Key Tronic Corporation (KTCC) Q3 2024 Earnings Call Transcript
Key Tronic Corporation (NASDAQ:KTCC) Q3 2024 Earnings Conference Call May 7, 2024 5:00 PM ET
Company Participants
Brett Larsen – Chief Financial Officer
Craig Gates – President & Chief Executive Officer
Conference Call Participants
Bill Dezellem – Titan Capital
Bob Poole – Bricoleur Capital
George Melas – MKH Management
Operator
Good day, and welcome to the Third Quarter Fiscal 2024 Key Tronic’s Corporation Conference Call. Today’s conference is being recorded.
At this time, I’d like to turn the conference over to Brett Larsen. Please go ahead.
Brett Larsen
Good afternoon, everyone. I am Brett Larsen, Chief Financial Officer of Key Tronic. I would 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 more information, you may review the risk factors outlined in the documents the company has filed with the SEC, specifically our latest 10-K, quarterly 10-Qs and 8-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 March 30, 2024. For the third quarter of fiscal 2024, we reported total revenue of $140.5 million compared to $164.6 million in the same period of fiscal year 2023. Revenue for the third quarter of fiscal 2024 was constrained by approximately $5 million, due to severe winter weather events that took Key Tronic’s facilities in Mississippi and Arkansas, offline for approximately two weeks.
In addition, we saw a softening demand for a number of different programs produced in Mexico. For the first nine months of fiscal 2024, our total revenue was $433.7 million compared to $425.5 million in the same period of fiscal 2023. For the third quarter of fiscal 2024, our margins and profitability were significantly impacted by an unusual combination of events. First, we incurred severance costs of approximately $3.7 million or $0.27 per diluted share as we reduced our workforce by over 450 employees in Mexico. The severance costs were incurred late in the third quarter, which limited the payroll expense reduction that could be recognized for the quarter.
We also continued to be adversely impacted by high labor costs and the interest expense, driven by the continued strengthening of the Mexican peso. Relative to the US dollar, the peso rose by approximately 5%, increasing our expenses by approximately $1.5 million or $0.11 per diluted share. Furthermore, the temporary facility closures in the US, due to severe weather resulted a loss of contribution margin of approximately $1 million or $0.07 per diluted share. As a result of these factors, our gross margin was 5.8%, and operating margin was a loss of 0.4% for the third quarter of fiscal 2024 compared to gross margin of 8.7% and an operating margin of 3.1% in the same period in the fiscal year 2023.
Our net loss was $2.2 million or $0.21 per share for the third quarter of fiscal 2024 compared to net income of $2 million or $0.18 per share for the same period of fiscal 2023. For the first nine months of fiscal 2024, the net loss was $802,000 or $0.07 per share compared to net income of $4.1 million or $0.38 per share for the same period of fiscal year 2023. As we also noted in today’s earnings release, we cured a breach of our fixed charge coverage ratio covenant in our asset-based revolving credit facility as of the end of the third quarter by executing a new amendment to the agreement with our lender today. This amendment will provide relief on the financial covenants for the next 12 months, increased the interest rate by 100 basis points and advance the maturity date of the agreement to September of 2025.
Turning to the balance sheet. We ended the third quarter of fiscal 2024 by reducing inventory by approximately $39 million or roughly 22% from the same time a year ago. These improvements in inventory levels primarily reflect increased component availability and our concerted effort to drive inventory reductions. We’re pleased to see our inventory levels continue 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 sourcing – materials resource planning algorithms. 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 third quarter, we also reduced our accounts payable leasing obligations and overall debt by a combined amount of $57.1 million from a year ago. Our current ratio was 2.8 times compared to 2.2 a year ago.
At the same time Accounts Receivable DSOs was at 83 days compared to 79 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 $0.7 million for the third quarter of fiscal 2024 and we expect total CapEx for the year to be around $5 million. 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, utilizing leasing facilities, as well as make efficiency improvements to prepare for growth and add capacity, particularly in our US and Vietnam locations.
