litigation reserve
  
 
17,000
 
  
 
0
 
Other income, net
  
 
(250
)
  
 
(706
)
    


  


Income (loss) before income tax provision
  
 
(17,345
)
  
 
493
 
Income tax provision
  
 
5,232
 
  
 
284
 
    


  


Net income (loss)
  
$
(22,577
)
  
$
209
 
    


  


Earnings (loss) per share:
                 
Earnings (loss) per common share—basic and diluted
  
$
(2.33
)
  
$
.02
 
 
 
 
See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
    
Two Quarters Ended

 
    
December 29, 2001

    
December 30, 2000

 
    
(in thousands)
 
Increase (decrease) in cash and cash equivalents:
                 
Cash flows from operating activities:
                 
Net income (loss)
  
$
(22,577
)
  
$
209
 
Adjustments to reconcile net income to cash used in operating activities:
                 
Depreciation and amortization
  
 
2,500
 
  
 
3,111
 
Provision for obsolete inventory
  
 
300
 
  
 
250
 
Provision for doubtful receivables
  
 
95
 
  
 
433
 
Provision for warranty
  
 
75
 
  
 
170
 
Litigation reserve
  
 
17,000
 
  
 
0
 
Loss on disposal of assets
  
 
(480
)
  
 
(661
)
Deferred income taxes
  
 
4,516
 
  
 
0
 
Changes in operating assets and liabilities:
                 
Trade receivables
  
 
(8,511
)
  
 
(5,351
)
Inventories
  
 
(2,098
)
  
 
(322
)
Other assets
  
 
285
 
  
 
(5,407
)
Accounts payable
  
 
755
 
  
 
2,282
 
Accrued compensation and vacation
  
 
295
 
  
 
611
 
Deferred sales proceeds
  
 
(312
)
  
 
0
 
Other liabilities
  
 
784
 
  
 
657
 
    


  


Cash used in operating activities
  
 
(7,373
)
  
 
(4,018
)
    


  


Cash flows from investing activities:
                 
Proceeds from sale of property and equipment
  
 
2
 
  
 
1,095
 
Proceeds from sale leaseback of real estate
  
 
0
 
  
 
4,030
 
Purchase of property and equipment
  
 
(590
)
  
 
(245
)
    


  


Cash provided (used) in investing activities
  
 
(588
)
  
 
4,880
 
    


  


Cash flows from financing activities:
                 
Payment of financing costs
  
 
(426
)
  
 
0
 
Proceeds from issuance of common stock
  
 
0
 
  
 
89
 
Borrowings under revolving credit agreement
  
 
8,231
 
  
 
1,212
 
    


  


Cash provided by financing activities
  
 
7,805
 
  
 
1,301
 
    


  


Accumulated foreign currency translation adjustment
  
 
(245
)
  
 
0
 
Net increase (decrease) in cash and cash equivalents
  
 
(401
)
  
 
2,163
 
    


  


Cash and cash equivalents, beginning of period
  
 
2,137
 
  
 
1,013
 
    


  


Cash and cash equivalents, end of period
  
$
1,736
 
  
$
3,176
 
    


  


 
See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION AND SUBSIDIARIES
 
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
 
The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments of a normal and recurring nature necessary for a fair presentation of results of operations for such periods. The results of operations for any interim period are not necessarily indicative of results for the full year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s annual report for the year ended June 30, 2001.
 
1.    INVENTORIES
 
      
December 29,
2001

    
June 30, 2001

 
      
(in thousands)
 
Finished goods
    
$
9,379
 
  
$
8,589
 
Work-in-process
    
 
2,884
 
  
 
2,088
 
Raw materials and supplies
    
 
12,871
 
  
 
12,636
 
Reserve for obsolescence
    
 
(2,735
)
  
 
(2,712
)
      


  


      
$
22,399
 
  
$
20,601
 
      


  


 
2.    COMMITMENTS
 
The amount of firm commitments to contractors and suppliers for capital expenditures was approximately $41,000 at December 29, 2001.
 
