Key Tronic Charts Asian Strategy Company Looks To Hiller For Help In Gaining Pacific Rim Foothold

Every offspring must eventually be weaned away from its nurturing parent, but this is not a good time, company officials say, for Key Tronic Corp. to face the future without Stanley Hiller.

According to Fred Wenninger, Key Tronic’s president and chief executive officer, the Spokanebased company is entering a critical stage of negotiations and planning in its efforts to establish its presence in the Pacific Rim.

Wenninger considers that presence vital to the company’s future, and he considers Hiller’s presence vital to the Pacific Rim endeavor.

So vital that a special meeting of Key Tronic’s shareholders has been called Tuesday to approve the restructuring of Hiller’s expiring options on 2.4 million shares of Key Tronic stock in a way that would assure Hiller’s continued involvement as board chairman for the next three years.

The meeting is at 1 p.m. at the company’s Sullivan Road headquarters.

“If the Hiller Group arbitrarily exercised their options and sold their shares,” Wenninger says, “it would have put us in a much more difficult position to find the best partner or solution for the company (in the Pacific Rim.)”

That’s why, Wenninger adds, in the middle of last year, he began to plan to convert Hiller’s options on 2.4 million shares of Key Tronic stock to a grant of 1 million shares of restricted stock. Hiller would earn 333,333 shares per year for three years, providing he maintains active involvement.

Hiller, 73, is the corporate turnaround expert who rescued Key Tronic from financial oblivion.

In previous years and previous projects, Hiller would likely have been anxious to step away at this point and move on to the next challenge.

But in an interview last year, he suggested there might not be another turnaround ahead. The Hiller Group will move to other projects, but Hiller himself might not direct the effort.

“I suppose if the right thing came along we would certainly look at it,” Hiller said. “But after 55 years and nearly 30 companies, well, you’re better off understanding you can’t go on forever.”

Last week, Hiller explained his willingness to stay on by saying, “I still have a great belief in the company. It has come through some tough periods, but at each point we’ve been able to move it forward. The next three years are important to stockholders and we would like to see that the job is completed.”

Founded in 1969, the computer keyboard manufacturer was one of Spokane’s first and biggest high-tech successes. At its peak in 1984, the company employed 2,500 and earned $11 million on sales of $131 million.

But as the computer industry matured and entered into an era of intense competition, Key Tronic couldn’t keep up with its off-shore competitors. From a peak value of $14.63 a share in 1986, by January 1992, Key Tronic stock had sunk to $2.50 a share - a price near which analysts said its shareholders would receive better value if the company was liquidated.

That’s when Hiller came onto the scene. Under his guidance, the stock price hit a peak of $18.25 in 1995. Since then, the company’s profitability has been reduced by volatility in the worldwide computer market and the stock has been in decline. Although it dipped below $6 in recent trading, Piper Jaffray maintains a strong “buy” rating and urges investors to be patient.

Based in Menlow Park, Calif., Hiller came to Key Tronic with a 25-year track record of success as a corporate life saver.

At age 18, he hired a mechanic, a welder and an architect and founded Hiller Aircraft Co. They made the first helicopter to fly in the Western United States, and went on to build airplanes and electronic components for spacecraft.

In 1967, Hiller left that company and formed The Hiller Group, and Key Tronic is the latest among nearly 30 successful rescues.

Wenninger and Ronald F. Klawitter, Key Tronic’s vice president of finance, say Hiller’s master stroke in the Key Tronic resurgence was the acquisition of a low-cost manufacturing facility in Juarez, Mexico. Key Tronic got the factory as part of its $26 million acquisition of Honeywell’s keyboard division in 1993.

Soon after, Hiller closed Key Tronic’s Cheney manufacturing facility and shifted the production lines to Juarez. The Mexico plant has been so successful that Key Tronic is now expanding it.

“In this community, I know there’s always anguish when people hear about us expanding in Juarez,” says Wenninger, “but in my mind there would be no Key Tronic at all if it wasn’t for that operation.”

“The acquisition of Honeywell wouldn’t have happened if Stan hadn’t been with the company,” Klawitter says. “That gave us Juarez and Juarez is what gives us that low-cost base to be competitive.”

True to the pattern he established in his other turnaround projects, Hiller began withdrawing from Key Tronic when he stepped aside as CEO in 1995.