For the fourth quarter of fiscal 2024, we’re seeing a rebound among our legacy customers relative to our third quarter and a strong backlog of new customer program opportunities. For the fourth quarter of fiscal 2024, we expect to report revenue in the range of $135 million to $145 million. While new programs continue to ramp in our Mexico facilities, efficiency improvements a muted rebound to pre-COVID production levels amongst existing Mexico customers and the continued pressure of a strengthening peso combined prompted us to reduce our overhead in our warehouse facilities.
In the fourth quarter, we expect to incur additional severance expense of approximately $500000 to $1 million from additional headcount reductions in our Mexico-based operations late in the fourth quarter. The payback period for this decision is expected to be under half of the year. Taking all these factors into consideration, we expect net income to be in the range of $0.03 just two $0.10 per diluted share.
In the fourth quarter of fiscal 2024 and moving into fiscal 2025, we expect continued sales growth in the US 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?
Craig Gates
Okay. Thanks Brett. During the latter half of fiscal 2024 we were taking necessary steps to reduce our workforce in Mexico due to the softening demand for a number of different programs with high support labor content with an expected to save us more than $10 million annually. In the coming quarters, we expect sales from Mexico based production to recover due to recently won programs and we do not anticipate needing to increase our headcount in coming periods, reflecting the significant improvements to our operating efficiencies.
At the same time our work site is being restructured to focus on higher volume manufacturing, while lower volume products with higher service loan requirements will migrate to our other sites. We’re also pleased to see overall improvements in our operating efficiencies and inventory levels and other improvements made on the balance sheet.
During the quarter, we continued to expand our customer base, winning new programs, involving up to $20 million in energy management account, around $5 million in the telecommunications account, around $3 billion in consumer audio account and around $5 billion in industrial manufacturing account. The strong pipeline of new business underscores that continued trend towards onshoring and dual sourcing or contract manufacturing. Global logistics problems in China US geopolitical tensions continue to drive OEMs to examine their traditional outsourcing strategies. We believe these customers increasingly realize that they have become overly dependent. Are there China-based contract manufacturers for that only product but also for design and logistics services?
Over ime the decision to onshore nearshore production is becoming more widely accepted as a smart long-term strategy. As a result we see opportunities for growth and those opportunities are becoming more clearly defined. At the same time, we are seeing a sustained trend of strong Mexican peso and continued increases in Mexican wages particularly along the US Mexican border. And it has become clear that these changes in 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 businesses that they are bringing back from China.
For those customers who struggles with China production due to the flexibility needs of the decreasing cost differential between our US and Mexico plants means that they will probably choose one of our US sites. They are we believe they can enjoy the ultimate flexibility engineering support and ease of communications. Meanwhile for those customers whose requirements had adapted to the China model of limited flexibility, challenging communications, small motion engineering support, our Mexican 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 US production facilities has increased approximately 15%.
In Q3 of 2024, production in the US represented about 30% of the total revenue. While our Vietnam facility continues to be a modest contributor to our overall revenue, a growing number of potential customers are actively evaluating the migration of their China-based manufacturing to our facility in Vietnam.
In coming years, we expect our Vietnam 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 Chinese component supply chain on an ongoing basis.
The combination of our global footprint and our expansive design capabilities is proven to be extremely effective in capturing the business. Many of our large and medium-sized manufacturing program wins are predicated on Key Tronic’s deep and broad design services. And once we have completed the design and ramped it into production, we believe our knowledge of the program’s specific design challenges makes that business extremely sticky.
We also continue to invest in vertical integration and manufacturing process knowledge, including a wide range of plastic molding, injection below gas assist multi-shot as well as PCB assembly, metal forming, painting, and coding, complex, high-volume automated assembly and the design, construction and operation of complicated test equipment. We believe this expertise will increasingly 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 Key Tronic, which is expected to make the transition to our facilities much less risky and tabling together a group of providers each limited to a portion of the value chain.