3.    SHORT-TERM AND LONG-TERM OBLIGATIONS
 
Short-term and Long-term Obligations consist of:
 
    
December 29, 2001

    
June 30, 2001

 
    
(in thousands)
 
Revolving line
  
$
16,340
 
  
$
8,109
 
Deferred compensation obligation
  
 
729
 
  
 
729
 
Deferred gain on sales
  
 
622
 
  
 
701
 
    


  


Total short-term and long-term obligations
  
 
17,691
 
  
 
9,539
 
Less current portion of long-term obligations
  
 
(150
)
  
 
(150
)
Less revolving line
  
 
(16,340
)
  
 
0
 
    


  


    
$
1,201
 
  
$
9,389
 
    


  


 
On August 24, 2001, the Company obtained a new revolving credit facility with CIT Group/Business Credit, Inc. for up to $25 million and paid off the GECC revolving loan. The Company recorded fees and penalties of $132,000 in conjunction with the refinancing. The new revolving loan is secured by the assets of the Company. For the first year of the financing agreement with CIT, interest will accrue at J.P. Morgan Chase prime rate plus 0.75% (5.50%) as well as an unused line fee of 0.50%. The agreement specifies four different levels of rates to be added to the base prime rate (between 0.25% and 1.00%) depending on the Company’s earnings before interest, taxes, depreciation, and amortization. The agreement contains financial covenants that relate to maximum capital expenditures, minimum earnings before interest expense, income tax, depreciation, and amortization, and minimum tangible net worth. The agreement is for a term of three years beginning on August 24, 2001 and ending on August 23, 2004. In addition to the financial covenants, the credit agreement restricts investments, disposition of assets, and the payment of dividends.

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Because of the litigation judgment described in Note 7, CIT has notified the Company that it is in default of certain financial covenants in its credit facility and all subsequent loans or advances under the credit facility will be at the lender’s sole discretion. As a result, the revolver loan balance of $16.3 million has been reclassified to current liabilities until the default is cured or waived.
 
4.    SUPPLEMENTAL CASH FLOW INFORMATION
 
      
Two Quarters Ended

      
December 29,
2001

  
December 30,
2000

      
(in thousands)
Interest payments
    
$614
  
$1,233
Income tax payments
    
542
  
310
 
5.    INCOME TAXES
 
The income tax provision for the second quarter of fiscal year 2002 was $5,455,000 versus an income tax provision of $178,000 for the second fiscal quarter of the prior year. The $5,455,000 provision for the second quarter of fiscal year 2002 is the result of provisions on the earnings of foreign subsidiaries of $504,000 and the elimination of the Company’s net deferred tax assets in the amount of $4,951,000. The deferred tax assets were written off as a result of the large financial loss for the quarter, which increased the Company’s net operating loss carry-forwards to over $65 million. Financial Accounting Standard No. 109 requires that management assess the sources of future taxable income, which may be available to recognize the deductible differences that comprise deferred tax assets. A valuation allowance against deferred tax assets is required if it is more likely than not that some or all of the deferred tax assets will not be realized. The valuation allowance was increased to the full value of the deferred tax assets. The Company’s tax loss carry-forwards begin expiring in 2006. The $178,000 provision for the second fiscal quarter of 2001 was the result of provisions on the earnings of foreign subsidiaries.
 
6.    EARNINGS PER SHARE
 
The Company has adopted Financial Accounting Standards No. 128 which requires the presentation of “basic EPS” and “diluted EPS”. Basic EPS is computed by dividing income available to common shareholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed by dividing income available to common shareholders by the weighted-average number of common shares and common share equivalents outstanding during the period. Key Tronic uses the Treasury Stock Method required by the standard in calculating the dilutive effect of common stock equivalents.
 
Because of the dilutive nature of outstanding options and warrants, the current quarter’s loss creates an antidilutive effect. Therefore the weighted average diluted shares equals the basic weighted average shares.
 
There were no adjustments to the income available to common shareholders for the first two quarters ended December 29, 2001 and December 30, 2000. The following table presents the Company’s calculations of weighted average shares outstanding (number of shares):
 
    
Weighted Avg. Shares

    
Adjustment for Potential Common Shares

  
Total

For the Quarter Ended
                
December 29, 2001
  
9,672,580
    
Antidilutive
  
9,672,580
December 30, 2000
  
9,670,808
    
246,074
  
9,916,882
For Two Quarters Ended
                
December 29, 2001
  
9,672,580
    
Antidilutive
  
9,672,580
December 30, 2000
  
9,662,989
    
265,601
  
9,928,590

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COMMITMENTS AND CONTINGENCIES
 
On December 20, 2001, a jury in Seattle federal court rendered a verdict finding that in 1993 Key Tronic misappropriated trade secrets and breached a confidentiality agreement with plaintiffs Fernando Falcon, Federico Gilligan and their company, F&G Scrolling Mouse LLC. The jury awarded damages of $16.5 million. Key Tronic strongly disagrees with the verdict and has filed post-trial motions seeking to overturn the verdict and will vigorously pursue an appeal if necessary. In addition to the $16.5 million judgment, the company has accrued an additional $0.5 million to cover expected legal costs.
 
