ktcc-20220101

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________________________________________________

FORM 10-Q

____________________________________________________________

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JANUARY 1, 2022

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE PERIOD FROM TO .

Commission File Number 0-11559

____________________________________________________________

KEY TRONIC CORPORATION

(Exact name of registrant as specified in its charter)

____________________________________________________________


Washington			91-0849125
(State of Incorporation)			(I.R.S. Employer Identification No.)

N. 4424 Sullivan Road

Spokane Valley, Washington 99216

(509) 928-8000

(Address of principal executive offices and registrant’s telephone number)

____________________________________________________________

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol	Name of each exchange on which registered
Common Stock, no par value	KTCC	NASDAQ Global Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements during the past 90 days. Yes ☒ No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulations S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated Filer

☐

Accelerated Filer

☒

Non-accelerated Filer

☐

Smaller reporting company

☒

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of February 9, 2022, 10,761,871 shares of common stock, no par value (the only class of common stock), were outstanding.

KEY TRONIC CORPORATION

Index


		Page No.

PART I.	FINANCIAL INFORMATION:

Item 1.	Financial Statements (Unaudited):	3

	Condensed Consolidated Balance Sheets	3

	Condensed Consolidated Statements of Income	4

	Condensed Consolidated Statements of Comprehensive Income (Loss)	5

	Condensed Consolidated Statements of Cash Flows	6

	Condensed Consolidated Statements of Shareholders’ Equity	7

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	32

Item 4.	Controls and Procedures	32

PART II.	OTHER INFORMATION:

Item 1.	Legal Proceedings	33

Item 1A.	Risk Factors	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds*

Item 3.	Defaults upon Senior Securities*

Item 4.	Mine Safety Disclosures*

Item 5.	Other Information*

Item 6.	Exhibits	33

Signatures		34

* Items are not applicable

“We,” “us,” “our,” “Company,” and “Key Tronic,” unless the context otherwise requires, means Key Tronic Corporation and its subsidiaries.

PART I: FINANCIAL INFORMATION

Item 1: Financial Statements

KEY TRONIC CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands; except share data)


	January 1, 2022		July 3, 2021
ASSETS
Current assets:
Cash and cash equivalents	$	1,046	$	3,473
Trade receivables, net of allowance for doubtful accounts of $330 and $275	123,413		110,324
Contract assets	25,968		24,781
Inventories, net	157,750		137,329
Other	35,374		23,345
Total current assets	343,551		299,252
Property, plant and equipment, net	29,004		35,735
Operating lease right-of-use assets, net	19,068		15,745
Other assets:
Deferred income tax asset	10,637		9,656
Other	8,247		1,458
Total other assets	18,884		11,114
Total assets	$	410,507	$	361,846
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	131,842	$	92,823
Accrued compensation and vacation	7,357		11,471
Current portion of debt, net	4,991		2,143
Other	22,938		20,268
Total current liabilities	167,128		126,705
Long-term liabilities:
Term loans	6,817		7,906
Revolving loan	96,435		90,362
Operating lease liabilities	13,649		11,428

Other long-term obligations	3,843		1,740
Total long-term liabilities	120,744		111,436
Total liabilities	287,872		238,141
Commitments and contingencies (Note 8)
Shareholders’ equity:
Common stock, no par value—shares authorized 25,000; issued and outstanding 10,762 and 10,762 shares, respectively	47,324		47,181
Retained earnings	75,854		74,452
Accumulated other comprehensive income	(543)		2,072
Total shareholders’ equity	122,635		123,705
Total liabilities and shareholders’ equity	$	410,507	$	361,846

See accompanying notes to consolidated financial statements.

KEY TRONIC CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited, in thousands, except share and per share amounts)


	Three Months Ended				Six Months Ended
	January 1, 2022		December 26, 2020		January 1, 2022		December 26, 2020
Net sales	$	134,456	$	128,262	$	267,218	$	251,469
Cost of sales	124,648		117,640		247,272		230,832
Gross profit	9,808		10,622		19,946		20,637
Research, development and engineering expenses	2,498		2,392		4,947		4,637
Selling, general and administrative expenses	5,659		5,510		11,254		10,484
Total operating expenses	8,157		7,902		16,201		15,121
Operating income	1,651		2,720		3,745		5,516
Interest expense, net	1,095		848		2,087		1,529
Income before income taxes	556		1,872		1,658		3,987
Income tax provision (benefit)	(31)		292		256		688
Net income	$	587	$	1,580	$	1,402	$	3,299
Net income per share — Basic	$	0.05	$	0.15	$	0.13	$	0.31
Weighted average shares outstanding — Basic	10,762		10,760		10,762		10,760
Net income per share — Diluted	$	0.05	$	0.14	$	0.13	$	0.30
Weighted average shares outstanding — Diluted	11,057		11,385		11,055		11,040

See accompanying notes to consolidated financial statements.

