FORWARD-LOOKING STATEMENTS

References in this report to "the Company", "Key Tronic", "KeyTronicEMS", "we", "our", or "us" mean Key Tronic Corporation together with its subsidiaries, except where the context otherwise requires.

This Quarterly Report contains forward-looking statements in addition to historical information. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined in "Management's Discussion and Analysis of Financial Condition and Results of Operations-Risks and Uncertainties that May Affect Future Results." Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management's opinions only as of the date hereof. The Company undertakes no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaims any obligation to do so. Readers should carefully review the risk factors described in periodic reports the Company files from time to time with the Securities and Exchange Commission, including Year-end Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

Overview

KeyTronicEMS is a leader in electronic manufacturing services and solutions to original equipment manufacturers of a broad range of products. We provide engineering services, worldwide procurement and distribution, materials management, world-class manufacturing and assembly services, in-house testing, and expertise in providing customer service. Our international production capability provides our customers with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. We continue to make investments in all of our operating facilities to give us the production capacity and logistical advantages to continue to win new business. The following information should be read in conjunction with the consolidated financial statements included herein and with Part II Item 1A, Risk Factors included as part of this filling.

Our mission is to provide our customers with superior manufacturing and engineering services at the lowest total cost for the highest quality products, and create long-term mutually beneficial business relationships.

Executive Summary

Net sales of $95.5 million for the third quarter of fiscal year 2012 increased by 50.6 percent as compared to net sales of $63.4 million for the third quarter of fiscal year 2011. The increase in net sales was primarily driven by an increase in revenues related to new programs for both new and longstanding customers and a net increase in demand related to current customer programs, partially offset by the negative impact of the uncertain macroeconomic environment. We believe that we are well positioned in the electronic manufacturing services (EMS) industry to win new business in coming periods and profitably grow our revenue as the economy recovers.

The concentration of our top five customers' sales increased to 72.6 percent of total sales in the third quarter of fiscal year 2012 from 64.1 percent in same period of the prior fiscal year. Our current customer relationships involve a variety of products, including consumer electronics, electronic storage devices, plastics, household products, gaming devices, specialty printers, telecommunications, industrial equipment, military supplies computer accessories and electronic whiteboards. The total number of our customers generating revenue during the third quarter of fiscal year 2012 was 42, as compared to 29 during the same period of the previous fiscal year.

Sales to our largest customers may vary significantly from quarter to quarter depending on the size and timing of customer program commencement, forecasts, delays, and design modifications. We remain dependent on continued sales to our significant customers and most contracts with customers are not firm long-term purchase commitments. We seek to maintain flexibility in production capacity by employing skilled temporary and short-term labor and by utilizing short-term leases on equipment and manufacturing facilities. In addition, our capacity and core competencies for printed circuit board assemblies (PCBAs), precision molding, tool making, assembly, and engineering can be applied to a wide variety of products.

Gross profit as a percent of sales was 9.1 percent for the third quarter of fiscal year 2012 as compared to 6.7 percent for same quarter of the prior fiscal year. The increase in gross profit as a percentage of net sales was primarily due to a decrease in material costs as a percentage of net sales as well as increased leverage of certain overhead costs.

Operating income as a percentage of sales for the third quarter of fiscal year 2012 was 4.9 percent compared to 1.5 percent for the same quarter of the prior fiscal year. The increase in operating income as a percentage of sales was primarily due to the increase in gross profit and our continued success in leveraging our operating expenses.

Net income for the third quarter of fiscal year 2012 was $3.4 million or $0.32 per diluted share, as compared to $0.7 million or $0.07 per diluted share for the third quarter of fiscal year 2011. The increase in net income as a percent of sales for the third quarter of fiscal year 2012 as compared to the same period in fiscal year 2011, is the result of an increase in net sales coupled with an improvement in our gross margin and operating income as discussed above and in further detail in the "Results of Operations" section.

