Strattec Security Corp: Form 10-Q for the period ended Sep 29, 2024

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis should be read in conjunction with STRATTEC SECURITY CORPORATION’s accompanying Condensed Consolidated Financial Statements and Notes thereto and its Annual Report. Also, refer to discussion of prior period corrections under Basis of Financial Statements included in the Notes to Condensed Consolidated Financial Statements in this Form 10-Q. Unless otherwise indicated, all references to quarters and years refer to fiscal quarters and fiscal years.

Overview and Outlook

With a history spanning over 110 years, STRATTEC has consistently been at the forefront of innovation in vehicle security, transitioning from mechanical to integrated electro-mechanical systems. Our largest customers are three leading automotive OEMs in North America, but we also provide products to most other OEMs around the world. Our offering is comprised of products primarily related to vehicle and power access, security and authorization and select user interface controls. Vehicle and power access solutions include power sliding doors, tailgates and lift gate systems, as well as power deck lid systems. We also design and manufacture highly-engineered latches and door handles. Security and authorization products are comprised of mechanical and electronically enhanced locks and keys, fobs, passive entry passive start systems (PEPS), steering column and instrument panel ignition lock housings and related solutions. We established our leading market position within North American automotive customers initially with our legacy mechanical locks and keys. We built upon that reputation with our engineering expertise in security and vehicle access, our flexible and responsive service and our deep relationships with our customers.

Under new leadership since July 1, 2024, with the appointment of Jennifer L. Slater as CEO, STRATTEC is at the beginning stages of identifying the future path of its product portfolio, determining the optimal operating and cost structure and developing a strategy to strengthen profitability and drive sustainability. Through fiscal 2025 and beyond, we expect to modernize our operations with upgraded information systems, simplify our product portfolio, optimize our operating footprint, capitalize on our leading market positions and strong customer relationships and leverage our engineering expertise to drive innovative, sticky solutions to increase market penetration.

Summary of the quarter ended September 29, 2024 (first quarter fiscal 2025)

Our first quarter financial results are best understood by also recognizing that the first quarter of fiscal 2024 included some one-time benefits. Net sales of $139.1 million were up year-over-year by $3.7 million, or 2.7%. However, last year’s first quarter had benefited from $8.0 million in one-time customer pricing effects. Excluding that impact, underlying sales for the first quarter of fiscal 2025 would have increased by $11.6 million, or 9.1%. The increase included approximately $2.2 million that was associated with higher ongoing customer pricing captured after the first quarter of fiscal 2024. The remaining underlying sales growth was primarily driven by higher volume of Hyundai / Kia vehicle models that contain our power doors and latches as well as increased sales to Ford for new latch and multi-tailgate access content. These improvements helped to offset a large decline in sales to Stellantis, which reflected a combination of lower program vehicle production, expired programs, and reduced content on certain programs as well as some of the one-time pricing comparator.

The one-time pricing in last year’s first quarter also flowed through to gross profit. Gross profit in the current quarter of $18.9 million was relatively unchanged to prior year, however, last year’s first quarter had a $7.1 million benefit of the flow through of the one-time pricing impact after factoring for $900,000 of one-time higher prices paid to suppliers. Gross profit margin for the first quarter fiscal 2025 was 13.6% compared with 13.8% in the prior-year period. The impact of the one-time pricing benefit was 470 basis points in last year’s first quarter.

Net income for the quarter was $3.7 million, down $462,000 compared with the prior-year period. We are focused on improving profitability and reducing working capital requirements. Total cash increased by $9.0 million to $34.4 million at September 29, 2024 compared with June 30, 2024. Pre-production costs, which includes customer tooling, decreased $6.9 million as tooling associated with customer launches in the latter half of fiscal 2024 were approved and billed in the quarter. This was somewhat offset by higher inventory.

Current Market Conditions

We serve the automotive industry, primarily in North America. Approximately 63% of our sales in the first quarter of fiscal 2025 were to the three large automobile manufacturers in the U.S. The automotive industry can be cyclical based on economic conditions, especially as it impacts consumers. As a result, demand for our products are influenced by industry conditions. In addition to our interactions with our customers, we monitor monthly forecasts provided by S&P Global. While they are forecasting that North American light vehicle production will grow modestly between 2024 and 2028, the near-term monthly trends have been softening. In fact, S&P Global’s light vehicle production forecasts for our fiscal period have declined 4.5% in its October 2024 report from its July 2024 report, and a similar softening is forecasted cumulatively with our largest three customers.