The Company currently has fifteen lawsuits by computer keyboard users which are in state or federal courts in New York. These suits allege that specific keyboard products manufactured by the Company were sold with manufacturing, design and warning defects which caused or contributed to injury. The alleged injuries are not specifically identified but are referred to as repetitive stress injuries (RSI) or cumulative trauma disorders (CTD). These suits seek compensatory damages and some seek punitive damages. It is more likely than not that compensatory damages, if awarded, will be covered by insurance; however, the likelihood that punitive damages, if awarded, will be covered by insurance is remote. A total of 123 lawsuits have been dismissed in California, Connecticut, Florida, Illinois, Kansas, Kentucky, Maryland, Massachusetts, Michigan, New Jersey, New York, Pennsylvania and Texas.
 
FORWARD-LOOKING STATEMENTS
 
This Quarterly Report contains forward-looking statements in addition to historical information. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risks and Uncertainties That May Affect Future Results.” Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management’s opinions only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revision to forward-looking statements. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q
 
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
CAPITAL RESOURCES AND LIQUIDITY
 
Operating activities used $7.4 million of cash during the two quarters of fiscal year 2002 versus $4.0 million during the same period of the prior year. The change in cash for operating activities is due in part to the increased accounts receivable. This increase was caused by increased shipments in the first two quarters to a newly acquired EMS customer. Also contributing to the change in cash for operating activities is the increased levels of inventories for the company. This increase is attributable to additional raw materials needed for the major EMS customer that began production during the first two quarters of fiscal year 2002.
 
During the first two quarters of fiscal year 2002, $0.6 million was expended in capital additions versus $0.2 million spent in capital additions in the same period in the previous fiscal year. The Company anticipates capital expenditures of approximately $1.3 million through the remainder of the current fiscal year ending June 29, 2002. Actual capital expenditures may vary from anticipated expenditures depending upon future results of operations. See RISKS AND UNCERTAINTIES THAT MAY AFFECT FUTURE RESULTS, pages 13-14. Capital expenditures are expected to be financed with internally generated funds.
 
On August 24, 2001, the Company obtained a new revolving credit facility with CIT Group/Business Credit, Inc. for up to $25 million and paid off the GECC revolving loan. The Company recorded fees and costs of $132,000 in conjunction with the refinancing. The

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new revolving loan is secured by the assets of the Company. For the first year of the financing agreement with CIT, interest will accrue at J.P. Morgan Chase prime rate plus 0.75% (5.50%) as well as an unused line fee of .5%. The agreement specifies four different levels of rates to be added to the base prime rate (between 0.25% and 1.00%) depending on the Company’s earnings before interest, taxes, depreciation, and amortization. The agreement contains financial covenants that relate to maximum capital expenditures, minimum earnings before interest expense, income tax, depreciation, and amortization, and minimum tangible net worth. The agreement is for a term of three years beginning on August 24, 2001 and ending on August 23, 2004. In addition to the financial covenants, the credit agreement restricts investments, disposition of assets, and the payment of dividends.
 
As a result of the litigation judgment described in Note 7 to the financial statements, the Company has been notified by CIT Group/Business Credit, Inc. (lender) that the Company is in default of certain financial covenants in its credit facility and all subsequent loans or advances under the credit facility will be at the lender’s sole discretion. Should any action be taken by the plaintiffs which results in either a levy or execution on any assets of the Company, the lender has stated that it will immediately stop all further financing. The Company is dependent upon loans and advances from the lender to fund its working capital requirements. A levy or execution would disrupt funding and require the Company to file under Chapter 11 of the U.S. Bankruptcy Code in order to continue operating.
 
The Company is currently in negotiations with the plaintiffs attempting to reach a settlement of this matter in an amount and on terms that will permit the Company to continue with ongoing operations. The Company has made an offer to the plaintiffs, which the Company believes is in excess of the estimated amount the plaintiffs would recover from a levy or execution in a Chapter 11 proceeding. Any settlement must be approved by the lender and the Company’s Board of Directors. If a settlement can be reached with the plaintiffs, the Company believes that cash, cash equivalents, funds available under the line of credit, and internally generated funds can satisfy cash requirements for a period in excess of 12 months.
 
Real estate held for sale is carried at the lower of cost or net realizable value. In September of 1997, the Company signed a five year operating lease with a local company for this property. The lease terms include an option to buy the property upon notice at any time during the course of the lease. The lessee has notified the company that lessee intends to exercise its option to buy the property.
 
