Strattec Security Corp: Form 10-Q for the period ended Dec 27, 2015

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 2015 Annual Report which was filed with the Securities and Exchange Commission as an exhibit to its Form 10-K on September 4, 2015. Unless otherwise indicated, all references to years refer to fiscal years.

Outlook

During the first six months of fiscal year 2016, we experienced stronger sales demand for our components from our major North American automotive customers, Fiat Chrysler Automobiles, General Motors Company and Ford Motor Company, as it relates to light trucks and both sport and car based utility vehicles in comparison to passenger cars, which was likely influenced by lower gas prices. If gas prices continue to remain low over the next six months, we anticipate this consumer buying trend to continue through the remainder of the 2016 fiscal year.

Analysis of Results of Operations

Three months ended December 27, 2015 compared to the three months ended December 28, 2014

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

The sales to Fiat Chrysler Automobiles in the current year quarter decreased slightly due to lower customer vehicle production volume and content on vehicles for which we supply components. The decrease in sales to General Motors Company in the current year quarter was attributed to incremental service parts sales of $6 million shipped in the prior year quarter, which incremental sales did not continue during the current year quarter ended December 27, 2015. Increased sales to Ford Motor Company in the current year quarter were attributed to increased product content on locksets and latches, in particular related to the new F-150 pick-up truck for which we supply components. Sales to Tier 1 Customers during the current year quarter decreased in comparison to the prior year quarter. These customers primarily represent purchasers of vehicle access control products, such as latches, fobs, and driver controls, that we have developed in recent years to complement our historic core business of locks and keys. The increase in sales to Hyundai / Kia in the current year quarter was principally due to higher levels of sales on the Kia Sedona minivan for which we supply components.

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Direct material costs are the most significant component of our cost of goods sold and comprised $57.0 million or 67.9 percent of cost of goods sold in the current year quarter compared to $55.7 million or 66.7 percent of cost of goods sold in the prior year quarter. The increase in material costs of $1.3 million or 2.3 percent and the increase in material costs as a percentage of cost of goods sold between these quarterly periods was due to a less favorable product mix in the current year quarter as compared to the prior year quarter. The prior year quarter included increased sales of service parts to General Motors Company, as discussed above, which typically have lower material cost percentages as compared to parts sold for new vehicle programs.

The remaining components of cost of goods sold consist of labor and overhead costs which decreased $900,000 or 3.2 percent in the current year quarter as compared to the prior year quarter. Reductions in current quarter labor and overhead costs, including a decrease of $680,000 in expense provisions for the accrual of bonuses under our incentive bonus plans, a reduction of approximately $2.4 million in the U.S. dollar value of our Mexican operations due to a favorable Mexican peso to U.S. dollar exchange rate, and a lump sum bonus totaling $311,000 paid to our Milwaukee represented hourly workers during the prior year quarter resulting from the ratification of a new 4-year labor contract, which impacts were mostly offset by higher depreciation expense, higher repair and maintenance expense, and increased labor costs associated with a less favorable product sales mix in the current year quarter. The average U.S. dollar / Mexican peso exchange rate increased to approximately 16.73 pesos to the dollar in the current year quarter from approximately 13.82 pesos to the dollar in the prior year quarter.

Gross profit and gross profit as a percentage of net sales in the current year quarter were consistent with the prior year quarter as a result of overall sales and cost of goods sold being consistent between periods as discussed above.

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

Engineering, selling and administrative expenses increased approximately $700,000 between periods. The increase in these costs in the current year quarter as compared to the prior year quarter was due to higher selling and engineering costs associated with current product programs as well as new product programs under development, which increased costs were partially offset by reduced expense provisions for the accrual of bonuses under our incentive bonus plans during the current year period over the prior year period.

Income from operations in the current year quarter was $7.4 million compared to $8.0 million in the prior year quarter. This reduction was the result of an increase in engineering, selling and administrative expenses in the current year quarter as compared to the prior year quarter as discussed above.

The equity (loss) income of joint ventures was comprised of the following in the current year quarter and prior year quarter (in thousands):

VAST LLC’s operations in both China and Brazil were negatively impacted during the current year quarter by both a slow-down in automotive sales and impacts of foreign currency as it relates to purchases of components outside of their local markets. We anticipate VAST do Brasil will require a capital contribution of approximately $600,000 collectively by all VAST partners to fund operations during the remainder of fiscal 2016. STRATTEC’s portion of the capital contributions is anticipated to be $200,000.

