Strattec Security Corp: Form 10-Q for the period ended Mar 30, 2025

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. Unless otherwise indicated, all references to quarters and years refer to fiscal quarters and fiscal years.

Business Overview

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 other OEMs around the world. Our offering is comprised of products primarily related to vehicle 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, 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.

Current Business Update

In conjunction with a change in leadership in 2024, we are in the process of developing a strategy to strengthen the Company’s profitability and deliver sustainable sales growth. We expect to improve our business with upgraded systems and processes and a focus on productivity and efficiencies in our manufacturing operations. We are reviewing our product portfolio, focusing on improving our working capital management and modernizing our support functions. We believe this optimized cost structure will allow us to capitalize on our technical engineering expertise, market leading positions and strong customer relationships to generate innovative solutions and predictable sales growth with new and existing customers.

Volatility in the North American automotive industry is driven by supply chain disruptions, global inflation, thinning labor availability, rising global commodity costs and a changing global trade and geopolitical climate. These macro conditions, coupled with changes in production volumes by OEMs in response to new vehicle consumer demand impact our sales and profitability levels. Based on recent third party industry projections, it is expected that North American light vehicle production will be flat over the next several years with fiscal 2026 OEM production levels forecasted to be down approximately 6-8%, with a recovery in fiscal 2027 and 2028. Lower near term North American light vehicle production estimates, which are subject to change, are a result of recent tariff uncertainties and related demand impacts. Despite short term market softening, we have delivered 5% year-to-date sales growth, the result of new program launches, pricing actions and increased volumes on the platforms we serve.

The United States government has recently announced additional tariffs on goods imported into the U.S. from numerous countries, with certain exemptions such as USMCA-compliant imports. In response, multiple nations have countered with reciprocal tariffs and other actions. Like other automotive suppliers, we source raw materials and components from a global supply chain with final assembly for our products completed in our Mexico operations. We ship approximately 65% of our sales (majority of which are USMCA compliant) to customer production sites in the United States, with the balance shipped to other countries. We continue to monitor the dynamic global trade environment and are taking actions to mitigate the cost impact of additional tariffs and understand any associated changes in customer demand and production build schedules. Prior to any mitigation efforts, we estimate that the annual impact of the incremental tariffs is a $9-$12 million increase in our cost of goods sold. Mitigation actions include, but are not limited to, changes in our global supply chain, pass through of costs to customers and changes in our logistics processes. However, our inability to enact these, and other mitigation actions, may have a material adverse impact on sales, earnings and liquidity (refer to Part II, Item 1A. Risk Factors in this Form 10-Q).

Given our operations in Mexico, our financial results are impacted by labor inflation, the result of government mandated minimum wages, and we have exposure to changes in foreign currency exchange rates. We strive to mitigate the impact of these cost increases through supply chain and manufacturing efficiencies, strategic pricing and peso forward contracts. During fiscal 2025 we have taken actions to improve our cost structure, including the elimination of a shift in our Milwaukee operations and a restructuring of our Mexico operations. The restructuring activities are expected to generate approximately $5 million of annual cost reductions.

During the balance of fiscal 2025, we are focused on mitigating the impact of the additional tariffs, executing new initiatives to improve our cost structure, driving cash flow through improved asset and working capital utilization and securing new platforms to solidify future sales growth.

Analysis of Results of Operations

Three months ended March 30, 2025 (third quarter fiscal 2025) compared with the three months ended March 31, 2024 (third quarter fiscal 2024)

Third quarter fiscal 2025 net sales were $144.1 million, an increase of $3.3 million (2.3%) compared to the prior year third quarter. Net sales increased due to $2.5 million of price increases, favorable mix of $2.2 million and net new program launches of $1.6 million, which more than offset $3.0 million in lower sales volumes on existing platforms. Net sales to our customers in the third quarter were as follows (in millions):

Meaningful drivers of the change in net sales for key customers are as follows:

• General Motors Company net sales decreased 4% due to reduced shipments across all product categories, partially offset by the launch of a door handle program for the Equinox platform.
• Ford Motor Company net sales grew 6% due to increased shipments and both increased content per platform and higher value content related to power tailgate and related latch products.
• Stellantis net sales increased 14% primarily due to new key and lockset content on the Dodge Ram Heavy Duty truck platform.
• Hyundai Motor Group net sales increased 5% due to higher demand and inventory destocking in the prior year for power access products on the Hyundai Staria platform.
• Tier 1 customer sales decreased 6% due to reduced shipments of door handle products.

Third quarter fiscal 2025 gross profit was $23.1 million, compared to $14.7 million in the comparable prior year period. Gross profit margin improved year-over-year from 10.4% to 16.0% as a result of the strengthening of the US dollar, pricing actions, favorable product mix and improved leverage of our fixed cost structure.