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
The Company is subject to the risk of fluctuating interest rates in the normal course of business. The Company’s major market risk relates to its secured debt. A portion of the Company’s accounts receivable and inventories are used as collateral for its term and revolving debt. The interest rates applicable to the Company’s revolving loan fluctuate with the JP Morgan Chase Bank prime rate.
 
The Company does not enter into derivative transactions or leveraged swap agreements.
 
Although the Company has international operations, the functional currency for all active subsidiaries is the U.S. dollar. The Company imports for its own use raw materials that are used in its manufacturing operations. Such purchases are denominated in U.S. dollars and are paid under normal trade terms.
 
NET SALES
 
Net sales for the fiscal 2002 second quarter ended December 29, 2001 were $50.5 million compared to $52.6 million for the second quarter of the previous year. For the six months ended December 29, 2001, sales were $85.1 million compared to $103.8 million for the same period of the previous year. The decrease in revenue for the six months ended was due primarily to a significant decrease in orders from one major EMS customer which was partially offset by an increase in orders from two new EMS customers. The revenue decline was also attributable to a decline in the Company’s keyboard sales. Keyboard orders continue to see a slowing of business demand and a decline of original equipment manufacturer (OEM) customer contracts. This drop in revenue was slightly offset by newly acquired EMS business, primarily by one major program that went into full production during the second quarter of 2002.
 
EMS revenue accounted for 90.5% of total revenue in the second quarter of fiscal year 2002 versus 78.1% of total revenue in the second quarter of fiscal year 2001. For the six months ended December 29, 2001, EMS revenue accounted for 88.5% of total revenue versus 76.6% of total revenue for the same time period of the prior fiscal year. The increase in EMS revenue in the second quarter is due primarily to the addition of two major EMS programs, partially offset by a decrease in orders from another EMS customer.

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Keyboard revenue decreased 57% for the second quarter of fiscal year 2002 compared to the second quarter of fiscal year 2001. For six months ended December 29, 2001, keyboard revenue decreased 62% over the same period of the prior year. The decrease in keyboard revenue is due primarily to weak demand in the distribution keyboard market and a significant drop in OEM contracts.
 
COST OF SALES
 
Cost of sales was 90.3% of revenue in the second quarter of fiscal year 2002, compared to 91.5% for the second quarter of fiscal year 2001. Cost of sales was 91.8% of revenue for the six months ended December 29, 2001 compared to 90.6% for the same period of the prior year. Cost of sales for the second quarter of fiscal year 2002 decreased slightly because of a major EMS program that helped utilize excess capacity in the Company’s production facilities. For the six months ended December 29, 2001 compared to the prior year, the slight increase was primarily due to lower plant utilization resulting from reduced volumes, although a new major EMS program that reached full production in the second quarter of fiscal 2002 helped to temper the increase.
 
RESEARCH, DEVELOPMENT AND ENGINEERING
 
Research, development and engineering (RD&E) expenses were $0.7 million in the second quarter of fiscal year 2002 and $0.6 million for the same period of fiscal year 2001. As a percentage of sales, RD&E expenditures were 1.4% in the second quarter of fiscal year 2002, compared to 1.1% for the same period of the prior year. RD&E expenses were $1.2 million for the six months ended December 29, 2001, compared to $1.4 million for the same period of the prior year. As a percentage of sales, RD&E expenditures were 1.5% of the current six month period versus 1.3% for the same period of the prior fiscal year.
 
SELLING EXPENSES
 
Selling expenses were $0.7 million in the second quarter of fiscal year 2002 compared to $1.2 million in the second quarter of fiscal year 2001. Selling expenses as a percentage of revenue were 1.5% for the quarter compared to 2.3% in the same quarter of fiscal year 2001. For the six months ended December 29, 2001, selling expenses were $1.5 million compared to $2.7 million for the same period of the prior year. As a percentage of revenue for the current six month period, selling expenses were 1.7% compared to 2.6% for the same period of the prior year.The decrease in selling expenses was due to an overall decline in keyboard revenue. Keyboards have higher selling costs associated with it than does EMS revenue.
 
GENERAL AND ADMINISTRATIVE
 
General and administrative (G&A) expenses remained fairly constant. They were $2.4 million in the second quarter of fiscal 2002 and $2.5 million for the first quarter of fiscal 2001. As a percentage of revenue, G&A expenses were 4.8% in the second quarter of fiscal years 2002 and 2001. For the six months ended December 29, 2001, G&A expenses were $4.2 million compared to $4.7 million for the same period of the prior year. As a percentage of revenue G&A expenses for the first six months of fiscal 2002 were 4.9% versus 4.5% for the same period of the prior year.
 
INTEREST
 
Interest expense was $359,000 in the second quarter of fiscal 2002 compared to $674,000 for the second quarter of fiscal year 2001. This decrease resulted from lower debt outstanding and reduced interest rates during the quarter.
 
INCOME TAXES
 
The income tax provision for the second quarter of fiscal year 2002 was $5,455,000 versus an income tax provision of $178,000 for the second fiscal quarter of the prior year. The $5,455,000 provision for the second quarter of fiscal year 2002 is the result of provisions on the earnings of foreign subsidiaries of $504,000 and the elimination of the Company’s net deferred tax assets in the amount of $4,951,000. The deferred tax assets were written off as a result of the large financial loss for the quarter, which increased the Company’s net operating loss carry-forwards to over $65 million. Financial Accounting Standard-No. 109 requires that management assess the sources of future taxable income, which may be available to recognize the deductible differences that comprise deferred tax assets. A valuation allowance against deferred tax assets is required if it is more likely than not that some or all of the deferred tax assets will not be realized. The valuation allowance was increased to the full value of the deferred tax assets. The

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Company’s tax loss carry-forwards begin expiring in 2006. The $178,000 provision for the second fiscal quarter of 2001 was the result of provisions on the earnings of foreign subsidiaries.
 
ESOP
 
No contributions to the Employee Stock Ownership Plan (ESOP) were made during the second quarter of fiscal years 2002 and 2001.
 
BACKLOG
 
The Company’s backlog at the end of second quarter of fiscal year 2002 was $44.8 million compared to $81.5 million at the end of fiscal year 2001, and $7.6 million at the end of the second quarter of fiscal year 2001. The decrease in the backlog from fiscal year end is primarily attributable to shipments made against a year long blanket purchase order from a new EMS customer reducing the amount still open.
 
RISKS AND UNCERTAINTIES THAT MAY AFFECT FUTURE RESULTS
 
The following risks and uncertainties could affect the Company’s actual results and could cause results to differ materially from past results or those contemplated by the Company’s forward-looking statements. When used herein, the words “expects”, “believes”, “anticipates” and similar expressions are intended to identify forward-looking statements.
 
Potential Fluctuations in Quarterly Results.    The Company’s quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including changes in overall demand for computer products, success of customers’ programs, timing of new programs, new product introductions or technological advances by the Company, its customers and its competitors and changes in pricing policies by the Company, its customers and its competitors. For example, the Company relies on customers’ forecasts to plan its business. If those forecasts are overly optimistic, the Company’s revenues and profits may fall short of expectations. Conversely, if those forecasts are too conservative, the Company could have an unexpected increase in revenues and profits.
 
Litigation Judgment.    As a result of the litigation judgment described in Note 7 to the financial statements, the Company has been notified by CIT Group/Business Credit, Inc. that the Company is in default of certain financial covenants in its credit facility and all subsequent loans or advances under the credit facility will be at the lender’s sole discretion. Should any action be taken by the plaintiffs which results in either a levy or execution on any assets of the Company, the lender has stated that it will immediately stop all further financing. The Company is dependent upon loans and advances from the lender to fund its working capital requirements. A levy or execution would disrupt funding and require the Company to file under Chapter 11 of the U.S. Bankruptcy Code in order to continue operating. The company’s success depends on its ability to attract and maintain customers and its ability to maintain its supplier relationships and obtain trade credit. There can be no assurance that the company will not lose customer and supplier relationships as a result of the uncertainty created by the litigation judgment.
 
The Company is currently in negotiations with the plaintiffs attempting to reach a settlement of this matter in an amount and on terms that will permit the Company to continue with ongoing operations. The Company has made an offer to the plaintiffs, which the Company believes is in excess of the estimated amount the plaintiffs would recover from a levy or execution in a Chapter 11 proceeding. Any settlement must be approved by the lender and the Company’s Board of Directors. There can be no assurance that the Company and plaintiffs will be able to reach a settlement of this matter.
 
Competition.    The EMS and keyboard industries are intensely competitive. Most of the Company’s principal competitors are headquartered in Asian countries that have a low cost labor force. Those competitors may offer customers lower prices on certain high volume programs. This could result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect the Company’s business, operating results and financial condition. In addition, competitors can copy the Company’s non-proprietary designs after the Company has invested in development of products for customers, thereby enabling such competitors to offer lower prices on such products due to savings in development costs.
 
