STRATTEC SECURITY CORPORATION — Fiscal 2017 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended April 2, 2017, compared with March 27, 2016. The request references “2016 Q3,” but the filing is for fiscal 2017 third quarter. Results are unaudited and presented in thousands except per-share amounts.
Business Context
STRATTEC designs and manufactures automotive access-control products, including mechanical and electronic locks and keys, latches, handles, ignition housings, and power access systems. Operations and customers span North America, Mexico, Europe, Asia, and South America. The company consolidates majority-owned ADAC-STRATTEC and STRATTEC Power Access entities and accounts for VAST and SAL joint ventures under the equity method.
Financial Highlights
| Metric | Q3 FY2017 | Q3 FY2016 | Nine Months FY2017 | Nine Months FY2016 |
|---|---|---|---|---|
| Net sales | $109.7 million | $94.0 million | $308.9 million | $293.1 million |
| Gross profit | $17.4 million | $14.5 million | $45.5 million | $49.6 million |
| Gross margin | 15.9% | 15.4% | 14.7% | 16.9% |
| Operating income | $5.5 million | $3.8 million | $10.9 million | $17.2 million |
| Operating margin | 5.0% | 4.1% | 3.5% | 5.9% |
| Net income attributable to STRATTEC | $3.5 million | $1.9 million | $5.4 million | $8.6 million |
| Diluted EPS | $0.95 | $0.52 | $1.48 | $2.35 |
Q3 net income benefited from $1.5 million of other income, including a $2.7 million unrealized gain on Mexican peso forward contracts. Nine-month net income included a $424,000 deferred tax liability related to a change in the company’s assertion regarding permanent reinvestment of Mexican earnings.
Cash Flow, Liquidity, and Debt
- Nine-month operating cash flow was $12.2 million, compared with $8.4 million in the prior-year period.
- Capital expenditures were $26.6 million, compared with $14.3 million, producing net investing cash use of $28.7 million.
- Net financing cash provided was $5.9 million, including $30.0 million of borrowings and $24.0 million of repayments.
- Cash declined to $5.0 million from $15.5 million at July 3, 2016. Approximately $680,000 was held in Mexico.
- Borrowings totaled $26.0 million at April 2, 2017: $12.0 million under STRATTEC’s facility and $14.0 million under the ADAC-STRATTEC facility. Both facilities expire August 1, 2019.
- The company was in compliance with all credit-facility covenants. Facilities are secured by U.S. cash, receivables, inventory, and fixed assets.
- Receivables from Fiat Chrysler, General Motors, and Ford totaled $16.6 million, $14.1 million, and $9.8 million, respectively.
Material Changes Versus the Prior Comparable Period
- Q3 sales increased 16.7%, driven by higher content and production volumes for General Motors and Ford, increased Tier 1 and commercial/OEM sales, and higher Hyundai/Kia volumes. Nine-month sales increased 5.4%, despite lower Fiat Chrysler sales related to the discontinued Chrysler 200 and Dodge Dart and lower Chrysler Pacifica volume.
- Q3 gross margin improved modestly because of higher volume and favorable peso translation, although quality initiatives, production costs, royalties, higher Mexican wages, start-up costs, and mix pressures offset part of the benefit.
- Nine-month gross margin fell to 14.7% from 16.9%, and operating income fell 36.4%, primarily due to customer price reductions, less favorable mix, manufacturing quality costs, production and expediting costs, higher wages and royalties, and Leon facility start-up costs.
- VAST equity earnings increased to $1.5 million from $689,000 for the nine months. SAL generated a $1.4 million equity loss, with STRATTEC funding substantially all start-up costs and recognizing 100% of losses up to its committed support.
- Capital spending increased substantially as the company constructed a new paint and assembly facility in Leon, Mexico. The company contributed $3.06 million toward the required $6.0 million ADAC-STRATTEC capital contribution.
- No shares were repurchased during the nine-month period. The company expects modest or no repurchase activity for the remainder of fiscal 2017 to conserve cash.
Guidance, Outlook, Risks, and Unusual Items
- Management expects North American light-vehicle production over the next calendar year to be flat or slightly below 2016 levels. Capital spending is expected to remain high through calendar 2017.
- Fiscal 2017 capital expenditures are expected to total approximately $32 million. The Leon facility is expected to become operational during the September 2017 fiscal quarter; total project spending is expected to be approximately $22 million, of which $18.2 million had been incurred by April 2, 2017.
- ADAC-STRATTEC sales are currently approximately $60 million, with management expecting approximately $110 million within two years based on newly awarded business.
- Management expects VAST’s Brazil operations to require approximately $750,000 of additional collective funding during the remainder of fiscal 2017, including an estimated $250,000 STRATTEC share. SAL funding is expected to require approximately $500,000 in additional loans through fiscal 2017.
- Key risks include automotive production and customer demand, customer model changes and purchasing actions, price reductions, raw-material costs, warranty claims and recalls, manufacturing quality, Mexican peso and other foreign-currency movements, interest rates, competitive and technological developments, and the concentration of receivables among major automakers.
- Mexican peso forward contracts had aggregate notional amounts of $18.0 million and generated a $1.1 million nine-month unrealized gain, which may reverse depending on future exchange rates.
- The company maintains a $1.3 million environmental reserve for its Milwaukee facility and believes it is adequate, although active remediation could still be required.
- The qualified pension plan has not yet been terminated. Management intends to request an IRS determination letter before the end of calendar 2017 and anticipates termination before the end of calendar 2018; the resulting settlement impact has not been determined.
- Management reported no material changes to previously disclosed risk factors, no material legal proceedings, and effective disclosure controls.
Investor Verification Checklist
- Verify whether Leon, Mexico facility completion and start-up costs remain on schedule and within the approximately $22 million project estimate.
- Assess liquidity after planned capital expenditures, additional joint-venture funding, dividends, and required debt service, given the $5.0 million cash balance.
- Monitor customer production forecasts, especially Fiat Chrysler, Ford, and General Motors, and the effect of discontinued or reduced-volume vehicle programs.
- Separate recurring operating performance from volatile peso-forward-contract gains and other foreign-currency items.
- Review manufacturing quality, scrap, sorting, warranty, and expediting costs for evidence of sustained margin pressure.
- Track SAL funding requirements, the Westinghouse guarantee liability, and the company’s exposure to future SAL losses.
- Evaluate the financial and accounting consequences of the planned pension termination and upcoming revenue-recognition and lease accounting changes.