Q2 2024 Key Tronic Corp Earnings Call

Operator: You are currently holding for today's second quarter fiscal 2024 Keytronic Corporation conference call. We are admitting additional participants and plan to be underway shortly. We appreciate your patience and ask that you please remain on line. We appreciate your patience and ask that you please remain on line. [inaudible] Good day, and welcome to the Keytronic Corporation conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Brett Larson. Please go ahead. Good afternoon, everyone.

You're currently holding for today's second quarter fiscal 2020 for key Tronic Corporation Conference call Weird meeting additional participants and plan to be underway. Shortly we appreciate your patience and ask that you. Please remain up.

[music].

Good day and welcome to the second quarter fiscal 2020 for key Tronic Corporation Conference call. Today's conference is being recorded at this time I would like to turn the conference over to Mr. Brett Larsen. Please go ahead.

Good afternoon, everyone I am Brett Larsen Chief Financial Officer of key Tronic.

Brett Larson: I am Brett Larson, Chief Financial Officer of Keytronic. I would like to thank everyone for joining us today on our investor conference call. Joining me here at our Spokane Valley Headquarters is Craig Gates, our president and chief executive officer, and Tony Voorhees, our vice president of finance and corporate controller. 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.

Like to thank everyone for joining us today for our Investor Conference call.

Joining me here in our Spokane Valley headquarters is Craig Gates, our President and Chief Executive Officer, and Tony Voorhees, Our Vice President of Finance and corporate controller.

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.

For more information you May review the risk factors outlined in the documents the company has filed with the SEC.

Brett Larson: Specifically, our latest 10K, quarterly 10Qs, and 8K. 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, and a recorded version of this call will be available on our website. Today, we released our results for the three-month end of December 30, 2023.

Specifically, our latest 10-K quarterly 10, Qs and eight Ks.

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 and a recorded version of this call will be available on our website.

Today, we released our results for the three months ended December 30th 2023 for the second quarter of fiscal 2024, we reported total revenues of $154.4 million up 18% from $123 $7 million in the <unk>.

Brett Larson: For the second quarter of fiscal 2024, we reported total revenues of $154.4 million, up 18% from $123.7 million in the same period of fiscal 2023. Revenue growth for the second quarter of fiscal 2024 was driven by increased production at our U.S.-based and Vietnam-based facilities as well as by the sale of approximately 8.1 million dollars of inventory from a discontinued program. For the first six months of fiscal 2024, total revenue was $293.2 million, up 12% from $261 million in the same period of fiscal 2023.

Same period of fiscal 2023.

Revenue growth for the second quarter of fiscal 2024 was driven by increased production at our U S based and Vietnam based facilities as well as by the sale of approximately $8 $1 million of inventory from a discontinued program.

For the first six months of fiscal 2024 total revenue was $293.2 million up 12% from $261 million in the same period of fiscal 2023.

Brett Larson: For the second quarter of fiscal 2024, our gross margin was 8.1%, and our operating margin was 2.7% compared to a gross margin of 7.2% and an operating margin of 2.9% in the same period of fiscal 2023. The increase in gross margin for the second quarter of fiscal 2024 reflects a favorable product mix for the quarter and improves operating efficiency. In recent periods, our improved production efficiencies, strategic labor cost reductions, and the gradual stabilization in its supply chain have been largely offset by the strengthening of the Mexican peso relative to the US dollar and increasing labor costs in Mexico and in the US. For the second quarter of fiscal 2024, net income was $1.1 million, or roughly $0.10 per share, compared to $1 million, or $0.09 per share, for the same period of fiscal 2023. For Net income was $1.4 million, or $0.13 per share, compared to $2.1 million, or $0.20 per share, for the same period in fiscal 2023.

For the second quarter of fiscal 2024 gross margin was eight 1% and our operating margin was two 7% compared to gross margin of seven 2% and an operating margin of two 9% in the same period of fiscal 2023.

The increase in gross margin for the second quarter of fiscal 2024 reflects a favorable product mix for the quarter and improved operating efficiencies.

In recent periods, our improved production efficiencies strategic labor cost reductions and the gradual stabilization in its supply chain have been largely offset by the strengthening of the Mexican peso relative to the U S dollar and increasing labor cost in Mexico and in the.

U S.

For the second quarter of fiscal 2024, net income was $1 $1 million were roughly 10 cents per share compared to $1 million or <unk> <unk> per share for the same period of fiscal 2023.

For the first six months of fiscal 2024.

Net income was $1 $4 million or <unk> 13 per share compared to $2 $1 million or <unk> 20 per share for the same period of fiscal 2023.

Brett Larson: As we've discussed, our profitability in fiscal 2024 continues to be negatively impacted by increased labor costs in both the U.S. and Mexico and by higher interest rates on our line of credit. Turning to the balance sheet, we ended the second quarter of fiscal 2024 by reducing inventory and contract assets, which are finished products, by approximately $48.3 million, or roughly 24% from the same time a year ago. These improvements in inventory levels primarily reflect increased component availability and our concerted efforts to drive inventory reduction. Total inventory turns increased to 3.8 times in the second quarter of fiscal 2024, up from 2.6 turns a year ago.

As we've discussed our profitability in the fiscal 'twenty 'twenty four continues to be negatively impacted by increased labor costs in both the U S and Mexico and by higher interest rates on our line of credit.

Turning to the balance sheet, we ended the second quarter of fiscal 2024 by reducing inventory and contract assets, which are finished products by approximately $48 $3 million were roughly 24% from the same time a year ago.

These improvements in inventory levels, primarily reflect increased component availability and our concerted efforts to drive inventory reductions.

Total inventory turns increased to three eight times in the second quarter of fiscal 2024 up from two six turns a year ago.

Brett Larson: We are pleased to see our inventory levels continue to become more in line with our current revenue. However, at the same time, the state of the worldwide supply chain still requires us to drive demand for parts differently than in historical periods. Our customers have revamped their forecasting methodologies, and we have significantly modified and improved our material resource planning algorithm. As a result, we should be better equipped for future disruptions in the supply chain even as we continue to manage inventory more cost effectively. During the second quarter, we also reduced our accounts payable, leasing obligations, and overall debt by a combined amount of $51 million from a year ago. At the same time, accounts receivable DSOs were at 85 days compared to 78 days a year ago, which we believe reflects some increased delays in collections from certain customers, despite continuing improvement from most customers with respect to disruption from Supply Chain Issues. Total capital expenditures were about $2.1 million for the second quarter of fiscal 2024, and we expect total CapEx for the year to be around $8 million.

We are pleased to see our inventory levels continued to become more in line with our current revenue.

At the same time the state of the worldwide supply chain still requires that we drive demand for parts differently than in historical periods.

Our customers have revamped their forecasting methodologies and we have significantly modified and improved our material resource planning algorithms.

As a result, we should be better equipped for future disruptions in the supply chain, even as we continued to manage inventory more cost effectively.

Yeah.

During the second quarter, we also reduced our accounts payable leasing obligations and over and overall debt by a combined amount of $51 million from a year ago.

At the same time accounts receivable Dsos was at 85 days compared to 778 days a year ago, which we believe reflects some increased delays in collections from certain customers.

Despite continuing improvement of most customers with respect to disruptions from supply chain issues.

Total capital expenditures were about $2 $1 million for the second quarter of fiscal 2024, and we expect total capex for the year to be around $8 million.

Brett Larson: 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 leasing facilities as well as make efficiency improvements to prepare for growth and add capacity, particularly in our U.S. and Vietnam locations. For the third quarter of fiscal 2024, we're seeing steady demand for most established programs relative to the second quarter. As previously announced, the large program with a leading power equipment company is now expected to resume materially in fiscal 2025 with a redesigned product. For the third quarter of fiscal 2024, we expect to report revenue in the range of $135 million to $145 million.

While we're keeping a careful eye on capital expenditures, we plan to continue to invest selectively in our production equipment.

<unk> equipment, and plastic molding capabilities utilized leasing leasing facilities as well as make efficiency improvements.

Prepare for growth.

And add capacity, particularly in our U S and Vietnam locations.

For the third quarter of fiscal 2024, we're seeing steady demand for most established programs relative to our second quarter.

As prudent as previously announced the large program the large program with a leading power equipment company is now expected to rezone materially in fiscal 2025 with a redesigned product.

For the third quarter of fiscal 2024, we expect to report revenue in the range of $135 million to $145 million.