Material costs decreased $1.1 million year-over-year on lower production levels and favorable product mix. Labor and overhead costs decreased $4.0 million year-over-year reflecting a $4.4 million benefit from changes in foreign currency exchange rates and a $1.1 million net reduction in manufacturing labor costs from lower headcount and related fringe benefit costs. Favorable changes in foreign currency exchange rates and lower labor costs more than offset the $1.3 million impact of merit and government mandated minimum wages increases in our Mexico operations and the $0.8 million increase in tariffs resulting from recent changes in U.S. regulations.

Engineering, selling and administrative expenses were $16.0 million in the third quarter of fiscal 2025, compared to $12.7 million in the prior year period. Increased expenses included $1.1 million of business transformation and restructuring costs, $1.2 million of incremental equity compensation and annual bonus expense and higher third party engineering spend of $0.4 million reflecting the timing of development projects.

Interest expense relates to outstanding borrowings under our joint venture credit facility and was $0.2 million in the current and prior year quarter.

Investment income increased to $0.5 million in the third quarter from $0.1 million in the prior year reflecting increased levels of cash and cash equivalents, which are invested in overnight money market funds.

Other expense, net was $0.02 million in the third quarter compared to $0.2 million in the prior year. The reduction was primarily due to changes in foreign currency exchange rates and gains or losses on peso forward contracts.

The effective income tax rate was 22.4% and 32.7% for the third quarter of fiscal 2025 and 2024, respectively. The effective tax rate for the third quarter of fiscal 2024 was impacted by a shift in our global earnings mix. The effective tax rate for both periods exceeds the U.S. federal statutory rate primarily because of the foreign rate differential, state income taxes, limitations on the utilization of foreign tax credits, non-deductible items and discrete items.

Nine months ended March 30, 2025 compared with the nine months ended March 31, 2024

Net sales in the nine months of fiscal 2025 were $413.1 million, an increase of $18.4 million, or 4.7% compared to the prior year period. Net sales growth was driven by $17.0 million of net new program launches as well as favorable mix. Additionally, higher production volumes on certain existing platforms and customer inventory builds increased sales by $3.0 million. Higher sales and $6.1 million of accretive pricing more than offset the benefit from the prior year period which had $9.9 million of one-time retroactive pricing recoveries. Net sales to our customers in the first nine months of fiscal 2025 were as follows (in millions):

Meaningful drivers of the change in net sales for key customers are as follows:

• General Motors Company net sales increased 2% primarily due to overall volume increases for full size SUVs and pickups as well as new door handle volume for the Equinox EV, which were partially offset by several key and lockset programs ending.
• Ford Motor Company net sales grew 14% mostly due to increased volumes and new tailgate and power end gate content on the Ford F-Series and Super Duty trucks.
• Stellantis net sales declined 23% due to the combination of lower vehicle production volumes for several programs and the end of several passenger car programs, partially offset by new content on the Dodge Ram Heavy Duty truck platform.
• Hyundai Motor Group net sales increased 29% due to higher demand for power sliding door products and an increase in OEM inventory levels.

Gross profit was $59.2 million in the first nine months of fiscal 2025, compared to $46.9 million in the comparable prior year period. Despite favorable one-time pricing recoveries in the prior year, gross profit margin improved year-over-year from 11.9% to 14.3% as a result of the strengthening of the US dollar, pricing actions and improved leverage of our fixed cost structure on higher sales volumes.

Material costs increased $8.9 million year-over-year on higher production levels. Labor and overhead costs decreased $2.8 million year-over-year. Excluding the $10.6 million benefit from changes in foreign currency exchange rates, conversion costs increased $7.8 million due to higher sales volumes, a $3.1 million increase in Mexico labor costs, $1.2 million in increased tariff costs and increased provisions for annual bonus expense of $1.4 million, offset by a $1.8 million reduction in depreciation expense.

Engineering, selling and administrative expenses were $44.9 million in the first nine months of fiscal 2025, compared to $38.8 million in the prior year period. Increased expenses include additional executive transition costs of $1.1 million, $0.6 million of incremental equity compensation expense, increased annual bonus provision of $2.3 million and $1.1 million of restructuring charges. These cost increases were partially offset by lower third party engineering spend of $0.6 million.

Interest expense relates to outstanding borrowings under our joint venture credit facility and was $0.8 million and $0.7 million in the current year period and prior year period, respectively.

Investment income increased to $1.3 million in the current year period from $0.3 million in the prior year period reflecting increased levels of cash and cash equivalents, which are invested in overnight money market funds.

