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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended July 3, 2004

OR

For the transition period from              to             

Commission File Number 0-11559

KEY TRONIC CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (509) 928-8000

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act: Common stock, no par value

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  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x.

The aggregate market value of the voting stock held by non-affiliates of the Registrant was $21,281,076 as of December 27, 2003.

The number of shares of Common Stock of the Registrant outstanding as of September 3, 2004 was 9,675,913 shares.

The Exhibit Index is located at pages 40 - 41.

Documents Incorporated by Reference:

The following documents are incorporated by reference to the extent specified herein:

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KEY TRONIC CORPORATION

2004 FORM 10-K

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FORWARD-LOOKING STATEMENTS

This Annual 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 revise or publicly release the results of any revision to forward-looking statements. 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 Quarterly Reports on Form 10-Q.

PART I

Item 1. BUSINESS

Overview

Key Tronic Corporation (dba KeyTronicEMS Co.), a Washington corporation organized in 1969, and its subsidiaries (hereinafter collectively called the “Company”, “Key Tronic”, or “we” unless the context otherwise requires) are principally engaged in electronic manufacturing services (EMS) and consumer related products manufacturing for original equipment manufacturers (OEMs). The Company also manufactures keyboards and other input devices for personal computers, terminals, and workstations primarily in standard layouts that can be sold directly from inventory on hand.

Presently, Key Tronic is known as an independent provider of product realization services for OEMs in a variety of industries. Historically, Key Tronic was principally a manufacturer of electronic keyboards, but after assessing its strengths and capabilities, the Company shifted its focus to electronic manufacturing services (EMS).

Operations are currently conducted in facilities in the United States, China, Mexico, and Ireland. The Company’s global production capability provides customers with benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs and reduced product fulfillment time.

The EMS industry is comprised of companies that provide a range of manufacturing services for OEMs. The EMS industry has experienced rapid growth over the past several years as more OEMs shift to outsourcing manufacturing, and this trend is expected to continue in the future.

Marketing

The Company provides manufacturing services for outsourced OEM products. Key Tronic provides a mix of EMS services including: product design, surface mount technologies (SMT) for printed circuit assembly, tool making, precision molding, liquid plastic injection molding, prototype design, full box builds, and printing screened silver flexible circuit membranes.

The percentage of revenues from EMS services for the fiscal years ended July 3, 2004, June 28, 2003, and June 29, 2002 were 91.1%, 88.6%, and 89.4%, respectively. Sales of such products have historically not been seasonal in nature, but may be seasonal in the future, due to changes in the types of products manufactured.

The following customers accounted for 10% or more of consolidated revenues in the three fiscal years presented below:

For the fiscal years ended July 3, 2004, June 28, 2003, and June 29, 2002, the five largest customers in each year accounted for 58%, 64%, and 85% of total sales, respectively.

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Although keyboard manufacturing is still included in the Company’s product offerings, annual keyboard sales continue to decline. During the fiscal years ended July 3, 2004, June 28, 2003, and June 29, 2002, the Company realized revenues of approximately $12.9 million, $14.6 million, and $18.3 million, respectively, from the sale of keyboards representing approximately 8.7%, 11.1%, and 10.4% of consolidated revenues. The keyboard market has continued to trend toward standard keyboard layouts. In order to accommodate the demand for standard products, the Company maintains a purchase-from-stock program. The most popular standard layouts are built and stocked for immediate availability. These products serve as enhancements to or replacements for the original system-supplied keyboards.

The Company markets its products and services primarily through its direct sales department aided by strategically located field sales people and distributors. Although the Company established relationships with several independent sales organizations to assist in marketing the Company’s EMS product lines in the U.S., commissions earned and paid are insignificant.

Manufacturing

Since inception, the Company has made substantial investments in developing and expanding an extensive capital equipment base to achieve selective vertical integration in its manufacturing processes. The Company has invested significant capital into surface mount technologies (SMT) for high volume manufacturing of complex printed circuit board assemblies. The Company designs and develops tooling for injection molding machines and manufactures the majority of plastic parts used in the products it manufactures. Additionally, the Company has invested in equipment to produce printed flexible circuit membranes.

Key Tronic uses a variety of manual and highly automated assembly processes in its facilities, depending upon product complexity and degree of customization. Automated processes include component insertion, SMT, flexible robotic assembly, computerized vision system quality inspection, automated switch and keytop installation, and automated functional testing.

The Company’s automated manufacturing processes enable it to work closely with its customers during the design and prototype stages of production and to jointly increase productivity and reduce response time to the marketplace. Key Tronic uses computer-aided design techniques and unique software to assist in preparation of the tool design layout and tool fabrications, to reduce tooling costs, improve component and product quality, and enhance turnaround time during product development.

