Brett Larsen
Thanks Tony. While we did not meet revenue expectations in our first quarter of fiscal 2025 due to unavoidable delays for a few programs. We are pleased to see our, our improved operating efficiencies and margins begin to take place a recent workforce reduction in Mexico trimming of nonprofitable programs and making, making a concerted effort to reduce working capital are starting to pay off, the weakening Mexican peso during the quarter also further strengthened our reported margins.
We also continue to reduce our inventories which are now much more in line with our revenue levels.
Over the longer term, we expect that these strategic changes will improve our overall profitability.
During the first quarter, we continued to expand our customer base winning new programs involving manufacturing production equipment, vehicle lighting and commercial pest control.
The strong pipeline of potential new business underscores the continued trend towards onshore onshoring and dual sourcing of contract manufacturing.
Global logistics problems in China, Us, geopolitical tensions may continue to drive OEM to reexamine their traditional outsourcing strategies.
We believe these customers increasingly realize that 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 near shore 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 continued wage increases in Mexico as it has become clear that these changes in the base cost of Mexican production are longstanding, we have rightsized our operations in order to remain cost competitive.
It has also become clear that our customers near shoring from China may have a different calculus for selecting a geographic location for business.
We believe our Mexico operations provide a full suite of vertical manufacturing for customers looking to nearshore their manufacturing processes.
Our Mexico capabilities include plastic molding, sheet metal fabrication and paint printed circuit board, assembly and final production assembly all contained within a consolidated campus for those customers who struggled with China production due to their flexibility requirements. We believe our US sites offer outstanding flexibility, engineering support and ease of communications while our Vietnam facility continues to be a modest contributor to our overall revenue. A growing number of potential customers are actively evaluating a migration of their China based manufacturing to our facility in Vietnam.
A significant amount of this fiscal year's planned capital expenditures are scheduled to add additional capacity and capability in our denying Vietnam location in coming years. We expect our Vietnam facility to play a major role in future growth, while our China growth has slowed, and many companies have decided to take risk mitigation steps with their China manufacturers. The fact remains that many components still 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.
Additionally, our China production facility continues to be profitable, continues to build legacy Key Tronic programs and has found recent success in winning new programs with direct Chinese customers.
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 deep and broad design services.
And once we have completed the design and ramped it into production, we believe our knowledge of a program specific design challenges makes that business extremely sticky.
We anticipate continued increase in number and capability of our design engineers in coming quarters.
We also continue to invest in vertical integration and 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 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.
We believe global logistics problems increased costs of capital geopolitical tensions and a heightened concern about supply chain will continue to drive the favorable trend of contract manufacturing. Returning to North America as well 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 customer driven delay temporarily disrupted our growth and profitability in the first quarter of fiscal 2025 we move for as we move further into fiscal 2025 with a strong pipeline of potential new business and we're seeing significant improvements in our operating efficiencies and a continued weakening. Peso.
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 the potential for profitable growth over the longer term.
This concludes the formal portion of our presentation.
Tony and I will now be pleased to answer your questions.
Operator
Thank you. If you would like to signal with questions, please press star one on your touchtone telephone. If you're joining us today, using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. (Operator Instructions)
Again. That is star one. If you would like to signal with questions, star one and our first question will come from Bill Dezellem with Titan Capital.
Bill Dezellem
Thank you. Let's start with the three wins that you noted in the press release. What is the size of those?
Brett Larsen
Sure. First two are around 5 million and the third is just under.
Bill Dezellem
Great. Thank you. And, and then let's talk if you would please and, and go into some more depth on the circumstances of, of the three programs that were were delayed.
Brett Larsen
Sure, three of those programs did have roughly a 9 $9 million impact to the overall quarter. The first was a delay in production for some qli qualification improvements on a you know, essentially, their product that production successfully resumed in the early part of October.
The second was a new updated version and fortunately as of last week, we're back ramping production of that and expect by the third quarter of this fiscal year, to be back up to the, the level it was historically.
And then the third is, is the Nextgen design that likely will delay until roughly, the middle of our third quarter, February or March time frame.