Other expense, net was $0.4 million in the current year period compared to other income, net of $0.8 million in the prior year. The change was primarily due to changes in foreign currency exchange rates and gains or losses on peso forward contracts.

The effective income tax rate was 24.6% and 25.7% for the current year and prior year period, respectively. The effective tax rate for both periods exceeds the U.S. federal statutory rate primarily because of the foreign rate differential, state income taxes, limitations on the utilization of foreign tax credits, non-deductible items and discrete items.

Liquidity and Capital Resources

At March 30, 2025, we had $62.1 million of cash and cash equivalents, of which $2.0 million was held by our foreign subsidiaries and $60.1 million was held domestically. Excess cash is held in money market funds. The following table summarizes our cash flows provided by (used in) operating, investing and financing activities (in millions):

Cash flow from operations was $41.5 million for the nine months of fiscal 2025, compared to a use of cash from operations in the prior year period. Fiscal 2025 year-to-date cash flow from operations is the result of cash earnings and a $17.5 million reduction in working capital, including reduced purchasing and inventory levels on higher sales, recovery of pre-production costs and extended payment terms with our suppliers.

Net cash used in investing activities was $4.2 million during the first nine months of fiscal 2025 compared to $4.1 million in the prior year period. Capital expenditures to support new customer programs upgrades to our IT hardware and network environment and replacement and automation of manufacturing equipment were $4.2 million in the current year period compared to $6.1 million in the prior year period. The prior year also included $2.0 million in proceeds received from the sale of our interest in a previous joint venture.

Net cash provided by financing activities resulted from the sale of common stock under our employee stock purchase plan. In addition, during the first nine months of fiscal 2025, we borrowed and repaid amounts under the joint venture revolving credit agreement for short term cash requirements.

At March 30, 2025, there were no borrowings outstanding under the $40.0 million STRATTEC revolving credit agreement and $13.0 million outstanding under the $20.0 million joint venture revolving credit agreement. The Company was in compliance with all covenants under its credit facilities at March 30, 2025. We believe that the revolving credit line, combined with our existing cash and anticipated operating cash flows will be adequate to meet operating, debt service and capital expenditure funding requirements for the foreseeable future.

Primary Working Capital Management

We use primary working capital as a percentage of sales (PWC %) as a key metric of working capital management. We define this metric as the sum of net accounts receivable and net inventory less accounts payable, divided by the past three months sales annualized. The following table shows a comparison of primary working capital (dollars in millions):

Despite higher accounts receivable on increased sales, a $6.1 million reduction in inventory levels and a $16.7 million increase in accounts payable drove the improvement in PWC% to 19% at the end of the third quarter of fiscal 2025.

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 were no changes 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, we are providing the following update to the “Business Risks – Cross-border or Tariffs” risk factor contained in our Annual Report.

Business Risks

Cross-border Trade Issues or Tariffs – Our operations are impacted by international or cross-border trade dynamics, particularly the import and export of products and goods into and out of the United States and trade tensions among nations. The shipping of goods across national borders is often more expensive and complicated than domestic shipping. Customs and duty procedures and reviews, including duty-free thresholds in various key markets, the application of tariffs, and security-related governmental processes at international borders, may increase costs, discourage cross-border purchases, delay transit and create shipping uncertainties. The imposition of non-tariff barriers, including localized content rules and government procurement restrictions, may further limit our ability to operate efficiently across borders.

We manufacture our products in Mexico and rely on a global supply chain to deliver raw materials and components that we need to manufacture our products. Our business benefits from certain free trade agreements, such as the United States-Mexico-Canada Agreement. However, recent shifts in trade policy have resulted in new or higher tariffs on goods imported from numerous countries, and some countries have imposed retaliatory tariffs on imports from the United States, which has created meaningful uncertainty. These changes may result in significantly increased production costs, pricing volatility and administrative complexity in determining country-of-origin compliance for automotive components.

Changes in U.S. trade relations with foreign countries involved in our business, including but not limited to Mexico, Canada, China, and European countries, could have a material effect on global economic conditions and significantly decrease global trade, which could adversely impact our production costs, purchased material costs, ability to compete, customer demand, short-term vehicle production levels and relationships with suppliers and customers. Should universal tariffs be implemented as initially announced in April 2025, we anticipate a significant adverse impact on our future costs, which could reduce profitability on certain of our products and have a material adverse effect on our results of operations, financial condition and cash flows. The ultimate impact of changes to tariffs and trade barriers will depend on various factors, including the timing, amount, scope and nature of any tariffs and trade barriers that are implemented. Refer to Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-Q for further discussion of the impact of these tariffs.