In fact, most of the new customers we have on-boarded take advantage of the one-stop shop capabilities we provide. We believe global logistics problems, China-US political tensions and heightened concerns about supply chains 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 prospective customers. While the enforcement combinations of factors temporarily disrupted our growth and profitability in the third quarter, we move into the fourth quarter of Fiscal 2024 with a strong pipeline of potential new business while we’re seeing improvement in our operating efficiencies, recent wage increases, higher interest rates and a strong pace that will dampen our growth and profitability in the fourth quarter.
Moreover, we will continue to rebalance our manufacturing across our facilities in Mexico, the US and Vietnam. We remain very encouraged by our progress and potential for profitable growth over the long term.
As we’ve previously discussed, Brett will succeed me as President and Chief Executive Officer at the end of June, while I expect to remain a member of the Board. Additionally, Tony will become our Chief Financial Officer.
Since this will be my 60th and last quarterly investor conference call, I want to express my deep gratitude to our shareholders, customers and vendors. I want to express my sincere thanks to our outstanding employees for their dedication and commitment to our success. It has been a great honor to lead this team, and I have full confidence that Brett, Tony and their outstanding team will continue to take Key Tronic to new heights.
This concludes the formal portion of our presentation. Brett, Tony and I with I’ll be pleased to answer your questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] The first question comes from the line of Bill Dezellem with Titan Capital. Please go ahead.
Bill Dezellem
Thank you. Craig, you preempted my first question, but I did miss the energy management. What was the size of that one?
Craig Gates
Bill, it was like parting gift to you. That was up to $20 million.
Bill Dezellem
Okay. That’s excellent. Thank you. Would you please walk through each of these and highlight maybe important aspects to them, whether they’re existing customers or whether they are new customers? What was — what, if anything was unique about these wins that highlight the competitive advantage that you all have or something else interesting. And I do appreciate the parting gift.
Craig Gates
Thank you. You’re welcome. The first one is an interesting one because this — it’s a new customer. This customer came to us almost two years ago and had an edict that they needed to significantly increase their outsourcing in Mexico. And – they played a significant role in helping us upgrade our metal coating capability because they have a very high-end requirement for withstanding the salt spray test. So after a number of changes to our chemistry and in our painting process, we were able to pass that long-term salt spray test. And since then, the floodgates have opened and they have been giving us more quotes and awards than we can handle. So that’s been a two-year success story that we were never sure was really the pot of gold at the end of the rainbow the customer was telling us, but our technical folks hung in there. And in the end, it’s going to be a very nice and longstanding program.
Bill Dezellem
And so is this a single program? Or is this up to $20 million, one of the many programs that they are giving you?
Craig Gates
It’s already more than one program, and there are many more to come.
Bill Dezellem
That’s helpful. And the other three?
Craig Gates
The other three are pretty much run of the mill in terms of standard reasons why they chose Key Tronic. The consumer audio is a customer in-house today. This was just a new program, right? The other two are new customers and new programs for Key Tronic.
Bill Dezellem
Thank you. That’s helpful. And then if I may, jumping to the softening demand that’s referenced in the press release and then possibly Brett, in your opening remarks, you referenced that, that has maybe even turned to a rebound, would you pull all of that together for us, please?
Brett Larsen
This is somewhat of a COVID hangover. A lot of people, you and I have discussed this. We’re concerned a year ago that there was a massive COVID hangover. And what we found is that it’s scattered and spotty. A couple of our large customers did have too much inventory that they had built or had us build for them as parts became available and what we’re really come driven false demand signals, tempted them to continue building at a high rate, but it wasn’t widespread and as we’ve seen just in the last two or three months, those customers have drawn their inventory down of the products we make for them to the point that they’re forecast and orders are rebounding to the normal throughput levels that we would expect. So that’s really — that’s the overall set of circumstances, it’s governing what we talked about as a softening and then a slight return of muted return, I think we used toward.
Bill Dezellem
So from your standpoint, if you were to look out just from an overall economic view, is it your sense that demand continues reasonably strong, I’ll call it, end demand, and now you’ve worked through some inventory, excess inventory and so we — that volatility, if we were to exclude that, we’re discontinuing with more of the same of decent demand. Is that a fair way to look at what you’re experiencing?
Brett Larsen
Yes.