Bill Dezellem
All right. So, Brett, since, since I've never actually run a manufacturing business, this question is coming from a point of ignorance, but if the second of the three programs restarted this month, why is it not until next quarter that they'll be fully ramped?
Brett Larsen
It's actually the, the, it is a, for a couple of reasons, one is that the materials required have a longer lead time, some of the new updated version required some, some changes in some of the components. So, some of that has a little bit of a longer lead time to get full production and the rest is just ramping staff and production back up right in the middle of, right in the middle of the holiday.
No, just, you know, with the anticipated couple of weeks of holidays, this, this quarter as well.
Bill Dezellem
Okay. Thank you. And then the one that is not ramping until February or March, what are the dynamics that are leading to, what seems like a, a long delay to get that one on back on track.
Brett Larsen
There's some seasonal demand for that particular product. So, the customer is, is cautiously, reviewing the current design and making certain modifications. The delay in that really doesn't hurt their demand cycle. And, you know, again, we're, we're expecting that to come back online in February.
Bill Dezellem
Okay. That is, that is helpful. And then did, did I understand correctly in the opening remarks and, and what you have said that each of these were existing programs, but the next generation and, and the issues were tied to qualification of the next generation.
Brett Larsen
Yes, all three were, that is correct.
Bill Dezellem
And, and Brett was that next gen qualification tied to something to do with their end customers or with the product working its way through the Key Tronic plants.
Brett Larsen
No, it's really on their side. It's design and capability and just taking it to the next gen of that particular product. It was scheduled to be more seamless on all three of those and, and each of them, unfortunately, we, we did see some hiccups in the actual timing of when we can get production.
Bill Dezellem
So, none of these were a function of something that you all didn't do well or a misstep on your side, essentially.
Brett Larsen
Absolutely not. In fact, I think we have helped each of in each of those three instances in providing some expertise. I think that has actually expedited the resolution of all three.
Bill Dezellem
Okay, great. Thank you. And, and then Tony, would you please reexplain the capitalized variants that you referenced in your opening remarks? I either may have been distracted or otherwise didn't quite follow what you were, what you were conveying.
Tony Voorhees
You bet. Thanks for the question, Bill.
Yeah, so we did write down our capitalized variances by about $800,000 during the quarter. Those capitalized variances occur or occurred when we had higher costed products sitting in inventory. And as we sell through or ship those products to our customers will see those capitalized variances come off of our balance sheet. So, as they are, as they come off, our capitalized variances will kind of reflect that. It just so happens that in this case, there are write down of inventory and we expect, like I kind of mentioned in my, in my opening remarks there, we expect to see that to continue to happen for another quarter or two, possibly.
Bill Dezellem
So, essentially, the net effect is that your, that your gross margin ends up being hurt by the amount of the capitalized variants right down. Essentially, it's said in the old-fashioned way, you're just working through higher cost inventory.
Tony Voorhees
That's exactly correct though. I should have just said that.
Bill Dezellem
Okay. And, you said you'll be working through that higher cost inventory for another one quarter or, more?
Tony Voorhees
Two quarters.
Bill Dezellem
Okay. Thank you. And then something that I have have never really thought a great deal about. But in the opening remarks, Brett, I think you mentioned Chinese business for China in your Shanghai plant. And the question that, that it prompts is why would a Chinese customer choose Key Tronic Shang Shanghai facility rather than one of the myriads of Chinese competitors?
Brett Larsen
That's a good point. You know, I think, I think we offer a pretty good solution similar to how we do in each of our global locations. We have quite a bit of technical expertise for the size of operation. We are, you know, the, if you were to look at all of the different legacy products, we've built in that Shanghai facility, they're very well versed and very experienced in building product. And you know, I think that's, that's something that, that, that shows through as they're looking now for more local Chinese OEMs is to provide, you know, hey, these are all the types in different industries that we've built for in the past and we can offer similarly those type of, of, of products for a, you know, for a Chinese customer.