The Company purchases materials and components for its products from many different suppliers both domestic and international. Key Tronic develops close working relationships with its suppliers, many of whom have been supplying products to the Company for several years.

Foreign Markets

Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas as of and for the years ended July 3, 2004, June 28, 2003, and June 29, 2002 is summarized in the following table. Net sales provided below are based on the shipping destination.

For the year ended July 3, 2004, 44.5% of the Company’s foreign net sales were to customers in Mexico, 29.7% were to customers in Europe, 20.1% were to customers in Canada, and the remaining 5.7% were spread among customers in Asia and South America.

For the year ended June 28, 2003, 71.7% of the Company’s foreign net sales were to customers in the Far East, 14.6% were to customers in Mexico, 10.0% were to customers in Europe, and the remaining 3.7% were spread among customers in Canada and South America.

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For the year ended June 29, 2002, 45.4% of the Company’s foreign net sales were sold to customers in Mexico, 44.3% were to customers in the Far East, 6.6% were to customers in Europe, and the remaining 3.7% were spread among customers in Canada and South America.

Backlog

At August 1, 2004, the Company had an order backlog of approximately $68.1 million. This compares with a backlog of approximately $34.9 million at August 2, 2003. Order backlog is not necessarily indicative of future sales but can be indicative of trends in expected future sales revenue. Order backlog consists of purchase orders received for products expected to be shipped approximately within the next fiscal year, although shipment dates are subject to change due to design modifications, customer forecast changes, or other customer requirements.

Research, Development, and Engineering

Research and development and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials, depreciation and allocated information technology and facilities costs. The Company’s RD&E expenses were $2.6 million, $2.9 million, and $2.6 million in fiscal years 2004, 2003, and 2002, respectively. In fiscal years 2004, 2003, and 2002, the Company focused most of its RD&E efforts on current customer EMS programs. The higher cost in fiscal year 2003 compared to fiscal years 2004 and 2002 is due primarily to a 10% pay reduction during most of fiscal years 2004 and 2002. Part of the increase in 2003 was due to a decrease in the amounts charged to the Company’s customers.

Competition

The market for the products and services the Company provides is highly competitive. There are numerous competitors in the EMS industry, many of which have substantially more resources and are more geographically diverse. Key Tronic competes primarily on the basis of responsiveness, creativity, vertical production capability, quality, and price.

Trademarks and Patents

The Company owns several keyboard patents; however, since the Company’s current focus is electronic manufacturing services, management believes that these patents will not have a significant impact on future revenues. The Key Tronic name and logo are federally registered trademarks, and the Company believes they are valuable assets of its business. During 2001, Key Tronic began operating under the trade name “KeyTronicEMS Co.” to better identify its primary business concentration.

Employees

As of July 3, 2004, the Company had approximately 2,847 employees compared to 2,687 on June 28, 2003 and 1,995 on June 29, 2002. The increase in employees is due primarily to additional production workers hired in the Company’s Juarez facility to ramp-up for more labor intensive customer programs. The Company can have significant fluctuations in product demand. The Company seeks to maintain flexibility in its workforce by utilizing skilled temporary and short-term contract labor in its manufacturing facilities in addition to full-time employees. The Company’s employees in Reynosa, Mexico, are represented by local unions. The Company has no history of any material interruption of production due to labor disputes.

The Company considers its employees its primary strength and makes considerable efforts to maintain a well-qualified staff. The Company’s employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year before-tax income targets. The Company maintains a 401(k) plan for U.S. employees, which provides a matching company contribution of up to 4% on a portion of the employee’s contribution, and also provides group health, life, and disability insurance plans. The Company also maintains stock option plans for certain employees and outside directors.

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Item 2. PROPERTIES

The Company has manufacturing and sales operations located in the United States, Mexico, China, and Ireland. The table below lists the locations and square footage of the Company’s facilities as of July 3, 2004:

The geographic diversity of these locations allows the Company to offer services near its customers and its major electronics markets, while reducing labor costs. The Company considers the productive capacity of its current facilities sufficient to carry on the Company’s current business.

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Item 3. LEGAL PROCEEDINGS

On December 20, 2001, a jury in Seattle federal court rendered a verdict in the case of F&G Scrolling Mouse, LLC, Fernando Falcon and Federico Gilligan v. Microsoft Corporation, Honeywell, Inc., and Key Tronic Corporation, United States District Court for the Western District of Washington, Case No. C99-995C (the “litigation”) finding that Key Tronic misappropriated trade secrets and breached a confidentiality agreement with Plaintiffs. The jury awarded damages to the Plaintiffs in the amount of $16.5 million. The judgment against the Company was subsequently increased to approximately $19.2 million through an award of pre-judgment interest. On October 24, 2002, the Company reached a settlement of the litigation with the Plaintiffs (hereafter called “F&G”). Under the terms of the settlement, the Company has agreed to pay F&G a total of $7.0 million. The Company was required to make an initial payment to F&G of $2.5 million, as well as make quarterly payments to F&G of $200,000 or 50% of Key Tronic’s operating income, whichever is greater, until the total payment of $7.0 million has been made, provided the total payment is completed by December 15, 2005. The remaining amount to be paid of the $7.0 million settlement was approximately $2.5 million at July 3, 2004.