STRATTEC is not the primary beneficiary and does not control STRATTEC Advanced Logic, LLC (“SAL LLC”). Accordingly, our investment in SAL LLC is accounted for using the equity method. Notwithstanding the existence of the SAL Credit Facility described herein, as a result of STRATTEC’s guaranty of such credit facility and as a result of borrowing limitations imposed by the bank under such credit facility, even though we maintain a 51 percent ownership interest in SAL LLC, effective with our fiscal 2015 fourth quarter, 100 percent of the funding for SAL LLC was being made through loans from STRATTEC to SAL LLC and the guaranty of the SAL Credit Facility. Therefore, effective with our fiscal 2015 fourth quarter, STRATTEC began recognizing 100 percent of the losses of SAL LLC. In addition, the following loss was included in our current quarter equity loss of joint ventures for SAL LLC (thousands of dollars):

Loss on Guaranty of SAL LLC Credit Facility $ 24

SAL LLC has a $1.5 million revolving credit facility with BMO Harris Bank N.A., which is fully guaranteed by STRATTEC. As of December 27, 2015, STRATTEC had a recorded liability equal to the estimated fair value of the guarantee of $1.1 million, which amount is equal to outstanding borrowings on the SAL LLC credit facility as of December 27, 2015. STRATTEC’s proportionate share of the guarantee, based on our ownership percentage in SAL LLC, totals $561,000, and accordingly we have increased our investment in SAL LLC as of December 27, 2015 by this amount. Our joint venture partner did not guarantee their proportionate share of the SAL LLC credit facility. As a result, STRATTEC recorded a loss equal to our partner’s proportionate share of the guarantee based on their ownership interest in the joint venture of $24,000 in the current quarter, $27,000 in our fiscal quarter ended September 27, 2015, and $488,000 in our fiscal quarter ended June 28, 2015.

Included in other income, net in the current year quarter and prior year quarter were the following items (in thousands):

Foreign currency transaction gains during the current year quarter resulted from activity associated with foreign denominated assets held by our Mexican subsidiaries. We entered into the Mexican Peso currency forward contracts to minimize earnings volatility resulting from changes in exchange rates affecting the U.S. dollar cost of our Mexican operations. Our Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in the Trust are considered trading securities.

Our effective tax rate was 32.5 percent for the current year quarter. Our effective tax rate for our fiscal year ended June 28, 2015, before the impact of a net reduction in our liability for unrecognized tax benefits was 30.2 percent. The increase in our current year quarter effective tax rate from our fiscal 2015 effective tax rate was the result of the impact of the non-controlling interest portion of our pre-tax income during each period.

Six months ended December 27, 2015 compared to the six months ended December 28, 2014

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

The decreased sales to Fiat Chrysler Automobiles in the current year period were due to lower customer vehicle production volume, primarily on the Dodge and Chrysler Minivans, and lower content on vehicles for which we supply components. The decrease in sales to General Motors Company in the current year period was attributed to incremental service parts sales of $34 million shipped in the prior year period for parts used to support a recall campaign, which incremental sales did not continue during the current year to date period ended December 27, 2015. Increased sales to Ford Motor Company in the current year period were attributed to increased product content on locksets and latches, in particular for the new F-150 pick-up truck for which we supply components. Sales to Tier 1 Customers during the current year period decreased slightly in comparison to the prior year period. These customers represent purchasers of vehicle access control products, such as latches, fobs, and driver controls, that we have developed in recent years to complement our historic core business of locks and keys. The increase in sales to Hyundai / Kia in the current year period was principally due to higher levels of sales on the Kia Sedona minivan for which we supply components.

Direct material costs are the most significant component of our cost of goods sold and comprised $110.3 million or 67.3 percent of cost of goods sold in the current year period compared to $115.8 million or 65.2 percent of cost of goods sold in the prior year period. The reduction in material costs of $5.5 million or 4.7 percent between these six month periods was due to reduced sales volumes in the current year period over the prior year period as discussed above. The increase in material costs as a percent of cost of goods sold is the result of reduced sales of service parts to General Motors Company as discussed above, which typically have lower material cost percentages as compared to parts sold for new vehicle production.