Brett Larson: While new programs continue to ramp up in our Mexico facilities, efficiency improvements, a muted rebound to pre-COVID production levels amongst existing Mexico customers, and the continued pressure of a strengthened peso have combined to create an excess of overhead in our Juarez facility. After careful consideration and analysis, we expect to incur a severance expense of approximately $1 million to $2.5 million from headcount reductions in our Mexico-based operation. These severance expenses are unfortunate but a clear requirement. Among other considerations, the payback period for this decision is expected to be under a half of a year. Taking all these factors into consideration, we expect net income in the range of breakeven to $0.15 per diluted share.

While new programs continue to ramp in our Mexico facilities efficiency improvements.

Muted rebound to pre COVID-19 production levels amongst existing Mexico customers and the continued pressure of our strength in peso have combined to create an excess of overhead in our warehouse facilities.

After careful consideration and analysis, we expect to incur a severance expense of approximately $1 million to $2 $5 million from headcount reductions in our Mexico based operations.

These severance expenses are unfortunate, but a clear requirement.

Other considerations the payback period for this decision is expected to be under a half of the year.

Taking all these factors into consideration we expect net income in the range of breakeven to <unk> 15 per diluted share.

Craig Gates: In the second half of calendar 2024, we expect continued sales growth in the U.S. and Vietnam, and we have a strong pipeline of potential new business. Over the longer term, we believe that we are increasingly well positioned to win new programs and to continue to profitably expand our business. That's it for me, Craig.

In the second half of calendar 2024, we expect continued sales growth in the U S and Vietnam, and we have a strong pipeline of potential new business.

Over the longer term, we believe that we are increasingly well positioned to win new programs and to continue to profitably expand our business.

Is it for me Craig.

Craig Gates: Okay, thanks, Brett. During the second quarter of fiscal 2024, we continue to ramp up many new programs produced in our U.S. and Vietnam facilities, and we remain profitable. We're also pleased to see improvements in operating efficiencies, inventory levels, and other improvements made on the balance sheet. Moving into the third quarter of fiscal 2024, we continue to see the favorable trend of contract manufacturing returning to North America. As a result, we continue to expand our customer base and run new programs involving security products, medical devices, and Military Aerospace. Global logistics problems and China-U.S. geopolitical tensions continue to drive OEMs to examine their traditional outsourcing strategies. We believe these customers increasingly realize they have become overly dependent on their China-based contract manufacturers for not only product but also for design and logistics services. Over time, the decision to onshore or nearshore production is becoming more widely accepted as a smart long-term strategy.

Okay. Thanks, Brett.

During the second quarter of fiscal 2024.

We continue to ramp many new programs produced in our U S and Vietnam facilities, and we remain profitable.

We're also pleased to see improvements in our operating efficiencies inventory levels and other improvements made on the balance sheet.

Moving into the third quarter of fiscal 2024, we continue to see the favorable trend of contract manufacturing returning to North America.

As a result, we continue to expand our customer base and won new programs involving security products medical devices and.

And military aerospace.

Okay.

Global logistics problems in China U S. Geopolitical tensions continue to drive Oems to examine their traditional outsourcing strategies.

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

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

Craig Gates: As a result, we see opportunities for continued growth, and those opportunities are becoming more clearly defined over time. At the same time, we are seeing a sustained trend of a strong Mexican peso and continued wage increases in Mexican wages, particularly along the U.S.-Mexico border. As it has become clear that these changes in the base cost of Mexican production are long-standing, it has also become clear that customers have a different calculus for selecting a geographic location, for business they are bringing back from China, and for those customers who struggled with Chinese production due to their flexibility needs. The decreasing cost differential between our U.S. and Mexico plants means they will probably choose one of our U.S. sites. There, we believe, they can enjoy the ultimate in flexibility, engineering support, and ease of communication.

As a result, we see opportunities for continued growth and those opportunities are becoming more clearly defined overtime.

At the same time, we are seeing a sustained trend of a strong Mexican peso and continued wage increases in Mexican wages, particularly along the U S Mexico border.

As it has become clear that these changes in the base cost of Mexican production, our long standing and has also become clear that customers have a different calculus for selecting a geographic location for.

For business, they are bringing back from China.

For those customers, who struggled with China production due to their flexibility needs.

The decreasing cost differential between our U S and Mexico plants means they will probably choose one of our U S sites.

There we believe they can enjoy the ultimate flexibility engineering support and ease of communication.

Craig Gates: Meanwhile, for those customers whose requirements have adapted to the China model of limited flexibility, Challenging communications, and slow-motion engineering support, our Mexico facilities remain the answer. Therefore, we are reconfiguring our Mexico sites to endeavor to be a lower cost, high quality, but more commodity level service provider. Over the past 12 months, revenue from our U.S. production facilities has increased approximately 15 percent. In Q2 of 2024, production in the U.S. represented about 31% of our total revenue.

Meanwhile, for those customers, whose requirements had adapted to the China model of limited flexibility.

Challenging communications in slow motion engineering support our Mexico facilities remain the answer.

Therefore, we are reconfiguring, our Mexico sites to endeavor to be a lower cost high quality.

But more commodity level service provider.

Over the past 12 months revenue from our U S production facilities has increased approximately 15%.

In Q2 of 2020 for production in the U S represented about 31% of our total revenue.

Craig Gates: While our Vietnam facility continues to be a modest contributor to our over-revenue at approximately 4%, production there has increased by about 29% over the past 12 months. Moreover, a growing number of potential customers are actively evaluating a migration of their China-based manufacturing to our facility in Vietnam. In the coming years, we expect our Rietnow facility to play a major role in our growth. While Chinese growth has slowed, and many companies have decided to take risk mitigation steps with their Chinese manufacturers, the fact remains that many components must be sourced from China.

While our Vietnam facility continues to be a modest contributor to our over revenue at approximately 4%.

Production, there has increased by about 29% over the past 12 months.

Moreover, a growing number of potential customers are actively evaluating a migration of their China based manufacturing to our facility in Vietnam.

In the coming years, we expect a readout facility to play a major role in our growth.

While China growth has slowed and many companies have decided to take risk mitigation steps with their China manufacturers. The fact remains that many components must be sourced from China.

Our procurement group in Shanghai, which serves the entire corporation remains important for managing the China component supply chain on an ongoing basis.

Craig Gates: Our procurement group in Shanghai, which serves the entire corporation, remains important for managing the Chinese component supply chain on an ongoing basis. The combination of our global footprint and our expansive design capabilities is proving to be extremely effective in capturing new business. Many of our large and medium-sized manufacturing program wins are predicated on Keytronic'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 successful. We have also invested in vertical integration and manufacturing process knowledge, including a wide range of plastic molding, injection, blow, gas assist, and 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.

The combination of our global footprint and our expansive design capabilities is proving to be extremely effective in capturing new business. Many of our large and medium sized manufacturing program wins are predicated on key tronic is deep and broad design services.

And once we have completed the design and ramped into production. We believe her knowledge of a program specific design challenges makes that business extremely sticky.

We also invested in vertical integration 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.

This expertise may set us apart from our competitors have a similar size.

As a result.

Customer looking to leave their contract manufacturer, we will find a one stop shop and key tronic, which is expected to make the transition to our facilities much less risky and cobbling together a group of providers each limited to a portion of the value chain.

In fact, most of the new customers, we have onboard and take advantage of the one stop shop capabilities, we provide.

We believe global logistics problems, China U S political tensions and heightened concerns about supply chains will drive.

We will continue to drive the favorable trend in contract manufacturing returning to North America.

Craig Gates: This expertise may set us apart from our competitors of a similar size. As a result... A customer looking to leave their contract manufacturer will find a one-stop shop in Keytronic, which is expected to make the transition to our facilities much less risky than cobbling together a group of providers, each limited to a portion of the value chain. In fact, most of the new customers we have onboarded take advantage of the one-stop shop capabilities we provide.

As well as to our expanding Vietnam facilities, we continue to see improvement across the metrics associated with business development.

Including a significant increase in the number of active quotes with prospective customers.

As we move into the second half fiscal 2024, with a strong pipeline of potential new business.

While we're seeing some improvement in our gross margin.

Recent wage increases higher interest rates and a strong peso will dampen our growth and profitability in the near term.

Craig Gates: We believe global logistics problems, China-U.S. political tensions, and heightened concerns about supply chains will drive, and will continue to drive, the favorable trend of contract manufacturing returning to North America, as well as to our expanding Vietnam facilities. We continue to see improvement across the metrics associated with business development, including a significant increase in the number of active quotes with reflective. We move into the second half of fiscal 2024 with a strong pipeline of potential new business. While we're seeing some improvement in our gross margin. Recent wage increases, higher interest rates, and a strong peso will dampen our growth and profitability in the near term.

