# Strattec Security Corp: Form 10-Q for the period ended Sep 30, 2018

- Company: [Strattec Security Corp](/companies/strt.md) (CIK 933034)
- Form: 10-Q
- Filed: 2018-11-08
- Accepted by EDGAR: Nov 8, 2018, 06:05 ET
- Period: 2018-09-30
- Accession: 0001564590-18-028239
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/933034/000156459018028239/strt-10q_20180930.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/933034/000156459018028239/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2018-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2018-07-02 to 2018-09-30 | $117.2m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Cost of revenue | 3 months, 2018-07-02 to 2018-09-30 | $102.0m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2018-07-02 to 2018-09-30 | $15.2m | us-gaap:GrossProfit |
| Operating income | 3 months, 2018-07-02 to 2018-09-30 | $4.2m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2018-07-02 to 2018-09-30 | $407.0k | us-gaap:InterestExpense |
| Income tax | 3 months, 2018-07-02 to 2018-09-30 | −$20.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2018-07-02 to 2018-09-30 | $3.5m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2018-07-02 to 2018-09-30 | $0.93 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2018-07-02 to 2018-09-30 | $0.95 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2018-07-02 to 2018-09-30 | 3,711,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2018-07-02 to 2018-09-30 | $7.8m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2018-07-02 to 2018-09-30 | $4.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2018-07-02 to 2018-09-30 | $514.0k | us-gaap:PaymentsOfDividendsCommonStock |
| Cash and equivalents | at 2018-09-30 | $10.3m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2018-09-30 | $155.6m | us-gaap:AssetsCurrent |
| Total assets | at 2018-09-30 | $312.9m | us-gaap:Assets |
| Current liabilities | at 2018-09-30 | $72.5m | us-gaap:LiabilitiesCurrent |
| Shareholders' equity | at 2018-09-30 | $166.0m | us-gaap:StockholdersEquity |
| Shares outstanding | at 2018-10-01 | 3,738,357 shares | dei:EntityCommonStockSharesOutstanding |

## Management's discussion and analysis

As filed, 35,184 characters.

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 2018 Annual Report which was filed with the Securities and Exchange Commission as an exhibit to its Form 10-K on September 6, 2018. Unless otherwise indicated, all references to quarters and years refer to fiscal quarters and fiscal years.

### Outlook

During the fiscal years ended July 1, 2018 and July 2, 2017, 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 both lower gas prices and consumer preferences. If gas prices continue to remain flat or slightly higher over the next few years, we anticipate this consumer buying trend will continue. As we look out over the remainder of calendar 2018, the current sales projections from our third party forecasting service indicate that North American light vehicle production will remain flat or slightly lower than the levels experienced during calendar year 2017.

### Analysis of Results of Operations

#### Three months ended September 30, 2018 compared to the three months ended October 1, 2017

|  | Three Months Ended September 30, 2018 | October 1, 2017 |
| --- | ---: | ---: |
| Net Sales (in millions) | $117.2 | $102.5 |

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

|  | Three Months Ended September 30, 2018 | October 1, 2017 |
| --- | ---: | ---: |
| Fiat Chrysler Automobiles | $30.3 | $24.1 |
| General Motors Company | 25.3 | 20.3 |
| Ford Motor Company | 15.5 | 15.4 |
| Tier 1 Customers | 17.8 | 15.8 |
| Commercial and Other OEM Customers | 21.0 | 17.9 |
| Hyundai / Kia | 7.3 | 9.0 |
|  | $117.2 | $102.5 |

Sales to Fiat Chrysler Automobiles increased in the current year quarter as compared to the prior year quarter due to higher product content on the components we supply. The increase in sales to General Motors Company in the current year quarter as compared to the prior year quarter was attributed to higher production volumes and content on models for which we supply components. Sales to Ford Motor Company in the current year quarter were essentially flat in comparison to the prior year quarter. Sales to Tier 1 Customers increased in the current year quarter as compared to the prior year quarter due to higher production volumes on products we supply. Sales to Commercial and Other OEM Customers during the current year quarter increased in comparison to the prior year quarter due to new customer programs at Honda of America Manufacturing, Inc. and Volkswagen. These customers, along with our Tier 1 Customers, represent purchasers of vehicle access control products, such as latches, fobs, driver control steering column locks and door handles and related components, that we have developed in recent years to complement our historic core business of locks and keys. The decreased sales to Hyundai / Kia in the current year quarter as compared to the prior year quarter were due to lower levels of production on vehicles for which we supply components.