If the total of $7.0 million is not paid by 12/15/2005, the total settlement amount increases on 12/15/2005 to $7.6 million. If payment of $7.6 million is not completed by 12/15/2006 the total settlement amount increases to $8.2 million. If payment of $8.2 million is not completed by 12/15/2007 the total settlement amount increases to $8.8 million. If payment of $8.8 million is not completed by 12/15/2008 the total settlement amount increases to $9.7 million. If payment of $9.7 million is not completed by 12/15/2009 the total settlement amount increases to $10.6 million. If payment of $10.6 million is not made by 12/15/2010 the total settlement amount increases to $11.5 million. Any unpaid balance remaining at 12/15/2011 will accrue interest thereafter at prime plus 1 ¹/2% per annum until paid. If the Company fails to make any minimum quarterly payment when due, Plaintiffs have the right to accelerate all remaining payments in the amount of $11.5 million less any amounts previously paid.

Reported earnings for the year ended June 28, 2003, include a one-time benefit of $12.2 million ($1.26 per share) for reversal of a previously recorded litigation accrual.

On March 31, 2004 a former employee of the Company filed a complaint against the Company in the Superior Court of the State of Washington, Spokane County. Anthony DeStefano, Jr. v Key Tronic Corporation, Case No. 04201480-2. The complaint asserted claims for breach of contract, wrongful withholding of wages and wrongful discharge and sought an unspecified amount of damages. The complaint was dismissed with prejudice on September 8, 2004 with each party bearing its own costs.

The Company is party to certain other lawsuits or claims in the ordinary course of business. We do not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on our financial position, results of operations or cash flow. Also see Note 8 to the Consolidated Financial Statements.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

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PART II

Item 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Key Tronic Corporation’s common stock is traded on the NASDAQ National Market System under the symbol “KTCC”. Quarterly high and low closing sales prices for Key Tronic common stock for fiscal years 2004 and 2003 were as follows:

High and low stock prices are based on the daily closing price reported by the NASDAQ National Market System. These quotations represent prices between dealers without adjustment for markups, markdowns, and commissions, and may not represent actual transactions.

Holders And Dividends

As of July 3, 2004, the Company had 1,380 shareholders of record. The Company’s current financing agreement contains a covenant that prohibits the declaration or payment of dividends (see Note 4 to Consolidated Financial Statements). The Company has not paid a cash dividend and does not anticipate payment of dividends in the foreseeable future.

Item 6: SELECTED FINANCIAL DATA

The following selected consolidated financial data of the Company should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and related notes, and other information included in this report.

Financial Highlights

(Dollars in thousands, except per share amounts)

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Item 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations

Overview

Key Tronic Corporation is an independent provider of electronic manufacturing services (EMS) for original equipment manufacturers (OEMs). The Company’s core strengths include innovative design and engineering expertise in SMT, electronics, mechanical engineering, precision molding and tooling, combined with high-quality, low-cost production and assembly on a global basis. Our global production capability provides customers with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. The following information should be read in conjunction with the consolidated financial statements included herein and the “Risk and Uncertainties” section beginning on page 16.

The EMS industry has historically experienced growth as more OEMs shift to outsourced manufacturing. Key Tronic sales in fiscal year 2004 increased by 14% over 2003 results. With the current turnaround of end-market demand and recent new product programs awarded, the Company expects to increase revenues once again in fiscal year 2005 – however, actual results will depend on actual levels of customer orders. We believe that we are well positioned in the EMS industry to expand our customer base and continue business growth within our current capacity.

The total number of Key Tronic EMS customers continued to increase during fiscal 2004. Some of these customers have programs that represent small annual sales while others have multi-million-dollar potential. The concentration of the Company’s largest customers has also declined as the top five customers sales decreased to 58% of total sales in 2004 from 64% in 2003 and 85% in 2002. The Company’s current customer relationships involve a variety of products, including consumer electronics and plastics, household products, gaming devices, specialty printers, educational toys, exercise equipment, and computer accessories.

The EMS industry is intensely competitive, and Key Tronic, at this time, estimates it has less than 1% of the potential market. The Company believes that it can acquire new business in the future, particularly those programs that require innovative design and engineering, short lead times, or small initial volumes. The Company is planning for growth in coming quarters by utilizing current capacity, improving manufacturing processes, and investing in additional manufacturing equipment.