KEY TRONIC CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited, in thousands)


	Three Months Ended				Six Months Ended
	January 1, 2022		December 26, 2020		January 1, 2022		December 26, 2020
Comprehensive income (loss):
Net income	$	587	$	1,580	$	1,402	$	3,299
Other comprehensive income (loss):
Unrealized gain (loss) on hedging instruments, net of tax	(1,084)		2,926		(2,615)		4,194
Comprehensive income (loss)	$	(497)	$	4,506	$	(1,213)	$	7,493

Other comprehensive income (loss) for the three months ended January 1, 2022 and December 26, 2020, is reflected net of tax expense (benefit) of approximately $(0.5) million and $0.8 million, respectively. Other comprehensive income (loss) for the six months ended January 1, 2022 and December 26, 2020, is reflected net of tax expense (benefit) of approximately $(0.8) million and $1.5 million, respectively.

See accompanying notes to consolidated financial statements.

KEY TRONIC CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOW

(Unaudited, in thousands)


	Six Months Ended
	January 1, 2022		December 26, 2020
Operating activities:
Net income	$	1,402	$	3,299
Adjustments to reconcile net income to cash used in operating activities:
Depreciation and amortization	2,613		3,368
Amortization of interest rate swap	151		125
Amortization of deferred loan costs	69		35
Provision for obsolete inventory	365		446
Provision for warranty	228		36
Provision for doubtful accounts	54		(21)

Share-based compensation expense	143		114
Deferred income taxes	(175)		39
Changes in operating assets and liabilities:
Trade receivables	(13,143)		(13,961)
Contract assets	(1,187)		1,118
Inventories	(20,786)		(4,865)
Other assets	(13,537)		1,665
Accounts payable	39,019		(10,268)
Accrued compensation and vacation	(4,114)		(1,388)
Other liabilities	(1,630)		3,435
Cash used in operating activities	(10,528)		(16,823)
Investing activities:
Purchase of property and equipment	(2,766)		(6,963)
Proceeds from sale of fixed assets	2		—

Cash used in investing activities	(2,764)		(6,963)
Financing activities:
Payment of financing costs	(118)		(561)
Proceeds from issuance of long term debt	7,004		11,000
Interest rate swap termination fee	—		(925)
Repayments of long term debt	(1,066)		(11,066)
Borrowings under revolving credit agreement	289,963		163,483
Repayments of revolving credit agreement	(283,841)		(133,691)
Principal payments on finance leases	(1,077)		—
Cash provided by financing activities	10,865		28,240
Net (decrease) increase in cash and cash equivalents	(2,427)		4,454
Cash and cash equivalents, beginning of period	3,473		553
Cash and cash equivalents, end of period	$	1,046	$	5,007


Supplemental cash flow information:
Interest payments	$	1,811	$	1,533
Income tax payments, net of refunds	$	530	$	897
Recognition of operating lease liabilities and right-of-use assets	$	5,246	$	—
Recognition of financing lease liabilities and right-of-use assets	$	5,973	$	—

See accompanying notes to consolidated financial statements.