The remaining components of cost of goods sold consist of labor and overhead costs which decreased $8.4 million or 13.5 percent in the current year period as compared to the prior year period as the variable portion of these costs decreased due to the reduction in sales volumes between six month periods. Also impacting the reduction in labor and overhead costs in the current year period as compared to the prior year period was a decrease of $4.0 million in expense provisions for the accrual of bonuses under our incentive bonus plans, a reduction of approximately $4.8 million in the U.S. dollar value of our Mexican operations due to a favorable Mexican peso to U.S. dollar exchange rate, and a lump sum bonus totaling $311,000 paid to our Milwaukee represented hourly workers during the prior year period resulting from the ratification of a new 4-year labor contract, which impacts were partially offset by the benefits of a more favorable absorption of the fixed portion of our labor and overhead costs during our prior year period due to the higher sales volumes in the prior year period and higher depreciation expense, higher repair and maintenance costs, and increased labor costs associated with a less favorable product mix in the current period as compared to the prior year period. The average U.S. dollar / Mexican peso exchange rate increased to approximately 16.55 pesos to the dollar in the current year period from approximately 13.48 pesos to the dollar in the prior year period.

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The reduction in gross profit in the current year period as compared to the prior year period was the result of the reduction in sales and a less favorable product mix, partially offset by the reduction in cost of goods sold as discussed above. The reduction in gross profit as a percentage of net sales in the current year period as compared to the prior year period was the result of reduced sales of service parts related to the General Motors customer recall campaign noted above, which typically have higher gross profit margins as compared to gross profit margins on parts sold for new vehicle production, and reduced customer production volumes resulting in less favorable absorption of our fixed manufacturing costs. These unfavorable impacts to the gross profit margin as a percentage of net sales were partially offset by a decrease in expense provisions for the accrual of bonuses under our incentive bonus plans, a reduction in the U.S. dollar value of the cost of our Mexican operations due to a favorable Mexican peso to U.S. dollar exchange rate, and a lump sum bonus paid to our Milwaukee represented hourly workers during the prior year quarter resulting from the ratification of a new 4-year labor contract, all as discussed above.

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

Engineering, selling and administrative expenses decreased approximately $1.9 million between periods. The reduction in these costs in the current year period as compared to the prior year period was due to reduced expense provisions for the accrual of bonuses under our incentive bonus plans, partially offset by to higher selling and engineering costs associated with current product programs as well as new product programs under development.

Income from operations in the current year period was $13.3 million compared to $22.8 million in the prior year period. This reduction was the result of decreased sales and reduced gross profit margins in the current year period as compared to the prior year period, partially offset by a reduction in engineering, selling and administrative expenses, all as discussed above.

The equity (loss) income of joint ventures was comprised of the following in the current year period and prior year period (in thousands):

VAST LLC’s operations in both China and Brazil were negatively impacted during the current year period by both a slow-down in automotive sales and impacts of foreign currency as it relates to purchases of components outside of their local markets. We anticipate VAST do Brasil will require a capital contribution of approximately $600,000 collectively by all VAST partners to fund operations during the remainder of fiscal 2016. STRATTEC’s portion of the capital contributions is anticipated to be $200,000.

STRATTEC is not the primary beneficiary and does not control STRATTEC Advanced Logic, LLC (“SAL LLC”). Accordingly, our investment in SAL LLC is accounted for using the equity method. Notwithstanding the existence of the SAL Credit Facility described herein, as a result of STRATTEC’s guaranty of such credit facility and as a result of borrowing limitations imposed by the bank under such credit facility, even though we maintain a 51 percent ownership interest in SAL LLC, effective with our fiscal 2015 fourth quarter, 100 percent of the funding for SAL LLC was being made through loans from STRATTEC to SAL LLC and the guaranty of the SAL Credit Facility. Therefore, effective with our fiscal 2015 fourth quarter, STRATTEC began recognizing 100 percent of the losses of SAL LLC. In addition, the following losses were included in our current year period equity loss of joint ventures for SAL LLC (thousands of dollars):

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During the current year period, a loan in the amount of $150,000 was made from STRATTEC to SAL LLC in support of operating expenses and working capital needs. A valuation reserve of $150,000 was recorded related to this loan. As of December 27, 2015, the outstanding loan amount from STRATTEC to SAL LLC totaled $250,000. The related valuation allowance related to this loan also totaled $250,000.