Hiller moved to the board chairman position, but even without his day-to-day involvement, his continued affiliation with the company is invaluable, Klawitter says. His experience and the credibility his reputation brings helps in winning customers and in deal-making.

In all of his turnaround deals, Hiller and his group accepted no salary for their involvement. While they were compensated by the companies for their expenses, they made their considerable profits through stock options. By acquiring options on stock at certain values, how much money they made in any deal depended upon how high they could take the stock price.

The Key Tronic deal called for Hiller to be compensated with two sets of options.

Hiller exercised the first option in 1995 when he bought 750,000 shares held by Key Tronic founder Lewis G. Zirkle at $6 per share. Hiller sold 500,000 of the shares at a profit of $6.50 per share.

The deal also granted Hiller options on 2.4 million shares of Key Tronic stock at $4.50 per share. Hiller has granted some of those options to other key executive and board members who helped shaped the turnaround. Those options were to be exercised before March 1.

But the board negotiated a brief extension so they could present an alternative to shareholders.

Klawitter said the board was concerned that the market wouldn’t have been able to absorb 2.4 million shares if the option was exercised and they were dumped on the market. “It would have been disruptive and sent the wrong signals,” he said, particularly during negotiations with potential Pacific Rim partners.

“The other factor was the desire for the continued involvement of Stan Hiller with this company,” Klawitter adds.

Hiller’s return on the 1 million shares of restricted stock will depend on the company’s performance. And releasing the shares a third at a time over a three-year period gives the marketplace a better chance to absorb them.

Plus, the deal requires Hiller’s continued involvement during a time Wenninger sees as critical to Key Tronic’s future success.

Hiller’s present passion is the completion and opening of a museum on the San Francisco peninsula this year that details the rich history of aviation in Northern California.

The museum is funded through a trust established by Hiller. It centers around his remarkable collection of antique and historic aircraft.

And the combination of that project, his chairmanship of the Key Tronic board, probably suits him about right at this point in his life.

It suits Wenninger, too, as he can draw on Hiller’s experience, prestige and credibility in carrying out Key Tronic’s Asian strategy.

“Not only are our customers moving their manufacturing operations to the Pacific Rim,” Wenninger says, “but they are also moving their research and development operations there.

“The more I see of this, the more I feel this is something we have to do.”

Hiller agrees. “The idea of extended operations into the Pacific Basin is an important step for this company,” he says.

Wenninger says Key Tronic is in discussions about forming a strategic partnership with about a half dozen firms that already have a presence in the Pacific Rim. At the same time, he said, Key Tronic is also exploring the alternative of establishing independent operations there.

Meanwhile, Wenninger is developing a strategy that will expand Key Tronic beyond its base as a keyboard manufacturer.

The need to do so was brought home in his first day on the job last year when IBM curtailed a major order, sinking Key Tronic profits. Shortly thereafter, another major customer found itself high on inventory and significantly cut its orders.

The good news, Wenninger says, is the keyboard market is growing rapidly. The bad news is that competitive pressures push prices down just as rapidly as the growth occurs. That means you have to be constantly growing your market and reducing your prices just to stay in the same place.

With keyboard sales proving a solid financial base, the company has developed a strategy to leverage its core strengths in complementary new markets.

Those strengths are a rapid engineering capability, a highly sophisticated plastics molding capability, and the ability to produce sophisticated electronics.

The company wants to appeal to other divisions of its keyboard customers who may wish to manufacture plastic electronic devices with high engineering content.

The total marketplace for these “engineered devices” is vast Wenninger says.

This strategy is remarkably similar to the solutions Key Tronic management looked to in the pre-Hiller days when Key Tronic was failing. And might seem at odds with Hiller’s back-to-basics turnaround strategy.

But the difference between now and then, Wenninger points out, is that previous administrations looked to those alternatives without first fixing Key Tronic’s fundamental financial base. They didn’t first establish Key Tronic’s ability to compete in the low-cost production arena that all of its keyboard manufacturing competitors enjoyed.

But Hiller - and the Juarez production facility - have now established Key Tronic’s low-cost manufacturing capability.

“I feel good about the future based on the opportunities I see,” says Wenninger. “It’s a tough business, but I guess I’ve never been more optimistic than I am now.”

, DataTimes ILLUSTRATION: 2 Photos (1 Color)