KEY TRONIC CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited, in thousands; except share data)


	Three Months Ended				Six Months Ended
	January 1, 2022		December 26, 2020		January 1, 2022		December 26, 2020
Total shareholders’ equity, beginning balances	$	123,057	$	118,607	$	123,705	$	115,557

Common stock (shares):
Beginning balances	10,762		10,760		10,762		10,760
Exercise of stock appreciation rights	—		—		—		—
Ending balances	10,762		10,760		10,762		10,760

Common stock:
Beginning balances	$	47,249	$	47,009	$	47,181	$	46,946
Share-based compensation	75		51		143		114

Ending balances	47,324		47,060		47,324		47,060

Retained Earnings:
Beginning balances	$	75,267	$	71,830	$	74,452	$	70,111
Net income	587		1,580		1,402		3,299
Ending balances	75,854		73,410		75,854		73,410

Accumulated other comprehensive income:
Beginning balances	$	541	$	(232)	$	2,072	$	(1,500)
Unrealized gain (loss) on hedging instruments, net	(1,084)		2,926		(2,615)		4,194
Ending balances	(543)		2,694		(543)		2,694
Total shareholders’ equity, ending balances	$	122,635	$	123,164	$	122,635	$	123,164

See accompanying notes to consolidated financial statements.

KEY TRONIC CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.Basis of Presentation

The consolidated financial statements included herein have been prepared by Key Tronic Corporation and subsidiaries (the Company) pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted. The year-end condensed consolidated balance sheet information was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The financial statements reflect all normal and recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2021.

The Company’s reporting period is a 52/53 week fiscal year ending on the Saturday closest to June 30. The three and six month periods ended January 1, 2022 and December 26, 2020, were 13 and 26 week periods, respectively. Fiscal year 2022 will end on July 2, 2022, which is a 52 week year. Fiscal year 2021 which ended on July 3, 2021, was a 53 week year.

Certain Significant Risks and Uncertainties Related to Outbreak of Coronavirus Disease 2019 (“COVID-19”)

Due to the COVID-19 pandemic, the Company has seen extreme shifts in demand from its customer base, and shifts in supply chain and logistics risks. The possibility of future temporary closures, as well as adverse fluctuations in customer demand, freight and expedite costs, precautionary safety expenses and labor shortages, collectability of accounts, and future supply chain disruptions during the rapidly changing COVID-19 environment can materially impact operating results. Additionally, continued adverse macroeconomic conditions and significant currency exchange fluctuations can also materially impact operating results.

2.Significant Accounting Policies

Reclassifications

Certain prior period reclassifications were made to conform with the current period presentation. These reclassifications had no effect on reported income, comprehensive income, cash flows, total assets, or shareholders' equity as previously reported.

Earnings Per Common Share

Basic earnings per common share (EPS) is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income (loss) by the combination of other potentially dilutive weighted average common shares and the weighted average number of common shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the exercise of equity awards were used to repurchase common shares at the average market price during the period. The computation of diluted EPS does not assume conversion, exercise, or contingent issuance of common stock equivalent shares that would have an anti-dilutive effect on EPS.

Derivative Instruments and Hedging Activities

The Company has entered into foreign currency forward contracts that are accounted for as cash flow hedges. The effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (AOCI) and is reclassified into earnings in the same period in which the underlying hedged transaction affects earnings. The derivative’s effectiveness represents the change in fair value of the hedge that offsets the change in fair value of the hedged item.

The Company uses derivatives to manage the variability of foreign currency fluctuations of expenses in our Mexico facilities. The foreign currency forward contracts have terms that are matched to the underlying transactions being hedged. As a result, these transactions fully offset the hedged risk and no ineffectiveness has been recorded.

The Company’s foreign currency forward contracts potentially expose the Company to credit risk to the extent the counterparty may be unable to meet the terms of the agreement. The Company minimizes such risk by utilizing a counterparty with a strong credit rating. The Company’s counterparty to the foreign currency forward contracts is a major banking institution. This institution does not require collateral for the contracts, and the Company believes that the risk of the counterparty failing to meet their contractual obligations is remote. The Company does not enter into derivative instruments for trading or speculative purposes.

Income Taxes

We compute our interim income tax provision through the use of an estimated annual effective tax rate (ETR) applied to year-to-date operating results and specific events that are discretely recognized as they occur. In determining the estimated annual ETR, we analyze various factors, including projections of our annual earnings, taxing jurisdictions in which the earnings will be generated, the impact of state and local income taxes, our ability to use tax credits and available tax planning alternatives. Discrete items, including the effect of changes in tax laws, tax rates, and certain circumstances with respect to valuation allowances or other unusual or non-recurring tax adjustments, are reflected in the period in which they occur as an addition to, or reduction from, the income tax provision, rather than included in the estimated annual ETR.

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences and benefits attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as tax credit and net operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities for a change in tax rates is recognized in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized.

We utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments based on new assessments and changes in estimates and which may not accurately forecast actual outcomes. Our policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax expense. The tax years 2004 through the present remain open to examination by the major U.S. taxing jurisdictions to which we are subject. Refer to Note 6 for further discussions.

Recently Issued Accounting Standards

In January 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2021-01, Reference Rate Reform (Topic 848) to identify alternative reference rates that are more observable or transaction based and less susceptible to manipulation. The Company is currently assessing the effects on its consolidated financial statements, and if it will elect this optional standard.

In March of 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments, which clarifies specific issues raised by stakeholders. Specifically, the ASU clarifies the following: 1) that all entities are required to provide the fair value option disclosures in ASC 825, Financial Instruments 2) clarifies that the portfolio exception in ASC 820, Fair Value Measurement, applies to nonfinancial items accounted for as derivatives under ASC 815, Derivatives and Hedging; 3) clarifies that for purposes of measuring expected credit losses on a net investment in a lease in accordance with ASC 326, Financial Instruments - Credit Losses, the lease term determined in accordance with ASC 842, Leases, should be used as the contractual term; 4) clarifies that when an entity regains control of financial assets sold, it should recognize an allowance for credit losses in accordance with ASC 326; and 5) aligns the disclosure requirements for debt securities in ASC 320, Investments - Debt Securities, with the corresponding requirements for depository and lending institutions in ASC 942, Financial Services - Depository and Lending. The amendments in the ASU have various effective dates and transition requirements which are dependent on timing of adoption of ASU 2016-13. The Company is currently assessing the effects on its consolidated financial statements, and it intends to adopt the guidance as they become effective.

In June 2016, the FASB issued ASU 2016-13 “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” and also issued subsequent amendments to the initial guidance: ASU 2018-19, ASU 2019-04 and ASU 2019-05, which replaces the existing incurred loss impairment model with an expected credit loss model and requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected. The guidance is effective for the Company beginning in the first quarter of fiscal year 2024 with early adoption permitted. The Company is currently assessing the impact on its consolidated financial statements, and it intends to adopt the guidance when it becomes effective in the first quarter of fiscal year 2024.

3.Inventories

Total inventory as of January 1, 2022 is $157.8 million compared to $137.3 million as of July 3, 2021. Substantially all of the Company’s inventory balances are raw materials.

4.Long-Term Debt

On September 3, 2021, the Company entered into an amendment to the Company’s current loan agreement with Bank of America. The amendment increases the Company’s current credit facility of $93 million to $120 million, subject to the Company’s borrowing base, maturing on September 3, 2026. As of January 1, 2022, the Company had an outstanding balance under the asset-based revolving credit facility of $97.0 million, $0.3 million in outstanding letters of credit and $17.3 million available for future borrowings.

As of July 3, 2021, the Company had an outstanding balance under the credit facility with Bank of America of $90.9 million, $0.3 million in outstanding letters of credit and $2.1 million available for future borrowings.

Generally, the interest rate applicable to loans under the Bank of America loan agreement will be, at the Company’s option: (i)(A) the base rate which is the highest of (1) the prime rate for the applicable day (as such rate is determined from time to time by the Bank), (2) the federal funds rate for the applicable day plus 0.50%, and (3) LIBOR for a 30-day interest period as of the applicable day plus 1.00% (provided that in no event shall the base rate be less than zero), plus the applicable interest margin for base rate loans; and (B) LIBOR rate for an applicable interest period (provided that in no event shall the LIBOR rate be less than 0.50%), plus the applicable interest margin for LIBOR rate loans. Depending on average daily excess borrowing availability over applicable periods under the Credit Facility, applicable interest margins on: (x) base rate loans will be 1.25-1.75%; and (y) LIBOR rate loans will be 2.25-2.75%, resetting on a quarterly basis beginning in early 2021. If there is an event of default under the loan agreement, all loans and other obligations will bear interest at a rate of an additional 2.00% on the otherwise applicable interest rates. In addition to interest charges, the Company is required to pay a fee of 0.25% per annum on the unused portion of the Credit Facility, monthly in arrears.

Under the new loan agreement with Bank of America, the asset-based revolving credit facility bears interest at LIBOR plus 2.5%, as elected by the Company.

