Key Tronic (NASDAQ:KTCC) reported its FY2014 earnings numbers, which didn't in themselves hold any surprises, as much of them were anticipated by management in the preliminary Q4 results announcement. In fiscal 2014 revenues were down 15% mostly due to two large customers having difficulties in their own businesses (management stated that within those businesses, they had actually won share from other EMS manufacturers). Net margin was down to 2.5% from 3.5% in fiscal 2013. Even though the year was challenging, the company made significant progress with new programs, customers and capabilities.
In the original write-up, it was anticipated that the company needs net margins of 3-4% (along with revenue growth) in order for the thesis to play out. The Q4 conference call reinforced the thought that those margins are certainly reachable, perhaps even conservative. Management stated that from CDR they see getting a very meaningful amount of incremental revenues, since CDR's customers they talked with were hoping to have more business with them, but the lack of capabilities at CDR was holding them back. With Key Tronic's wider capabilities we can expect them to get significantly more business with the existing CDR customers (of which none were overlapping with Key Tronic's existing customers). As CEO Gates mentioned: "In the due diligence visits we've seen a number of cases where one plus one is probably going to equal 2.7 or 2.8." And all this, they expect to happen while at least maintaining CDR's margins which are around Key Tronic's margins. Additionally, as some comments in the original write-up mentioned, revenue growth is a significant driver of margin expansion. Key Tronic's CFO said that they see gross margins possibly being in double-digits as they get back to $90 to $100 million in quarterly sales (incremental gross margin on revenue increases around 15-20%, although same applies on the downside). Since it should be reasonable to expect operating expenses at those revenue levels to be around 4%, net margins can definitely reach the required 4% level and even go above 5% if the CDR acquisition proves to be positive for the margins, not only sales.
The negatives from the report were mostly that two of their big customers continued to face headwinds resulting in declining sales for Key Tronic. Even though as management said, they've won share from other EMS manufacturers that those two companies use(d), which goes to show their satisfaction with Key Tronic. The future in this regard is uncertain, but the most plausible scenarios seem to be that the revenues from these customers either continue to drop somewhat or stay approximately flat (which is what the customers have told Key Tronic and what they hope to be correct). Overall, the original thesis got more power behind it and it certainly seems like Key Tronic is a company with a very favourable future ahead of it.
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