Keytronic Company of the Year

Tuesday, 01 December 2009

Written by Mike Buetow 

How a maker of branded computer peripherals became our EMS Company of the Year.

December 2003. That’s the last quarter Keytronic failed to turn a profit.

For those counting at home, that’s 23 straight quarters of positive earnings. An enviable track record, considering the vast majority of the world’s EMS companies have been plagued with the manufacturing version of the H1N1 virus during the past 12 months.

Through the four quarters ended in September, Keytronic managed net income of $178 million and net profits of $1 million. While most of the Tier 1 to 3 companies saw revenues fall 20% or more during that period, Keytronic’s were down just 14%. Those figures are not going to blow over anyone at, say, its Washington state neighbor Microsoft, but for the EMS industry, they show remarkable financial consistency. Moreover, the company is carrying no debt, having paid down all outstanding loans during its past fiscal year.

Keytronic is an interesting blend. Founded in 1969, it’s been an ODM since before the term existed. After a near-death experience as it watched the average selling prices of its core keyboard products fall off the cliff, it today ranks as the top performer among Tier 3 electronics manufacturing services providers (EMS companies with annual sales of $100 million to $400 million).

One sign of a well-built company is its ability to withstand changes in top management. KeyTronicEMS is undergoing just such a change now. The management team is transitioning to the next generation, as longtime president and CEO Jack Oehlke stepped down in April. He has been succeeded by Craig Gates, previously the company’s executive vice president and general manager, who has experience in engineering, marketing and sales in his 15-year tenure at Keytronic.

Surrounding Gates is a surfeit of experience, starting with CFO Ron Klawitter, who started with Keytronic in 1992; vice president of worldwide operations Douglas G. Burkhardt, whose tenure dates to May 1989; and vice president of engineering and quality Lawrence Bostwick, who joined the company in February 2006. (Gates and Oehlke’s relationship actually dates to Honeywell’s Microswitch division, where they worked together before joining Keytronics.) Oehlke remains on the board of directors, however, and three other directors have been with the company since before the 2001-03 downturn. It’s an experienced group.

Markets served range from computer and industrial printers, telecommunications (satellite units, tracking devices and data transmission gear), and automotive and medical (diagnostic devices and sensors). It has a foot in the consumer market as well.

Keytronic has a staff of about 2,000 workers at five plants around the world, two each in the US and Mexico, and one in China. The primary domestic manufacturing site is a 140,000 sq. ft. building in Spokane, WA, which doubles as its headquarters. (It also has a 150,000 sq. ft. distribution center in El Paso, TX.) In Shanghai, it boasts a 63,000 sq. ft. high-volume SMT plant. Its largest sites reside in Mexico: the 375,000 sq. ft. Juarez campus, which houses four buildings and where some 85% of production takes place, and the 240,000 sq. ft. Reynosa facility.

Keytronic’s model marries ODM and EMS work, and the company was one of the first (and few) companies to successfully expand from original design and product development to contract assembly. The company’s genesis lies as reportedly the first independent supplier to make a PC keyboard for heavy-duty office use, and Keytronic has been granted almost 40 patents in high-end computer peripherals, specifically keyboards and mice. But keyboards now are a small fraction of its overall sales – less than $2 million a quarter. Yet the company persists because, as Gates says, it makes money.
“We look at it every year and it comes up profitable, so we keep doing it.”

In making the transition, in 1998, from an OEM to an EMS, Keytronic has beaten the odds. Many notable OEMs tried – and failed – to develop contract assembly units. Likewise, many EMS companies bought – and then shuttered – OEM operations. In fact, Gates calls the migration “a desperation move.” At the time, a turnaround group ran Keytronic. Its focus, recalls Gates, “was to be the last keyboard company standing.” However, PC keyboard ASPs were beginning to plunge (and have since fallen from about $60 to close to $3). “It was pretty clear it was not a business you wanted to be in,” he says.

It was the threat of that abyss that led then-CEO Oehlke, Klawitter and Gates to go into EMS. In hindsight, it seemed a natural move. Recalls Gates: “We knew we had a number of strengths: facilities in the US, China, and Mexico. We were vertically integrated; we had plastic moldings and PCBs. We knew how to get product from one spot to another. It was an overt decision.”

Still, the company eased into EMS. “One of the first contract programs was manufacturing a control panel for HP printers,” Gates says. “It looked like a keyboard – it had LEDs and components – but it wasn’t. We went from there to printers and other things. We were lucky or hardworking enough or smart enough to stay ahead of the decline in keyboards.”

Every company seeks success over the long haul, of course. Now in its sixth year of consecutive quarterly profitability, Keytronic sees itself as owning certain attributes unique to EMS companies in its size range. For starters, the geographical reach. With plants in China, Mexico and the US, it covers a lot of territory that few firms below Tier 2 can equal. Also, the three plants operate as if they were one. All three sites have identical equipment sets and processes. All production planning is performed from Spokane.