SAL LLC has a $1.5 million revolving credit facility with BMO Harris Bank N.A., which is fully guaranteed by STRATTEC. As of December 27, 2015, STRATTEC had a recorded liability equal to the estimated fair value of the guarantee of $1.1 million, which amount is equal to outstanding borrowings on the SAL LLC credit facility as of December 27, 2015. STRATTEC’s proportionate share of the guarantee, based on our ownership percentage in SAL LLC, totals $561,000, and accordingly we have increased our investment in SAL LLC as of December 27, 2015 by this amount. Our joint venture partner did not guarantee their proportionate share of the SAL LLC credit facility. As a result, STRATTEC recorded a loss equal to our partner’s proportionate share of the guarantee based on their ownership interest in the joint venture of $51,000 in the six month period ended December 27, 2015 and $488,000 in our fiscal quarter ended June 28, 2015.

Included in other income, net in the current year period and prior year period were the following items (in thousands):

Foreign currency transaction gains during the current year period resulted from activity associated with foreign denominated assets held by our Mexican subsidiaries. We entered into the Mexican Peso currency forward contracts to minimize earnings volatility resulting from changes in exchange rates affecting the U.S. dollar cost of our Mexican operations. Our Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in the Trust are considered trading securities.

Our effective tax rate was 32.1 percent for the current year period. Our effective tax rate for our fiscal year ended June 28, 2015, before the impact of a net reduction in our liability for unrecognized tax benefits was 30.2 percent. The increase in our current year period effective tax rate from our fiscal 2015 effective tax rate was the result of the impact of the non-controlling interest portion of our pre-tax income during each period.

Liquidity and Capital Resources

Outstanding Receivable Balances from Major Customers

Our primary source of cash flow is from our major customers, which include Fiat Chrysler Automobiles, General Motors Company 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 December 27, 2015 was as follows (in millions):

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Cash Balances in Mexico

We earn a portion of our operating income in Mexico, which is deemed to be permanently reinvested. As of December 27, 2015, $10.2 million of our $17.9 million cash and cash equivalents balance was deemed to be permanently reinvested in Mexico. A portion of our cash balances in Mexico will be used for future capital expenditures and a future plant expansion in Mexico as discussed herein. We currently do not intend nor foresee a need to repatriate these funds. We expect existing domestic cash and cash equivalents and cash flows from operations to continue to be sufficient to fund our operating activities and cash commitments for investing and financing activities, such as regular quarterly dividends and capital expenditures, for at least the next 12 months and thereafter for the foreseeable future. Should we require more capital in the U.S. than is generated by our operations domestically, for example to fund significant discretionary activities, such as acquisitions of businesses and share repurchases, we could elect to repatriate future earnings from foreign jurisdictions or raise capital in the U.S. through borrowings under our revolving credit facility. These alternatives could result in higher effective tax rates, increased interest expense, or other dilution of our earnings.

Cash Flow Analysis

Net cash provided by operating activities was $3.2 million during the current year period compared to $17.7 million during the prior year period. The change in operating cash flow between periods was due to a reduction in our operating profit in the current year period as compared to the prior year period, as discussed above under Analysis of Results of Operations, and an increase in working capital requirements in the current year period as compared to the prior year period. The change in our working capital requirements between periods was the result of an increase in accounts receivable balances during the current year period of $2.1 million compared to a reduction in accounts receivable balances during the prior year period of $6.8 million. Accounts receivable balances as of the beginning of the prior year period were increased as a result of the impact of $11 million in incremental service parts sales in support of a General Motors recall campaign during our quarter ended June 29, 2014, which balances were collected as of the end of the prior year period.

Significant cash payments impacting net cash provided by operating activities during both the current year period and prior year period included cash payments made under our incentive bonus plans and cash payments for Federal, state and foreign income taxes. Cash payments under our incentive bonus plans totaled $5.2 million in the current year period compared to $7.3 million during the prior year period. Cash payments made for Federal, state and foreign income taxes totaled $2.4 million during the current year period compared to $10.2 million during the prior year period. Additionally, a $6 million payment was made during the current year period to settle certain accrued customer price concessions and related warranty matters.

Net cash used by investing activities of $8.5 million during the current year period and $17.6 million during the prior year period included capital expenditures of $8.1 million and $17.0 million, respectively. Capital expenditures during each period were made in support of requirements for new product programs and the upgrade and replacement of existing equipment. Prior year period capital expenditures of $2.1 million and $4.5 million were also made for the purchase of additional facilities in Juarez, Mexico and Auburn Hills, Michigan, respectively. Net cash used by investing activities during the current year period also included a $150,000 loan to our joint venture, STRATTEC Advanced Logic LLC, in support of operating expenses and working capital needs as well as a cash capital contribution of $220,000 to our joint venture, VAST LLC, for purposes of funding operations in Brazil. Net cash used by investing activities during the prior year period also included a $384,000 cash capital contribution to our joint venture, VAST LLC, for purposes of funding operating expenses and a $215,000 loan to our joint venture, VAST LLC, in support of VAST LLC’s purchase of the non-controlling interest in VAST do Brasil and in support of funding operating costs of the Brazil entity.

Net cash used in financing activities during the current year period of $1.9 million included repayments of borrowings under credit facilities of $5.5 million, $932,000 of regular quarterly dividend payments to shareholders and $1.6 million of dividend payments to non-controlling interests in our subsidiaries, partially offset by $5.5 million of additional borrowings under credit facilities and $584,000 of proceeds received from stock option exercises and related excess tax benefits. Net cash used in financing activities of $22,000 during the prior year period included $854,000 of regular quarterly dividend payments to shareholders, $882,000 of dividend payments to non-controlling interests in our subsidiaries and $500,000 of repayments of borrowings under credit facilities, partially offset by $1.5 million of additional borrowings under credit facilities and $714,000 of proceeds received from stock option exercises and related excess tax benefits.

VAST LLC Cash Requirements

No cash capital contributions were made to VAST LLC during the current year period or the prior year period. We currently anticipate that both VAST China and Minda-VAST Access Systems have adequate debt facilities in place over the next fiscal year to cover each businesses’ future operating and capital requirements. VAST do Brasil, due to economic conditions in Brazil, will likely require additional capital contributions of $600,000 in the aggregate by all VAST partners to fund operations during the remainder of fiscal year 2016. STRATTEC’s portion of the capital contributions is anticipated to be $200,000.

STRATTEC Advanced Logic, LLC Cash Requirements

Beginning with the fourth quarter of fiscal year 2015, STRATTEC provided 100 percent of the financial support to fund the start-up operating losses of STRATTEC Advanced Logic, LLC due to our partner’s inability to contribute capital to this joint venture. We anticipate STRATTEC will continue to fund 100 percent of the start-up costs through fiscal year 2016.

Future Capital Expenditures

We anticipate capital expenditures will be approximately $19 million to $20 million in fiscal 2016 in support of requirements for new product programs, the upgrade and replacement of existing equipment, and our portion of the purchase of land by ADAC-STRATTEC de Mexico (ASdM) for the construction of a new facility in the mid-Mexico area. Capital expenditures totaled $8.1 million for the six month period ended December 27, 2015. On January 20, 2016, ASdM, a wholly owned subsidiary of ADAC-STRATTEC LLC which is a joint venture between STRATTEC SECURITY CORPORATION and ADAC Automotive, signed a “Letter of Intent” to purchase land in Leon, Mexico. ASdM intends to construct a new manufacturing facility on this land in the mid-Mexico area. This facility is expected to be used primarily to paint and assemble door handle products. Currently, the ADAC-STRATTEC LLC joint venture has net sales of approximately $60 million. With newly awarded customer business, we anticipate net sales will increase to approximately $120 million within the next two years. Total capital expenditures required for the land, facility, paint system, and assembly equipment is expected to total approximately $20 million. We anticipate financing the required capital expenditures through a combination of partner capital contributions, bank loans, and current operating cash flow.

Stock Repurchase Program

Our Board of Directors has 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 December 27, 2015. A total of 3,655,322 shares have been repurchased over the life of the program through December 27, 2015, at a cost of approximately $136.4 million. No shares were repurchased during the six month periods ended December 27, 2015 or December 28, 2014. Additional repurchases may occur from time to time and are expected to continue to be funded by cash flow from operations and current cash balances. 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 2016.

Credit Facilities

STRATTEC has a $30 million secured revolving credit facility (the “STRATTEC Credit Facility”) with BMO Harris Bank N.A. ADAC-STRATTEC LLC has a $10 million secured revolving credit facility (the “ADAC-STRATTEC Credit Facility”) with BMO Harris Bank N.A, which is guaranteed by STRATTEC. The credit facilities both expire August 1, 2018. Borrowings under either credit facility are secured by our cash balances, accounts receivable, inventory and fixed assets located in the U.S. Interest on borrowings under both credit facilities is at varying rates based, at our option, on LIBOR plus 1.0 percent or the bank’s prime rate. 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. Outstanding borrowings under the STRATTEC Credit Facility totaled $7.5 million at December 27, 2015 and $7 million at June 28, 2015. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $3.6 million and 1.2 percent, respectively, during the six months ended December 27, 2015. There were no borrowings under the STRATTEC Credit facility during the six months ended December 28, 2014. Outstanding borrowings under the ADAC-STRATTEC Credit Facility totaled $2.5 million at December 27, 2015 and $3.0 million at June 28, 2015. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $3.1 million and 1.3 percent, respectively, during the six months ended December 27, 2015. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $3.8 million and 1.2 percent, respectively, during the six months ended December 28, 2014.

STRATTEC Advanced Logic LLC (“SAL LLC”) has a $1.5 million revolving credit facility (the “SAL Credit Facility’) with BMO Harris Bank N.A., which is fully guaranteed by STRATTEC. Interest on borrowings under the SAL Credit Facility is at varying rates based, at SAL LLC’s option, on LIBOR plus 1.0 percent or the bank’s prime rate. The SAL Credit Facility currently has a maturity date of February 16, 2016. Outstanding borrowings under the SAL Credit Facility as of December 27, 2015 totaled $1.1 million. As of December 27, 2015, STRATTEC had a recorded liability related to its guarantee of $1.1 million, which amount is equal to the estimated fair value of its guarantee of this credit facility as of December 27, 2015.

SAL LLC maintains a license agreement with Westinghouse allowing SAL LLC to do business as Westinghouse Security. STRATTEC guaranteed all payments due under the Westinghouse agreement. As of December 27, 2015, STRATTEC has a recorded liability related to this guarantee of $250,000, which amount is equal to the amount of future payments required under the agreement and the estimated fair value of the guarantee as of December 27, 2015

Inflation and Other Changes in Prices

Inflation Related Items: Over the past several years, we have been impacted by rising health care costs, which have increased our cost of associate medical coverage. A portion of these increases have been offset by plan design changes and associate wellness initiatives. We have also been impacted by increases in the market price of zinc and brass and inflation in Mexico, which impacts the U. S. dollar costs of our Mexican operations. We have negotiated raw material price adjustment clauses with certain, but not all, of our customers to offset some of the market price fluctuations in the cost of zinc. We have contracts with Bank of Montreal that provide for bi-weekly Mexican peso currency forward contracts for a portion of our estimated peso denominated operating costs. Refer to discussion under Item 3 Quantitative and Qualitative Disclosures About Market Risk included herein.

Joint Ventures and Majority Owned Subsidiaries

We participate in certain Alliance Agreements with WITTE Automotive (“WITTE”) and ADAC Automotive (“ADAC”). WITTE, of Velbert, Germany, is a privately held automotive supplier. WITTE designs, manufactures and markets automotive components, including locks and keys, hood latches, rear compartment latches, seat back latches, door handles and specialty fasteners. WITTE’s primary market for these products has been Europe. ADAC, of Grand Rapids, Michigan, is a privately held automotive supplier and manufactures engineered products, including door handles and other automotive trim parts, utilizing plastic injection molding, automated painting and various assembly processes.

The Alliance Agreements include a set of cross-licensing agreements for the manufacture, distribution and sale of WITTE products by STRATTEC and ADAC in North America, and the manufacture, distribution and sale of STRATTEC and ADAC products by WITTE in Europe. Additionally, a joint venture company, Vehicle Access Systems Technology LLC (“VAST LLC”), in which WITTE, STRATTEC and ADAC each hold a one-third interest, exists to seek opportunities to manufacture and sell each company’s products in areas of the world outside of North America and Europe.