Bill Dezellem
Great. Thank you. And then let me jump to the severance, if I may. Severance came late in the quarter, as you pointed out. Why was that? Because this is something, if I recall that we talked about on the last call, and so I would have expected it maybe to happen sooner.
Brett Larsen
Well, when you affect people’s lives and many of these people have been with us for quite some time, you want to be absolutely sure, you’re doing the right thing and you’re doing it with the right people. So it took us a little longer than we thought to get it done, but we are confident that we have done it in a caring and professional manner and done what needed to be done.
Bill Dezellem
And Craig, this sounds a little bit different than layoffs that you have had in the past where demand falls off and line workers are laid off. I’m just getting a different vibe than historical layoffs. Am I over reading into this? Or is there something more to be discussed here?
Craig Gates
There’s a lot more to be discussed because these layoffs represent a significant strategic change in how we view Mexico versus America versus China versus Vietnam. We tried to get at it in my prepared remarks, but actually the way I think about it is a little bit more simpler and crude, I think in the flowered way we put it.
That is in the past year, six months to the year there’s been a C change in the average makeup of the customers who are interested in Mexico. So take this as clear as this is the average. It’s not every customer, but what’s happened is that the people who wanted to be in China, but are not being allowed to do so by management, [indiscernible] are now making up a significant portion of the folks that are interested in more ads.
So those people were either in China or were headed to China and they were going — China driven mainly by costs and we’re willing to accept a lack of flexibility in moving orders in and out, lack of ability to send their engineers into the factory of short term lack of ability to get their parts here and a week rather than a month and a half back of ability to do business in English versus the mix. So they had companies had become used to all that or were ready to endure all that in return for the lowest possible price they could get.
A lot of those people are being told it’s too risky, you’re not going to go to China and figure something else out. So they end up knocking on our door, but they had sticker shock when they saw the cost that we were proposing out of rewards plan because the war has planned was configured for a different set of people.
And those set of people were the ones who didn’t want to go to China, knew that they couldn’t live with all the disadvantages I just listed and were willing to pay a little more to be in Mexico and enjoy all the near shore advantages Mexico has to offer, so those people used to make up the majority of our available market share.
Now the majority of our available market share on average is made up by the people on the other side of the fence who want to be in China or are not being allowed to go there. So that means that all of the overhead in our factory in Mexico, people overhead, the quality, technicians, the engineers, the folks who worked in scheduling and on the plant for material handlers, program managers all those people that we had built up over the years to provide US-based service levels when added costs were not willing to be paid for by this new set of customers.
And so those are the folks that made up the majority of this layoff, which has never happened before in our history. So those folks are long-term employees of Key Tronic. The wage structure and the laws of Mexico require a significant severance pay off for folks in that category.
And you’re exactly right. This is nowhere near the normal type of layoff, but it’s strategically positions the Mexican facility can compete and win as we’ve seen in the last six months, a new breed of customer that represents a very big available market. So that’s why it took longer than normal. That’s why the severance was much higher than normal and that’s why you’re sensing that it was different than normal.
Bill Dezellem
That’s a really insightful. Thank you Craig. And so these — because these are not your standard line workers that you’ll bring back with higher production rates, your cost structure is permanently being lower than is what you’re saying?
Craig Gates
Yes.
Bill Dezellem
Does it somehow also affect the capacity of the facility. And I’m not — not necessarily the layoffs Craig, but the restructuring to have essentially less flexibility. That sounds to me like you’ll have more hours of lines up and running and fewer and less time down with the customer noodling over whether they ought to do something a little different or whatever. Is that correct interpretation or not?
Craig Gates
It is. And in fact we have groomed a very small number of customers who no longer fit into the model that you just described. So it will result in more product being made with less line workers because every time you have to shut a line down and change it over, not only did you have to have a bunch of engineers and quality folks and material handlers out there swapping line over, inevitably, you couldn’t time it perfectly. So you had line workers who were milling around waiting for some part or some process to come up the way it should. So it’s going to turn much more into a bang, bang, slapping parts together. And I don’t want to say that in a low quality news. But it’s going to be a lot more of just run something at high volume than it is switch over every 10 minutes because the customer called up and it’s freaking out.
