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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarter Ended December 27, 2003

Commission File Number

Number 0-11559

KEY TRONIC CORPORATION

North 4424 Sullivan

Spokane, Washington 99216

(509) 928-8000

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 for the past 90 days.    Yes  x    No  ¨.

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

At February 9, 2004, 9,672,580 shares of Common Stock, no par value (the only class of common stock), were outstanding.

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KEY TRONIC CORPORATION

Index

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PART I: FINANCIAL INFORMATION

Item 1: Financial Statements

KEY TRONIC CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes to consolidated financial statements.

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KEY TRONIC CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

BASIS OF PRESENTATION

In the opinion of management, the accompanying unaudited consolidated interim financial statements reflect all adjustments of a normal and recurring nature necessary for a fair presentation, in all material respects, of the financial position, results of operations, and cash flows for the periods presented. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the interim periods are not necessarily indicative of the results for the entire year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Form 10-K report for the fiscal year ended June 28, 2003. Certain reclassifications have been made for consistent presentation.

On October 24, 2002, the Company announced the settlement of the litigation with F&G Scrolling Mouse LLC as explained in greater detail in Note 8 to these financial statements. Because this settlement was material to the Company’s financial position and results of operations, and because the settlement was reached prior to publication of the six months ended December 28, 2002 quarterly report, the financial statements of the first quarter of fiscal year 2003 have been adjusted to incorporate the settlement within them. Readers should be aware that the reported earnings for the six months ended December 28, 2002, include a one-time benefit for reversal of previously recorded litigation expense.

1. NEW ACCOUNTING PRONOUNCEMENTS

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The Standard requires that certain freestanding financial instruments be classified as liabilities, including mandatorily redeemable financial instruments, obligations to repurchase the issuer’s equity shares by transferring assets and certain obligations to issue a variable number of shares. SFAS No. 150 is effective for financial instruments entered into or modified subsequent to May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. However, in October 2003, certain provisions of SFAS No. 150 have been deferred indefinitely. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the Statement and still existing at the beginning of the interim period of adoption. The Company adopted SFAS No. 150 on July 1, 2003. The adoption of this standard did not have a material effect on the Company’s consolidated financial statements.

2. INVENTORIES

3. LONG-TERM OBLIGATIONS

On August 22, 2001, the Company entered into a finance agreement with CIT Group/Business Credit, Inc. for up to $25 million. The revolving loan is secured by substantially all the assets of the Company. The

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agreement specifies four different levels of margin to be added to the prime rate between 0.25% and 1.00% depending on certain financial covenants calculated by the Company. The prime rate is based on the JP Morgan Chase prime rate. The margin applicable at December 27, 2003 was 0.50%. The full rate of interest as of December 27, 2003 was 4.5%. On November 19, 2002 a third amendment to the financing agreement was signed. The amendment contains financial covenants that relate to total equity, earnings before interest, taxes, depreciation and amortization (EBITDA), and a minimum fixed charge ratio. The amendment also extended the term of the agreement by one year. The agreement was effective on August 24, 2001, (the closing date of the agreement) and will now terminate on August 23, 2005. A fifth amendment was entered into as of September 30, 2003. This amendment changes the existing financial covenants by raising the minimum monthly EBITDA requirement and slightly raising the minimum fixed charge ratio. At the Company’s request, the amount of the credit facility was reduced to $20 million from $25 million. The Company believes the original credit facility amount was more than the Company could utilize and the reduction to $20 million will result in a decrease in the annual fees paid by the Company under the credit facility. The fifth amendment also permits the Company to include the accounts receivable from one of the Company’s foreign customers, and a portion of the Company’s finished goods inventory, as borrowing collateral. As of December 27, 2003, the Company was in compliance with all loan covenants. At December 27, 2003, the outstanding revolving credit balance was approximately $9,719,000 compared to approximately $9,864,000 at fiscal year end June 28, 2003.

4. SUPPLEMENTAL CASH FLOW INFORMATION

As of December 27, 2003, and June 28, 2003, the Company’s cash balances included restricted cash of $600,089 and $1,142,069, respectively. The $600,089 includes two amounts; $506,308 is a deposit required by the state of Washington for self-insurers that would cover the Company’s maximum calculated workers’ compensation liability in the event of default by the Company. The remaining $93,780 is the amount of uncollected funds in the Company’s depository account as of December 27, 2003. Such funds are considered restricted, because they cannot be used for any other purpose than to decrease the Company’s revolving debt.