However, we will continue to rebalance our manufacturing across our facilities in Mexico U S and Vietnam.

We remain very encouraged by our progress and potential for growth over the long term.

In preparation for our future, we recently announced our leadership succession plan beginning June 30th.

I am very pleased that our board of directors named breath to succeed me as President and Chief Executive Officer, I expect it to remain a member of the board.

We are most fortunate that Brett joined key Tronic and 22004 and has served as our executive Vice President Administration Chief.

<unk> financial officer, and Treasurer since 2015.

He has assumed ever increasing roles and responsibilities over the past 20 years.

Right and I have worked very closely and he has been a critical member of the management team formulating and executing our strategies over the years.

Craig Gates: Moreover, we will continue to rebalance our manufacturing across our facilities in Mexico, the U.S., and Vietnam. We remain very encouraged by our progress and potential for growth over the long term. In preparation for our future, we recently announced our leadership succession plan beginning June 30th. I'm very pleased that our board of directors named Brett to succeed me as president and chief executive officer.

In addition, Tony will be promoted to executive Vice President of administration, Chief Financial Officer, and Treasurer Tony.

Tony has served in various financial management roles with US since 2010 and has worked closely with breath for many years.

I am confident Toni and their outstanding team will continue to take key tronic to new Heights.

This concludes the formal portion of our presentation, Bret Tony and I will now be pleased to answer your questions.

Thank you.

If you are dialed in via the telephone and would like to ask a question. Please signal by pressing star one on your telephone keypad.

Craig Gates: I expect to remain a member of the board. We are most fortunate that Brett joined Keytronic in 2004 and has served as our Executive Vice President of Administration, Chief Financial Officer, and Treasurer since 2015. He has assumed ever-increasing roles and responsibilities over the past 20 years.

If you are using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment again. Please press star one to ask a question.

Your first question comes from the line of Bill <unk> with Titan capital.

Craig Gates: Brett and I have worked very closely with Tony, and he has been a critical member of the management team formulating and executing our strategies over the years. In addition, Tony will be promoted to Executive Vice President of Administration, Chief Financial Officer, and Treasurer. Tony has served in various financial management roles with us since 2010 and has worked closely with Brett for many years. I am confident Brett, Tony, and their outstanding team will continue to take Keytronic to new heights.

Please go ahead.

Thank you first of all congratulations to all three of you or retiring and promotions.

So let's start with my.

My normal first question would you discuss each of the three program runs in terms of size.

And then any interesting.

Details around them. Please.

Yeah. The security products are between 10 and 20.

$1 million, a year and thats with an existing customer.

The medical devices are around I don't know two to five.

And military aerospace is around 3% to 10.

So the medical devices in the military are both new customers.

Operator: This concludes the formal portion of our presentation. Brett, Tony, and I will now be pleased to answer your questions. If you are dialed in via the telephone and would like to ask a question, signal by pressing star one on your telephone. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach us. Again, please press star 1 to ask a question.

Too.

Many military.

Android aerospace products have very high level of qualifications.

Are required.

Sometimes we wonder if it's to the point of excess.

And then next thing you know our Doorbells offer client and maybe it's not the excess so my question is.

Did you go through.

Yes.

Higher level of qualification then would be that would be normal for security product or.

Bill Dezellem: Your first question comes from the line of Bill Dezellem with Titan Capital. Please go ahead. Thank you. First of all, congratulations to all three of you for retiring in promotion. So, let's start with my normal first question. Would you discuss each of the three program wins in terms of size and then any interesting details around them, please?

HVAC product or.

Anything of that nature.

Yes.

And would you like to expand on that further.

Okay.

There are two aspects of that.

One is we were concerned since this was.

I guess really our first significant.

Military aerospace program in quite some time.

That the contractual requirements would be so far out of line that we could never reach.

Common ground with the customer.

Craig Gates: Yeah, the security products are between 10 and 20 million dollars a year, and that's with an existing customer. The medical devices are around, I don't know, two to five. And military aerospace is around three to 10. So medical devices and the military are both new customers, too. Many military and or aerospace products have a very high level of qualification. Dezellem, William Dezellem, Key Tron, Sometimes we wonder if it's to the point of excess.

And that turned out to be unfounded.

So even though we started huawei apart.

It seems like we're.

We're going to be able to make that work as far as the.

Contractual relationship goes.

Then as far as the.

Actual manufacturing capabilities and qualification capabilities and in fact in this case specialized manufacturing equipment.

We did go through a significant.

Qualification period and analysis by our new customer to determine if indeed, we could get there.

And then the.

Some of that is going to continue to serve us well with other perspective military customers and aerospace customers.

And Craig is this a customer that is of a size that would.

Craig Gates: And then next thing you know, a door blows off a plane, and maybe it's not safe to access. So, my question is... Did you go through some higher level of qualification than would be normal for a security product or HVAC product or anything of those? Yeah. Would you like to expand on that further? Okay. There are two aspects to that. One is we were concerned since this was, I guess really, our first significant military aerospace program in quite some time, that the contractual requirements would be so far out of line that we could never reach common ground with the customers. And that turned out to be unfounded. So even though we started a long way apart,

It would give you the opportunity for a significant amount of business over the coming years.

Our program is successful.

Yes, it's one of the big guys.

Great. Thank you and then I.

Believe on the last conference call.

Was a fair amount of uncertainty that you.

Alright, interjected into what you were seeing in the macro environment and with your customers' money or I shouldn't say may some of which that you said you were seeing a pullback in demand at that point I believe you said it was nothing.

You were panicking over but directionally the arrow was pointed.

The wrong way.

This quarter did we hear correctly.

That.

Craig Gates: It seems like we're going to be able to make that work as far as a contractual relationship goes. Then as far as the actual manufacturing capabilities and qualification capabilities, and, in fact, in this case, specialized manufacturing equipment, did go through a significant. Go to Beadaholique.com for all of your beading supply needs! qualification period and analysis by our new customer to determine if indeed we could get there. And then some of that is going to continue to serve us well with other prospective military customers and aerospace customers. And Craig, is this a customer that is of a size that would give you the opportunity for a significant amount of business over the coming years if this program is successful? Yeah, it's one of the big guys.

Demand is stable and so you would you would have a different perspective now than you did then and im.

Im hoping youll talk around those various points. Please.

Okay.

This quarter.

We would say that the demand has stabilized there are still ups and downs, but theres not a consistent down.

We're still confused about the directions of the economy overall.

Our customers are still confused.

There has been.

I think part of why we say our arrow is.

As horizontal rather than down or up.

Is that a couple of the larger customers.

We had been.

Tightening up inventory as they feared and oncoming recession.

Yes.

Or as they burned off some COVID-19 driven inventory.

Craig Gates: And then, I believe on the last conference call, there was a fair amount of uncertainty that you interjected into what you were seeing in the macro environment and with your customers, many, or I shouldn't say many, some of which, that you said you were seeing a pullback in demand. At that point, I believe you said it was nothing that you were panicking over, but directionally, the arrow was pointed the wrong way.

And now that seems to have gotten behind them and us and so they are.

Increasing their orders again.

But saying that one of those customers. One division has had their forecast almost to a third of what it was while another the other three divisions are increasing their forecast.

It's not a.

I don't think were at a time right now where we can say it's stabilized. It's just that right now the puts and takes are about balancing out.

Craig Gates: This quarter, did we hear correctly that demand is stable? And so you would have a different perspective now than you did then. And I'm hoping you'll talk about those various points, please. Okay. This quarter.

There's a lot of.

Go ahead.

After you please.

There's a lot of data that says that even though unemployment looks good.

Craig Gates: We would say that demand has stabilized. There are still ups and downs, but there's not a consistent decline. We're still confused about the direction of the economy overall. And our customers are still confused. There has been, I think part of why we say our arrow is horizontal rather than up or down, is that a couple of the larger customers had been tightening up inventory as they feared an oncoming recession and or as they burned off some COVID-driven inventory, and now that seems to have gotten behind them and us, and so they are increasing their orders again, but One of those customers, one division has hacked their forecast almost to a It's just that right now, the puts and takes are about balancing out. There's a lot of... Go ahead, after you please.

The actual job market is quite a bit tighter than what we've got used to post COVID-19. There is a lot of data that people everybody was the great. The great retirement, great separation.

That data.

Has switched to people are staying in their jobs. The data that says that people, even though they don't like it are coming back to the office.