On August 14, 2020, the Company also entered into a $5.0 million equipment financing facility relating to the Company’s existing U.S. manufacturing equipment that bears interest at 4.85% and matures on August 14, 2025. Under this loan agreement, equal monthly payments of approximately $94,000 commenced on September 14, 2020 and will continue through the maturity of the equipment financing facility on August 14, 2025. As of January 1, 2022, the Company had an outstanding balance of $3.8 million. As of July 3, 2021, the Company had an outstanding balance of $4.2 million under the Bank of America equipment term loan agreement.

On November 24, 2020, the Company entered into a $6.0 million equipment financing facility related to the Company’s existing manufacturing equipment that bears interest at 5.52% and matures on April 24, 2026. Under this loan agreement, equal monthly payments of $100,000 commenced on May 24, 2021 and will continue through the maturity of the equipment financing facility on April 24, 2026. As of January 1, 2022, the Company had an outstanding balance of $5.2 million. As of July 3, 2021, the Company had an outstanding balance of $5.8 million.

The interest rates on outstanding debt as of January 1, 2022 range from 3.25% - 5.52% compared to 3.25% - 5.52% as of July 3, 2021.

Debt maturities as of January 1, 2022 for the next five years and thereafter are as follows (in thousands):


Fiscal Years Ending	Amount
2022 (1)	$	1,076
2023	2,190
2024	2,239
2025	2,290
2026	1,187
Thereafter	97,009
Total debt	$	105,991
Unamortized debt issuance costs	(574)
Long-term debt, net of debt issuance costs	$	105,417

(1) Represents scheduled payments for the remaining six-month period ending July 2, 2022.

The Company must comply with certain financial covenants, including a fixed charge coverage ratio and a cash flow leverage ratio. The credit agreement requires the Company to grant certain inspection rights to Bank of America, limit or restrict the Company’s cash management; limit or restrict the ability of the Company to incur additional liens, make acquisitions or investments, incur additional indebtedness, engage in mergers, consolidations, liquidations, dissolutions, or dispositions, pay dividends or other restricted payments, prepay certain indebtedness, engage in transactions with affiliates, and use proceeds. The Company was in compliance with all financial covenants as of January 1, 2022.

5.Income Taxes

The Company expects to repatriate a portion of its foreign earnings based on increased net sales growth driving additional capital requirements domestically, cash requirements for potential acquisitions and to implement certain tax strategies. The Company currently expects to repatriate approximately $7.4 million of foreign earnings in the future. All other unremitted foreign earnings are expected to remain permanently reinvested for planned fixed assets purchases and improvements in foreign locations.

Repatriations of cash will generally be tax-free in the U.S. However, withholding taxes in China may still apply to any such future repatriations. Management has not changed its indefinite investment assertions with regard to the portion of accumulated earnings and profits in China that may be repatriated in the future. Accordingly, management estimates that future repatriations of cash from China may result in approximately $0.7 million of withholding tax. We do not anticipate there would be any offsetting foreign tax credits in the U.S. and as such, this potential liability is a direct cost associated with actual repatriations. Withholding taxes would not apply to future repatriations from Mexico or Vietnam.

The Company has available approximately $6.5 million of gross federal research and development tax credits as of January 1, 2022. ASC 740 requires the Company to recognize in its financial statements uncertainties in tax positions taken that may not be sustained upon examination by the taxing authorities. Accordingly, as of January 1, 2022, the Company has recorded $2.7 million of unrecognized tax benefits associated with these federal tax credits, resulting in a net deferred tax benefit of approximately $3.8 million.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the COVID-19 pandemic. The CARES Act is not expected to have a material impact on the provision or timing of cash payments for income taxes. However, under the CARES Act, AMT credits not previously refunded for the 2018 tax year became refundable in the 2019 taxable year rather than in years 2019-2021, and taxpayers could elect to claim 100% of the AMT credits in the first taxable year beginning in 2018 by applying for a tentative refund claim on or before December 31, 2020. The Company made this election by applying for a tentative refund claim in the fourth quarter of fiscal year 2020. The Company is continuing to evaluate the impacts of other aspects of the CARES Act, and at this time the Company does not believe they will have a material impact on our consolidated financial position, results of operations, or cash flows.