5. INCOME TAXES

The income tax provision for the second quarter of fiscal year 2004 was $110,000 compared to an income tax provision of $116,000 for the second quarter of the prior fiscal year. The provisions for the first six months of fiscal years 2004 and 2003 were $283,000 and $355,000, respectively. The provisions for the second quarters and first six months of fiscal years 2004 and 2003 were attributable to the taxable earnings of foreign subsidiaries. The Company has tax loss carryforwards of approximately $54 million, which expire in varying amounts in the years 2006 through 2022. Management has determined that a valuation allowance equal to any deferred tax asset is appropriate.

6. EARNINGS PER SHARE

Basic EPS is computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed by dividing net income by the weighted-average number of common shares and common share equivalents outstanding during the period (in thousands, except per share info. and shares outstanding):

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At the quarter and six months ended December 27, 2003, stock options were excluded from the computation of diluted earnings per share as they were anti-dilutive due to the net loss that occurred in both periods. During the second quarter and six months ended December 28, 2002, there were no dilutive shares as the option prices were higher than the average market price.

7. STOCK OPTIONS

As allowed by SFAS No. 123, “Accounting for Stock Based Compensation”, the Company accounts for its employee stock option plans in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation (FIN No. 44). Accordingly, no compensation is recognized for employee or director stock options granted with exercise prices greater than or equal to the fair value of the underlying common stock at date of grant. If the exercise price is less than the market value at the date of grant, the difference is recognized as deferred compensation expense, which is amortized over the vesting period of the options. The Company accounts for stock options issued to non-employees in accordance with the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” under the fair value based method.

For purposes of disclosure under SFAS No. 123 and No. 148, the following is the pro forma effect of the options had they been recorded under the fair value based method (in thousands, except per share info):

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The fair value of each option grant is estimated on the date of grant using the following assumptions: 0% dividend yield, stock price volatility of 81.2% to 81.3% and risk free interest rates of 4.6% to 6.1%.

8. COMMITMENTS AND CONTINGENCIES

The amount of firm commitments to contractors and suppliers for capital expenditures was approximately $1.2 million at December 27, 2003.

The Company leases some of its facilities, certain equipment, and automobiles under non-cancelable lease agreements. These agreements expire on various dates during the next nine years.

The Company provides warranties on certain product sales, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. We currently establish warranty reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required in future periods.

Components of the reserve for warranty costs during the six months ended December 27, 2003:

Litigation Settlement: 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

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$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. As of December 27, 2003, the Company made payments to F&G totaling approximately $4.0 million.

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 six months ended December 28, 2002, include a one-time benefit of $12.2 million ($1.26 per share) for reversal of previously recorded litigation expense.

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

FORWARD-LOOKING STATEMENTS

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 revise or publicly release the results of any revision to forward-looking statements. Readers should carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including year end reports on Form 10-K and Quarterly Reports on Form 10-Q.

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 electronics, mechanical engineering, and precision molding and tooling combined with high-quality, low-cost production and assembly on a global basis. This global production capability provides customers with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time.

The EMS industry has historically experienced growth over the long-term as more OEMs shift to outsourced manufacturing, and industry trends continue to be very positive. The Company believes that it is positioned in the EMS industry to expand its customer base and continue business growth.

Key Tronic currently has 22 EMS customers, up from 15 at the end of the second quarter of fiscal 2003. Some of these customers have programs that represent small annual revenue streams and some have multi-million-dollar potential. The Company’s new customer relationships involve a variety of products, including consumer electronics and plastics, household products, gaming devices, educational toys, exercise equipment, specialty printers and computer accessories.

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The EMS industry is intensely competitive, and Key Tronic, at this time, has under 1% of the potential market. The Company is planning for growth in coming quarters by expanding its manufacturing capacity and continuing to improve its manufacturing processes. The Company believes that it can win new business, particularly those programs that may be initially too small for larger contract manufacturers. Current challenges facing the Company include the following:

The Company continues to maintain a strong balance sheet in spite of recent financial losses with a current ratio of 2.1 to 1 and a debt to equity ratio of .4 to 1. The Company maintains a good working relationship with its asset-based lender, and it believes that internally generated funds and its revolving line of credit should provide adequate capital for its planned growth.