Would seem to contradict the data that says unemployment is very low.

Wage increases.

They have taken a pause over the last quarter and a half.

So it's very hard for us to say, we have a handle on what's going to happen next.

And those wage pauses I presume, you're referring to to the U S and that doesn't that is not talking to Mexico correct.

Correct correct, yes.

So let's use that as a segue to Mexico would you please expand on.

On what you were doing in Mexico.

In the near term with the restructuring.

Craig Gates: There's a lot of data that says that even though unemployment looks good, the actual job market is quite a bit tighter than what we've gotten used to post-COVID. There's a lot of data that people, you know, everybody was the great, the great retirement, the great separation.

Then longer term.

How you are thinking about it.

Really looking for more detail than you had in your opening remarks. Please.

Okay.

Okay.

No.

Boy Bill I'll work long and hard on those two paragraphs I hope there are self explanatory.

Craig Gates: That the data has switched to people staying in their jobs, data that says that people, even though they don't like it, are coming back to the office, would seem to contradict the data that says unemployment is very low, and wage increases seem to have taken a pause over the last quarter and a half. So it's very hard for us to say we have a handle on what's going to happen next. And those wage pauses, I presume you're referring to the U.S., and that is not talking to Mexico, correct? Yep. So let's use that as a segue to Mexico. Would you please expand on what you are doing in Mexico?

Yes.

Actually were and then we actually created a whole bunch more questions. So.

Okay.

Once you asked me a few of those questions, maybe we'll kick off that way alright.

Alright, so what.

What was the trigger point that made you decide that now is the time as opposed to six months from now or waiting waiting longer to two.

To make the decision.

We started.

Trying to look at all of the quotes we were seeing.

And really really dig hard into where we are coming out.

On just pure cost versus our competitors.

It's always a mix of service level.

Craig Gates: In the near term with the restructuring and then, longer term, how you are thinking about it, really looking for more detail than you had in your opening remarks. OK. So, Boy Bill, I worked long and hard on those two paragraphs. I hope they were self-explanatory.

Trust in the company.

Personal interrelationship and everything else that goes into a win or loss on a bid.

But we decided it was time with the increasing wages and peso that we needed to take a hard look at just separating that one component of a decision which is price.

Bill Dezellem: They actually were, and they actually created a whole bunch more questions, so... OK. Why don't you ask me a few of those questions? Maybe we'll kick off that way. All right, so what was the trigger point that made you decide now is the time as opposed to six months from now or waiting longer to make the decision? We started trying to look at all of the quotes we were seeing and really, really dig hard into where we were coming out on just pure cost versus our competitors. It's always a mix of service level, trust in the company, personal interrelationships, and everything else that goes into a win or a loss on a bid, but we decided it was time, with the increasing wages and pesos, that we needed to take a hard And after we did that, we dug into it hard.

And after we did that.

Dug into it hard.

We started looking at that.

In relation to the choices people are making on.

Where they wanted their product to go.

And.

It was it's kind of an interesting thing it's a split between the products that didn't ever really belong in China.

And before Covid we.

We had a hard time and we did it we grew the company doing it but we had a hard time selling.

Against the downsides.

What are the upside to China with the downside to China.

Yeah.

And now that.

People are.

<unk>.

Paying more attention to the downsides.

They are willing to pay more to avoid those downsides. So.

Sure.

Product that shouldn't have been in China, because it was either an immature product.

Or it was impossible to forecast the demand well.

Craig Gates: We started looking at that in relation to the choices people were making about where they wanted their product to go, and It was, it's kind of an interesting thing. It's a split between products that didn't ever really belong in China. And before COVID, we had a hard time, and we did it, we drew up the company doing it, but we had a hard time selling it against the downsides of China or the upsides of China with the downsides of China. And now that the people are paying more attention to the downsides. They're willing to pay more to avoid those downsides, and show a product that shouldn't have been in China because it was either an immature product, or it was impossible to forecast the demand well, or, say, changes in style require instantaneous changes in production. Even though it went to China, it still had all those disadvantages.

Or.

Say changes in style require instantaneous changes in production.

Even though it went to China.

It still had all those disadvantages and.

When the company the customer made the decision to come back.

When there isn't that massive delta between.

Mexico and the states.

Those customers, who really wanted all of that extra service are willing to pay.

For that service out of the states.

That's why.

We see the growth in our U S sites.

And that's not only customers that went to China, and then came back its customers who would have gone to China.

We are now.

Happy that they don't have to.

They are happy it's the folks that have to deal with the day to day business of getting product made.

And getting it to where it needs to be to get sold on time.

Craig Gates: And when the company, the customer, made the decision to come back, when there wasn't that massive delta between Mexico and the States. Those customers who really wanted all of that extra service are willing to pay for that service out of state. And that's why we see the growth in our U.S. site. And it's not only customers that went to China and then came back; it's customers who would have gone to China, and we're now happy that they don't have to.

So that.

I guess hurdle.

Has increased.

To the point, where we used to see new business opportunities for the U S sites.

That were in the one $3 million range and anybody with a bigger volume than that and I know volume isn't the same as revenue.

I'll, just say that as it is now.

So.

Those smaller programs, we're making it into our U S sites, but the bigger ones we were competing.

Or.

Out of our Mexico site only.

Craig Gates: When I say they are happy, it's the folks that have to deal with the day-to-day business of getting product made, getting it to where it needs to be to get sold on time. So that, I guess, the hurdle has increased to the point where we used to see new business opportunities for the U.S. site. Now we're in the one to three million dollar range, and anybody with a bigger volume than that, and I know volume isn't the same as revenue, but I just say that as it is now. Those smaller programs were making it into our U.S. sites, but the bigger ones we were competing for out of our Mexico site only.

And in the last year, we've seen a shift in that hurdle to where people are now wanting to put $10 billion programs $15 million programs.

And there are sites in the states.

Because they recognize the value of.

<unk>.

The service level that the states can provide at a price that is no longer so much higher than Mexico.

On the other hand that means that.

The hurdle rate to stay in Mexico has gotten higher.

And therefore.

The people who want to stay in China, That's got a balance that Mexico. The people want to say in Mexico.

Are willing to.

Deal with the type of service they get used to out.

Craig Gates: In the last year, we've seen a shift in that hurdle to where people are now wanting to put $10 million programs, $15 million programs, into our sites in the States because they recognize the value of the service level that the states can provide at a price that is no longer so much higher than Mexico. On the other hand, that means that the hurdle rate to stay in Mexico has gotten higher, and therefore the people who want to stay in China, I meant to say Mexico, the people who want to stay in Mexico are willing to deal with the type of service they got used to out of China. So they're not willing to pay for the extra services that we have put in place in Mexico over time. Dezellem, William Dezellem, and Key Tron, For example, if you're a customer and you call us up and say, hey, I know I had 10,000 widgets that I wanted next month. I need him back next week.

Out of China.

So theyre not willing to pay for the extra services that we had.

Put in place in Mexico over time.

And to make that clear.

For example, if you're a customer and you call us up and say Hey, I know I had 10000 widgets that I wanted next months.

I need them next week.

And the way, we would make that happen is through a lot of.

A lot of people in the salaried ranks who would hustle around.

And get parts across the border quickly and get lines changed over and monitor the switch and we will move employees and train employees.

And all that would happen in the customer would be happy.

But it costs more.

Now those customers, who need that type of service are willing to pay U S prices.

That leaves the folks who arent willing to pay for those prices.

With our Mexico facility competing against other.

Commodity type service levels out of Mexico.

So that means we can take a lot of this added service cost.

Out of our Mexico facility.

Craig Gates: And the way we would make that happen is through a lot of people in the salary ranks who would hustle around and get parts across the border quickly and get lines changed over and monitor the switch, and we would move employees and train employees. And all that would happen, and the customer would be happy, but it costs more. And now those customers who need that type of service are willing to pay US prices. That leaves the folks who aren't willing to pay for those prices, with our Mexico facility competing against other commodity-type service levels out of Mexico. So that means we can take a lot of this added service cost out of our Mexico facility without harming the customers who were willing to pay for it before because they're not there anymore. They've migrated.

Without harming the customers who are willing to pay for it before because they are not there anymore they've migrated.

Well that makes sense.

Great.

I believe it does makes sense, let me, let me try to play that back to make sure I'm hearing it correctly.

Which is.

Customers that are willing to pay.

Or who demand a higher level of service are willing to pay the extra price for the U S.

The customers, who want the lowest price theyre going to Vietnam.

<unk>.