Bill Dezellem
I’m sorry, go ahead.
Craig Gates
That type of work is migrating back to the states because people are willing to pay even more to get that level of service than they have been in the past.
Bill Dezellem
Fascinating. Okay. Thank you. And then lastly, if we exclude the severance and the winter weather shutdown, then we’re looking at $0.13 of earnings is what would have happened had you not had the one intended event and then the weather that surprised you?
Craig Gates
Yeah.
Bill Dezellem
Okay, great. Well, thank you. And I’ll let others ask additional questions. But thank you for all the time you have given me on these conference calls to ask questions over the last maybe even 60 calls. So thank you. Appreciate it. And Brett, we look forward to working more with you in the future.
Brett Larsen
Thank you, Bill. You’re more than welcome. And we’ve appreciated your insightful questions also.
Bill Dezellem
Thank you.
Operator
[Operator Instructions] Your next question comes from the line of Bob Poole with Bricoleur Capital.
Bob Poole
Hi, guys. So I’d like to apologize in advance, because I’m going to ask some tough questions and make some tough comments. And I hope you’ll — I think they need to be asked and the comments need to be made. So but I do apologize in advance, because this usually a pretty friendly forum. So first of all, I want to sort of wage a protest that the way you present your financial results is totally out of line with — I follow hundreds of companies. And you’re the only one who presents your results the way you do, without making adjustments for things like severance and so forth and presenting your results and your guidance. After things like severance, nobody else does that. And I don’t think that there’s any special pass to financial heaven for being so puritanical in that presentation. Brett, you and I’ve discussed this a little bit. How do you feel about this going forward?
Brett Larsen
Your comments are noted next.
Bob Poole
Okay. So the guidance is very hard to understand. And I’ll tell you why. You have you’re basically projecting flat revenues from the third quarter to the fourth quarter. And on 140 million of revenues, you had a $575,000 loss in Q3. That included 3.7 million of Mexican severance. So that should not exist in the fourth quarter. You’re taking out 10 million a year or 2.5 million of per quarter in Mexican labor that should not be there in fourth quarter.
I think the impact of the peso is likely to be — you’ve probably taken out half of your expenses in Mexico. The — if the impact of the peso, assuming it stays around the same level, there hasn’t been a significant, it seems to be pretty flat so far this quarter, that that should be 750 better in the fourth quarter. Which should bring — if something else wasn’t going on, that would bring operating income to $6.4 million, $6,375,000.
Taking into account, the 1% increase in your bank spread that’s probably about $1.2 million a year or $300,000 a quarter. So that keeps your interest from $2.8 to $3.1. That brings pre-tax income to $3.275, 20% tax rate brings you to roughly $2.6 million in after tax income on 10.8 million shares. That’s $0.24 a share. You’re talking about $0.3 to $0.10 a share. If I make the adjustment for the new information that Brett gave about $500,000 to $1 million more in severance in the fourth quarter, if I take that out, that gets you to $0.19 a share. So what am I missing? What haven’t you told us that is negative in the fourth quarter that accounts for the difference between $0.03 to $0.10 and $0.19?
Brett Larsen
Well, that’s a lot of moving pieces. I will let you know. I don’t know that I agree with all of your adjustments. Our expectations…
Bob Poole
Hey, come on then, please, Brett. Brett, tell me where I’m wrong.
Brett Larsen
I’m not going to get into an argument here. It’s not worth it, but I will let you know that the pace of recovery of $750,000 is not accurate. And I’m also ensuring that you know the cost structure of the year anticipating of the $10 million, that’s not immediate that that that is ramping over four quarters. So, both of those I think are likely incorrectly calculated and no additional material events are included in that projection of fourth quarter results.
Bob Poole
So, can you explain why if you’ve terminated all of these people, why you’re not and the — and the savings in a year’s $10 million, why is it not $2.5 million a quarter?
Brett Larsen
Because it’s not — we’re not done with severances. We mentioned that we still have $500,000 to $1 million of severance to occur in the fourth quarter. Those have not been fully done even as of today.
