STRATTEC Security Corporation — Form 10-Q Summary
Reporting period: Three months ended September 30, 2018, the company’s fiscal first quarter of fiscal 2019. The filing was signed November 8, 2018. STRATTEC designs and manufactures automotive access-control products, including locks, keys, latches, door handles, ignition housings and power-access systems, primarily for North American automotive customers. It also participates in the VAST Automotive Group and consolidates majority-owned ADAC-STRATTEC and STRATTEC Power Access operations.
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $117.2 million | $102.5 million | +14.3% |
| Gross profit | $15.2 million | $13.5 million | +12.8% |
| Gross margin | 13.0% | 13.1% | Down 0.1 percentage point |
| Income from operations | $4.2 million | $3.4 million | +21.4% |
| Net income attributable to STRATTEC | $3.5 million | $2.5 million | +41.2% |
| Diluted EPS | $0.93 | $0.67 | +38.8% |
| Operating margin | 3.5% | 3.3% | Improved |
| Cash dividends declared per share | $0.14 | $0.14 | Unchanged |
Sales growth reflected higher product content and production volumes for Fiat Chrysler and General Motors, new customer programs at Honda and Volkswagen, and higher Tier 1 customer volumes. Ford sales were essentially flat, while Hyundai/Kia sales declined. Product-group growth was strongest in Keys & Locksets and Door Handles & Exterior Trim.
Direct material costs increased 18.1% to $67.8 million and represented 66.5% of cost of goods sold, versus 64.5% in the prior-year quarter. New product launches, including the Leon, Mexico door-handle paint and assembly facility, increased production and expediting costs. These pressures were substantially offset by favorable Mexican peso exchange rates, which benefited the quarter by approximately $0.9 million.
Cash flow, liquidity and capital structure
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Cash provided by operating activities | $7.8 million | $0.4 million |
| Capital expenditures | $4.0 million | $7.6 million |
| Cash used in financing activities | $1.3 million | Cash provided of $7.5 million |
| Ending cash and equivalents | $10.3 million | $8.5 million |
| Total credit-facility borrowings | $51.0 million | Prior-period comparable total not clearly presented in the filing |
Cash increased $2.3 million during the quarter. Operating cash flow benefited from improved earnings and lower working-capital requirements compared with the prior year. At September 30, 2018, current assets were $155.6 million and current liabilities were $72.5 million. Cash held in Mexico was $1.5 million and was available for repatriation as needed.
STRATTEC had $24.0 million outstanding on its $40 million secured revolving facility, while ADAC-STRATTEC had $27.0 million outstanding on its $30 million secured facility. Both facilities bear interest generally based on LIBOR plus 1.0% or the bank’s prime rate. The company stated that it was in compliance with all financial covenants.
Material changes and unusual items
- The Tax Cuts and Jobs Act reduced the expected effective tax rate from approximately 23.5% to 8.0%. The quarter included a $20,000 tax benefit versus a $1.1 million tax provision in the prior-year quarter.
- The tax benefit included a $372,000 measurement-period adjustment related to the transition tax. Accounting for certain tax provisions, including GILTI, remained incomplete and provisional.
- Other expense was $245,000, compared with other income of $87,000 in the prior-year quarter. The current quarter included a $428,000 foreign-currency transaction loss, partially offset by $397,000 of realized and unrealized peso-forward-contract gains.
- Equity earnings from VAST LLC declined to $915,000 from $1.035 million. SAL LLC, whose biometric-lock business has been wound down, generated a $6,000 equity loss.
- STRATTEC adopted the new revenue-recognition standard effective July 2, 2018 using the modified retrospective method. The adoption resulted primarily in a $1.2 million balance-sheet reclassification, with no retained-earnings adjustment.
- The company’s frozen Qualified Pension Plan is expected to terminate, with substantially all plan assets intended for distribution before the end of December 2018. The timing and financial impact of the settlement had not been determined and remained subject to final Board approval.
Outlook, risks and contingencies
Management expected North American light-vehicle production during calendar 2018 to remain flat or slightly below 2017 levels, while consumer demand continued to favor light trucks and utility vehicles over passenger cars. Fiscal 2019 capital expenditures were expected to be approximately $12.0 million.
ADAC-STRATTEC’s newly completed Leon, Mexico facility is primarily supporting door-handle painting and assembly. Management expected annual ADAC-STRATTEC sales to increase from approximately $89 million in fiscal 2018 to approximately $110 million in fiscal 2019.
VAST’s Brazilian operation was expected to require approximately $300,000 of additional collective partner funding during the remainder of fiscal 2019, of which STRATTEC’s anticipated share was approximately $100,000. Minimal to no additional funding was expected for SAL LLC.
Key risks include automotive production and consumer demand, customer purchasing decisions, competitive pricing, product launches, raw-material prices, foreign exchange, interest rates, tariffs and trade policies, warranty and recall exposure, and the ability to recover cost increases from customers. The company had $1.3 million reserved for environmental remediation at its Milwaukee facility and stated that its warranty reserves were adequate. No material legal proceedings or material changes to previously disclosed risk factors were reported.
Investor verification checklist
- Verify whether sales growth and operating improvement continued after the quarter, particularly across Fiat Chrysler, General Motors, new Honda/Volkswagen programs and the Leon facility ramp-up.
- Monitor gross-margin pressure from higher material content, competitive pricing, launch costs and raw-material inflation.
- Reconcile cash generation with the $12.0 million fiscal 2019 capital-expenditure plan and assess debt reduction capacity.
- Review covenant headroom and the July 2019 reduction of the ADAC-STRATTEC credit-facility limit from $30 million to $25 million.
- Track final accounting for the Tax Cuts and Jobs Act, including the transition tax, GILTI and related valuation allowances.
- Assess the financial impact and settlement timing of the Qualified Pension Plan termination.
- Monitor Mexican peso exposure, forward-contract results, tariffs, warranty claims and potential environmental-remediation costs.