Business Context and Reporting Period
STRATTEC Security Corporation designs and manufactures automotive access-control products, including locks, keys, latches, handles, ignition components and power-access systems. It serves primarily North American automotive customers and participates in global operations through the VAST alliance and majority-owned joint ventures. The company has one reporting segment.
This Form 10-Q covers the three and six months ended December 27, 2015, compared with December 28, 2014. The filing was signed February 4, 2016. Fiscal 2016 year-to-date results therefore represent the first six months of the fiscal year.
Financial Performance and Liquidity
| Metric | Three Months Ended Dec. 27, 2015 | Prior Comparable Period | Six Months Ended Dec. 27, 2015 | Prior Comparable Period |
|---|---|---|---|---|
| Net sales | $102.5 million | $102.0 million | $199.0 million | $224.2 million |
| Gross profit | $18.6 million | $18.5 million | $35.1 million | $46.5 million |
| Gross margin | 18.2% | 18.1% | 17.6% | 20.7% |
| Income from operations | $7.4 million | $8.0 million | $13.3 million | $22.8 million |
| Net income attributable to STRATTEC | $3.4 million | $5.8 million | $6.7 million | $15.1 million |
| Diluted EPS | $0.93 | $1.58 | $1.83 | $4.13 |
| Net cash from operating activities | Not provided quarterly | Not provided quarterly | $3.2 million | $17.7 million |
Second-quarter sales increased approximately 0.5%, while operating income declined approximately 6.9% and diluted EPS declined approximately 41%. Year-to-date sales declined approximately 11.2%, operating income declined approximately 41.6%, and diluted EPS declined approximately 55.7%.
Engineering, selling and administrative expense was $11.2 million, or 10.9% of sales, in the quarter, compared with $10.5 million, or 10.3%, in the prior period. Year-to-date expense was $21.8 million, or 10.9% of sales, versus $23.7 million, or 10.6%.
- Cash and cash equivalents were $17.9 million at December 27, 2015, down from $25.7 million at June 28, 2015.
- Receivables were $60.8 million and inventories were $45.2 million, compared with $58.8 million and $34.8 million, respectively, at fiscal year-end.
- Total current assets were $143.5 million versus current liabilities of $67.7 million.
- Outstanding borrowings under STRATTEC and ADAC-STRATTEC credit facilities totaled $10.0 million. The facilities total $40 million and expire August 1, 2018.
- The company was in compliance with all applicable credit-facility covenants.
- Year-to-date capital expenditures were $8.1 million. Management expects fiscal 2016 capital expenditures of approximately $19 million to $20 million.
- Quarterly dividends declared were $0.13 per share, compared with $0.12 in the prior-year quarter.
Material Changes Versus the Prior Comparable Period
- Year-to-date revenue was adversely affected by the absence of approximately $34 million of prior-year General Motors service-parts sales related to a recall campaign.
- Year-to-date Fiat Chrysler sales declined to $60.3 million from $64.8 million because of lower vehicle production and content. Ford sales increased to $27.7 million from $23.4 million, driven principally by content on the new F-150.
- Year-to-date gross margin fell 310 basis points to 17.6%. Management attributed the decline to lower service-parts sales, less favorable product mix and reduced absorption of fixed manufacturing costs.
- Lower Mexican operating costs resulting from the weaker peso, reduced incentive-bonus provisions and lower variable labor and overhead costs partly offset the unfavorable volume and mix effects.
- Other income declined to $0.3 million year to date from $2.6 million. Foreign-currency transaction gains fell to $1.3 million from $2.4 million, while the company recognized $0.9 million of unrealized and $0.2 million of realized losses on peso forward contracts.
- Operating cash flow fell to $3.2 million from $17.7 million, primarily because of lower operating profit, increased receivables and a $10.4 million increase in inventory.
- A previously accrued customer warranty issue was settled during the six-month period, reducing the warranty liability by approximately $2.05 million. Management also disclosed a $6 million cash payment related to accrued customer price concessions and warranty matters.
- Equity losses from joint ventures were $0.3 million year to date versus equity earnings of $0.1 million in the prior period. SAL LLC accounted for $0.8 million of the current-period loss, including a $0.2 million loss related to its loan and credit-facility guarantee.
Guidance, Outlook, Risks and Unusual Items
Management reported stronger demand for components used in light trucks and sport- and car-based utility vehicles than for passenger cars, which it linked partly to lower gasoline prices. If gasoline prices remain low, management expects this purchasing trend to continue through the balance of fiscal 2016.
- Management expects VAST do Brasil to require approximately $0.6 million of additional aggregate partner capital during the remainder of fiscal 2016; STRATTEC’s anticipated share is approximately $0.2 million.
- STRATTEC expects to fund 100% of SAL LLC’s start-up costs through fiscal 2016 because its joint-venture partner is unable to contribute capital. SAL LLC had $1.1 million of borrowings under a facility fully guaranteed by STRATTEC, which matured February 16, 2016.
- On January 20, 2016, ADAC-STRATTEC de Mexico signed a letter of intent to purchase land in Leon, Mexico, for a planned manufacturing facility. Total required capital expenditures for land, the facility, paint systems and assembly equipment are expected to be approximately $20 million, funded through partner contributions, bank loans and operating cash flow.
- Outstanding peso forwards had aggregate notional amounts of $21 million and a recorded fair-value liability of $0.9 million at December 27, 2015. These instruments are not designated as hedges, so changes in fair value affect current earnings.
- Mexico-related currency exposure, commodity prices for zinc, brass, nickel silver, aluminum, steel and plastics, customer concentration, automotive production levels, warranty claims, product recalls and foreign operations are key risks.
- The company had $1.4 million reserved for environmental remediation at its Milwaukee facility and stated that the reserve was adequate. Active remediation could be required if natural attenuation does not support regulatory closure.
- The company expects voluntary contributions of approximately $3.0 million to its qualified pension plan during the remainder of fiscal 2016. The timing and financial impact of terminating the plan have not yet been determined.
- No material changes were reported to the risk factors in the 2015 Form 10-K. Management stated that disclosure controls were effective at a reasonable-assurance level.
Most Important Facts to Verify
- Whether North American vehicle production, product mix and the absence of prior-year GM recall-related service-parts sales continue to pressure revenue and margins.
- Whether operating cash flow improves after the significant inventory build and higher receivables recorded at December 27, 2015.
- The refinancing or repayment outcome for SAL LLC’s $1.1 million facility and the extent of additional STRATTEC funding required for SAL LLC.
- The final scope, timing and funding of the planned Leon, Mexico facility and the projected $19 million to $20 million fiscal 2016 capital-expenditure program.
- Potential earnings effects from peso forward contracts, Mexican peso movements and commodity-price changes.
- The adequacy of warranty, environmental, pension and guarantee reserves, including the $1.4 million environmental reserve and STRATTEC’s guarantees of SAL LLC obligations.
- Whether the company maintains covenant compliance and sufficient domestic liquidity, given that $10.2 million of its $17.9 million cash balance was held in Mexico and deemed permanently reinvested.