You had build Mexico on a higher service model.

Higher service lower cost, but not the lowest cost.

And that really is left Mexico in a in a no man's land and therefore.

Now you are needing to make an adjustment it sounds like if I'm hearing correctly you are taking.

The extra cost that went along with the higher level of service.

Bill Dezellem: Does that make sense? I believe it does make sense. Let me try to play that back to make sure that I'm hearing it correctly, which is customers that are willing to pay, or who demand a higher level of service, are willing to pay the extra price for the U.S., the customers who want the lowest price, they're going to Vietnam, which You had built Mexico on a higher service model, higher service, lower cost, but not the lowest cost, and that really has left Mexico in a no And it sounds like, if I'm hearing correctly, you are taking the extra cost that went along with the higher level of service out of the Mexican cost structure and will allow you to run big programs with fewer changeovers taking place because those changeovers will probably be in the U.S. or at super low cost in Vietnam. Am I hearing that somewhat close?

Out of the out of the Mexican cost structure and will allow you to run.

Bigger.

Programs and less changeovers, taking place because those changeovers will probably be in the U S.

For the Super low cost in Vietnam am I hearing that somewhat close.

Yes.

Okay. So I guess that leads to two additional questions.

My apologies for for dominating here so long so.

First of all.

Does that put Mexico.

Hey.

Okay.

Strange place for for now given that it's two thirds of your revenue and yet a little bit of of no man's land.

And.

And then secondarily, how quickly do you foresee Vietnam filling up.

And I guess thirdly coming back to Mexico.

Bill Dezellem: Yep. Okay, so that leads to two additional questions and my apologies for dominating here for so long. First of all, does that put Mexico in a strange place for now, given that it's two-thirds of your revenue and yet a little bit of no man's land? And then secondarily, how quickly do you foresee Vietnam filling up? And thirdly, coming back to Mexico, would you anticipate that the changes that you are making with this restructuring will then accelerate growth in Mexico that you otherwise wouldn't have been able to achieve because you just weren't positioned correctly? So the third question is the most important.

Do you anticipate that the changes that you are making with this restructuring will then accelerate.

Growth in Mexico.

Otherwise, we wouldn't have been able to win because you just werent positioned correctly.

So the third question is the most important.

And that is exactly what we expect.

We have already seen that.

As we have been pricing.

As if we had the new model completely.

Put in place, which we will by the time these programs actually hit.

Okay.

So thats the main impetus for doing this is that we have to have war is able to compete on a commodity basis.

And that doesn't mean that they won't be able to provide that.

Craig Gates: And that is exactly what we expect. We have already seen that, as we've been pricing, as if we had the new model completely put in place, which we will by the time these programs actually hit. So that's the main impetus for doing this is that we have to have war as able to compete on a commodity basis. And that doesn't mean that they won't be able to provide the extra services that some customers will want. But that will be optional and paid for by the time you use it rather than baked into the basic cost structure of warrants.

Extra services that some customers will want.

But that will be on an optional.

By the time you use it.

Rather than baked into the basic cost structure awards.

So it's a switch from we're standing there ready.

And we will do it for free.

Two we can do it if it's important enough that you want to pay for it.

But that comes down to.

Split in the customers.

People, who make the decision and people who have to live with it.

And typically the guy that makes the decision is mainly focused on.

Price only.

And the folks that have to live with the decisions are focused on the service level that they can get.

Craig Gates: So it's a switch from us being there ready, who will do it for free, who we can do it if it's important enough that you want to pay for it. But that comes down to people who make the decision and people who have to live with it. Typically, the guy that makes the decision is mainly focused on price only, and the folks that have to live with the decision are focused on the service level that they can get. And as the makeup of the customers coming back from China has changed over the years, well, as I should say, the makeup of the people that are interested in Mexico has changed over the years. The person making the decision that's interested only in price has got the louder voice, whereas in the past, it was more of a shared decision. Because the people that are coming out of China have sticker shock.

And as the.

Makeup of the customers.

Coming back from China.

As changed over the years.

Or as I should say the makeup of the people that are interested in Mexico has changed over the years.

The person, making the decision that's interested only in price has got a louder voice.

Whereas in the past it was more of a shared decision.

Because the people that are coming out of China has sticker shock.

When their order to move then they have to come to Mexico in our price in anybody else's prices more than China.

They don't like it.

And trying to sell.

A baked in service level, that's better than China.

Due to the person who's only evaluated on price.

It is an uphill battle didn't used to be as much as it is now.

So that's why we're making the change.

Craig Gates: When they're ordered to move, then they have to come to Mexico, and our price and anybody else's price is more than China, and they don't like it, trying to sell a baked-in service level that's better than China. The person who's only evaluated on price is an uphill battle. It didn't used to be as much as it is now.

I don't think its going to drive.

Any change in the attractiveness of Vietnam.

For the United States I don't think the tour.

Much interconnected.

Because they pretty much stand on their own.

They are all right.

Craig business puts you in an enviable position.

We're.

Upfront decision maker you can.

Can win them.

Because you have a lower price.

Craig Gates: So that's why we're making the, um... I don't think it's going to drive any change in the attractiveness of Vietnam for the United States. I don't think the two are that much interconnected because they pretty much stand on their own. Craig, does this put you in an enviable position? Where the upfront decision maker is, you can win them because you have a lower price. And then when the operator is basically being told you need to get something done and your job's on the line, if you're not able to accomplish it, they can come to you, and you'll have the ability, and they say, I don't care what it costs, and you're able to charge for that. That's certainly the intent.

And then when the operator.

Is basically being told you need to get something done in your jobs on the line if youre not able to accomplish is it taking the outcome. They can come to you and you'll have the ability and basically I don't care what it costs.

Loosely speaking.

And.

And youre able to charge for.

So you kind of win on both sides.

That's certainly the intent.

Okay, and then one additional question.

Ill step back in queue do you see a place for an additional facility or an additional geography within Mexico or somewhere else near I'm thinking inland.

Craig Gates: Okay, and one additional question, and I'll step back into the queue. Do you see a place for an additional facility or an additional geography within Mexico or somewhere else near, and I'm thinking inland where the, and when I say inland, I mean non-border, where the cost of labor is lower and yet you can still have the relative nearness of Mexico, or do you believe what you're doing here accomplishes all that you need from a geographic dispersion? Well, anytime over the last 20 years, we've kept an eye out for opportunities deeper within Mexico, and we continue to see, after much analysis and hand-wringing, that the delta in Direct Labor Wages that you receive by going deeper inland, as you say, to Mexico is mainly offset by the increase in salaries you have to pay to get people who want to work in salaried positions deeper into Mexico. And then you have the further offsetting disadvantage of shipping time and the further offsetting disadvantage of getting engineers across the border and eight hours in Mexico. So as of right now, We are staying pat on our Ora's hands.

Where are the.

And when I say online I mean non border.

Where the cost labor costs are lower and yet and yet you can still have the relative newness of Mexico or do you believe what you're doing here accomplishes all of it you mean from a geographic disc.

Dispersion.

Well anytime over the last 20 years.

Kept an eye out on.

Opportunities deeper within Mexico.

And.

We continue to see after much analysis than Handwringing.

That the Delta in <unk>.

Direct labor wages.

That you receive by going deeper inland as you say to Mexico.

Is <unk>.

Mainly offset by the increase in salaries, you have to pay to get people, who want to work and salaried physicians deeper into Mexico.

And then you have the further offsetting disadvantage of shipping time.

And the further offsetting disadvantage of getting engineers across the border and eight hours in the Mexico.

So as of right now we.

We are staying Pat on our or his hand.

Craig Gates: But that could change at any time as various factors that we don't control change. So we're prepared to change our decision right now after looking at it pretty hard. It appears that ORAS is the right answer for us.

But that could change at any time as.

Various factors that we don't control change so we're prepared to change our decision.

But right now <unk>.

After looking at it pretty hard.

It appears that or is the right answer for us.

Bill Dezellem: Okay. And I told you that would be my last question. But I'm going to change that and say, relative to the restructuring that you're doing, is this primarily the labor that you're laying off hourly labor or primarily salaried labor? So here's a quiz: which do you think it is?

Understood.

I told you that would be my last question.

Renege on that end and I would.

Relative to the restructuring.

Youre doing is this primarily the.

The labor and material lining off hourly labor or primarily salaried labor.

So here's a quiz, which do you think it is.