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, the Company would have inventory in excess of its reserves, and it would be necessary to charge the excess against future earnings. When the Company has purchased material based upon a customer’s forecast, it is usually covered by lead-time assurance agreements. These agreements 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

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sheet. The estimates used are based primarily on identification of specific 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. As the Company has made the transition from primarily manufacturing keyboards to electronic manufacturing services (“EMS”), its exposure to potential warranty claims has declined significantly. The Company’s warranty period for keyboards is significantly longer than that for EMS products. Also the Company does not warrant design defects in products manufactured for EMS customers.

Income Taxes: The Company is required to estimate income taxes in each of the jurisdictions in which it operates. This process involves estimating the actual current tax liability together with evaluating temporary differences in recognition of income (loss) for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s balance sheet. A valuation allowance against deferred tax assets is required whenever the recovery of the assets from future earnings is considered doubtful. As of December 27, 2003, the Company had approximately $54 million in tax loss carryforwards, which will begin expiring in 2006. In fiscal 2002, the Company wrote off its net deferred tax assets totaling approximately $5 million by recording additional income tax expense and increasing the valuation allowance for the deferred tax assets. The Company’s management made this decision as a result of the large financial loss recorded in that fiscal year and uncertainty due to a verdict rendered in the F&G Scrolling Mouse LLC litigation (see discussion of litigation settlement under Commitments and Contingencies).

Although the Company has a history of operating losses, it is possible that future earnings may require the reinstatement of all or a portion of the deferred tax assets. If this should occur, an income tax benefit would be recorded, and this would have a favorable effect on reported earnings per share in the period of the adjustment.

CAPITAL RESOURCES AND LIQUIDITY

Operating Cash Flow

Operating activities used $0.08 million of cash during the first six months of fiscal year 2004 versus $1.1 million of cash provided by operating activities during the same period of the prior year. The decrease in cash provided by operating activities was due to an increase in accounts receivable, and a decrease in accrued compensation and vacation, as well as a decrease in other liabilities. The increase in accounts receivable from the fiscal year end was due primarily to a reduction in revenue from one of the Company’s largest customers that pays early to receive a discount instead of paying in standard trade terms. The decrease in revenue from this customer was offset by increased revenue from other customers that have longer payment terms. This change in the mix of revenue resulted in higher days sales outstanding compared to last year. The decrease in accrued compensation and vacation was the result of the payment of incentive compensation bonuses that were previously accrued at the 2003 fiscal year end.

Offsetting the uses in cash were a decrease in inventories and an increase in the Company’s accounts payable to vendors. The decrease in inventories was due primarily to a concerted effort to reduce inventory on hand and reduce raw materials lead times. Also contributing to the reduction in inventories was a decrease in inventory in the channel of one of the Company’s major keyboard distribution customers. The increase in accounts payable resulted from the Company obtaining extended payment terms from a significant number of its vendors.

Capital Expenditures

During the first six months of fiscal year 2004, the Company spent $0.4 million versus $1.1 million for capital additions in the same period in the previous fiscal year. The Company’s capital expenditures for the first six

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months ended December 27, 2003 primarily consisted of purchases of manufacturing and computer equipment to support its worldwide operations. The $1.1 million in capital expenditures during the first six months of fiscal year 2003 was primarily for production equipment purchased for the Company’s Las Cruces facility. The Company anticipates capital expenditures of approximately $1.2 million through the remainder of the current fiscal year ending July 3, 2004. Actual capital expenditures may vary from anticipated expenditures depending upon future results of operations. See RISKS AND UNCERTAINTIES THAT MAY AFFECT FUTURE RESULTS, pages 17-18. Capital expenditures are expected to be financed with internally generated funds.

Financing Cash Flow

The Company continues to finance its operations through the CIT Group using a revolving credit facility. The revolving loan is secured by substantially all the assets of the Company. Interest applicable on this loan is based on a predetermined margin rate (see Note 3) plus the JP Morgan stated prime rate. The Company was paying total interest of 4.5% on the amount outstanding at the quarter ending December 27, 2003. The amount outstanding on the revolving loan on December 27, 2003 was $9,719,000. The Company has the ability to borrow up to $20 million under this credit facility with approximately $5.1 million available at December 27, 2003 based on collateral held at that time. Cash requirements of the Company are affected by the level of current operations and new EMS programs. The Company utilizes available cash to fund these requirements and believes it achieves its objectives and has positioned itself to grow and expand its business. Operating leases are often utilized when technical obsolescence and funding requirement advantages outweigh the benefits of equipment ownership.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

Payments Due by Period

Under the terms of the revolving credit agreement, the Company must meet a number of financial covenants. As of December 27, 2003, 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.