Bill Dezellem
Okay, thank you. And then a couple of additional questions please. So first of all, you, you are hitting the or, or your guidance for the second fiscal quarter, the lower end of that guidance is, is flat with this quarter's guidance and yet you're going to have some, I'll call it catch up revenue from a program, you know, that start resumed or started up in October.
Another one that started up in, this week or, or newish, why, why isn't that guidance a bit higher? It just seems either that you're being conservative or that there's something coming out of the, out of the, the revenue out of the bottom of the bucket if you will. That, that I'm not understanding.
Brett Larsen
No, that's a good, that's a good question, Bill.
I think if you look at our second quarter, we are typically a little lower in sales and shipments just due to the holidays. You know, I, I know that our, most of our facilities will be completely closed, Christmas week and then for half of the week, over Thanksgiving. So, part of it is just the amount of production time that's available during the quarter. I'd say we're about a week and a half light compared to, what we'll be able to do then in, in the third quarter. So that has a direct relationship on how much in shipments we can get out.
Bill Dezellem
Okay, thank you. And then one additional macro question we have seen and, different economic data points that would suggest opposite things and have heard different things from various companies about activity levels picking up versus activity levels staying pretty constant. What, what are you seeing when you look at at your broad base of customers at what's what's happening out there.
Brett Larsen
Bill, it's a mix for us as well. I would say on the whole, I would say that we're actually seeing some recovery in demand. If you net the, the, the ups and the downs, I think we mentioned that in our first quarter, actual production of legacy product was up 10% sequentially in Mexico, we're expecting that to be flat for, for this quarter and then an uptick again in Q3 and Q4 of this year. So cautiously optimistic that demand is, is actually shifting a little more positive. Be very interesting to see, see where things end up after this election cycle. But for now, I think a slight uptick on the net.
Bill Dezellem
Great. Thank you.
Operator
And our next question will come from George Melas with MKH management.
George Melas
Thank you, Operator, Bill and Tom.
So, congratulation on, on the gross margin, it's it, it's, it's really nice to see it into the digit.
Tom. I just want to understand that variance that you're talking about. Did it review the growth margin, but you need to improve it.
Tony Voorhees
Yeah, George, good question. That, that reduced our gross margin by about $800,000 for the quarter.
Brett Larsen
So gross margin actually would have even been better without writing off that capitalized variant.
George Melas
Okay. So that's that's quite a remarkable feat. And, and I was looking at your peers and it seems like in terms of both margins, I don't know, you sort of at the high end of the peers because of smaller scales and operating margin perspective is sort of slightly below some of your peers. But I think a lot of that is related to the scale and, and I think your, your 3.4% EBITDA margin is the best in over a decade.
So, and that's despite the, the variant. So that's quite remarkable.
It seems like now the the the balance sheet is is improving, but you still have a fairly high level of debt and in particular high interest expense and trying to understand how you, how you think you can improve your balance sheet and maybe refine the debt in the next year or so.
Brett Larsen
That's a great question, George. I think, you know that I think we're going to continue to drive improvements in working capital. You've seen a quarter over quarter decline in inventory that started about 18 months ago, I guess it's now 21 months ago. Where our expectations will continue to be managed as Tony mentioned. That is, that's critical to our, to our success. The cost of capital is having a significant detriment to our, our, our, our profit is, as you mentioned, the amount of interest costs that we're, we're paying on a quarter to quarter is frustrating for us as well. We are busily looking to refinance some portion of that debt and continue to drive some more liquidity. We we still feel uncomfortable with this amount of debt.
George Melas
Right. Okay. Okay. And just in terms of the in the guidance that you have for next quarter is the capitalized variance roughly at the same magnitude.
Brett Larsen
Roughly. Yes, I would say a slight, you know, around a million dollars. Yes.
George Melas
Okay. Okay, great. And let me ask you about and I hope I get this right, but you have this very large power generation customer that had some some design issues, I believe.
And basically, I think you had very little or no revenue from that customer for in the last few quarters. Is this customer still on the table? And is there a likelihood that you resume production with that customer?