Craig Gates: I would guess it would be more salaried labor. That's just how I'm thinking about what I thought I heard you say. Perfect, that's exactly right. We are communicating, and so if you are laying off that salaried workforce, essentially the fixed cost or some portion of the fixed cost there, when a customer who'd historically been able to say to you, gosh, I really need this quickly, how do you respond since it was in part because of those salaried people, I suspect some of them that will no longer be with you, made that happen?

Hi, I would guess it would be more salaried labor.

I'm thinking about what I thought I heard you say.

Perfect that's exactly right.

We are communicating.

And so.

So if you are are laying off that salaried workforce.

The fixed cost.

Some portion of the fixed costs, there when a customer who has historically been.

Able to say to you gosh I really need this quickly.

How do you respond since it was up in part because of the salaried people I suspect some of that.

We will no longer be with you worry, we're making that happen.

Craig Gates: So we're not laying them all off, but we've already seen that customers who need that and who are willing to pay for it. Create much less of a workload than what we were giving away as part of the total business proposition a year ago. So we still have the capability to do it, just on a smaller scale. And that scale is smaller because customers now have to pay for it, in many cases, versus getting it for free previously. Well, congratulations on the learnings, and it sounds like this is a little bit like the difference between going to an a la carte restaurant and a buffet, where we probably all tend to eat a little bit more at the buffet, simply because we do. That's a true statement.

So we're not laying them all off.

Quite a few of them off.

And we've already seen that the customers who.

Who.

Need that and who are willing to pay for it.

Great much less of a workload than what we were giving away as part of the total business proposition a year ago.

So we still have the capability to do it just on a smaller scale.

And that scale is smaller because customers now have to pay for it in many cases versus getting it for free previously.

Well congratulations on the learning centers.

Wins like this is a little bit like the difference between going to an Ala carte restaurants at a buffet that we'd probably do all of us tend to eat a little bit more at the buffet simply because we can.

That's a true statement.

Craig Gates: Part of it is learning, but part of it is what has changed in the marketplace as people have come out of China who were there before. So it's not so much learning as it is analysis of the change and reacting to it. Great, thank you. I'll step back in the queue and queue back in again. Thank you.

Part of it is learning, but part of it is what has changed in the marketplace as people have come out of China, who were there before.

So it's not so much learning as it is analysis of the change in reacting to it.

Great. Thank you.

Ill step back in queue.

Q back yet again, thank you.

Yes.

Once again, if you would.

Like to ask an audio question. Please press star one.

Cancel this request please press star two.

Okay.

Unnamed Analyst: Good afternoon, guys. That was a very, very interesting discussion earlier with Bill, so thank you for that. Thank you, Bill. Quickly, I have some questions that are much more numbers-oriented.

Your next question comes from the line of George Melas with MK H management.

Good afternoon guys.

There was a very very interesting discussions earlier with them. So thank you for that thank you Bill.

Great.

Questions that are much more.

Numbers oriented.

Unnamed Analyst: The 8.1 million dollars in inventory sales. Was that at no gross margin? There was no gross margin on it, but we were able to charge a few fees for the transportation and recycling.

The inland.

$8 1 million.

Zero.

Was that at no gross margin.

There was no gross margin on it but we were able to.

Charge, a few fees for the transportation and recycling of that.

So there was that there wasn't that much dilution in the actual gross margin when you offset those too.

Brett Larson: So there wasn't that much dilution in the actual gross margin when you... Okay, because I was trying to say, I was trying to see that if your gross margin had no profit on those sales, your gross margin really was 86 instead of 81. So if you excluded those inventories, roughly what would have been the gross margin? roughly about 8.3, 8.4 percent.

Okay, because I was trying to say I was trying to see that if your gross margin. If you had no. If you had no profit on those sales.

Gross margin really was a.

Tim said Warner.

So if you exclude those inventory sales.

What would have been the gross margin.

Roughly about 834%.

Unnamed Analyst: Okay. Okay, so it's a little bit more than that. Okay, great. Okay, looking at the op-ed, I think USG&A expected to be sort of flattish, but it was up for new product development, is at the lowest level it's been in three years at 1.8. Are there some... some chargers, some.

Okay.

Okay. So it's a little bit more than that okay great.

Okay looking at the Opex.

I think your SG&A is expected to be sort of flattish sequentially, but it was.

A lot of development.

Is that the lowest collateral.

Is there some.

Some chargers.

Brett Larson: Can you help explain those numbers? We're taking a real serious look at, of course, salaried positions. The other thing is that there have been some changes to Payroll Benefit. We've been able to reduce some costs there as well. I would anticipate, prospectively, that we will see a slight increase to our op-ex, but nothing substantial. We really have taken a sharp pencil to our operatives.

Can you help explain those number.

We've taken a real serious look at it.

Yes.

Of course salaried positions.

The other is that there have been some changes in.

Payroll benefits that we've been able to reduce some costs there as well.

I would anticipate prospectively that we will see a slight increase to two two.

Our opex, but nothing substantial we really have taken a sharp pencil to our operating expenses.

Unnamed Analyst: Okay. OK. So essentially, you see the SDNA being well-designed and product development coming up just a little bit. Correct. Okay. Now, I want to try to understand the guidance, including the charges. If I look at the guidance of 0 cents to 15 cents, that implies a net income of 0 to, let's say, 1.6, and if I add back the charges, of 1 to 2.5.

Okay.

Okay.

So essentially you are seeing.

SG&A being relatively flat.

That's been coming up just a little bit.

Correct.

Okay.

Okay now I wanted to try to understand the guidance.

Kimberly.

Charge it.

So I looked at the guidance.

Zero cents students and that implies a mono camera zero to one.

<unk>.

And if I add back the charges.

Of one to 2.5.

Brett Larson: I think in the midpoint, I get to roughly two and a half million dollars, what I would call adjusted net income, and to get to two and a half million, and if you have an interest expense of three million, and a tax rate of 20%. That implies an EBIT of roughly $6 million. And then we add back the OPEX of $8 million. That implies a gross profit of $14 million, which implies a gross margin of $10 million. So I'm just trying to see if I got the numbers right or maybe where I'm off.

<unk> in the midpoint I get to roughly $2 5 million.

What I would call adjusted net income.

And to get to Q&A.

Yes.

And a few hands.

Interest expense of three mode yet.

And the tax rate.

The percent that implies an EBIT of roughly 6 million.

And then if we add back the Opex 8 million.

That implies a gross profit of 14.

This implies the gross margin.

So I'm just trying to see.

If I got the numbers right or maybe where.

Brett Larson: No, we are expecting an increase in gross margin in this quarter, one because of the layoffs and because of the actual cost reductions that are going to occur. So roughly. You know, we mentioned it was going to take less than a half a year. So roughly 60% of those costs decreases 60% of the severance is offset by payroll cost reductions in the quarter. Additionally, we expect our debt to continue to decrease as we continue to drive inventory down. My expectation is that interest won't be. $3 million; it'll be something less than that for this next quarter. And, you know, again, I think your op-ex of roughly a million is probably a good investment. OK.

Oh gosh.

No we are expecting an increase in gross margin.

In this quarter, one because of the layoffs because of the actual cost reductions that are there.

That are going to transpire.

So roughly.

We mentioned it was going to take less than.

Then a half a year or so.

Roughly 60% of those costs.

Increases 60% of the severance is offset by.

The real cost reductions in the quarter.

Additionally, we expect our debt to continue to decrease as we continue to drive inventory down.

My expectation is that interest won't be three.

$3 million it'll be something less than that.

Okay for this quarter.

And.

Again I think.

Your opex of roughly $8 million is probably a good a good guess.

Unnamed Analyst: But then that implies a gross margin that's well north of 9%. That's our expectation. Okay, so that would be a really nice inclusion compared to just moldings and quarters.

Okay.

But then that implies a gross margin that's well north of 9%.

That's our expectation.

Okay, so that would be a really nice growth.

Alright.

Compared to more recent quarters.

Brett Larson: Yeah, we're, we've been in a situation where we make money in America, we lose money in Mexico, and then we make money in Mexico, we lose money in America. Looks like we're heading towards a position where we're going to make money on all the sites. So, hopefully that comes to fruition, and we don't get another surprise.

Yes, we're we've been in a situation, where we make money out of American we lose money in Mexico, and then we make money in Mexico, we lose money out of America.

It looks like we're heading towards a position, where we're going to make money out of all the sites.

So.

Hopefully that comes to fruition and we don't get another surprise.

Unnamed Analyst: O.P. D. Quay said, "And the Mexican peso, I mean, I was just doing the math, it's up double digits over here. It's down just a little bit, a nudge sequentially. We do have college content that will help us in Q3.