The Company maintains a strong balance sheet with a current ratio of 1.75 and a long-term debt to equity ratio of 0.58. The Company had approximately $9.1 million available from a revolving line of credit at July 3, 2004. The Company maintains a good working relationship with CIT Group/Business Credit, Inc., its asset-based lender, and it believes that internally generated funds and its revolving line of credit should provide adequate capital for planned growth.

Net Sales

Net sales in fiscal 2004 were $148.9 compared to $130.9 million and $175.6 million in fiscal years 2003 and 2002, respectively. The increase during 2004 compared to 2003 is related to the Company’s successful expansion of the number of manufacturing

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programs with existing customers and acquiring new significant customers during the year, offset in part, by a large decrease in demand from a single customer. Sales revenue resulting from new customers attained in 2004 was approximately $8.2 million, while the net increase of sales to existing customers was approximately $9.8 million. Sales of keyboards accounted for only 8.7% of total sales in fiscal 2004 compared to 11.1% in fiscal 2003.

The decrease in sales revenue during 2003 compared to 2002 is due to decreased shipments to some of the Company’s primary customers as a result of a slowdown in end-market demand and the effects of a legal judgment on our ability to acquire new customers. This legal judgment was settled in the second quarter of fiscal 2003, and further information is set forth in Note 8 of the Consolidated Financial Statements contained herein. Sales revenue resulting from new customers acquired in 2003 was approximately $5.4 million, while the net decrease of sales to existing customers was approximately $50.1 million. Keyboard sales were 11.1% of sales in fiscal 2003 compared to 10.4% in fiscal 2002.

Gross Profit

In fiscal year 2004, gross profit on sales was 8.9% of revenues compared to 11.4% in fiscal year 2003 and 8.5% in fiscal year 2002. The decrease in 2004 was due primarily to the product mix and costs associated with the start-up of new manufacturing programs, offset in part by an insurance settlement in 2004 of $475,000. The increase in the gross profit percentage in fiscal year 2003 compared to fiscal year 2002 was due primarily to the product mix, improvements in operating efficiencies, and lower material costs.

Gross profit margins reflect a number of factors that can vary from period to period, including product mix, start-up costs and efficiencies associated with new programs, product life cycles, sales volumes, capacity utilization of the Company’s resources, management of inventories, component pricing and shortages, end market demand of our customers’ products, fluctuations and timing of customer orders, and competition within the EMS industry. These and other factors can cause variations in our operating results. There can be no assurance that gross margins will not decrease in future periods.

Cost of Sales

Total costs of material as a percentage of sales were approximately 58.1%, 57.0%, and 64.8% in fiscal years 2004, 2003, and 2002, respectively. The change from year-to-year is directly related to sales product mix. Products sold in 2004 and 2003 were more labor intensive, thereby decreasing costs of material as a percentage of sales.

Direct production costs (direct labor and manufacturing overhead) have increased to 18.3% of total sales in fiscal 2004 from 16.0% in 2003 and 15.6% in 2002. Approximately half of the increase in 2004 is the result of start-up costs associated with new manufacturing programs. These start-up costs included increasing the Company’s manufacturing and storage space in Juarez, Mexico. The remaining increase in 2004 is due primarily to additional employees required for more labor-intensive products.

The Company provides for obsolete and non-saleable inventories based on specific identification of inventory against current demand and recent usage. The amounts charged to expense were $162,000, $203,000, and $2,225,000 in fiscal years 2004, 2003, and 2002, respectively.

The Company provides for warranty costs based on historical experience and anticipated product returns. The amounts charged to expense were fairly consistent at approximately $193,000, $150,000, and $215,000 in fiscal years 2004, 2003, and 2002, respectively. The Company does not warrant design defects for EMS customers.

Cost of sales also includes freight costs of $2.5 million in fiscal year 2004 compared to $2.0 million in fiscal year 2002, and $2.4 million in fiscal year 2001. Freight costs have increased to 1.8% of total sales in 2004 from 1.5% in 2003 and 1.4% in 2002. The Company’s freight costs have increased as the Company continues to expand global procurement and as a result of increased shipping rates and fuel surcharges.

Research, Development and Engineering

Research and development and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials, depreciation and allocated information technology and facilities costs. The Company’s RD&E expenses were $2.6 million, $2.9 million, and $2.6 million in fiscal years 2004, 2003, and 2002, respectively. In fiscal years 2004, 2003, and 2002, the Company focused most of its RD&E efforts on current customer EMS programs. The higher cost in fiscal year 2003 compared to fiscal years 2004 and 2002 is due primarily to a 10% pay reduction during most of fiscal years 2004 and 2002. Part of the increase in 2003 was due to a decrease in the amounts charged to the Company’s customers.