Brett Larsen
Good question, George. It's, it's a power equipment provider and we have not had any substantial revenue from that particular customer for at least three quarters. We still are in discussions with them. They're looking at potentially requesting some more product in, in next season. So next season would be next summer and fall period. So, it's still on the table. And I think the relationship is still strong with them. Now, it's just determining whether the redesigned product that we came up with would be a good fit for their total offering?
George Melas
Okay. And so, you were very involved in the product redesign.
Brett Larsen
Yes. Absolutely.
George Melas
Okay. Great.
And then one final one, and it's kind of a hypothetical, but if you had been able to produce that extra $9 million from those three programs that were delayed, and you assume sort of a similar gross margin and then it pretty much falls to the pretax line. It seems like it would have added almost a million dollars in pretax income and taxing that, let's say at 20% maybe roughly $0.07per share. Is that sort of a right calculation.
Brett Larsen
On paper? Yes, George.
George Melas
Yes. And, and, and what would be different in reality? No.
Brett Larsen
II I think, yes, I think the incremental margin on $9 million worth of business would have equated to, you know, at least another million dollars of margin. So. Yes.
George Melas
Great, great.
Okay. And then just my final question on the gross margin being so focused on it. Is it assuming the pal remains where it is now? Is it a sustainable level of growth margin?
Brett Larsen
We'd like to say so. Yeah, I think our goal has always been 9% to 10%. We just exceeded that for the first time and that I that I can remember. And yeah, we want to continue to drive that efficiency and, and that profitability. The peso definitely has helped. You'll see on our balance sheet that we have entered into some forward contracts. We're about 50% hedged for the rest of the fiscal year at some fairly high or, or low, low cost peso. So yeah, I my expectation is that, that, that gross margin will continue to remain healthy as long as some other unforeseen event doesn't happen.
George Melas
Okay. And so that's you, you can, you remember many years ago you were somewhat hedged, you had these three years rolling hedges.
And so, so you re entered into some hedges at this point because you, you saw the opportunity.
Brett Larsen
Yeah, we, we saw the opportunity and you know, at the point in time, we saw the weakness in June, we started making some some hedges and we've continued to do so. You know, and that's, that's part of our business practices to, to take advantage of a we can pay so, when possible, but even more so to be able to more accurately budget our production costs moving forward and make sure that that's included in our price to our customers.
George Melas
Right. Right. Right. Okay, great. Okay. I, I look forward to the time when the, the balance sheet keeps improving and then would have a really big impact on on the bottom line.
Thank you.
Brett Larsen
Thanks George.
Operator
And our next question will come from Bill Dezellem with Titan Capital.
Bill Dezellem
Thank you. I have two follow up questions first, relative to the Mexican operations restructuring?
Are, are those activities now? Complete. And if so has the benefit fully flowed through the P&L in the first fiscal quarter or will it be in a future quarter?
Brett Larsen
That's a complex question bill. It's a great one.
You know, part of that cost is still stuck in capitalized variances.
So, while the actual labor or the wages that we're paying now, yes, are 100%.
We're, we're, we're seeing that, that, that improvement in our wages that we're paying. However, some of the higher cost inventory is still stuck on the balance sheet as we write through that.
So actual production costs. Yes, bill, I think those are, those are definitely, that's a big part of why we were able to achieve 10% plus gross margin this quarter.
Is because of those reductions in force to say that we're done. I don't think we'll ever be done. I think there's always, we're going to continue to look for, for ways to be, to be more efficient.
And you know, I think the fact that we were able to go through those reductions with limited to no impact to timeliness of building product for our customers. Is there, is there some more efficiencies that we can gain? Is there some additional head counts that that may not be required? So, so to say that we're done, I don't think we're done. We'll continue to, to monitor that and continue to, to, compare that to the current load down in Mexico. But yes, the reductions that we did earlier in this calendar year, we're fully seeing, in a, in overall wage, wage reduction. That was a long-winded answer.
But hopefully able to address your question.
Bill Dezellem
It, well, it did and it expanded on it a bit which, which was very helpful, but just to be clear, the activities that you, or cost cutting that you had originally identified that was done at the beginning of the, the fiscal Q1, even though there may be more to, more to come as, as you put a finer finer look on it.
Brett Larsen
That is correct. That is correct.
Bill Dezellem
So I'm going to try to piece a couple of things together here. It because I've not heard you in the past talk about the capitalized variances and, and so I'm thinking about the significant cost reductions that you had in place at the beginning of the quarter.
And so ultimately, you're producing product at a, at a lower cost than what was in inventory. And so is, is essentially the rest restructuring that you have done. And we completed with at the beginning of the quarter, the reason that we now have a call out for for these capitalized variances or said another way because you, you cut costs and, and that was done at the beginning of the quarter, but you then had a flow through of that higher cost inventory that, that's not a phenomenon that you've experienced in the past. And so that's why it's a new, a new call out this quarter and then we'll carry, we'll carry it forward a bit longer.
Brett Larsen
Yeah, I think the magnitude of the write down of that capitalized variant, that's one of the reasons why we, we discussed it this, this quarter.
Bill Dezellem
And is it a correct supposition that had you not done the cost reductions or the restructuring that, that there wouldn't have been this capitalized variance because your current inventory cost would be very similar to your prior or old inventory cost.
Brett Larsen
That is correct. Yes.
Bill Dezellem
Okay. That's that, that is helpful.
And then one additional question and I'm going to go back quite some time now a ago, but you all had at one point had a real focus on that return on capital. And I'm wondering to what degree that's entering into your current or future mindset and, and just would love to get a perspective on that, please.
Brett Larsen
Yeah, 100%. Yes. That is definitely our, our goal. That is what we're looking at each and every program is highly scrutinized. What is the amount of capital or we're not just looking at top line revenue. We're even not just looking at the margins that's generated from shipments of that program.
We're also looking at how much capital is employed on that particular program and is it a good fit for Key Tronic. So, we have done some trimming of some certain programs. And I would also say that we've even put a, a finer filter on new quote opportunities coming into the sales funnel based off of that same you know, KP I is, is, is what is, what is the true return on invested capital in that potential program.
So yeah, that definitely top of mind, a lot of, you know, I think that's driven us to get there is just, you know, the cost of capital is, is exponentially what it was, you know, two or three years ago.
Bill Dezellem
Right. Great. Thank you for the additional perspective.
Brett Larsen
You bet.
Operator
As a reminder. If you would like to signal with questions, please press star one again, star one. If you would like to ask questions, we'll go to George Melas with MKH management.
George Melas
Hi guys, thanks for taking the follow up a quick question on CapEx.
They were very low in the first quarter. They seem to be sort of more normal for the rest of the year. But I think you said a big chunk of that is slated for Vietnam. Is this based on, are you, are you spending, are you putting capital there ahead of customers ahead of revenue or is that more like a success-based CapEx? Where if you have new customers going to Vietnam, you will spend that money.
Brett Larsen
It's, George, great question. That's actually a little bit of both. We see a customer that is headed there and we're taking the opportunity to go ahead and build out some additional capacity beyond what just that customer is going to require.
We're excited for, for what Vietnam could be in the future. You know, we've had some incredible success of a Greenfield there in, in Danang and you know, seeing where, where costs are at in Mexico, the geopolitical tension in China II, I just think it's, it's worth us to strategically invest in that Vietnam facility.
So, you know, will the amount of CapEx that we're investing in Danang be immediately utilized by that new customer? Absolutely not. We're going to have some extra capacity, and it'll show very, very well to potential customers visiting.
George Melas
Okay. And is right now, I I gather is, is less than 10% of revenue now. But do you expect you expect it to, to reach those levels by the end of Fiscal25?
Brett Larsen
I'd like to say yes, I, you know, by, by, by early next fiscal year, I think they'll easily be 10% of total revenue.
George Melas
Okay, great good luck with everything.
Brett Larsen
Thanks George.
Operator
And that does conclude the question answer session. I'll now turn the conference back over to you for any additional remarks.
Brett Larsen
We appreciate you joining our conference call today, Tony and I look forward to speaking to you again next quarter. Thank you.
Operator
Thank you that does conclude today's conference. We do thank you for your participation. Have an excellent day. (Operator Instructions)