Okay great.

And.

The Mexican peso I mean, I was just doing the math double digit year over year.

Its down just a little bit.

Sequentially.

Okay.

We do have some knowledge.

That will help us in Q3.

Brett Larson: Oh, you have some hedges, OK. Because at some point, I think you stopped hedging, right? Yeah, we entered into some hedges a few months ago that will take us through the March quarter. Okay, so maybe we'll talk a little bit about your hedging philosophy. It's just so damn hard to hedge, and it's expensive.

Okay.

Go ahead okay.

At some point that thing you had Scott hedging rates.

Yeah, we entered into some hedges a few months ago that will take us through the March quarter.

Okay. So maybe.

Talk a little bit, but core hedging philosophy, it's just hard to hedge.

It's expensive.

Brett Larson: How do you guys sort of think about it? In an ideal world, no, in an ideal world with, ample liquidity and, we would have hedged. Roughly 50% of three years' Mexican expenses. Yeah. We're far from that.

How do you guys sort of think about it.

Yes.

In an ideal.

No in an ideal world with.

Yeah.

Ample liquidity and.

We would have hedged.

Roughly 50%.

Of.

Three years Mexican expenses.

Yeah.

We're far from that.

Brett Larson: We did take advantage of a blip in the softening of the peso that occurred a few months ago. I wish we would have made more contracts. But it's difficult to project the future. When we can't figure out what the economy is going to do, then we can't figure out what the Mexican peso is going to do. We can't figure out what the head.

We did take advantage of a blip in.

And the softening of the peso that occurred a few months ago.

Wish we would've made tower contracts.

But it's difficult to <unk>.

Project the future.

We can't figure out what the economy is going to do then we can figure out what the Mexican peso is going to do and we can't figure out what the hedge.

Unnamed Analyst: Sure. So we do have some hedges in place that will help us during this third quarter, and we'll continue to monitor the peso to the dollar and enter into more contracts if we can. Okay, great. Um... Good, and from a customer concentration perspective, last quarter we talked about just one customer right now being 10% of the 10% category. Is that still pretty much the case?

Sure.

Okay.

So we do we do have some hedges in place that will help us during the during the third quarter.

And we will continue to monitor.

The peso to the dollar and enter into more contracts if we can.

Okay great.

Great and just from a customer concentration perspective on the last quarter, we talked about just.

One customer right now being 10% of.

In the 10%.

Category.

That still pretty much the case.

Brett Larson: That is still correct. We have one customer at about 10%. Okay. Great, and Brett, congratulations, we're excited about your promotion and wish you all the best. Thank you. Thank you, guys. Thank you, www.microsoft.com.ca Hi, guys.

That is still correct, we have one customer about 10%.

Okay great.

Great and Brad Congratulations.

And about your production.

Wish you all the best.

Thank you.

Okay.

Thank you guys.

Thank you.

Your next question comes from the line of Bob <unk> with <unk> capital.

Unnamed Analyst: Congratulations. It looks like things are like all arrows, maybe except for revenues here in the very near term are pointed in the right direction, which is great. And of course, I'm referring to, you know, inventories down, margins up, and pipeline up. So that's all great. And with that, Craig, I would ask you, we haven't spoken before, but I've spoken to Brett, about the timing of your retirement. You've gone through the storm, and it appears that the sun is coming up, and you have chosen that as your time to step aside.

Hi, guys.

Congratulations it looks like things are like all arrows, maybe except for.

Revenues here in the very near term are pointed in the right direction, which is.

Great of course, I'm, referring to inventories down margins up.

And.

And pipeline up so that's all great and with that Craig I would ask you we haven't spoken before but I've spoken to Brett.

About the timing of your REIT.

Retirement.

You've gone through the storm and it appears that the Sun is coming up and you are.

You choose that as your time to step aside can you talk a little bit about it.

Craig Gates: Can you talk a little bit about the timing of the transition? And then Brett, if you would care to comment at all about what, if anything, you've put as priorities, you know, under your new leadership. Okay. Well, I'm 65. I've been working since I was eight years old, starting in my dad's trailer court.

The timing of the transition and then.

And then Brett if you would.

Care to comment at all about what.

What if anything you.

Put guys like priorities.

Under your new leadership.

Okay.

Well I am 65.

I have been working since I was.

Eight years old started in my Dad's trailer court.

Craig Gates: And I've had enough. So, I actually was thinking about retiring quite a bit earlier. And then COVID and everything else came along, and I thought I needed to stay to make sure everything was, to make sure I could feel proud of how I was leaving the thing when I did leave.

And I've had enough.

So.

I actually was thinking about retiring quite a bit earlier.

And then Covid and everything else came along and I thought I needed to stay to make sure everything was.

As to make sure I could feel proud of how I was leaving the thing when I did leave.

Craig Gates: So, this last year has not been as much of a glide slope as I had hoped it would be. But as you say, we've had a major victory in driving inventory down. I think we've had a major victory. Growing our U.S. sites and even with the wage increases in the peso, and issues in Mexico, I think we're As you say, the arrow is up there, and what's going to happen there is proven by the previous big wins down there. So my timing is strictly based on the fact that I'm 65 years old. I've got two grandkids that live in town, and they grow up really fast, so it was time for me to quit.

So.

This last year has not been as much as the glide slope as I hoped it would be.

But as you say, we've had a major victory in driving inventory down.

I think we've had a major victory in.

Growing our U S sites.

Even with the wage increases in peso.

Issues in Mexico, I think we are.

As you say the arrow is up there and what's going to happen there as proven by the previous big wins down there. So my timing is strictly based on the fact that.

I am 65 years old I got two grandkids that live in town.

And they get old really fast so it was time for me to quit.

Craig Gates: There's no issue with that. That's where the company's headed. I'm very confident in Brett and the team we've got put together here, and, As we said, I'm going to be staying on the board, so it's not like I got beat and I'm running into the bushes in defense. And it was nice of you to leave Brett with a six times inventory turn goal.

There is no issue with.

With where the company is headed.

Confident in Brent and the team we've put together here.

And.

As we said I'm going to be staying on the board. So it's not like I'm not like I got beat that run into the bushes and defeat.

And it was nice of you.

Nice of you to leave Brett with a six times inventory turn goal.

Unnamed Analyst: Yeah, it is. I'll have to remind him that that never occurred during his tenure. I would reiterate that this was a well-planned transition. It's comforting to know that Craig will remain on the board and still provide a lot of the technical support that I think he had so much value for. I would not anticipate any real sea changes in the direction we're headed.

Yeah.

It is I'll have to remind you that never occurred during his tenure.

[laughter] alright.

I would reiterate that this was a well planned transition.

It's comforting to know that Craig will remain on the board and still provide a lot of the technical support that I think.

He adds so much value to.

I would not anticipate any real see changes in the direction we're headed.

Brett Larson: As Craig has mentioned, we are extremely impressed with the management team at Keytronic, and you know, we've been hit with a lot of things in the market, including a very strong peso, a considerable amount of inflationary pressure, and interest costs. But yet, we continue to drive profitability and expect that to improve. So this is really a well-planned transition. Okay, that's awesome.

As Craig has mentioned.

We're extremely impressed with the management team at key tronic.

And.

We've been hit with a lot of.

Things in the market, including a very strong peso considerable amount of inflationary pressure interest costs.

But yet still we continue to to drive profitability and expect that to improve so.

This is this is really a well planned transition.

Okay, that's awesome in the last quarter.

Unnamed Analyst: In the last quarter, Lee, on the conference call, you talked about making some changes in Mexico then that potentially were gonna save you $5 million a year. I was expecting to see possibly some severance type things in the quarter just reported. Was there any severance or unusual expense in the quarter just reported? Nothing material.

<unk> Conference call you talked about making some changes in Mexico, then that potentially we're going to save you $5 million a year.

I was expecting to see possibly some severance type things in the quarter just reported.

Was there any severance or unusual expense in the quarter just reported.

Yeah.

Nothing material I think there was a small amount of.

Brett Larson: I think there was a small amount of severance, but not to the level that we expected. Okay. And then would it be, you know, reasonable to tie, you know, when you talk about six months and you talk about sort of the upper end of the severance range being two and a half million, is that, you know, does that tie then to the $5 million a year savings in Mexico? Yeah, roughly does.

Severance, but not to the level that we expect in Q3.

Okay, and then would it be.

<unk> Hi, when you talk about six months.

You talk about sort of the upper end of all severance range being $2 5 million.

Is that.