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Selling

Sales and marketing expenses consist principally of advertising and marketing programs, salaries and benefits for sales and marketing personnel, sales commissions, and travel expenses. Selling expenses were $1.9 million, $2.3 million, and $2.8 million in fiscal years 2004, 2003, and 2002, respectively. The decrease in 2004 was related to a reduction in promotional programs, commissions, and bonuses paid. The decreases in fiscal year 2003 compared to fiscal year 2002 were due primarily to a reduction in promotional programs and marketing expenses related to keyboard sales. Sales of keyboards through distribution require greater promotional and marketing programs than sales of EMS products.

General and Administrative

General and administrative expenses consist of employee related costs, travel expenses and allocated information technology and facilities costs for finance, legal, human resources and executive functions, outside legal and accounting fees, provision for doubtful accounts and business insurance costs. General and administrative expenses were $7.0 million, $7.2 million and $8.4 million in fiscal years 2004, 2003, and 2002, respectively. The decrease in fiscal year 2004 compared to fiscal year 2003 was due primarily to a 10% reduction in salaries that was in effect for most of the fiscal year offset in part by increasing business insurance premiums. The decrease in fiscal year 2003 compared to 2002 was primarily due to a year over year decline in legal expenses as a result of the settlement of the F&G litigation. Other contributing factors were a decreased provision for doubtful accounts, lower telephone expenses, decreased staffing in Ireland, and the adoption of SFAS 142, which ceased the amortization of goodwill.

Interest Expense

The Company had net interest expenses of $1.1 million, $1.0 million, and $1.3 million in fiscal years 2004, 2003, and 2002, respectively. Net interest expense has remained fairly consistent, as the Company has increased its borrowings while interest rates have decreased. The Company does not currently use derivatives in hedging interest rate risk. During 2004, the Company began to utilize short-term fixed LIBOR rates on portions of its revolver for short-term interest savings in anticipation of rate increases.

Other Income, Net

The Company had net other income of $23,000, $237,000, and $358,000 in fiscal years 2004, 2003, and 2002, respectively. Other income in fiscal year 2003 is primarily proceeds from the sale of an equity security. The other income for fiscal year 2002 is primarily the result of recognizing gains on the sale of two of the Company’s buildings and related equipment.

Income Tax Provision

The Company had income tax expense of $611,000 in fiscal year 2004 compared to $600,000 in fiscal year 2003 and $5,416,000 in fiscal year 2002. The tax provisions for fiscal years 2004 and 2003 are primarily the result of foreign taxes on the earnings of foreign subsidiaries. Income tax expense in fiscal year 2002 was due primarily to establishing a 100% valuation allowance against the Company’s net deferred tax assets after a litigation judgment was awarded to F&G Scrolling Mouse. These assets totaled $4.5 million. Prior to the award of this judgment, Key Tronic had almost $45.9 million in tax loss carry-forwards. Financial Accounting Standard No. 109 requires that management assess the sources of future taxable income, which may be available to recognize the deductible differences that comprise deferred tax assets. A valuation allowance against deferred tax assets is required if it is more likely than not that some or all of the deferred tax assets will not be realized. Because the litigation judgment was considered evidence of the Company’s possible inability to utilize the balance of the deferred tax assets, the valuation allowance was increased to the full value. The Company’s tax loss carry-forwards begin expiring in 2006. The remaining $900,000 of the Company’s income tax provision in 2002 was due to foreign income taxes on the earnings of foreign subsidiaries.

International Subsidiaries

The Company offers customers a complete global manufacturing solution. The Company’s facilities provide its customers the opportunity to have their products manufactured in the facility that best serves specific product manufacturing and distribution needs. Foreign subsidiaries are located in the following locations:

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Foreign sales from worldwide operations, including domestic exports, were $14.5 million in fiscal year 2004 compared to $16.2 million and $32.3 million in fiscal years 2003 and 2002, respectively. Foreign sales were 9.7% of net sales in fiscal 2004 compared to 12.4% and 18.4% in fiscal years 2003 and 2002, respectively. Sales from Key Tronic Europe, Ltd. represented approximately 2.0% of consolidated sales in fiscal year 2003 compared to 3.3% and 3.0% in fiscal years 2003 and 2002, respectively. The decrease in foreign sales for fiscal year 2004 when compared to fiscal year 2003 is a result of declining keyboard sales from the Company’s subsidiary in Ireland. The decrease in foreign sales for fiscal year 2003 is primarily the result of declining sales to the foreign subsidiaries of one EMS customer and the continuing decline of keyboard sales. Although the Company hopes to expand its EMS business to include the European market, sales within Europe currently are primarily of electronic keyboards. Key Tronic Computer Peripheral Co., Ltd., the Company’s subsidiary in Shanghai, China, has had only minimal sales to customers in China over the past three fiscal years.

Capital Resources and Liquidity

Cash flows used in operating activities were $(17,000) in fiscal year 2004 compared to $(544,000) used in fiscal year 2003 and $919,000 of cash provided by operating activities in fiscal year 2002.