19

|  | Three Months Ended September 30, 2018 | October 1, 2017 |
| --- | ---: | ---: |
| Cost of Goods Sold (in millions) | $102.0 | $89.0 |

Direct material costs are the most significant component of our cost of goods sold and comprised $67.8 million or 66.5 percent of our cost of goods sold in the current year quarter compared to $57.4 million or 64.5 percent of our cost of goods sold in the prior year quarter. The increase in our direct material costs between these quarters of $10.4 million or 18.1 percent was due to increased sales volumes in the current year quarter as compared to the prior year quarter. The increase in our direct material costs as a percentage of our cost of goods sold in the current year quarter as compared to the prior year quarter was due to an increase in sales of products for certain electrical and latch programs in the current year quarter over the prior year quarter, for which the material content represents a more significant portion of the total cost of the product. This trend is expected to continue for the remainder of our fiscal year 2019.

The remaining components of our cost of goods sold consist of labor and overhead costs which increased $2.6 million or 8.2 percent to $34.2 million in the current year quarter from $31.6 million in the prior year quarter as the variable portion of these costs increased due to the increase in sales volumes between the three month periods. Additionally, higher production and expediting costs associated with new product launches occurring during the current year quarter to meet certain customer schedules, in particular in connection with door handle paint and assembly facility in Leon, Mexico, increased costs in the current year quarter as compared to the prior year quarter. These cost increases were partially offset by the impact of a favorable Mexican peso to U.S. dollar exchange rate affecting our operations in Mexico. The U.S. dollar value of our Mexican operations was favorably impacted by approximately $900,000 in the current year quarter as compared to the prior year quarter due to a favorable Mexican peso to U.S. dollar exchange rate between these quarterly periods. The average U.S. dollar / Mexican peso exchange rate increased to approximately 18.96 pesos to the dollar in the current year quarter from approximately 17.95 pesos to the dollar in the prior year quarter.

|  | Three Months Ended September 30, 2018 | October 1, 2017 |
| --- | ---: | ---: |
| Gross Profit (in millions) | $15.2 | $13.5 |
| Gross Profit as a percentage of net sales | 13.0% | 13.1% |

The increase in gross profit dollars in the current year quarter as compared to the prior year quarter was attributed to the increase in sales, partially offset by the increase in cost of goods sold as discussed above. Gross profit as a percentage of net sales was consistent between periods. The current quarter gross profit as a percentage of net sales included the impact of a favorable Mexican peso to U.S. dollar exchange rate impacting the U.S. dollar value of our Mexican operations, as discussed above, as well as more favorable absorption of our fixed manufacturing costs due to increased production volumes as compared to the prior year quarter. These favorable impacts were offset by higher production and expediting costs, as discussed above, and lower gross profit margins on products associated with certain new electrical, latch and lockset programs. The lower gross margins associated with these programs is the result of competitive pricing.

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

|  | Three Months Ended September 30, 2018 | October 1, 2017 |
| --- | ---: | ---: |
| Expenses (in millions) | $11.0 | $10.0 |
| Expenses as a percentage of net sales | 9.4% | 9.8% |

Engineering, selling and administrative expenses increased during the current year quarter as compared to the prior year quarter. The current year quarter as compared to the prior year quarter included an increase in engineering costs related to our ADAC-STRATTEC LLC door handle and exterior trim products.

Income from operations was $4.2 million in the current year quarter compared to $3.4 million in the prior year quarter. This improvement was the result of the quarter over quarter increase in the gross profit margin, partially offset by an increase in engineering, selling and administrative expenses in the current year quarter as compared to the prior year quarter, all as discussed above.

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

|  | Three Months Ended September 30, 2018 | October 1, 2017 |
| --- | ---: | ---: |
| Vehicle Access Systems Technology LLC | $915 | $1,035 |
| STRATTEC Advanced Logic, LLC | (6) | (9) |
|  | $909 | $1,026 |

Our Vehicle Access Systems Technology LLC (“VAST LLC”) joint ventures in China and India continue to report profitable operating results while our joint venture in Brazil continues to report losses due to our limited amount of business in that region. 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. During all periods presented in this report, 100 percent of the funding for SAL LLC was being made through loans from STRATTEC to SAL LLC. Therefore, during all periods presented in this report, even though STRATTEC maintains a 51 percent ownership interest in SAL LLC, STRATTEC recognized 100 percent of the losses of SAL LLC up to our committed financial support. The business of SAL LLC has been wound down to sell only commercial biometric locks.