We maintain a strong balance sheet with a current ratio of 2.5 and a long-term debt to equity ratio of 0.22. Total cash used in operating activities as defined on our cash flow statement was $6.9 million during the nine months ended March 31, 2012. We maintain sufficient liquidity for our expected future operations and had $16.2 million in borrowings on our $30.0 million revolving line of credit with Wells Fargo Bank, N.A. of which $13.8 million remained available March 31, 2012. We believe cash flow generated from operations, our borrowing capacity, and leasing opportunities should provide adequate capital for planned growth.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. These estimates and assumptions are based on historical results as well as future expectations. Actual results could vary from our estimates and assumptions.

The accounting policies and estimates listed below are those that we believe are the most critical to our consolidated financial condition and results of operations. They are also the accounting policies that typically require our most difficult, subjective and complex judgments and estimates, often for matters that are inherently uncertain. Please refer to the discussion of critical accounting policies in our most recent Annual Report on Form 10-K for the fiscal year ended July 2, 2011, for further details.

• Inactive, Obsolete, and Surplus Inventory Reserve

• Allowance for Doubtful Accounts

• Accrued Warranty

• Income Taxes

• Stock-Based Compensation

• Impairment of Long-Lived Assets

• Derivatives and Hedging Activity

RESULTS OF OPERATIONS

Comparison of the Three Months Ended March 31, 2012 with the Three Months Ended April 2, 2011

The financial information and discussion below should be read in conjunction with the Consolidated Financial Statements and Notes.

The following table sets forth certain information regarding the components of our condensed consolidated statements of income for the three months ended March 31, 2012 as compared to the three months ended April 2, 2011. It is provided to assist in assessing differences in our overall performance (in thousands):

                                                                           Three Months Ended
                                         March 31,          % of          April 2,          % of                         % point
                                           2012           net sales         2011          net sales       $ change       change
Net sales                               $    95,527            100.0 %    $  63,424            100.0 %    $  32,103            -  %
Cost of sales                                86,803             90.9         59,195             93.3         27,608          (2.4 )

Gross profit                                  8,724              9.1          4,229              6.7          4,495           2.4
Operating expenses:
Research, development and engineering         1,153              1.2            919              1.4            234          (0.2 )
Selling, general and administrative           2,879              3.0          2,373              3.7            506          (0.7 )

Total operating expenses                      4,032              4.2          3,292              5.2            740          (1.0 )

Operating income                              4,692              4.9            937              1.5          3,755           3.4
Interest expense, net                           130              0.1            172              0.3            (42 )        (0.2 )

Income before income taxes                    4,562              4.8            765              1.2          3,797           3.6
Income tax provision                          1,168              1.2             41              0.1          1,127           1.1

Net income                              $     3,394              3.6 %    $     724              1.1 %    $   2,670           2.5 %

Effective income tax rate                      25.6 %                           5.4 %

Net Sales

The increase in net sales from the prior year period was primarily driven by an approximate $21.2 million increase in revenues related to new programs for both new and longstanding customers as well as an $11.3 million increase in revenues related to increased demand from current customer programs. This increase was partially offset by the negative impact of program losses of approximately $0.4 million.

During the three months ended March 31, 2012, we continued to ramp up our new customer programs and further diversified our customer portfolio across a wide range of industries. Despite the macroeconomic uncertainty, we remain strongly positioned to win new business and expect to see a modest growth in revenue during the remainder of the year, driven by increased production levels of new programs for both new and longstanding customers. Sales in the fourth quarter of fiscal year 2012 are expected to be in the range of $93 million to $98 million. Future results will depend on actual levels of customers' orders, the timing of the startup of production of new product programs and the impact of the industry-wide shortages in the global supply chain. We believe that we are well positioned in the EMS industry to continue expansion of our customer base and continue long-term growth.

Gross Profit

Gross profit as a percentage of sales for the three months ended March 31, 2012 was 9.1 percent compared to 6.7 percent for the three months ended April 2, 2011. This 2.4 percentage point increase is primarily related to a 0.9 percentage points decrease in material costs as a percent of net sales, as well as a 1.5 percentage points improvement in leveraging of certain overhead costs. The level of gross margin is impacted by facility utilization, product mix, timing, severity and steepness of new program ramps, pricing within the electronics industry and material costs, which can fluctuate significantly from quarter to quarter.