We work to overcome production declines by getting product on new platforms and increasing content on next versions of existing platforms. There can be no guarantee however that these efforts can be sufficient to overcome overall lower production rates.

Analysis of Results of Operations

Three months ended September 29, 2024 (first quarter fiscal 2025) compared with the three months ended October 1, 2023 (first quarter fiscal 2024)

Net sales to each of our customers or customer groups in the current year quarter and prior year quarter were as follows (in millions):

Quarter-over-quarter sales increased $3.7 million. The prior year quarter included $8.0 million of one-time retroactive price increases, which were agreed to during the quarter for parts shipped in our fiscal year ended June 30, 2023. The current year quarter included $2.2 million of on-going price increases agreed to subsequent to the prior year quarter for parts supplied in the current quarter. In addition to net pricing changes, the following items specifically impacted sales to the noted customer groups between quarters including the net price changes:

• Sales to General Motors Company increased primarily due to new door handle volume for the Equinox EV, which impact was partially offset by several lockset supply programs ending.
• Sales to Ford Motor Company grew mostly due to new tailgate latch content supplied on the Ford F-Series Pickups.
• Sales to Tier 1 Customers increased primarily due to increased volume of door hardware content that ultimately is supplied for the F-Series Super Duty Pickup as well as for the Stellantis Wagoneer, a new program.
• Sales to Commercial and Other OEM Customers, which are comprised of aftermarket products and vehicle access control products, such as latches, fobs, driver controls and door handles, increased primarily due to new business awarded by Aston Martin and a leading EV OEM.
• Sales to Hyundai / Kia grew primarily due to higher demand for power door products required to meet an overall increase in customer vehicle production build timing.
• Sales to Stellantis declined primarily due to the combination of lower vehicle production volumes of the Dodge Ram Pickup, Pacifica and the end of several passenger car programs. We also had reduced content on the Dodge Ram Pickup.

The change in total cost of goods sold reflects higher sales in the current quarter compared with prior year first quarter (which included $900,000 in one-time retroactive price increases paid to key suppliers). Total direct material costs in the first quarter of fiscal 2025 benefited from $1.3 million in lower raw material and purchased component costs. Labor and overhead costs were relatively consistent between the comparative periods as cost benefits were offset by higher costs as noted below:

Cost Decrease

• A favorable foreign exchange benefit of $2.7 million due to change in U.S. dollar to Mexican peso exchange rates. The average U.S. dollar/Mexican peso exchange rate increased to approximately U.S. dollar/19.30 pesos in the current year quarter from approximately U.S. dollar/17.14 pesos in the prior year quarter, reducing the U.S. dollar cost of our Mexican operations.

Cost Increases

• Mexico manufacturing costs increased by $1.4 million driven by government mandated minimum wage increases effective January 1, 2024, partially offset by a reduction in other manufacturing costs.
• The first quarter of fiscal 2025 included $650,000 of accrued expenses for our short-term incentive bonus plan. No bonus expense provisions were recorded in the prior year quarter.
• Higher shipping costs of $400,000 were related to expedited shipments.

Higher variable labor and overhead costs were offset by more favorable absorption of fixed overhead costs resulting from production volume increases.

Last year’s first quarter benefited by 4.7 percentage points due to the impact of one-time retroactive pricing. Excluding that effect, gross profit and margin improved as a result of higher sales, reduced raw material and purchased component costs, a favorable foreign exchange rate, production efficiencies in Mexico and reduced royalty costs which more than offset the unfavorable impacts of higher Mexican wage and benefit costs and freight costs, as well as short-term incentive bonus plan accruals.

Engineering, selling and administrative expenses in the current year quarter and prior year quarter were as follows:

Engineering, selling and administrative expenses increased $1.3 million year over year mostly as a result of $820,000 of accruals for our short-term incentive plan and $550,000 of one-time CEO transition costs in the current quarter. No bonus expense provisions were recorded in the prior year quarter.