The cash used in operations during fiscal year 2004 was due primarily to an increase of $7.4 million in accounts receivables and $3.9 million in inventory but these were offset by an increase in operating liabilities of $9.0 million. The increase in accounts receivable is due to an increase of sales during the last two months of the fiscal year. The increase in inventory is due to a build up of raw materials for existing and new customers to support demand in the first quarter of 2005. Also contributing to the use of cash was $1.3 million paid to F&G under the settlement agreement.

Capital expenditures were $1.6 million, $2.1 million, and $1.1 million in fiscal years 2004, 2003, and 2002, respectively. The Company also uses a variety of operating leases to fund the purchase of operating equipment.

The Company’s primary financing activity in fiscal years 2004, 2003, and 2002 was borrowing and repayment under the Company’s debt agreements.

The Company has entered into a financing agreement with CIT Group/Business Credit, Inc. (CIT) which provides a revolving credit facility up to $20 million. The revolving loan is secured by the assets of the Company. The interest rate provisions allow for a variable rate based on either the prime rate or LIBOR rate. The agreement specifies four alternative levels of margin to be added to these base rates depending on compliance with certain financial covenants. The range of interest being paid to CIT on outstanding balances was 4.34 – 4.75% as of July 3, 2004. The agreement and subsequent amendments contain financial covenants that relate to total equity, earnings before interest, taxes, depreciation and amortization, and a minimum fixed charge ratio. The revolving loan matures August 23, 2006. As of July 3, 2004, the Company was in compliance with all loan covenants. At July 3, 2004, the outstanding revolving loan balance was $10.9 million compared to $9.9 million at fiscal year end June 28, 2003. The increase in the loan balance was due primarily to required payments to F&G in compliance with the settlement of the legal judgment and capital expenditures. Based on eligible collateral, approximately $9.1 million was available from the revolving line of credit as of July 3, 2004.

In addition to the Company’s revolving credit facility payment obligations and normal operating expenses, the Company has a $2.5 million litigation settlement payment obligation, various lease commitments, and other long term obligations of $1.1 million.

The Company believes that funds available under the revolving credit facility, projected cash from operations, and leasing capabilities will be sufficient to meet our working and fixed capital requirements through fiscal year 2005 and the foreseeable future.

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Contractual Obligations and Commitments

In the normal course of business, the Company enters into contracts, which obligate the Company to make payments in the future.

The table below sets forth the Company’s significant future obligations by fiscal year:

Payments Due by Fiscal Year (in thousands)

Under the terms of the revolving credit agreement, the Company must meet a number of financial covenants. As of July 3, 2004 the Company was in compliance with all of its loan covenants. Breaching one or more of these covenants could have a material impact on the Company’s operations or financial condition.

In addition, the Company leases most of its administrative and manufacturing facilities. A complete discussion of properties can be found in Part 1, Item 2 at “Properties”. Leases have proven to be an acceptable method for the Company to acquire new or replacement equipment and to maintain many facilities with a minimum impact on its operating cash flows.

In addition to the cash requirements presented in tabular format, the Company also owes its suppliers approximately $24.4 million for accounts payable and shipments in transit at the end of the fiscal year. The Company generally pays its suppliers in a range from 30 to 120 days depending on terms offered. Quarterly payments to suppliers normally average between $20 and $25 million. These payments are financed by the Company’s revolving line of credit.

The Company believes that funds available under the revolving credit facility and internally generated funds can satisfy cash requirements for a period in excess of 12 months.

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Critical Accounting Policies

Revenue Recognition: The Company recognizes revenue primarily when products are shipped. Staff Accounting Bulletin 101 states that revenue generally is realized or realizable and earned when all of the following criteria are met:

The Company believes that it meets the above criteria for the following reasons:

Inactive, Obsolete and Surplus Inventory Reserve: The Company reserves for inventories that it deems inactive, obsolete or surplus. This reserve is calculated based upon the demand for the products that the Company produces. Demand is determined by expected sales or customer forecasts. If expected sales do not materialize, then the Company would have inventory in excess of its reserves and would have to charge the excess against future earnings. In the case where the Company has purchased material based upon a customer’s forecast, the Company is usually covered by lead-time assurance agreements with each customer. These contracts state that the financial liability for material purchased within lead-time and based upon the customer’s forecasts, lies with the customer. If the Company purchases material outside the lead-time assurance agreement and the customer’s forecasts do not materialize, the Company would have the financial liability and would have to charge the excess against future earnings.

Allowance for Doubtful Accounts: The Company values its accounts receivable net of an allowance for doubtful accounts. This allowance is based on estimates of the portion of accounts receivable that may not be collected in the future, and the amount of this allowance is disclosed in the Company’s Consolidated Balance Sheets. The estimates used are based primarily on specific identification of potentially uncollectible accounts. Such accounts are identified using publicly available information in conjunction with evaluations of current payment activity. However, if any of the Company’s customers were to develop unexpected and immediate financial problems that would prevent payment of open invoices, the Company could incur additional and possibly material expenses that would negatively impact earnings.