Included in gross profit are charges related to changes in the allowance for obsolete inventory. We recorded a provision of approximately $534,000 and $58,000 for obsolete inventory during the three months ended March 31, 2012 and April 2, 2011, respectively. We adjust the allowance for estimated obsolescence as necessary in an amount equal to the difference between the cost of inventory and estimated market value based on assumptions as to future demand and market conditions. The reserves are established for inventory that we have determined customers are not contractually responsible for and for inventory that we believe customers will be unable to purchase.

Operating Expenses

Total research, development, and engineering (RD&E) expenses were $1.2 million and $0.9 million during the three months ended March 31, 2012 and April 2, 2011, respectively. This $0.3 million increase is primarily related to an increase in labor related expenses.

Total RD&E expenses as a percent of net sales were 1.2 percent and 1.4 percent during the three months ended March 31, 2012 and April 2, 2011, respectively. This 0.2 percentage point improvement in RD&E is primarily related to our continued success in leveraging operating expenses as a percent of net sales.

Total selling, general and administrative (SG&A) expenses were $2.9 million during the three months ended March 31, 2012 compared to $2.4 million during the three months ended April 2, 2011.This $0.5 million increase in SG&A during the three months ended March 31, 2012 as compared to the three months ended April 2, 2011 is primarily related to an increase in labor related expenses.

Total SG&A expenses as a percent of net sales were 3.0 percent during the three months ended March 31, 2012 compared to 3.7 percent during the three months ended April 2, 2011. This 0.7 percentage point improvement in SG&A is primarily related to our continued success in leveraging operating expenses as a percent of net sales.

Total operating expenses were $4.0 million or 4.2 percent of net sales for the three months ended March 31, 2012 and $3.3 million or 5.2 percent of net sales for the three months ended April 2, 2011. The 1.0 percentage points improvement in operating expenses as a percent of net sales is primarily related to our successful leveraging of RD&E and SG&A expenses as a percent of net sales.

Interest

Interest expense decreased to $130,000 during the three months ended March 31, 2012 from $172,000 during the three months ended April 2, 2011. The decrease in interest expense is primarily due to a decrease in our long-term debt interest rate, partially offset by an increase in interest expense related to capital lease obligations.

Income Taxes

The effective tax rate for the three months ended March 31, 2012 was 25.6 percent compared to 5.4 percent for the same period in fiscal year 2011. For further information on taxes see footnote 5 of the "Notes to Consolidated Financial Statements".

Our judgments regarding deferred tax assets and liabilities may change due to changes in market conditions, changes in estimates, changes in tax laws or other factors. If assumptions and estimates change in the future the valuation allowance will be adjusted accordingly and any increase or decrease will result in an additional deferred income tax expense or benefit in subsequent periods.

RESULTS OF OPERATIONS

Comparison of the Nine Months Ended March 31, 2012 with the Nine Months Ended April 2, 2011

The financial information and discussion below should be read in conjunction with the Consolidated Financial Statements and Notes.

The following table sets forth certain information regarding the components of our condensed consolidated statements of income for the nine months ended March 31, 2012 as compared to the nine months ended April 2, 2011. It is provided to assist in assessing differences in our overall performance (in thousands):

                                                                           Nine Months Ended
                                        March 31,          % of          April 2,          % of                         % point
                                           2012          net sales         2011          net sales       $ change       change
Net sales                               $  249,742            100.0 %    $ 187,802            100.0 %    $  61,940            -  %
Cost of sales                              229,145             91.8        172,157             91.7         56,988           0.1

Gross profit                                20,597              8.2         15,645              8.3          4,952          (0.1 )
Operating expenses:
Research, development and engineering        3,266              1.3          2,794              1.5            472          (0.2 )
Selling, general and administrative          8,229              3.3          7,575              4.0            654          (0.7 )