Included in Other (Expense) Income, net in the current year quarter and prior year quarter were the following items (in thousands):

|  | Three Months Ended September 30, 2018 | October 1, 2017 |
| --- | ---: | ---: |
| Foreign Currency Transaction Loss | $(428) | $(137) |
| Unrealized Gain (Loss) on Peso Forward Contracts | 225 | (258) |
| Realized Gain on Peso Forward Contracts | 172 | 458 |
| Pension and Postretirement Plans (Cost) Credit | (318) | 112 |
| Rabbi Trust Gain | 79 | 89 |
| Other | 25 | (177) |
|  | $(245) | $87 |

Foreign currency transaction losses during the current year quarter and prior 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. Unrealized gains on the peso forward contracts recognized as a result of mark-to-market adjustments as of September 30, 2018 may or may not be realized in future periods, depending on the actual Mexican peso to U.S. dollar exchange rates experienced during the balance of the contract period. Pension and postretirement plan impacts include the components of net periodic benefit cost other than the service cost component. Our Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in the Trust are considered trading securities.

Our income tax provision for the three month period ended September 30, 2018 was impacted by the Tax Cuts and Jobs Act of 2017 (“the Act”), which was signed into law on December 22, 2017 with an effective date of January 1, 2018. The Act made broad and complex changes to the U.S. tax code that affected our tax provision beginning January 1, 2018, including but not limited to (1) a reduction in the U.S. statutory tax rate to 21 percent following its effective date and a change in the measurement of our deferred tax assets and deferred tax liabilities resulting from the reduction in the statutory rate, (2) changes in the U.S. taxation of non-U.S. earnings, and (3) bonus depreciation that will allow for full expensing of qualified property. The current year quarter included a tax benefit of $20,000 compared to a tax provision of $1.1 million in the prior year quarter. This change is the result of a reduction in the expected effective tax rate between periods as well as a current year quarter discrete benefit of $372,000, which represents measurement period adjustments to the one-time transition tax on non-previously taxed post 1986 accumulated foreign earnings. The expected effective tax rate between years decreased from approximately 23.5 percent in the prior year quarter to 8 percent in the current year quarter as a result of the reduction in the U.S. statutory rate and changes in the U.S. taxation of non-U.S. earnings.

The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Act. SAB 118 provides a measurement period that should not extend beyond one year from the Act’s enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Act is incomplete but it is still able to determine a reasonable estimate of the tax effect, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provision of the tax laws that were in effect immediately before the enactment of the Act.

In connection with our analysis of the impact of the Act, we recorded a discrete net tax benefit in the six month period ended July 1, 2018 primarily consisting of (1) the impact of the change in measurement of our deferred tax assets and liabilities, (2) the one-time transition tax on non-previously taxed post 1986 accumulated foreign earnings, and (3) the impact of changing our annualized effective tax rate. Measurement period adjustments recorded in the three month period ended September 30, 2018 totaled $372,000. For various reasons that are discussed more fully below, we have not completed our accounting for the income tax effects for certain elements of the Act. However, we were able to make reasonable estimates of certain effects and, therefore, we recorded provisional adjustments of these elements in the accompanying condensed financial statements. We identified these items as provisional since our analysis of each of the items is not complete.

The Act reduces the corporate tax rate to 21 percent, effective January 1, 2018. For certain of our net deferred tax assets, we have recorded a provisional adjustment to reflect the reduction in the corporate tax rate. While we are able to make a reasonable estimate of the impact of the reduction in the corporate rate, it may be affected by other analyses related to the Act, including, but not limited to, the impact of our calculation of deemed repatriation of deferred foreign income and the impact of full expensing for certain assets.

The Deemed Repatriation Transition Tax (“Transition Tax”) is a tax on previously untaxed accumulated and current earnings and profits (E&P) of certain of our foreign subsidiaries. To determine the amount of the Transition Tax, we must determine, in addition to other factors, the amount of post-1986 E&P of the relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. We were able to make a reasonable estimate of the Transition Tax and recorded a provisional Transition Tax obligation in the accompanying condensed financial statements. However, we are continuing to gather additional information to more precisely compute the amount of the Transition Tax.

We must assess whether our valuation allowance analyses are affected by various aspects of the Act (e.g., deemed repatriation of deferred foreign income, Global Intangible Low-Taxed Income (“GILTI”) inclusions, and new categories of Foreign Tax Credits). Since, as discussed herein, we have recorded provisional amounts related to certain portions of the Act, any corresponding determination of the need for, or change in, a valuation allowance is also provisional.

Our accounting for the following elements of the Act is incomplete, and we were not yet able to make reasonable estimates of the effects. Therefore, no provisional adjustments were recorded for the following elements in our accompanying condensed financial statements.

Because of the complexity of the new GILTI tax rules, we are continuing to evaluate this provision of the Act and the application of ASC 740. Under U.S. GAAP, we are allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method”). Our selection of an accounting policy with respect to the new GILTI tax rules will depend, in part, on analyzing our global income to determine whether we expect to have future U.S. inclusions in taxable income related to GILTI and, if so, what the impact is expected to be. Because whether we expect to have future U.S. inclusions in taxable income related to GILTI depends on not only our current structure and estimated future results of global operations but also our intent and ability to modify our structure and/or our business, we are not yet able to reasonably estimate the effect of this provision of the Act. Therefore, we have not made any adjustments related to potential GILTI tax in our financial statements and have not made a policy decision regarding whether to record deferred taxes on GILTI.

Additionally, our income tax provisions for the three months ended September 30, 2018 and October 1, 2017 were affected by the non-controlling interest portion of our pre-tax income. The non-controlling interest impacts the effective tax rate as ADAC-STRATTEC LLC and STRATTEC POWER ACCESS LLC entities are taxed as partnerships for U.S. tax purposes.

### 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 September 30, 2018 was as follows (in millions):

|  |  |
| --- | ---: |
| Fiat Chrysler Automobiles | $19.9 |
| General Motors Company | $20.7 |
| Ford Motor Company | $9.1 |

### Cash Balances in Mexico

We earn a portion of our operating income in Mexico. As of September 30, 2018, $1.5 million of our $10.3 million cash and cash equivalents balance was held in Mexico. These funds are available for repatriation as deemed necessary.

### Cash Flow Analysis

| Cash Flows from (in millions): | Three Months Ended September 30, 2018 | October 1, 2017 |
| --- | ---: | ---: |
| Operating Activities | $7.8 | $0.4 |
| Investing Activities | $(4.0) | $(7.6) |
| Financing Activities | $(1.3) | $7.5 |

The change in operating cash flow between periods was impacted by improvement in our overall financial result and a reduction in working capital requirements in the current year period as compared to an increase in working capital requirements in the prior year period. The period over period decrease in net working capital requirements totaled $5.8 million. The decrease in our working capital requirements between periods was made up of the following working capital changes between periods (in millions):

|  | Increase (Decrease) in Working Capital Requirements Three Months Ended September 30, 2018 | October 1, 2017 | Change |
| --- | ---: | ---: | ---: |
| Accounts Receivable | $4.4 | $(1.2) | $5.6 |
| Inventory | $(0.4) | $3.9 | $(4.3) |
| Other Assets | $(2.7) | $2.2 | $(4.9) |
| Accounts Payable and Accrued Liabilities | $(1.4) | $0.9 | $(2.3) |

The period over period change in the accounts receivable balances reflected an increase in our accounts receivable balances during the current year period and a reduction in our accounts receivable balances during the prior year period. The period over period change is the result of the timing of sales during each quarter. The increase in accounts receivable balances during the current year period reflected increased sales levels toward the end of the current year period as compared to the end of our June 2018 quarter. The reduction in accounts receivable balances during the prior year period reflected reduced sales levels toward the end of the prior year period as compared to the end of our June 2017 quarter. The period over period change in inventory reflected an increase in inventory balances during the prior year period, which was the result of ramping up for new customer program launches. The period over period change in other assets reflected a reduction in our other assets balances in the current year period and an increase other assets balances during the prior year period. The current year period reduction was the result of a reduction in customer tooling balances while the prior year increase was the result of increases in customer tooling balances. Customer tooling balances consisted of costs incurred for the development of tooling that will be directly reimbursed by our customer whose parts are produced from the tool. Changes in customer tooling balances during each period was the result of the timing of tooling development spending required to meet customer production requirements and related customer billing for cost reimbursement. The quarter over quarter change in accounts payable and accrued liability balances reflected a decrease in working capital requirements in the current year period and a slight increase in working capital requirements in the prior year period. This current period decrease in working capital requirements was the result of increased value added tax payable balances in Mexico resulting from increased sales.