Income from operations was $5.1 million in the current year quarter compared with $6.1 million in the prior-year quarter reflecting the impact of increased engineering, selling and administrative expenses on relatively unchanged gross profit.

Equity loss from joint ventures was $265,000 in the prior year quarter. Effective June 30, 2023, STRATTEC sold its one-third interest in VAST LLC to WITTE. Refer to the discussion of the Equity Loss from Joint Ventures included in the Notes to Financial Statements within this Form 10-Q for additional information. The prior quarter loss was the result of additional professional fees incurred during the period related to the sale.

Included in Other Income, net was comprised of (in thousands):

20

Changes in Other Income, net included:

• Foreign currency transaction gains and losses resulted from activity associated with foreign denominated assets held by our Mexican subsidiaries.
• The Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in the Trust are considered trading securities.
• We entered into the Mexican peso currency forward contracts to reduce earnings volatility resulting from changes in exchange rates affecting the U.S. dollar cost of our Mexican operations. Unrealized gains and losses on the peso forward contracts recognized as a result of mark-to-market adjustments as of September 29, 2024 may or may not be realized in future periods, depending on actual Mexican peso to U.S. dollar exchange rates experienced during the balance of the contract period.
• Pension and postretirement plan costs include the components of net periodic benefit cost other than the service cost component.

Our effective tax rate was 28.6 percent and 23.7 percent for the three-month periods ended September 29, 2024 and October 1, 2023, respectively. The effective tax rate for the three-month periods ended September 29, 2024 and October 1, 2023 were impacted by the foreign tax rate differential. The effective tax rate for the three-month period ended September 29, 2024 was also impacted by a limitation on the utilization of our foreign tax credits and non-deductible items, which causes the effective tax rate to differ from the statutory tax rate.

Liquidity and Capital Resources

Working Capital (in millions)

Outstanding Receivable Balances from Major Customers

Our primary source of cash flow is from our major customers, which include General Motors Company, Stellantis and Ford Motor Company. As of the date of filing this Form 10-Q with the Securities and Exchange Commission, all of our major customers are making payments on their outstanding accounts receivable in accordance with the payment terms included on their purchase orders. A summary of our outstanding receivable balances from our major customers as of September 29, 2024 was as follows (in millions):

Cash Balances in Mexico

We earn a portion of our operating income in Mexico. As of September 29, 2024, $3.3 million of our $34.4 million cash and cash equivalents balance was held in Mexico. These funds are available for repatriation as deemed necessary.

Cash Flow Analysis (in millions)

21

The increase in cash provided by operating activities between periods was primarily due to a reduction in working capital requirements between periods. Working capital requirement changes between periods were comprised of the following items (in millions):

The reduction in our working capital requirements for the first quarter of fiscal 2025 was primarily due to the following:

• Higher accounts receivable reflects higher sales in the latter half of the quarter.
• Higher inventory for the current year period was due to higher purchased material inventory required to support increased sales of higher contented programs as well as the anticipated launch of a new program.
• The change in other assets reflects a reduction in customer tooling balances in the current year period. Customer tooling balances are impacted by the timing of tooling development spend to meet customer production requirements and related customer billings for tooling cost reimbursement.
• Accounts payable and accrued liability balances reflects increases for parts purchased from a foreign vendor, partially offset by a reduction in accrued salaries and benefits. Accounts payable balances for each period reflected the timing of purchases and payments with our vendors based on normal, established payment terms.

Net cash used in investing activities of $2.1 million was for capital expenditures to support new product programs as well as the upgrade and replacement of existing equipment. We anticipate total capital expenditures will be approximately $15 million in fiscal 2025. Net cash used in investing activities of $920,000 during the prior year period included $2.0 million in proceeds received from the fourth quarter fiscal 2023 sale of our investment in the VAST LLC joint venture and $2.9 million in capital expenditures for new product programs and the upgrade and replacement of existing equipment.

Net cash provided by financing activities of $13,000 was from $13,000 received for purchases under our employee stock purchase plan. The $3 million of borrowings under our credit facility were repaid during the period resulting in no net change in cash during the period. Net cash provided by financing activities of $17,000 during the prior year period included $2 million of borrowings under our credit facility, which borrowings were repaid during the period resulting in no net change in cash during the period, and $17,000 received for purchases under our employee stock purchase plan.