Accrued Warranty: An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. Management reviews the adequacy of this accrual quarterly based on historical analysis and anticipated product returns. Over the course of the past three years, the Company’s warranty expense has decreased. The declines in warranty expense and the related accrual account are directly related to the change in the composition of the Company’s revenue from keyboards to EMS products. As the Company has made the transition from manufacturing primarily keyboards to primarily EMS products, its exposure to warranty claims has declined significantly. The Company’s warranty period for keyboards is generally longer than that for EMS products. Also the Company does not warrant design defects for EMS customers.

Goodwill

In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Under the statement, the Company records intangible assets that are acquired individually or with a group of other assets in the financial statements at acquisition. Goodwill will be tested for impairment annually. The Company adopted SFAS No. 142 on June 30, 2002, and completed its impairment test during the second quarters of fiscal years 2004 and 2003. The tests did not indicate an impairment of the Company’s stated goodwill of $765,000.

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The net effect of adopting this accounting standard was to eliminate annual amortization expense of $128,000. In accordance with SFAS No. 142, the effect of this accounting change is reflected prospectively. Comparative disclosure as if the change had been retroactively applied to fiscal year 2002 is as follows (no tax effect has been included because of offsetting tax valuations):

New Accounting Pronouncements

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (FIN 46). In December 2003, the FASB issued a revision to FIN 46 to make certain technical corrections and address certain implementation issues that had arisen. FIN 46, as revised, clarifies existing accounting literature regarding the consolidation of entities in which a company holds a “controlling financial interest”. A majority voting interest in an entity has generally been considered indicative of a controlling financial interest. FIN 46 specifies other factors (variable interests) which must be considered when determining whether a company holds a controlling financial interest in, and therefore must consolidate, an entity (variable interest entities). The adoption of FIN 46 had no impact on the Company’s overall financial position and results of operations as the Company has no variable interest entities.

In April 2003, the FASB issued SFAS No. 149, “Amendments of Statement 133 on Derivative Instruments and Hedging Activities,” which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133. This statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material impact on the Company’s financial statements.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. Financial instruments that are within the scope of the statement, which previously were often classified as equity, must now be classified as liabilities. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on the Company’s financial statements.

In December 2003, the SEC issued Staff Accounting Bulletin No. 104 (SAB 104), “Revenue Recognition.” SAB 104 supercedes SAB 101, “Revenue Recognition in Financial Statements.” The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of EITF No. 00-21, “Revenue Arrangements with Multiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s “Revenue Recognition in Financial Statements Frequently Asked Questions and Answers” (“the FAQ”) issued with SAB 101 that had been codified in SEC Topic 13, “Revenue Recognition.” Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on the Company’s financial statements.

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RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE RESULTS

The following risks and uncertainties could affect the Company’s actual results and could cause results to differ materially from past results or those contemplated by the Company’s forward-looking statements. When used herein, the words “expects”, “believes”, “anticipates” and similar expressions are intended to identify forward-looking statements.

Potential Fluctuations in Quarterly Results The Company’s quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including changes in overall demand for customers’ products, success of customers’ programs, timing of new programs, new product introductions or technological advances by the Company, its customers and its competitors and changes in pricing policies by the Company, its customers, its suppliers and its competitors. For example, the Company relies on customers’ forecasts to plan its business. If those forecasts are overly optimistic, the Company’s revenues and profits may fall short of expectations. Conversely, if those forecasts are too conservative, the Company could have an unexpected increase in revenues and profits. The products which the Company manufactures for its customers have relatively short product lifecycles, therefore the Company’s business, operating results and financial condition are dependent in significant part on the Company’s ability to obtain orders from new customers and new product programs from existing customers.

Competition The EMS industry is intensely competitive. Competitors may offer customers lower prices on certain high volume programs. This could result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect the Company’s business, operating results and financial condition. The Company’s inability to provide comparable or better manufacturing services at a lower cost than its competitors could cause sales to decline. In addition, competitors can copy the Company’s non-proprietary designs after the Company has invested in development of products for customers, thereby enabling such competitors to offer lower prices on such products due to savings in development costs.

Concentration of Major Customers At present, the Company’s customer base is highly concentrated and could become even more concentrated. The Company’s largest EMS customer accounted for 16% of net sales in fiscal year 2004. This same customer accounted for 31% of sales in 2003 and 39% in 2002. For the fiscal years ended 2004, 2003, and 2002, the five largest customers accounted for 58%, 64% and 85% of total sales, respectively. There can be no assurance that the Company’s principal customers will continue to purchase products from the Company at current levels. Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers, and the Company’s customers have certain rights to extend or delay the shipment of their orders. The loss of one or more of the Company’s major customers, or the reduction, delay or cancellation of orders from such customers, could materially and adversely affect the Company’s business, operating results and financial condition.