VAST do Brasil services customers in South America. Effective March 21, 2014, VAST LLC purchased the remaining non-controlling interest in VAST do Brasil. VAST Fuzhou, VAST Great Shanghai and VAST Shanghai Co. (collectively known as VAST China), provide a base of operations to service our automotive customers in the Asian market. VAST LLC also maintains branch offices in South Korea and Japan in support of customer sales and engineering requirements.

Effective April 30, 2015, VAST LLC executed an agreement to become a 50:50 joint venture partner with Minda Management Services Limited an affiliate of both Minda Corporation Limited and Spark Minda, Ashok Minda Group of New Delhi, India (collectively “Minda”). VAST acquired a fifty percent equity interest in the former Minda-Valeo Security Systems joint venture entity, based in Pune, India, for approximately $12 million. This joint venture entity was renamed Minda-VAST Access Systems (“Minda-VAST”). The portion of the purchase price paid by each VAST LLC partner, STRATTEC, WITTE and ADAC, totaled $4 million during fiscal 2015. Minda-VAST has operations in Pune and Delhi and is expected to have annual sales of approximately $40 million during our fiscal year 2016. Minda and its affiliates cater to the needs of all major car, motorcycle, commercial vehicle, tractor and off-road vehicle manufacturers in India. They are a leading manufacturer in the Indian marketplace of security & access products, handles, automotive safety, restraint systems, driver information and telematics systems for both OEMs and the aftermarket.

The VAST LLC investments are accounted for using the equity method of accounting. The activities related to the VAST LLC joint ventures resulted in equity earnings of joint ventures to STRATTEC of approximately $478,000 during the six months ended December 27, 2015 and approximately $518,000 during the six months ended December 28, 2014. During the six months ended December 27, 2015, capital contributions totaling $660,000 were made to VAST LLC for purposes of funding operations in Brazil. STRATTEC’s portion of the capital contributions totaled $220,000. During the six months ended December 28, 2014 capital contributions totaling $384,000 were made to VAST LLC by each partner in support of operating expenses. During the six months ended December 28, 2014, a loan was made by each partner, STRATTEC, WIITE and ADAC, to VAST LLC totaling $215,000 for each partner in order to support VAST LLC’s purchase of the non-controlling interest in VAST do Brasil and to fund the operating costs of the Brazilian entity.

ADAC-STRATTEC LLC, a Delaware limited liability company, was formed in fiscal year 2007 to support injection molding and door handle assembly operations in Mexico. ADAC-STRATTEC LLC was 51 percent owned by STRATTEC and 49 percent owned by ADAC for all periods presented in this report. An additional Mexican entity, ADAC-STRATTEC de Mexico, is wholly owned by ADAC-STRATTEC LLC. ADAC-STRATTEC LLC’s financial results are consolidated with the financial results of STRATTEC and resulted in increased net income to STRATTEC of approximately $1.4 during the six months ended December 27, 2015 and approximately $1.1 million during the six months ended December 28, 2014.

STRATTEC POWER ACCESS LLC (“SPA”) was formed in fiscal year 2009 to supply the North American portion of the power sliding door, lift gate and deck lid system access control products which were acquired from Delphi Corporation. SPA was 80 percent owned by STRATTEC and 20 percent owned by WITTE for all periods presented in this report. The financial results of SPA are consolidated with the financial results of STRATTEC and resulted in decreased net income to STRATTEC of approximately $389,000 during the six months ended December 27, 2015 and increased net income of approximately $1.0 million during the six months ended December 28, 2014.

STRATTEC Advanced Logic, LLC (“SAL LLC”), was formed in fiscal 2013 to introduce a new generation of biometric security products based upon the designs of Actuator Systems LLC, our partner and the owner of the remaining ownership interest. SPA was 51 percent owned by STRATTEC for all periods presented in this report. The initial capitalization of SAL LLC totaled $1.5 million. STRATTEC’s portion of the initial capitalization totaled $765,000. Our investment in SAL LLC, for which we exercise significant influence but do not control and are not the primary beneficiary, is accounted for using the equity method. The activities related to SAL LLC resulted in an equity loss of joint ventures to STRATTEC of approximately $793,000 during the six months ended December 27, 2015 and approximately $449,000 during the six months ended December 28, 2014. Notwithstanding the existence of the SAL Credit Facility described herein, as a result of STRATTEC's guaranty of such credit facility and as a result of borrowing limitations imposed by the bank under such credit facility, even though we maintain a 51 percent ownership interest in SAL LLC, effective with our fiscal 2015 fourth quarter, 100 percent of the funding for SAL LLC was being made by STRATTEC through loans. Therefore, STRATTEC began recognizing 100 percent of the losses of SAL LLC through Equity (Loss) Earnings of Joint Ventures in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income as of our fiscal 2015 fourth quarter. In addition, the following losses were included in our Equity (Loss) Earnings of Joint Ventures for SL LLC for the six months ended December 27, 2015 (thousands of dollars):

See further discussion under Equity (Loss) Earnings of Joint Ventures included in Notes to Financial Statements herein.