Concentration of Major Customers.    At present, the Company’s customer base is highly concentrated, and there can be no assurance that its customer base will not become more concentrated. Three of the Company’s EMS customers accounted for 39%, 27%, and 5% of net sales during fiscal 2001. In 2000, these same customers accounted for 38%, 13% and 9% of the Company’s net sales. There can be no assurance that the Company’s principal customers will continue to purchase products from the Company at current levels. Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers and the Company’s

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customers have certain rights to extend or delay the shipment of their orders. The loss of one or more of the Company’s major customers or the reduction, delay or cancellation of orders from such customers could materially and adversely affect the Company’s business, operating results and financial condition.
 
Dependence on Key Personnel.    The Company’s future success depends in large part on the continued service of its key technical, marketing and management personnel and on its ability to continue to attract and retain qualified employees. The competition for such personnel is intense and there can be no assurance that the Company will be successful in attracting and retaining such personnel. The loss of key employees could have a material adverse effect on the Company’s business, operating results and financial condition.
 
Litigation.    The Company currently has fifteen lawsuits by computer keyboard users which are in state or federal courts in New York. These suits allege that specific keyboard products manufactured by the Company were sold with manufacturing, design and warning defects which caused or contributed to injury. The alleged injuries are not specifically identified but are referred to as repetitive stress injuries (RSI) or cumulative trauma disorders (CTD). These suits seek compensatory damages and some seek punitive damages. It is more likely than not that compensatory damages, if awarded, will be covered by insurance; however, the likelihood that punitive damages, if awarded, will be covered by insurance is remote. A total of 123 lawsuits have been dismissed in California, Connecticut, Florida, Illinois, Kansas, Kentucky, Maryland, Massachusetts, Michigan, New Jersey, New York, Pennsylvania and Texas.
 
Technological Change and New Product Risk.    The market for the Company’s products is characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and relatively short product life cycles. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. The Company’s success will depend upon its ability to enhance its existing products and to develop and introduce, on a timely and cost-effective basis, new products that keep pace with technological developments and emerging industry standards and address evolving and increasingly sophisticated customer requirements. Failure to do so could substantially harm the Company’s competitive position. There can be no assurance that the Company will be successful in identifying, developing, manufacturing and marketing products that respond to technological change, emerging industry standards or evolving customer requirements.
 
Dilution and Stock Price Volatility.    As of December 29, 2001, there were outstanding options and warrants for the purchase of approximately 2,000,000 shares of common stock of the Company (Common Stock), of which options and warrants for approximately 1,600,000 shares were vested and exercisable. Holders of the Common Stock will suffer immediate and substantial dilution to the extent outstanding options and warrants to purchase the Common Stock are exercised. The stock price of the Company may be subject to wide fluctuations and possible rapid increases or declines over a short time period. These fluctuations may be due to factors specific to the Company such as variations in quarterly operating results or changes in analysts’ earnings estimates, or to factors relating to the computer industry or to the securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have been unrelated to the operating performance of the specific companies whose stocks are traded.

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PART II.    OTHER INFORMATION:
 
Item 1.    Legal Proceedings
 
None
 
Item 4.    Submission of Matters to a Vote of Security Holders
 
None
 
Item 5.    Other Events
 
Item 6.    Exhibits and Reports on Form 8-K
 
(a)  Exhibits
 
None
 
(b)  The company filed the following current report on Form 8-K during the quarter ended December 29, 2001:
 
Current report on Form 8-K dated December 21, 2001 included information relating to the Company’s announcement that a jury in Seattle federal court had rendered a verdict finding that the Company misappropriated trade secrets and breached a confidentiality agreement with Plaintiffs Fernando Falcon, Federico Gilligan and their company, F&G Scrolling Mouse LLC. The jury awarded damages of $16.5 million and as a result of the verdict, the Company expected that, as of December 29, 2001 it would be in default of certain financial covenants in its credit facility maintained with a lender to the Company.
 

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SIGNATURES
 
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
 
KEY TRONIC CORPORATION
 
Signature

 
Date

     
/s/    JACK W. OEHLKE

Jack W. Oehlke
 
February 12, 2002
(Director, President and
Chief Executive Officer)
   
     
/s/    RONALD F. KLAWITTER

Ronald F. Klawitter
 
February 12, 2002
Principal Financial Officer
   
Principal Accounting Officer
   

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