And we also mentioned that that would take up to six months to fully recover that severance amount. So, to be able to say that that we’re recovering $2.5 million of expenses in the fourth quarter net of what we’re paying in severance, this is not accurate.
Bob Poole
So, actually Brett, if you go back, you’ve paid $3.7 million severance so far and let’s say you pay another $1 million, that’s $4.7 million. That — if you’re going to get that back in six months, that’s about $2.5 million a quarter Brett?
Brett Larsen
Again–
Bob Poole
I’m running working with your numbers, Brett. So, it’s not like I’m making this stuff up you know.
Brett Larsen
Bob we are talking a few hundred thousand dollars, $0.19 and our $0.10.
Bob Poole
That’s about a $1 million.
Brett Larsen
That fourth quarter severance is still in process.
Bob Poole
Right. So, yes, so I’ve taken that out to get to the $0.19.
Brett Larsen
I don’t — I disagree as well with your effective tax rate, I think you need to go back and recalculate that, particularly coming off of a loss in third quarter.
Bob Poole
You told us back in your guide–
Brett Larsen
25%.
Bob Poole
Is that what the is that with the — Yes. So, you need to update your business outlook because it’s says 20% Brett.
Brett Larsen
Correct.
Bob Poole
So, I’m working with your numbers. I mean you guys kind of get this together and it’s really bad. Okay. Next question. You’re sort of talking about a strong backlog business coming back, yet revenues really if you account for the fact that you lost $5 million of revenues last quarter that should have been $145 for the quarter and now you’re projecting you know sort of $140 at the midpoint. And Bill kind of asked this question, but it’s hard to reconcile your comments about business getting better and having a strong backlog and another 3% to 4% decline in revenues. How do you reconcile those?
Brett Larsen
I think the words I used were muted.
Bob Poole
Well, that’s net negative. That’s not muted benefit. That’s that muted decline?
Brett Larsen
Well, as you said Bob, this is becoming unpleasant and I don’t intend to argue with you semantics of what we said, we’re giving you a true representation of our belief of the revenue going forward. We’re giving you a true representation of the backlog we have and we’re giving you a true representation of the new customer pipeline we have as well with new quotes. So, that’s that.
Operator
Thank you. Your next question comes from the line of George Melas with MKH Management. Please go ahead.
George Melas
Thank you. Maybe just a question about the layoffs in this February and Craig you mentioned $10 million per day. When but when do you expect to get that $10 million in savings? And how much you expect that in the June quarter ending the quarter subtle after that?
Craig Gates
So, the quarter we’re in right now we’re going to get a portion of it. And as we get into July, August, September, we should be see most of it per quarter.
George Melas
Okay. So, does that mean that by September, you’re at the full run rate of $10 million?
Craig Gates
Yes, that’s correct. Yes.
George Melas
Okay, great. That’s helpful. And what — how much are you gaining in the June quarter?
Craig Gates
It is roughly between $1.5 million and $2 million.
George Melas
Okay. And why is that? Is that because more we reestablish the nuance, but you’re going to let go everybody as of March 31st, is that what it is?
Craig Gates
That is correct.
George Melas
Okay. Very good. Then a question that relates to what Bill was asking. Do you actually have some customers migrating from Mexico to Brazil. As they look at if you are reducing your — capability in Mexico, having it – fewer4 people to handle the project. The customers that you still have there that have these expectations. How do you manage that? I mean are we going to have like a bifurcated service almost in Mexico, the legacy customers have a certain kind of expectations and for the new customers it’s a different set of expectations.
Craig Gates
Yes that’s a very perceptive question. What we’re moving from is a factory that was loaded with the overall ability to handle anything that happens at any customer at any time. And we’re moving to a factory that is specifically loaded by customer to provide whatever services the customer decides that they would like to pay for. So it’s almost impossible. At least we found it to be so to control costs when you’re peanut butter doing it over the entire facility are nine facilities.