Stock Repurchase Program

Our Board of Directors authorized a stock repurchase program to buy back outstanding shares of our common stock. Shares authorized for buy back under the program totaled 3,839,395 at September 29, 2024 at which time there were 184,073 remaining shares authorized to be repurchased under the program. A total of 3,655,322 shares have been repurchased over the life of the program through September 29, 2024, at a cost of approximately $136.4 million. No shares were repurchased during the three-month periods ended September 29, 2024 or October 1, 2023

While additional repurchases may occur from time to time, based on the current economic environment and our preference to conserve cash for other uses, we anticipate modest or no stock repurchase activity for the remainder of fiscal year 2025. Stock repurchases, if any, are expected to be funded by cash flow from operations and current cash balances.

Credit Facilities

STRATTEC has a $40 million secured revolving credit facility (the “STRATTEC Credit Facility”) with BMO Harris Bank N.A. ADAC-STRATTEC LLC has a $20 million secured revolving credit facility (the “ADAC-STRATTEC Credit Facility”) with BMO Harris Bank N.A., which is guaranteed by STRATTEC. The ADAC-STRATTEC Credit Facility borrowing limit decreases to $18 million on August 1, 2025. The credit facilities both expire August 1, 2026. Borrowings under either credit facility are secured by our U.S. cash balances, accounts receivable, inventory, and fixed assets located in the U.S. Interest on borrowings under the STRATTEC Credit Facility were at varying rates based, at our option, on the bank's prime rate or SOFR plus 1.35 percent through September 5, 2023 and SOFR plus 1.85 percent subsequent to September 5, 2023. Interest on borrowings under the ADAC-STRATTEC Credit Facility were at varying rates based, at our option, on the bank's prime rate with no interest rate margin through May 30, 2024 and a 2 percent interest rate margin subsequent to May 30, 2024 or SOFR plus 1.35 percent through May 30, 2024 and SOFR plus 3.10 percent subsequent to May 30, 2024. Both credit facilities contain a restrictive financial covenant that requires the applicable borrower to maintain a minimum net worth level. The ADAC-STRATTEC Credit Facility includes an additional restrictive financial covenant that requires the maintenance of a minimum fixed charge coverage ratio. As of September 29, 2024, we were in compliance with all financial covenants required by these credit facilities.

There were no outstanding borrowings under the STRATTEC Credit Facility as of September 29, 2024 or June 30, 2024. There were no borrowings under the STRATTEC Credit Facility during the three-month period ended September 29, 2024. Outstanding borrowings under the ADAC-STRATTEC Credit Facility totaled $13 at both September 29, 2024 and June 30, 2024. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $13.7 million and 8.5 percent, respectively, during the three-month period ended September 29, 2024. We believe that the credit facilities are adequate, along with existing cash flows from operations, to meet our anticipated capital expenditure, working capital, dividend, and operating expenditure requirements.

Majority Owned Subsidiary

Refer to the discussion of Investment in Majority Owned Subsidiary included at Note 7 in Notes to Condensed Consolidated Financial Statements within this Form 10-Q.

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act, are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that the information required to be disclosed by the Company in reports that it files or submits under the Exchange Act are accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of such period, our disclosure controls and procedures were effective at reaching a level of reasonable assurance. It should be noted that in designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures. We have designed our disclosure controls and procedures to reach a level of reasonable assurance of achieving the desired control objectives.

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II

Other Information

An investment in our Common Stock involves risks. Before making an investment decision, you should carefully consider all of the information in this Quarterly Report, including the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Condensed Consolidated Financial Statements and related notes. In addition, you should carefully consider the risks and uncertainties described in the section entitled “Risk Factors” in our Annual Report. If any of the identified risks are realized, our business, financial condition and operating results could be materially and adversely affected. In that case, the trading price of our Common Stock may decline. In addition, other risks of which we are currently unaware, or which we currently do not view as material, could have a material adverse effect on our business, financial condition and operating results. As of the date of this Quarterly Report, there have been no material changes to the risk factors previously disclosed under the section entitled Risk Factors in our Annual Report.