Dependence on Suppliers The Company is dependent on many suppliers, including sole source suppliers, to provide key components and raw materials used in manufacturing customers’ products. Delays in deliveries from suppliers or the inability to obtain sufficient quantities of components and raw materials could cause delays or reductions in shipment of products to our customers which could adversely affect the Company’s operating results and damage customer relationships.

Dependence on Key Personnel The Company’s future success depends in large part on the continued service of its key technical, marketing and management personnel and on its ability to continue to attract and retain qualified employees. The competition for such personnel is intense and there can be no assurance that the Company will be successful in attracting and retaining such personnel. The loss of key employees could have a material adverse effect on the Company’s business, operating results and financial condition.

Foreign Manufacturing Operations Virtually all products manufactured by the Company are produced at the Company’s facilities located in Mexico and China. Accordingly, the Company’s operations are subject to a variety of risks unique to international operations including import and export duties and value added taxes, import and export regulation changes, the burden and cost of compliance with foreign laws and foreign economic and political risk.

Technological Change and New Product Risk The markets for the Company’s customers’ products is characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and relatively short product life cycles. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. The Company’s success will depend upon its customers’ ability to enhance existing products and to develop and introduce, on a timely and cost-effective basis, new products that keep pace with technological developments and emerging industry standards and address evolving and increasingly sophisticated customer requirements. Failure of the Company’s

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customers to do so could substantially harm the Company’s customers’ competitive positions. There can be no assurance that the Company’s customers will be successful in identifying, developing and marketing products that respond to technological change, emerging industry standards or evolving customer requirements.

Dilution and Stock Price Volatility As of July 3, 2004, there were outstanding options for the purchase of approximately 2,072,000 shares of common stock of the Company (Common Stock), of which options for approximately 1,914,000 shares were vested and exercisable. Holders of the Common Stock will suffer immediate and substantial dilution to the extent outstanding options to purchase the Common Stock are exercised. The stock price of the Company may be subject to wide fluctuations and possible rapid increases or declines over a short time period. These fluctuations may be due to factors specific to the Company such as variations in quarterly operating results or changes in analysts’ earnings estimates, or to factors relating to the EMS and computer industries or to the securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have been unrelated to the operating performance of the specific companies whose stocks are traded.

Item 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is subject to the risk of fluctuating interest rates in the normal course of business. The Company’s major market risk relates to its secured debt. The Company’s debt is secured by substantially all of the Company’s assets. The interest rates applicable to the Company’s revolving loan fluctuate with the JP Morgan Chase Bank prime rate and LIBOR rates.

The Company does not enter into derivative transactions or leveraged swap agreements.

Although the Company has international operations, the functional currency for all active subsidiaries is the U.S. dollar. The Company imports for its own use raw materials that are used in its manufacturing operations. Substantially all of the Company’s purchases are denominated in U.S. dollars and are paid under normal trade terms.

The table below presents principal (or notional) amounts and related weighted average variable rates by fiscal year of maturity. The weighted average variable interest rates for fiscal years 2004 through 2006 are estimated based on current rates as of August 23, 2004. These forward rates have been increased by current levels of margins based on the financing agreement with CIT. The Company’s revolving debt could increase or decrease depending upon cash needs over the period of time that the financing agreement remains in place with CIT. The JP Morgan Chase Bank prime rate and LIBOR will fluctuate with the market and could go up or down depending on market conditions.

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Item 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Reports of Independent Registered Public Accounting Firms

The Board of Directors and Shareholders

Key Tronic Corporation

Spokane, Washington

We have audited the accompanying consolidated balance sheets of Key Tronic Corporation and subsidiaries (the Company) as of July 3, 2004 and June 28, 2003, and the related consolidated statements of operations, shareholders’ equity and cash flows for the years then ended. We have also audited the schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Key Tronic Corporation and subsidiaries at July 3, 2004 and June 28, 2003, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

Also, in our opinion, the schedule presents fairly, in all material respects, the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, the Company changed its method for accounting for goodwill in fiscal 2003.

/s/ BDO Seidman, LLP

Spokane, Washington

August 19, 2004

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To the Shareholders and Board of Directors of Key Tronic Corporation:

We have audited the accompanying consolidated statements of operations, shareholders’ equity, and cash flows of Key Tronic Corporation and subsidiaries (the Company) for the year ended June 29, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects the results of operations and cash flows of Key Tronic Corporation and subsidiaries for the year ended June 29, 2002, in conformity with accounting principles generally accepted in the United States of America.

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KEY TRONIC CORPORATION

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS