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

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

KEY TRONIC CORPORATION

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 o.

At October 26, 2001, 9, 672,580 shares of Common Stock, no par value (the only class of common stock), were outstanding.

KEY TRONIC CORPORATION

Index

KEY TRONIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)

See accompanying notes to consolidated financial statements.

KEY TRONIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(continued, in thousands)

See accompanying notes to consolidated financial statements.

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

See accompanying notes to consolidated financial statements.

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

See accompanying notes to consolidated financial statements.

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

2. COMMITMENTS

The amount of firm commitments to contractors and suppliers for capital expenditures was approximately $60,000 at September 29, 2001.

3. LONG-TERM OBLIGATIONS

Long-term obligations consist of:

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, a margin of 0.75% will be applicable as an adder to the prime rate (6.00%) as well as a unused line fee of .5%. The agreement specifies four different levels of margin 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.

4. SUPPLEMENTAL CASH FLOW INFORMATION

5. INCOME TAXES

The income tax benefit for the first quarter of fiscal year 2002 was ($222,000) versus a provision $106,000 for the first fiscal quarter of the prior year. The ($222,000) benefit for the first quarter fiscal year 2002 is the result of tax provisions of $212,000 on the earnings of foreign subsidiaries and an income tax benefit of $(434,000) on the domestic losses of the Company. The $106,000 provision for the first quarter of fiscal 2001 was net of $(43,000) in tax benefits on the losses of foreign operations. The Company has tax loss carryforwards of approximately $48.8 million, which expire in varying amounts in the years 2006 through 2021

6. EARNINGS PER SHARE

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 quarters ended September 29, 2001 and September 30, 2000. The following table presents the Company’s calculations of weighted average shares outstanding (number of shares):

7. COMMITMENTS AND CONTINGENCIES

Litigation The Company currently has eleven 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 127 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 $4.3 million of cash during the first quarter of fiscal year 2002 versus $5.2 million during the same period of the prior year. This change in cash for operating activities is due primarily to the Company’s increase in accounts payable offset by the increase in inventory levels due to a build up of fabricated parts for a specific Electronic Manufacturing Services (EMS) customer. In previous filings, EMS was designated as Contract Design and Manufacturing (CDM).

During the first quarter of fiscal year 2002, the Company spent $0.3 million on 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 $1.4 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 10-11. 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 new revolving loan is secured by the assets of the Company. For the first year of the financing agreement with CIT, a margin of 0.75% will be applicable as an adder to the prime rate (6.00%) as well as a unused line fee of .5%. The agreement specifies four different levels of margin 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.

Real estate held for sale is carried at the lower of cost or net realizable value. In September of 1997, the Company entered into a five year operating lease with a local firm for property owned by the Company which is located in Cheney, Washington. Monthly lease payments received by the Company are $21,000. The lease terms include an option to buy the property upon notice at any time during the term of the lease.

The Company believes that funds available under the revolving credit facility and internally generated funds can satisfy cash requirements for a period in excess of 12 months.

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 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 first quarter ended September 29, 2001 were $34.6 million compared to $51.2 million for the first quarter of the previous year. The decrease is due to a significant decrease of orders from one significant customer as well as continuing decline in keyboard sales.

EMS revenue accounted for 85.5% of total revenue in the first quarter of fiscal year 2002 versus 75.1% of total revenue in the first quarter of fiscal year 2001. The increase in EMS revenue as a percentage of sales is a direct result of the Company’s strategy to grow this part of its business.

Keyboard and other sales were 14.5% of total revenue in the first quarter of fiscal year 2002 versus 24.9% of total revenue in the first quarter of fiscal year 2001. The decrease is due primarily to decreased customer orders for keyboards.

COST OF SALES

Cost of sales were 93.8% of revenue in the first quarter of fiscal year 2002, compared to 89.6% for the first quarter of fiscal year 2001. The cost of sales percentage increased due to lower sales, resulting in excess capacity in operations. During the first quarter of fiscal year 2002, management placed additional emphasis on material cost reductions through negotiations with major suppliers.

RESEARCH, DEVELOPMENT AND ENGINEERING

Research, development and engineering (RD&E) expenses were $0.6 million in the first quarter of fiscal year 2002 and $0.8 million for the same period of fiscal year 2001. As a percentage of sales, RD&E expenditures were 1.6% in the first quarter of fiscal year 2002 and 2001.

SELLING EXPENSES

Selling expenses were $0.7 million in the first quarter of fiscal year 2002 compared to $1.5 million in the first quarter of fiscal year 2001. Selling expenses as a percentage of revenue were 2.1% for the quarter compared to 3.0% in the same quarter of fiscal year 2001. These decreases can be attributed to reduced distribution keyboard sales, which resulted in lower costs for volume incentive rebates and cooperative advertising.

GENERAL AND ADMINISTRATIVE

General and administrative (G&A) expenses were $1.7 million in the first quarter of fiscal 2002 compared to $2.1 million in the first quarter of fiscal 2001. As a percentage of revenue, G&A expenses were 5.0% in the first quarter of fiscal 2002 versus 4.2% in the same quarter of the prior year. The percentage increase is due to lower revenues in the first quarter of fiscal 2002. During the first quarter of fiscal 2002, the Company ceased all significant operations in Ireland, and therefore reversed the cumulative translation adjustment of $245,000 previously recorded. Without this one-time adjustment, G&A expenses would have remained fairly constant for the period.

INTEREST

Interest expense was $341,000 in the first quarter of fiscal 2002 compared to $566,000 for the first quarter of fiscal year 2001. This decrease resulted primarily from a lower debt amount outstanding during the quarter and lower interest rates being charged from the prior year.

INCOME TAXES

The income tax benefit for the first quarter of fiscal year 2002 was $(222,000) versus a provision $106,000 for the first fiscal quarter of the prior year. The $(222,000) benefit for the first quarter fiscal year 2002 is the result of tax provisions of $212,000 on the earnings of foreign subsidiaries and an income tax benefit of $(434,000) on the domestic losses of the Company. The $106,000 provision for the first quarter of fiscal 2001 was net of $(43,000) in tax benefits on the losses of foreign operations. The Company has tax loss carryforwards of approximately $48.8 million, which expire in varying amounts in the years 2006 through 2021.

ESOP

No contributions to the Employee Stock Ownership Plan (ESOP) were made during the first quarter of fiscal years 2002 and 2001.

BACKLOG

The Company’s backlog at the end of first fiscal quarter of fiscal year 2002 was $49.3 million compared to $81.5 million at the end of fiscal year 2001 and $23.6 million at the end of the first quarter of fiscal year 2001. The decrease in the backlog from fiscal year end is attributable to orders shipped in the first quarter of fiscal year 2002 that had been held up in the fourth quarter.

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.

Competition The EMS and keyboard industries are intensely competitive. 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 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 eleven 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 127 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 September 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.

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

              10  Secured financing agreement with CIT Group/Business Credit, Inc.

              (b)  Reports on Form 8–K

                     None

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