Although the program managers all reside in the Spokane plant, they command much greater responsibility than many of their peers. (Gates calls them “mini CEOs.”) Being grouped together, and in proximity to engineering, permits greater cohesion for loading and other decisions. Keytronic sees this as a meaningful way to appeal to its US customer base, allowing them to communicate in US time zones and with native English speakers, without long and frequent trips across borders or oceans. For their part, PMs directly reap the rewards when their business with a customer grows, giving them additional incentive to please.

“When volume expands, [our customers] don’t have to speak Spanish and go every week to Mexico and preside over a lot of intramural debates between facilities,” explains Gates. “We ensure the procedures are exactly the same in each place. [Customers] don’t really need to re-qualify the programs in each place.”

No losing quarters. The 2008-09 downturn affected everyone. That Keytronic managed to remain profitable throughout is remarkable. It lays credit not at the feet of any special oracle, but rather the experience of its management and its laser-like attention to the balance sheet. “I don’t think we saw it coming any earlier than anyone else,” says Gates. “We have a very scarred management team that has been through a transition few have made, going from OEM to CM. Those ups and downs taught us you have to have a very tightly managed balance sheet. When that downturn hit, we weren’t strung out for cash. Same thing on the inventory side. We have learned not to have a lot of cash tied up in inventory.” Indeed, as of the June quarter, its cash conversion cycle was 74 days, and inventory days were 69. Both figures compare favorably with Tier 2 averages, and easily best Tier 3 competitors.

Unlike most large EMS firms that react to downturns by taking large restructuring charges and inventory write-downs, leading to some horrific quarterly figures, Keytronic operates under the simple principle that it will not lose money, ever. Doing so, the company believes, makes customers squeamish and reverberates for months. “Even a quarter’s loss makes our customers nervous. It slows the sales process, and it makes them concerned there may be more problems coming,” Gates asserts.

“Our balance sheet, inventory and cost structure – all three are managed in a way that we hope we never have to lose money because we can be aggressive on all three levels. We also do a complete re-budget every quarter. I think that’s unique in our industry.”

Interestingly, Gates also credits years of ramping programs up and down. This background gave the company the chops to move product and people as needed, and in real time.

From a performance standpoint, Keytronic’s metrics are straightforward. One is 12% return on invested capital. Another is to beat its peer group’s revenue growth rate. When it misses on those goals, employees see it in their paychecks.

Keytronic has reached the $200 million annual revenue threshold almost on the strength of just 10 customers, all of which it has supplied since 1998. In that time, it has lost, according to Gates, “maybe two of any size, and both were by our choice.”

Adds CFO Klawitter, “Two or three years ago, the bulk of our business was from nine or 10 customers. The other 18 came over the last two years.” In fact, just before the recession, Keytronic was scoring several new customer wins, and points to its success there – 40% of its revenue in the past quarter came from customers of fewer than 18 months – as playing a major role in its near-term results.

Its target customer program is in the range of $5 million to $30 million, too small to interest most Tier 1 firms. Yet Keytronic leverages its footprint, which includes a group in China that does most of its materials procurement, and vertical integration, which includes generous plastic molding capacity, with a responsiveness characteristic of Tier 3 firms. “We are of the size that we jump for our customers. If they were with a Tier 1, the customer wouldn’t get that kind of a jump,” Gates says.

“A lot of EMS companies’ costs are about the same. The differentiators come down to trust: Can the customer get the product when they need it to keep themselves in business? The people who understand that that is the core of a business relationship, those are the customers we want. Those who move every six months haven’t stopped to think about how much that costs them and us.”

Soft side. Every 18 months, all PMs, accounting, engineers and sales staff are trained on Keytronic’s EVA (Economic Value Added) philosophy, which looks at investments in plant space, equipment, working capital, and other operations, and reiterates the need for returns on investment. But in speaking with Gates and Klawitter, it is clear KeyTronic is no Wall Street bank. Management keeps tight reigns on operations at all sites, often via video conferencing. Business reviews are conducted quarterly with the entire company, and management meets daily with all PMs and support functions, covering every program. “It makes it very easy to communicate how we are doing and tell our folks how their individual actions are going to affect their paycheck,” Gates says.

For a company that relies so much on understanding and quantifying its business, Keytronic reveals a certain touchy-feely side. Take its program managers. Before assigning a PM to an account, management considers their skill set and how it fits with the customer’s need. “There are some program managers who are former engineers and pretty much ‘0s and 1s,’ ” says Gates. “If you match them up with a customer who stresses more ‘feelings,’ it’s not a good match. It’s organic process, but key in making this work. The tight management and flatness of the organization and level of detail senior staff is exposed to on a daily basis is unique to our business and seems core to our success.”

Gates himself seems genetically predisposed to the term “we.” Almost insistently during the course of an interview with Circuits Assembly, he spread credit among his colleagues. The subtle gesture adds credibility to his comments, like when he says, “We are all involved in details. We have no patience for creeping functionalism. A number of us came from big organizations, and where you go wrong is when you think the function is more important than the organization. And we always remember where the money comes from. What really matters is how we treat our customers and how we work together to make money.”

For its unique but systematic approach to the electronics manufacturing services rollercoaster, and its stellar performance in all types of business environments, Keytronic is Circuits Assembly’s 2009 EMS Company of the Year.

Mike Buetow is editor-in-chief of Circuits Assembly