Our exposure to market risk is limited to fluctuations in raw material commodity prices, interest rate fluctuations on borrowings under our secured revolving credit facilities and foreign currency exchange rate risk associated with STRATTEC’s foreign operations. We do not utilize financial instruments for trading purposes.

Interest Rates: We are subject to interest rate fluctuations on borrowings under our revolving credit facilities. At December 27, 2015, we had $10 million of outstanding borrowings under our credit facilities. The interest expense related to borrowings under the credit facilities during the six months ended December 27, 2015 was $44,000. A 10% increase or decrease in the interest rate on our borrowings would not have a material effect on our financial position, results of operations or cash flows.

Foreign Currency: We are subject to foreign currency exchange rate exposure related to the U.S. dollar costs of our manufacturing operations in Mexico. A portion of our manufacturing costs are incurred in Mexican pesos, which causes our earnings and cash flows to fluctuate due to changes in the U.S. dollar/Mexican peso exchange rate. We own and operate manufacturing operations in Mexico. As a result, a portion of our manufacturing costs are incurred in Mexican pesos, which causes our earnings and cash flows to fluctuate due to changes in the U.S. dollar/Mexican peso exchange rate. As of December 27, 2015, we have executed contracts with Bank of Montreal that provide for bi-weekly Mexican peso currency forward contracts for a portion of our estimated peso denominated operating costs. The current peso currency forward contracts include settlement dates that began on October 16, 2015 and end on June 15, 2017. No forward contracts were in place during fiscal 2015 or outstanding as of June 28, 2015. Additional contracts were entered into subsequent to December 27, 2015. Refer to Subsequent Event in Noted to Condensed Consolidated Financial Statements included herein. Our objective in entering into these currency forward contracts is to minimize our earnings volatility resulting from changes in exchange rates affecting the U.S. dollar cost of our Mexican operations. The Mexican peso forward contracts are not used for speculative purposes and are not designated as hedges. As a result, all currency forward contracts are recognized in our accompanying condensed consolidated financial statements at fair value and changes in the fair value are reported in current earnings as part of Other Income, net.

The following table quantifies the outstanding Mexican peso forward contracts as of December 27, 2015 (thousands of dollars, except average forward contract exchange rates):

The fair market value of all outstanding Mexican peso forward contracts in the accompanying Condensed Consolidated Balance Sheets was as follows (thousands of dollars):

The pre-tax effects of the Mexican peso forward contracts are included in Other Income, net on the accompanying Condensed Consolidated Statements of Operations and Comprehensive Income and consisted of the following (thousands of dollars):

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Raw Materials Commodity Prices: Our primary raw materials are high-grade zinc, brass, nickel silver, aluminum, steel and plastic resins. These materials are generally available from a number of suppliers, but we have chosen to concentrate our sourcing with one primary vendor for each commodity or purchased component. We believe our sources of raw materials are reliable and adequate for our needs. However, the development of future sourcing issues related to using existing or alternative raw materials and the global availability of these materials as well as significant fluctuations in the market prices of these materials may have an adverse effect on our financial results if the increased raw material costs cannot be recovered from our customers. Given the significant financial impact on us relating to changes in the cost of our primary raw materials, we now attempt to quote quarterly material price adjustments for changes in our zinc costs in our negotiations with our customers. Our success in obtaining these quarterly price adjustments in our customer contracts is dependent on separate negotiations with each customer. It is not a standard practice for our customers to include such price adjustments in their contracts. We have been successful in obtaining quarterly price adjustments in some of our customer contracts. However, we have not been successful in obtaining the adjustments with all of our customers.

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

There have been no material changes to the risk factors disclosed in our Form 10-K as filed with the Securities and Exchange Commission on September 4, 2015.