Northwest Investment Profiles -- Key Tronic Revival Is At Hand

TODAY THE SEATTLE TIMES examines Key Tronic Corp. in a periodic report on publicly traded Northwest companies from an investor's point of view. Key Tronic is based in Spokane. Its main products are keyboards for computers. Stock ticker symbol: KTCC. Friday's closing price: $10.375. 52-week range: $5.75-$11.50. -------------------------------

SPOKANE - Three years ago, Key Tronic Corp., one of this state's largest high-tech employers, was nearly dead.

"It had been walking in a coma since the mid-1980s," said Thomas Friedberg, an analyst who follows the company for Genesis Merchant Group in San Francisco.

Though Key Tronic was a world leader in making keyboards for personal computers, sales were stagnant and profits were sporadic or nonexistent.

A rigid management structure stifled most ideas other than those from the top. New ventures into laptop computers and Nintendo game cartridges failed, generating big asset write-offs.

Book value per share dropped from $7.09 in 1990 to $6 in 1991 to $5.21 in 1992 (it is now $5.38). The stock, which soared into the $14 range in 1986, had slumped to $2 by late 1991.

But now Key Tronic, the world's largest independent maker of keyboards for personal computers, seems to be back on track.

With its stock now flirting with double digits, Key Tronic is suddenly scrambling to increase production of a hot new product, the ergonomic Natural Keyboard it makes for Redmond's Microsoft Corp.

Egghead Software salespeople say the unusual keyboards, sculptured to angle and separate the right-hand and left-hand keys, are selling briskly at $99.99 apiece.

The keyboard is designed to promote better wrist posture, more comfort and fewer repetitive stress injuries among computer users.

Microsoft, which designed the keyboard and introduced it in September, initially thought 100,000 would be sold by the end of 1994. Sales have already exceeded that figure, and Microsoft says it has so many orders that it has asked Key Tronic to increase production to at least 100,000 a month in 1995.

That's not all that's going right at Key Tronic these days.

The company expects orders for another major new model to go into production early next year, but it has not said who its customer will be.

Key Tronic shipped 5.6 million keyboards of all types in 1994, up from 2.3 million in 1992.

And just last Friday, Key Tronic announced another new product, the $49 LifeTime Mouse that rests on two "feet" instead of the rolling rubber ball that's at the bottom of almost every computer mouse in use today.

The company says the new mouse, to be introduced at a national computer show next week, won't need cleaning (as conventional mice do) and will work on any surface, without a special mouse pad.

However, not everyone is sure this is pure good news for Key Tronic.

"I am still questioning whether they can turn these new orders into gross (profit) margins above about 15 percent," said Friedberg.

The question is important for Key Tronic. The economics of keyboard manufacturing amount to a constant race between manufacturing costs and selling prices: which ones drop faster?

Five years ago, Key Tronic sold its average keyboard for more than $60. Today, the average is about $25, though the figure has edged slowly upward in the past two quarters as the company has sold higher volumes of its more sophisticated, higher-priced models.

With several aggressive Japanese competitors looming, Key Tronic can't afford to rest on its laurels.

"The higher-priced products of today are going to become low-price products of tomorrow, and that's why cost-cutting is so important," Key Tronic shareholders were told at the company's annual meeting late last month by Stanley Hiller, chief executive officer.

"We offer an array of products that satisfy both the low and the high end" of the business, "but to accomplish this we have to run a hell of a tight ship," Hiller said.

While it addresses these problems, Key Tronic is struggling to achieve and sustain profitability during an extended "turnaround" period that began in March 1992 with new management headed by Hiller.

In the past two-and-a-half years, Hiller has orchestrated the start of a corporate revival, which he said is far from complete.

-- Sales, which bottomed at $124 million in 1992, hit $159 million in the fiscal year ended July 2, 1994. In the quarter ended Oct. 1, sales were $45.4 million, up 26 percent from a year earlier.

-- Though only one of Key Tronic's past four years ended with a profit ($3.8 million in 1993) and 1994's operating loss was $8.2 million, the company reported profit of $328,000 for the quarter ended Oct. 1, the first of its 1995 fiscal year.

The most recent quarter also was the first in a year and a half with an operating profit instead of operating loss. Hiller said the company will have a full-year profit - but he won't say how much.

-- Key Tronic is operating more efficiently. Operating expenses fell from 19.5 percent of sales in 1993 to 15 percent of sales in 1994.

-- Key Tronic stock has rebounded from a low of $2 in November 1991 to $10.375 Friday, down from a peak of $11.50 in September.

"Business is currently excellent and getting better," said Robert Toomey, an analyst with Piper Jaffray in Seattle who follows Key Tronic. Toomey believes the company's stock "should be worth $20" over the next two to three years. He has put a "strong buy" recommendation on the issue.

The stock's gain so far has made a small fortune for Hiller, who works without any salary or bonus.

Under a contract signed March 2, 1992, Hiller's only compensation has been tied to appreciation of the stock, which sold for $3.125 when the contract was signed. Hiller was given the right to buy 2.4 million shares from the company at $4.50 each. The options don't expire for several more years, and Hiller has not exercised them.

Hiller's gamble so far has paid off. And if Toomey is right that Key Tronic stock could be worth $20 in a few years, Hiller could walk away with gains of about $37 million.

However, Friedberg believes Toomey's projections are too optimistic. Though Friedberg has no formal recommendation on Key Tronic stock, "Unofficially, we think it is fully valued, based on our numbers," he said. "We need more proof" that Key Tronic can turn higher sales into higher profit margins.

Two weeks ago, Key Tronic announced a major refinancing agreement of its long-term debt to give the company access to $15 million more working capital while cutting its required annual debt payments from $4.4 million to $2 million.

"This gives us a lot of flexibility and the ability to grow," said Ronald Klawitter, chief financial officer.

Hiller said one of the major requirements for success in his turnaround of Key Tronic will be "innovative new products that capture the leadership of the industry. We are working on new technology in several important fields, and that is the cornerstone of rebuilding a company. You have to be a leader."

Hiller disagrees with the notion that a keyboard is "a dumb device. It is a very substantial interface between the machine and the human being, and there is a world of opportunity to try to improve it," he said.

"In the years to come, keyboards will become increasingly sophisticated," he said. "That means higher prices and, if you keep your costs down, higher margins."

However, Friedberg isn't sure Key Tronic will be able to charge its major customers enough to boost margins above 15 percent. "Last quarter they were 14 percent, and they have to be at least 15 percent to make money," Friedberg said.

But Toomey sees a brighter future for Hiller's turnaround efforts, which he credits with broadening the company's base of customers to include almost every major U.S. PC manufacturer. He said Hiller also has sharpened Key Tronic's focus and altered its management style so the company can react quickly to changes in the marketplace.

Key Tronic's future prosperity is far from a done deal, however, as even Hiller concedes. At the shareholders meeting, Hiller described his own view of the company's outlook as "conservative optimism."

"The foundations are indeed there, and the stock has seen an upward trend," Hiller said. "However, we don't want to let it get ahead of itself."