Net cash used by investing activities of $4.0 million during the current year period and $7.6 million during the prior year period were the result of capital expenditures made in support of requirements for new product programs and the upgrade and replacement of existing equipment. Prior year period capital expenditures also included $792,000 related to the construction of a new ADAC-STRATTEC facility and the purchase of related equipment in Leon, Mexico. Refer to discussion under ADAC-STRATTEC LLC Cash Requirements included herein.

Net cash used in financing activities during the current year period of $1.3 million included repayments of borrowings under credit facilities of $2.0 million, $514,000 of regular quarterly dividend payments to shareholders and $784,000 of dividend payments to non-controlling interests in our subsidiaries, partially offset by $2 million in additional borrowings under credit facilities. Net cash provided by financing activities of $7.5 million during the prior year period included $12.0 million of additional borrowings under credit facilities, which was partially offset by repayments of borrowings under credit facilities of $2.0 million, $508,000 of regular quarterly dividend payments to shareholders and $2.0 million of dividend payments to non-controlling interests in our subsidiaries.

### VAST LLC Cash Requirements

No capital contributions were made to VAST LLC during the three month periods ended September 30, 2018 or October 1, 2017. 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 the future operating and capital requirements of each business. During the three months ended September 30, 2018, VAST LLC made capital contributions to Sistema de Acesso Veicular Ltda totaling $300,000. Due to economic conditions in Brazil, we anticipate Sistema de Acesso Veicular Ltda, will require a capital contribution of approximately $300,000 collectively by all VAST LLC partners to fund operations during the remainder of fiscal year 2019. STRATTEC’s portion of these remaining capital contributions is anticipated to be $100,000.

### ADAC-STRATTEC LLC Cash Requirements

ADAC-STRATTEC de Mexico (ASdM), a wholly owned subsidiary of ADAC-STRATTEC LLC, which is a joint venture between STRATTEC SECURITY CORPORATION and ADAC Automotive, began the construction of a new manufacturing facility in Leon, Mexico during our fiscal 2017 and completed the construction during our fiscal 2018. Accordingly, during our fiscal 2018 the paint system and assembly equipment located at the new facility became fully operational. Total capital expenditures required for the land, facility, paint system, and assembly equipment totaled approximately $22.5 million. In connection with this facility construction, the ADAC-STRATTEC Credit Facility was amended effective as of March 27, 2018 to increase the borrowing limit to $30 million until June 30, 2019, at which time the borrowing limit will return to $25 million. This facility is being used primarily to paint and assemble door handle products. As of fiscal 2018, the ADAC-STRATTEC LLC joint venture had annual net sales of approximately $89 million. With newly awarded customer business, we anticipate annual net sales will increase to approximately $110 million during fiscal 2019.

### STRATTEC Advanced Logic, LLC Cash Requirements

During all periods presented in this report, STRATTEC provided 100 percent of the financial support to fund the start-up operating losses of SAL LLC through loans due to our joint venture partner’s inability to contribute capital to this joint venture. The business of SAL LLC has been wound down to sell only commercial biometric locks. We anticipate STRATTEC will provide minimal to no funding for SAL LLC in fiscal year 2019.

### Future Capital Expenditures

We anticipate capital expenditures will be approximately $12.0 million in fiscal 2019 in support of requirements for new product programs and the upgrade and replacement of existing equipment.

### 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 September 30, 2018. A total of 3,655,322 shares have been repurchased over the life of the program through September 30, 2018, at a cost of approximately $136.4 million. No shares were repurchased during the three month periods ended September 30, 2018 or October 1, 2017. 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 2019.