Total operating expenses                    11,495              4.6         10,369              5.5          1,126          (0.9 )

Operating income                             9,102              3.6          5,276              2.8          3,826           0.8
Interest expense, net                          357              0.1            319              0.2             38          (0.1 )

Income before income taxes                   8,745              3.5          4,957              2.6          3,788           0.9
Income tax provision                           930              0.4            758              0.4            172            -

Net income                              $    7,815              3.1 %    $   4,199              2.2 %    $   3,616           0.9 %

Effective income tax rate                     10.6 %                          15.3 %

Net Sales

The increase in net sales from prior year was primarily driven by an approximate $68.8 million increase in revenues related to new programs for both new and longstanding customers. This increase was partially offset by a $3.4 million net decline related to decreased demand from current customer programs and a $3.4 million decline related to program losses.

During the nine months ended March 31, 2012, we continued to ramp up our new customer programs and further diversified our customer portfolio across a wide range of industries. Despite the macroeconomic uncertainty, we remain strongly positioned to win new business and expect to see a modest growth in revenue during the remainder of the year, driven by increased production levels of new programs for both new and longstanding customers. Sales in the fourth quarter of fiscal year 2012 are expected to be in the range of $93 million to $98 million. Future results will depend on actual levels of customers' orders, the timing of the startup of production of new product programs and the impact of the industry-wide shortages in the global supply chain. We believe that we are well positioned in the EMS industry to continue expansion of our customer base and continue long-term growth.

Gross Profit

Gross profit as a percentage of sales for the nine months ended March 31, 2012 was 8.2 percent compared to 8.3 percent for the nine months ended April 2, 2011. This 0.1 percentage point decrease is primarily related to a 1.7 percentage points increase in material cost, as a percent of net sales, resulting from higher material content in certain new product offerings partially offset by a 1.6 percentage points improvement in leveraging of certain overhead costs. The level of gross margin is impacted by facility utilization, product mix, timing, severity and steepness of new program ramps, pricing within the electronics industry and material costs, which can fluctuate significantly from quarter to quarter.

Included in gross profit are charges related to changes in the allowance for obsolete inventory. We recorded a provision of approximately $0.7 million and $0.2 million for obsolete inventory for the nine months ended March 31, 2012 and April 2, 2011, respectively. We adjust the allowance for estimated obsolescence as necessary in an amount equal to the difference between the cost of inventory and estimated market value based on assumptions as to future demand and market conditions. The reserves are established for inventory that we have determined customers are not contractually responsible for and for inventory that we believe customers will be unable to purchase.

Operating Expenses

Total research, development, and engineering (RD&E) expenses were $3.3 million and $2.8 million during the nine months ended March 31, 2012 and April 2, 2011, respectively. This $0.5 million increase is primarily related to an increase in labor related expenses.

Total RD&E expenses as a percent of net sales were 1.3 percent and 1.5 percent during the nine months ended March 31, 2012 and April 2, 2011, respectively. This 0.2 percentage point improvement in RD&E is primarily related to our continued success in leveraging operating expenses as a percent of net sales.

Total selling general and administrative (SG&A) expenses were $8.2 million and $7.6 million during the nine months ended March 31, 2012 and April 2, 2011, respectively. This $0.6 million increase in SG&A during the nine months ended March 31, 2012 as compared to the nine months ended April 2, 2011 is primarily related to an increase in labor related expenses and to a lesser extent other overhead costs.

Total SG&A expenses as a percent of net sales were 3.3 percent during the nine months ended March 31, 2012 compared to 4.0 percent during the nine months ended April 2, 2011. This 0.7 percentage point improvement in SG&A is primarily related to our continued success in leveraging operating expenses as a percent of net sales.

Total operating expenses were $11.5 million or 4.6 percent of net sales during the nine months ended March 31, 2012 and $10.4 million or 5.5 percent of net sales during the nine months ended April 2, 2011. The 0.9 percentage point improvement in operating expenses as a percent of net sales is primarily related to our successful leveraging of RD&E and SG&A expenses as a percent of net sales.