When you have specifically talked with existing and new customers about what is it you’re looking for and this is your base price. And if you want to be able to call us and switch back and forth in the day we’re going to have to add this much support labor. And if you’re not willing to pay for in Mexico but you want it then you probably ought to go somewhere else. And if you do want to pay for it, maybe it makes more sense at the levels you think you’re going to need to move to the states. And so we have seen some customers who have decided to move their production two our one of our facilities in the States.
George Melas
Some [indiscernible] to Mexico or to [indiscernible]in the US?
Craig Gates
Yes not a large amount but some
George Melas
Okay. Yes I am just confused about how you run a plant like this or nine facilities always — a different set of expectations among different customers. And in a way I sort of love the fact that we were sort of like a real differentiation and design the handling difficult job that then were sticky. But it seems that these new customer is not really that, they’re pretty commodity oriented guy. Well maybe not – way too mismatch in to….
Craig Gates
No. It’s a really good question and I want to make sure we’re perfectly clear on it because it’s a very key strategic portion of our thinking through. Okay. So we talk about design capabilities with difficult designs and difficult products that make those products sticky. Those designs and those processes come out of the engineering staff in Spokane. The ability to manage a poorly designed or dodgy product that Key Tronic did design that we just transferred that has to come out of the folks in [indiscernible].
So when we cut our ability to provide service on a peanut butter level that means that if a customer wants to transfer to us a product that has a dodgy process, we know upfront say yes, we don’t we don’t want to call your baby ugly, but your baby’s kind of ugly and realize that you have quotes from other suppliers that are lower than our quote and we are happy to give you a quote that would be dirt floor levels of engineering support, but you’re not going to succeed building this product with this design in a factory without engineering services.
So we’re either going to have to agree that our price is going to be higher than what you’re hoping for or we’re going to have to help you change the design or you’re going to have to go somewhere else with this product. So that’s I don’t know if that helps you, but that is a little bit of insight to how we’re doing it.
And then secondly with customers that have said yes, we want we want this level of service. It’s much easier to control the costs since we already have a lot of practice in creating miniature factories within factories. So we have a little factory inside a big factory that we can say all right, we’re going to put one or two people on the support for this department and they’re not they’re not just on the overall salary supporting the whole company whenever a problem comes up. They’re only going to be full time on this department building this product for this customer, because this customer is paying for it.
So, it’s much easier to control the cost and much easier to calculate the cost when you’ve got it basically laser-pointed onto a product and a customer rather than smeared across an overall strategic intent of being high service for everybody. And we haven’t lost the ability to market ourselves as a high-service supplier out of Juarez. What we change is our ability to provide a low service cost for those people who want it.
So, it’s kind of like one of the few things I took away from business school was if you can’t be niche, you have to be low cost. So, we now have the ability, if we are not niche by virtue of design or service levels to be low cost out of Juarez by clearly defining to the customer upfront that if you’re going to want this, it’s going to cost this. Does that make sense?
George Melas
It does make sense. It’s an interesting thing to manage. Let me ask a question here that’s related to that. So, does that mean that the conversation that you have with your customers is meaningfully different than it was before?
Craig Gates
Yes.
George Melas
It’s almost like you’re proposing alternatives for them, and they can choose from that, but you didn’t do that really before.
Craig Gates
We didn’t have the opportunity to say, if you want to come to Juarez and be a low-cost, low-service customer, here is your new price, because we didn’t have the capability of removing all of that peanut-buttered overhead from our cost structure on a given quote. And even if you could do that, it takes a while to figure out on a human product, what that cost should be if you’re trying to come up with a new formula. And if you can’t do that quickly, it’s hard to convince the customer that you actually are going to have that ability to give them what they want in very, very low cost, low service.
So, we have right now almost 80 active quotes and people want two to three weeks of response time on a quote. And if you’re trying to recalculate your cost pressure every time you get a weird product, you can’t do it quick enough. It’s much easier to add, then it needs to try to find way subtract.
George Melas
Okay. And if you look at your customers now in Juarez, they are mostly the niche. They mostly the high service customers. The low cost is still a very small group, but do you think that’s where the growth will come?