### Credit Facilities

STRATTEC has a $40 million secured revolving credit facility (the “STRATTEC Credit Facility”) with BMO Harris Bank N.A., which expires August 1, 2021. ADAC-STRATTEC LLC has a $30 million secured revolving credit facility (the “ADAC-STRATTEC Credit Facility”) with BMO Harris Bank N.A., which is guaranteed by STRATTEC and expires August 1, 2020. The ADAC-STRATTEC Credit Facility borrowing limit decreases to $25 million effective July 1, 2019. 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 both credit facilities is at varying rates based, at our option, on the London Interbank Offering Rate (“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 $24 million at September 30, 2018 and $23 million at July 1, 2018. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $23.8 million and 3.1 percent, respectively, during the three months ended September 30, 2018. Outstanding borrowings under the ADAC-STRATTEC Credit Facility totaled $27 million at September 30, 2018 and $28.0 million at July 2, 2017. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $28.4 million and 3.1 percent, respectively, during the three months ended September 30, 2018.

### 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 and monthly 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 LLC has investments in Sistema de Acesso Veicular Ltda, VAST Fuzhou, VAST Great Shanghai, VAST Shanghai Co. and Minda-VAST Access Systems. Sistema de Acesso Veicular Ltda is located in Brazil and services customers in South America. 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. Minda-VAST Access Systems is based in Pune, India and is a 50:50 joint venture with Minda Management Services Limited, an affiliate of both Minda Corporation Limited and Spark Minda, Ashok Minda Group of New Delhi, India (collectively “Minda”). 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. VAST LLC also maintains branch offices in South Korea and Japan in support of customer sales and engineering requirements.

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 $915,000 million during the three months ended September 30, 2018 and $1.0 million during the three months ended October 1, 2017. During the three months ended September 30, 2018 and October 1, 2017, no capital contributions were made to VAST LLC.

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 $575,000 during the three months ended September 30, 2018 and approximately $416,000 during the three months ended October 1, 2017.

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 increased net income to STRATTEC of approximately $681,000 during the three months ended September 30, 2018 and approximately $623,000 during the three months ended October 1, 2017.

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. SAL LLC was 51 percent owned by STRATTEC for all periods presented in this report. 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 equity loss of joint ventures to STRATTEC of approximately $6,000 during the three months ended September 30, 2018 and approximately $9,000 during the three months ended October 1, 2017. During all periods presented in this report, 100 percent of the funding for SAL LLC was being made through loans from STRATTEC to SAL LLC. Therefore, for all periods presented in this report, even though STRATTEC maintains a 51 percent ownership interest in SAL LLC, STRATTEC recognized 100 percent of the losses of SAL LLC up to our committed financial support through Equity Earnings (Loss) of Joint Ventures in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income. The business of SAL LLC has been wound down to sell only commercial biometric locks. See further discussion under Equity Earnings (Loss) of Joint Ventures included in Notes to Condensed Consolidated Financial Statements herein.

## Market risk

As filed, 4,661 characters.

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 September 30, 2018, we had $51 million of outstanding borrowings under our credit facilities. The interest expense related to borrowings under the credit facilities during the three months ended September 30, 2018 was $407,000. 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 executed contracts with Bank of Montreal that provide for bi-weekly and monthly Mexican peso currency forward contracts for a portion of our estimated peso denominated operating costs. The peso currency forward contracts include settlement dates that began on October 16, 2015 and end on December 17, 2018. 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 (Expense) Income, net.

The following table quantifies the outstanding Mexican peso forward contracts as of September 30, 2018 (thousands of dollars, except average forward contract exchange rates):

|  | Effective Dates | Notional Amount | Average Forward Contractual Exchange Rate | Fair Value |
| --- | --- | ---: | ---: | ---: |
| Buy MXP/Sell USD | October 15, 2018 - December 17, 2018 | $3,000 | 20.02 | $186 |

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

| Not Designated as Hedging Instruments: Other Current Assets (Liabilities): | September 30, 2018 | July 1, 2017 |
| --- | ---: | ---: |
| Mexican Peso Forward Contracts | $186 | $(39) |

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

| Not Designated as Hedging Instruments: | Three Months Ended September 30, 2018 | October 1, 2018 |
| --- | ---: | ---: |
| Realized Gain | $172 | $458 |
| Unrealized Gain (Loss) | $225 | $(258) |

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.

## Controls and procedures

As filed, 2,199 characters.

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

## Risk factors

As filed, 157 characters.

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 6, 2018.

Filed Nov 8, 2018.
Source: SEC EDGAR, the filing index for accession 0001564590-18-028239. Last ingested by Listed: Nov 6, 2026, 02:27 ET. No prices; not investment advice.