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In addition, the Company leases most of its administrative and manufacturing facilities. A complete discussion of properties can be found in the Company’s annual 10-K Report that was filed in September 2003.

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 $14.9 million for accounts payable and shipments in transit at the end of the quarter. 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 $15 and $20 million. These payments are financed by the Company’s revolving line of credit.

As of December 27, 2003, the Company had open purchase order commitments for materials and other supplies of approximately $23 million and open orders for capital expenditures of approximately $1.2 million. Of the $23 million in open purchase orders, there are at least 3 blanket orders for annual requirements. Actual needs under these blanket purchase orders fluctuate with the Company’s manufacturing levels. In addition, the Company has contracts with its customers that minimize its exposure to losses for material purchased within lead-times necessary to meet customer forecasts.

Purchase orders generally can be cancelled without penalty within specified ranges that are determined in negotiations with the Company’s suppliers. These agreements depend in part on the type of product purchased as well as the circumstances surrounding any requested cancellations.

The majority of the $1.2 million in open purchase orders for capital expenditures will be billed back to the Company’s customers under various project agreements.

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.

RESULTS OF OPERATIONS

NET SALES

One of the Company’s major customers decreased orders during the second quarter and six months ended December 27, 2003. This was offset by increased sales to other customers.

Gross Margins

Gross margins decreased in both the second quarter and six months ended December 27, 2003. Even though sales increased in both periods, the overall sales mix of revenues changed. One of the Company’s major customers decreased orders significantly. These decreased orders were offset by increased orders from some of the Company’s other customers. The margins on offsetting sales are not as favorable as the margins on the decreased business.

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Research, Development and Engineering

(% are stated as of sales)

Research, development and engineering (R,D&E) expenses decreased for both the quarter and six months ended December 27, 2003 primarily due to a reduction in payroll expense.

Selling

(% are stated as of sales)

The decrease in selling expenses for the quarter and six months ended December 27, 2003 is primarily due to decreased commission expenses.

General and Administrative

(% are stated as of sales)

The decrease in overall general and administrative (G&A) expenses for the quarter and six months ended December 27, 2003 is primarily due to a reduction in payroll expense.

INTEREST

Interest expense has not fluctuated significantly because borrowing amounts and interest rates have been relatively stable.

INCOME TAXES

The income tax provision for the second quarter of fiscal year 2004 was $110,000 compared to an income tax provision of $116,000 for the second quarter of the prior fiscal year. The provisions for the first six months of fiscal years 2004 and 2003 were $283,000 and $355,000, respectively. The provisions for the second quarters and first six months of fiscal years 2004 and 2003 were attributable to the taxable earnings of foreign subsidiaries. The Company has tax loss carryforwards of approximately $54 million, which expire in varying amounts in the years 2006 through 2022. Management has determined that a valuation allowance equal to any deferred tax asset is appropriate.

BACKLOG

As of June 28, 2003, the Company had an order backlog of approximately $18.1 million. 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 other customer requirements. Order backlog should not be considered an accurate measure of future sales.

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RISKS AND UNCERTAINTIES THAT MAY 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 31% of net sales in fiscal year 2003. This same customer accounted for 39% of sales in 2002. Three of the Company’s EMS customers accounted for 9%, 8%, and 8% of net sales during fiscal year 2003. These same customers accounted for 10%, 13%, and 10% of net sales in fiscal year 2002. 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

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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 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.

Stock and Dilution Price Volatility As of December 27, 2003, there were outstanding options for the purchase of approximately 2,103,000 shares of common stock of the Company (Common Stock), of which options for approximately 1,936,000 shares were vested and exercisable. Of the outstanding options, 45% have exercise prices more than twice the closing price on December 27, 2003. 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 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 3. 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 term and revolving debt is secured substantially by 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. As of February 6, 2004, the JP Morgan Chase Bank prime rate was 4.00%.

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.

Item 4. Controls and Procedures

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PART II. OTHER INFORMATION:

Item 4. Submissions of Matters to a Vote of Security Holders

The Annual Meeting of Shareholders was held on October 23, 2003 at which shareholders voted on proposals as follows:

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

(b) Reports on Form 8-K

October 28, 2003 – Press Release Announcing Results for the Quarter Ended September 27, 2003

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

KEY TRONIC CORPORATION

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