Craig Gates
No, that’s not true. It’s a mix. Part of the revelation is on this is that as we were being forced by the wage rates and the peso, as we’re being forced to raise prices across the board on customers, we realized that the low service customers were going to bolt. And as we struggled to figure out how we could keep those customers in the face of these wage and peso problems, that was part of our revelation on, okay, wait a minute, we’re in a different market now.
George Melas
Got it. Okay. Super interesting. I had one more question, obviously, But in a way, if we go back two years ago, this would have come to you guys a little bit as a surprise Well, I guess it was for upon you, as you said, partly by the wage rates in the peso and then accelerated by the demand of some the people who were operating in China?
Craig Gates
It actually goes back four years to the beginning of COVID and the gradual and accelerating and to the answer every single procurement agent we spoke with to the question of where should I be? The answer was China.
And as COVID, and Trump, and China, and states, and tariffs, and supply chain, and all of that is added together, and I’m not sure the general public knows this, but it used to be a 100% in-fashion call, if you got a bunch of OEM, CEOs together five years ago, it would be almost embarrassing for them to say they were building anywhere, but China. They would be asked, what are you thinking? Their Board would be asking them, what are you thinking, why are you not in China? That has changed dramatically now as a result of all those economic and political and physical events that have happened in the last four years, so that the market we are operating in is dramatically different than the one we were in five years ago, four years ago. And that’s why we were doing what we were doing five years ago, and that’s why we’re changing what we’re doing now.
George Melas
Okay. Great. And then maybe a couple of more questions. From a gross margin perspective, is — and I think the idea is to try to get back to a 9% gross margin or maybe even higher is that still a possibility? Or does that sort of new strategy actually impair that?
Craig Gates
I think it’s still a possibility. I don’t think the strategy impairs it. And I think the ability to build more faster with less people — is a help rather than a hindrance to that
George Melas
Okay. Great. Craig, thank you very much for everything, for your time, for your answers. And you’re not going away, so I’m happy about that and Brett and Tony, best of luck with everything. We’ll have many more presentations.
Craig Gates
Thanks, George. It’s been good, knowing you.
George Melas
Thank you.
Craig Gates
Yes.
Operator
Thank you. Your next question comes from the line of Bill Dezellem with Tieton Capital. Please go ahead.
Q – Bill Dezellem
I actually have a follow-up relative to something that I believe, Craig, you said in one of your remarks that by structuring are to be lower cost, you’re opening yourselves up to a much larger market. Number one, did I hear that correctly? And then secondarily, by — by default, also structuring the US maybe to be more of that high touch in a more maybe a more obvious way, and I know it’s been that all along, but maybe a more obvious way, is that in any way expanding your potential market?
Craig Gates
I don’t think it changes to the US-based facilities are any more obvious than they have been in the past. They were structured to be high service at a price the changes to war has that flow through and result in bids and quoting being lower than what they used to be is a change that results in a bigger available market to us.
Q – Bill Dezellem
Do you have a quantification on that?
Craig Gates
No.
Q – Bill Dezellem
And then one additional question, please. You mentioned you have 80 quotes today. How does that compare to what we would have seen over the course of the last couple of years?
Craig Gates
It’s much higher.
Q – Bill Dezellem
By a factor of 2% or 5% or 5%.
Craig Gates
Oh, no, it’s probably a factor of — there are times where we had quotes maybe 20 or 30 in the funnel.
Q – Bill Dezellem
This is at least at least double, if not quadruple, maybe what you were accustomed to running at before.
Craig Gates
Yes.
Q – Bill Dezellem
Great. Well, congratulations, and I look forward to a few more of those at the up to $20 million mark.
Craig Gates
Us, too.
Q – Bill Dezellem
Enjoy your retirement.
Craig Gates
Thanks.
Operator
This concludes today’s question-and-answer session. I will now turn the call back to Craig Gates for any additional or closing remarks.
Craig Gates
Okay. Thank you, everyone, for participating in today’s conference call. I’ll speak for Brett and Tony you and I say they look forward to speaking with you next quarter. Adios.
Operator
This concludes today’s call. Thank you for your participation. You may now disconnect.