The Company is evaluating tax law changes and regulatory guidance issued through the quarter. Such changes and regulations include guidance under Sec. 162(m), Sec. 245A, Sec. 951A, foreign tax credits, and rules relating to consolidated NOL carryback claims. The Company is still evaluating the ongoing impact of these law and regulatory changes, and does not expect them to have a material impact on its provision for income taxes.

On January 27, 2021, the Company received official notice from the Vietnamese tax authorities, confirming tax benefits awarded (the “Tax Holiday”) related to the Company’s principal product line in Vietnam. The tax rate related to this product line will be zero percent for four years beginning with fiscal year 2021, then five percent for nine years, then ten percent for one year (as opposed to the normal twenty percent each year). Consequently, Management determined that the net operating loss in Vietnam more likely than not would result in minimal, if any, tax benefit, and the Company recorded a valuation allowance against the entire Vietnam net operating loss deferred tax asset ($0.2 million) in the third quarter of fiscal year 2021.

6.Earnings Per Share

The following table presents a reconciliation of the denominator in the basic and diluted EPS calculation and the number of antidilutive common share awards that were not included in the diluted earnings per share calculation. These antidilutive securities occur when equity awards outstanding have an option price greater than the average market price for the period.


	Three Months Ended
	(in thousands, except share and per share information)
	January 1, 2022		December 26, 2020
Net income	$	587	$	1,580
Weighted average shares outstanding—basic	10,762		10,760
Effect of dilutive common stock awards	295		625
Weighted average shares outstanding—diluted	11,057		11,385
Net income per share—basic	$	0.05	$	0.15
Net income per share—diluted	$	0.05	$	0.14
Antidilutive SARs not included in diluted earnings per share	619		—


	Six Months Ended
	(in thousands, except share and per share information)
	January 1, 2022		December 26, 2020
Net income	$	1,402	$	3,299
Weighted average shares outstanding—basic	10,762		10,760
Effect of dilutive common stock awards	293		280
Weighted average shares outstanding—diluted	11,055		11,040
Net income per share—basic	$	0.13	$	0.31
Net income per share—diluted	$	0.13	$	0.30
Antidilutive SARs not included in diluted earnings per share	619		324

7. Share-based Compensation

The Company’s incentive plan provides for equity and liability awards to employees and non-employee directors in the form of stock options, stock appreciation rights (SARs), restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock-based or cash-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service period, which is generally the vesting period, and is recorded as employee compensation expense in cost of goods sold, research, development and engineering, and selling, general and administrative expenses. Share-based compensation is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on historical experience and future expectations.

In addition to service conditions, SARs contain a performance condition. The additional performance condition is based upon the achievement of Return on Invested Capital (ROIC) goals relative to a peer group. All awards with performance conditions are evaluated quarterly to determine the likelihood that performance metrics will be achieved during the performance period. These awards are charged to compensation expense over the requisite service period based on the number of shares expected to vest. The SARs cliff vest after a three-year period from date of grant and expire five years from date of grant.

The grant date fair value for the awards granted below were estimated using the Black Scholes option valuation method:


	August 9, 2021		July 23, 2020
SARs Granted	165,000		155,000
Strike Price	$	7.17	$	6.94
Fair Value	$	2.73	$	2.32

Total share-based compensation expense recognized during the three months ended January 1, 2022 and December 26, 2020 was approximately $75,000 and $51,000, respectively. Total share-based compensation expense recognized during the six months ended January 1, 2022 and December 26, 2020 was approximately $143,000 and $114,000, respectively.

As of January 1, 2022, total unrecognized compensation expense related to unvested share-based compensation arrangements was approximately $0.6 million. This expense is expected to be recognized over a weighted average period of 2.18 years. No SARs were exercised during the three or six months ended January 1, 2022 or December 26, 2020.

8.Commitments and Contingencies

Litigation and Other Matters

The Company is party to certain lawsuits or claims in the ordinary course of business. The Company does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the financial position, results of operations or cash flow of the Company.

Warranties

The Company provides warranties on certain product sales. Allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. If actual return rates and/or repair and replacement costs differ significantly from management’s estimates, adjustments to recognize additional cost of sales may be required in future periods. The Company’s warranty reserve was approximately $25,000 as of January 1, 2022 and $25,000 as of July 3, 2021, respectively.

SEC Form 10-Q filed by Key Tronic Corporation