How does that tie into the $5 million a year, so you've given us.

In Mexico.

Brett Larson: And if the severance is smaller, does that mean the savings is smaller, or is the savings the same? And it's just a question of how much severance you have to give at the end. I think it's a combination of all those things, Bob, but we're still trying to make the final determination of what positions and trying to also ascertain the pipeline and how soon new programs will be started in Mexico. So there are still some unknowns there, but severance, whatever we do, there's a return of roughly a couple of quarters, so at the high level, yes, you would expect to have some $5 million in severance annually.

Yes, roughly does.

And if the if the severance is smaller does that mean the savings is smaller or is the savings the savings and it's just a question of how much severance you have to give at the end of the day.

I think it's a combination of all of those things Bob we're still trying to make the final determination of what positions trying to ask also ascertained the pipeline and how soon new programs will be started down in Mexico.

So there's still some unknowns there but.

With severance.

Whatever we do will be.

Our return of roughly a couple of quarters. So.

So at the high level, Yes, you would expect to have some $5 million of savings.

Annually okay.

Bob: Okay. Well, if George's calculations are correct, and they're consistent with my back of the envelope calculations, you know, Craig, thanks for getting the table set for, you know, and delivering, you know, this quarter. Hopefully, the kind of profitability that you've been saying for some time will be, you know, the eye-popping profitability that was, you know, was out there for you guys to achieve. It looks like you're gonna, you know, maybe do it in your last quarter. So congratulations on that and have a happy retirement. Thanks, I'll talk to you one more time.

Well if Georgia.

Calculations are correct.

They are consistent with my back of the envelope.

Craig Thanks for.

Thanks for getting the table set.

Four.

Delivering this quarter hopefully the kind of profitability that you've been saying for some time with the <unk>.

Hopping profitability.

<unk> was out there for you guys to achieve it looks like youre going to.

Maybe you do it in your last quarter, so congratulations for that and.

Have a happy retirement.

Thanks, I'll talk to you one more time this is my opinion ultimate.

Craig Gates: This is my penultimate. Yeah, well, I'm happy that I'm happy that you will get to take the victory lap for, you know, George's quarter. So yeah, that'll be great. I think George may be a little bit overexcited, but I still think things are headed in the right direction, so I'm happy with the way I'm leaving it. Yeah, I think George's math is pretty straightforward, so I'm... I'm going with George.

Sure.

How are you.

Yes.

I'm happy that I'm happy that you will get to take the victory lap for you know for Georges quarter. So yeah.

Yeah that'll be great.

I think George maybe a little bit over excited but I still think things are headed in the right direction. So I'm happy with the way I'm, leaving it.

Yeah.

Yes, I think Georgia, Georgia math is pretty straightforward so I'm I'm.

William J. Dezellem: Okay, www.microsoft.com.ca Well, thank you for the line of questioning that was just there. I would also like to say congratulations and thank you for doing something a little bit unusual, Craig, which is leaving when things are on the upswing and positioning them well and then stepping aside. So often I think that CEOs leave at the top and then have a crumble after they leave, or just the opposite end of the spectrum. So well done.

Go on with George.

Okay.

Okay.

Okay.

Your next question comes from the line of Bill <unk> with Titan capital.

Please go ahead. Thank you on.

On <unk> line of questioning network assist there.

I would also like to say congratulations and thank you for that.

Doing something a little bit unusual Craig, which is leaving when things are on the upswing.

Positioning them, well and then and then stepping aside so often I think that.

Ceos leave at the top and then.

And then you have a crumble after they leave or.

Or just the opposite ends of the spectrum, so well done.

Craig Gates: Thank you. Coming back to the Mexico-Vietnam phenomenon or situation, do you see customers moving production from Mexico to Vietnam, or is Vietnam's success in the future really going to be from new business going into that facility? Well, it's a little bit more of a complicated answer. Vietnam is growing, but it would be growing much faster if we had more critical mass in the country. But we missed out on a big deal last quarter, not because the customer was unhappy with what we had, but it was the old battle we used to fight when we first started this deal in this business. Which was, Well, I don't see that you're doing $100 million here, so I don't feel comfortable putting up my $20 million.

Coming back to.

To the Mexico Vietnam.

Phenomenon owner situation do you see customers moving production from Mexico to Vietnam or Vietnam success in the future, it's really going to be from from new business going into into that facility.

Well.

It's a little bit more of a complicated answer Vietnam is growing but it would be growing much faster. If we had more critical mass in Vietnam.

But we missed out on a big deal last quarter, not because the customer was unhappy with what we had but it was the old battle, we used a five when we first started in this deal in this business.

Which was well I don't see that Youre doing $100 million here, So I don't feel comfortable funding by $20 million year.

Craig Gates: So that's part of the stumbling block in getting a new site up and running and growing the way it should be growing on paper, is there's a critical mass problem. We do expect one of our larger customers to move a significant portion of their business to Vietnam. And that would be the business that they serve Asia with. We're not quite done with that discussion, but I would expect that decision to be made, probably by the end. And that would give us what we think is a required critical mass to make Vietnam much easier to sell rather than try to sell it before. Somebody can look at it and go, oh, I'm already buying into a known thing rather than I'm taking part in the growth of something new.

So thats part of the stumbling block in getting a new site.

Up and running and growing the way it should be growing on paper.

There's a critical mass problem.

We do expect one of our larger customers to move a significant.

<unk> of their business to Vietnam, and that would be the business that they serve Asia with.

We're not quite done with that discussion, but I would expect that decision to be made.

Probably by the end of June.

And that would give us.

What we think is required critical mass to make vietnam be much easier to sell rather than trying to sell it before.

Somebody can look at it go MRE buying into unknown thing rather than I am taking part in a growth of something new.

Craig Gates: Craig, how is it that the other contract manufacturers that are starting Greenfield and Vietnam are winning business? Seems like that would be a... Boy, this massive movement of firms wanting to go to Vietnam is a common problem. So I'm not sure who's winning what in other Vietnam locations, so I can't speak to that.

Yeah.

Craig how is it that the other.

Other contract manufacturers that are starting greenfield in Vietnam are winning business. It seems like that would be a.

Boy this massive movement.

Firms wanting to go to Vietnam, Mr Common problem.

So I'm not sure who's winning what in other Vietnam location, So I can't I can't speak to that.

Yes, no problem and then.

Craig Gates: No problem. And then one point of clarification that I think... Super obvious. I just want to make sure that I'm not misreading that your guidance for this quarter of 0 cents of earnings to 15 cents of earnings includes the $1 million to $2.5 million headcount reduction severance, which at the 20% tax rate equates to 7 to 18 cents. So the 0 to 15 cents includes 7 to 18 cents of cost.

One point of clarification that I think is.

Super Super obvious I, just want to make sure that I'm not misreading that.

Guidance for for this quarter.

Zero cents of earnings to 15 cents of earnings includes the one mailing into $2 5 million head count reduction.

Severance which at the.

At the 20% tax rate equates to 7% to 18%.

Zero to 15 include.

2018 sensor costs is that correct.

William J. Dezellem: Is that correct? Yep. Great, thanks. Appreciate the time and letting me come back into queue.

Yep Okay.

Okay, great. Thank you.

I appreciate the time and not letting me come back in the queue.

Yes.

Craig Gates: Yep. And if you're wondering what the hell these guys are doing, how come they can't figure out... what the severance cost is? The labor law in Mexico is quite a bit more convoluted or complicated than that here in the States.

If you're wondering through.

<unk> asked it but if you're wondering what the Hell are these guys doing outcome. They can't figure out what the severance cost is.

The <unk>.

Labor law in Mexico is quite a bit more.

Convoluted or complicated than that here in the states.

Craig Gates: So it's an iterative process determining how many, who, and how much it'll cost. We're not feckless; we're just working our way through a pretty complex situation. William Dezellem, William Dezellem, Key Tron, I will now turn the call back. Okay, thank you. We appreciate your time and questions, and Brett, Tony, and I. Look forward to speaking to you again next quarter, for me the last time and for Tony the first time. Bye, www.mustwatch.eu

So it's an iterative process on determining.

How many who and how much it will cost.

So.

We're not feckless, well just work our way through a pretty complex situation.

Yeah.

This concludes today's question and answer session I will now turn the call back to Craig gates for any additional or closing remarks.

Okay. Thank you.

I appreciate your time and questions and Bret Tony.

Look forward to speaking to you again next quarter for me the last time in for Tony The first time.

Yes.

All right.

This concludes today's call. Thank you for your participation and you may now disconnect.

[music].