Interest

Interest expense during the nine months ended March 31, 2012 remained relatively flat as compared to the same nine month period of the previous year.

Income Taxes

The effective tax rate for the nine months ended March 31, 2012 was 10.6 percent compared to 15.3 percent for the same period in fiscal year 2011. The decreased effective tax rate for the nine months ended March 31, 2012 is primarily attributable to the additional federal R&D tax credits recognized during the first half of fiscal 2012. For further information on taxes see footnote 5 of the "Notes to Consolidated Financial Statements".

Our judgments regarding deferred tax assets and liabilities may change due to changes in market conditions, changes in estimates, changes in tax laws or other factors. If assumptions and estimates change in the future the valuation allowance will be adjusted accordingly and any increase or decrease will result in an additional deferred income tax expense or benefit in subsequent periods.

Backlog

On March 31, 2012, we had an order backlog of approximately $72.6 million. This compares with a backlog of approximately $46.2 million on April 2, 2011. The increase in backlog at March 31, 2012, when compared to April 2, 2011, reflects an increase in new customers and programs. Order backlog consists of purchase orders received for products expected to be shipped within the next 12 months, although shipment dates are subject to change due to design modifications or changes in other customer requirements. Order backlog should not be considered an accurate measure of future sales.

CAPITAL RESOURCES AND LIQUIDITY

Operating Cash Flow

Net cash used in operating activities for the nine months ended March 31, 2012 was $6.9 million, compared to net cash used in operating activities of $11.3 million during the same period of the prior fiscal year.

This $4.4 million year-over-year decrease is primarily related to a $13.0 million increase in inventory, a $19.3 million increase in accounts receivable, and partially offset by a $14.8 million increase in accounts payable during the nine months ended March 31, 2012. As compared to an $11.3 million of cash flows used in operating activities during the nine months ended April 2, 2011, which resulted primarily from a $5.8 million increase in inventory, a $7.7 million increase in trade receivables, and a $1.2 million decrease in accounts payable. The increase in inventory and accounts receivable during the nine months ended March 31, 2012 was attributable to our revenue growth and anticipated growth in production levels for a number of new programs. The increase in accounts payable during the nine months ended March 31, 2012 was primarily driven by the timing of purchases and cash payments resulting from our growth in revenues and production. Accounts payable fluctuates with changes in inventory levels, volume of inventory purchases and negotiated supplier terms. We purchase inventory based on customer forecasts and orders, and when those forecasts and orders change, the amount of inventory may also fluctuate.

Investing Cash Flow

Cash flows used in investing activities were $3.6 million during the nine months ended March 31, 2012 as compared to $3.6 million during the nine months ended April 2, 2011. Our investing cash flows primarily consist of capital expenditures to purchase manufacturing facilities and equipment to support production and to a lesser extent leasehold improvements at our corporate headquarters. During the first nine months of fiscal year 2012, our investing activities included $1.8 million related to the purchase of a building and land in Juarez, Mexico.

Operating and capital leases are often utilized when potential technical obsolescence and funding requirement advantages outweigh the benefits of equipment ownership. Capital expenditures and periodic lease payments are expected to be financed with internally generated funds.

Financing Cash Flow

Cash flows provided by financing activities were $9.8 million during the nine months ended March 31, 2012 as compared to $14.7 million in the same period of the previous fiscal year. Our primary financing activity during the first nine months of fiscal year 2012 and 2011 was borrowing and repayment under our revolving line of credit facility. Our credit agreement with Wells Fargo Bank N.A. provides a revolving line of credit facility of up to $30 million, subject to availability. The agreement specifies that the proceeds of the revolving line of credit be used primarily for working capital and general corporate purposes of the Company and its subsidiaries. Borrowings under this revolving line of credit bear interest at either a "Base Rate" or a "Fixed Rate", as elected by . . .