Item 2
STRATTEC SECURITY CORPORATION AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following Management’s Discussion and Analysis should be read in conjunction with the Company’s accompanying Financial Statements and Notes thereto and the Company’s 2004 Annual Report. Unless otherwise indicated, all references to years refer to fiscal years.
Analysis of Results of Operations
Three months ended December 26, 2004 compared to the three months ended December 28, 2003
Net sales for the three months ended December 26, 2004, decreased $1.6 million to $48.4 million compared to net sales of $50.0 million for the three months ended December 28, 2003. Overall sales to the Company’s largest customers decreased in the current quarter compared to the prior year quarter levels. Sales to DaimlerChrysler Corporation increased significantly during the quarter to $12.8 million compared to $9.5 million due to a more favorable vehicle content mix. Sales to Delphi Corporation were flat at $8 million. Sales to General Motors Corporation were $10.8 million compared to $14.0 million due to a combination of price reductions, discontinued models and lower levels of production on certain vehicles the Company supplies. Sal
es to Mitsubishi Motor Manufacturing of America, Inc. were $1 million in the current quarter compared to $2.1 million in the prior year quarter due to lower vehicle production volumes. Sales to Ford Motor Company decreased slightly to $8.5 million compared to $9.0 million due to pre-programmed price reductions. The Ford Motor Company sales in the current quarter do not reflect approximately $600,000 of new lockset content relating to the Ford Mustang, which was sold directly to Ford’s joint venture partner Auto Alliance. Sales to other industrial customers also decreased in comparison to the prior year quarter.
Gross profit as a percentage of net sales was 23.6 percent in the current quarter compared to 24.2 percent in the prior year quarter. The gross profit margin reduction during the current quarter is primarily the result of reduced sales as noted above, which results in lower production volumes, changes in customer product content with lower margins and higher purchased material costs for brass and zinc. The average zinc price per pound increased to $0.59 in the current quarter compared to $0.51 in the prior year quarter. The average brass price per pound increased to $1.92 in the current quarter from $1.55 in the prior year quarter. The Company uses an average of approximately 750,000 pounds of zinc per month and an average of approximately 200,000 pounds of brass pe
r month.
Engineering, selling and administrative expenses were $4.8 million in the current quarter, compared to $5.0 million in the prior year quarter.
Income from operations was $6.6 million in the current quarter compared to $7.1 million in the prior year quarter. The decrease is primarily the result of the decreased sales and gross profit margin as discussed above.
The effective income tax rate for the current quarter was 37.0 percent compared to 37.5 percent in the prior year quarter. The overall effective tax rate differs from the federal statutory tax rate primarily due to the effects of state income taxes.
Six months ended December 26, 2004 compared to the six months ended December 28, 2003
Net sales for the six months ended December 26, 2004, decreased $1.4 million to $93.0 million compared to net sales of $94.4 million for the six months ended December 28, 2003. The overall reduction in sales is the result of lower customer vehicle production, discontinued models and pre-programmed price decreases. The negative factors were partially offset by new program sales and additional content changes on existing products. The change in sales to the Company’s largest customers in the current period compared to the prior year period include General Motors Corporation at $22.2 million compared to $26.6 million, Delphi Corporation at $14.8 million compared to $15.0 million, DaimlerChrysler Corporation at $23.7 million compared to $18.3 million, Ford Motor Co
mpany at $15.6 million compared to $16.3 million and Mitsubishi Motor Manufacturing of America, Inc. at $2.2 million compared to $3.9 million. The Ford Motor Company sales in the current period do not reflect approximately $700,000 of new lockset content relating to the Ford Mustang, which was sold directly to Ford’s joint venture partner Auto Alliance.
Gross profit as a percentage of net sales was 23.9 percent in the current period as well as the prior year period. Gross profit margins were favorably impacted by the Company’s ongoing cost reduction initiatives including lean manufacturing initiatives and the movement of certain assembly operations from Milwaukee to the Juarez, Mexico facilities. This was offset as a result of reduced sales as noted above, which resulted in lower production volumes, changes in customer product content with lower margins and higher purchased material costs for brass and zinc. The average zinc price per pound increased to $0.58 in the current period compared to $0.50 in the prior year period. The average brass price per pound increased to $1.89 in the current period from $1.46 i
n the prior year period. The Company uses an average of approximately 750,000 pounds of zinc per month and an average of approximately 200,000 pounds of brass per month.
Engineering, selling and administrative expenses were $10.0 million in the six months ended December 26, 2004, compared to $9.9 million in the prior year period.
Income from operations was $12.2 million in the current period compared to $12.7 million in the prior year period. The decrease is primarily the result of the decreased sales as discussed above.
The effective income tax rate for the current period was 37.0 percent compared to 37.5 percent in the prior year period. The overall effective tax rate differs from the federal statutory tax rate primarily due to the effects of state income taxes.
Liquidity and Capital Resources
The Company generated cash from operating activities of $1.1 million in the six months ended December 26, 2004 compared to $9.9 million in the six months ended December 28, 2003. The decreased generation of cash from operating activities is primarily due to a decrease in accounts payable and accrued liabilities of $12.3 million in the current period compared to $4.0 million in the prior year period primarily as a result of the changes in accounts payable balances. There was a significant increase in the accounts payable balance in the prior year period as a result of lengthening payment terms with a significant supplier as well as the timing of payments in accordance with normal payment terms. There was a reduction in the accounts payable balance in the current year
which was based on normal payment terms with suppliers. In addition, an $8 million contribution to the Company’s qualified pension plan was made during the current period compared to $5 million in the prior year period.
Capital expenditures during the six months ended December 26, 2004, were $2.0 million compared to $3.0 million during the six months ended December 28, 2003. The Company anticipates that capital expenditures will be approximately $5.0 million in fiscal 2005, primarily in support of requirements for new product programs and the upgrade and replacement of existing equipment.
The Board of Directors of the Company has authorized a stock repurchase program to buy back up to 3,239,395 outstanding shares. Over the life of the repurchase program through December 26, 2004, a total of 3,040,592 shares have been repurchased at a cost of approximately $111.9 million. During the quarter ended December 26, 2004, 12,500 shares were repurchased at a cost of approximately $787,000. Additional repurchases may occur from time to time. Funding for the repurchases was provided by cash flow from operations.
The Company has a $50.0 million unsecured, revolving credit facility (the "Credit Facility"), which expires October 31, 2005. There were no outstanding borrowings under the Credit Facility at December 26, 2004. Interest on borrowings under the Credit Facility are at varying rates based, at the Company’s option, on the London Interbank Offering Rate or the bank’s prime rate. The Credit Facility contains various restrictive non-financial covenants. The Company believes that the Credit Facility is adequate, along with cash flow from operations, to meet its anticipated capital expenditure, working capital and operating expenditure requirements.
The Company has not been significantly impacted by inflationary pressures over the last several years, except for rising health care costs which have increased the Company’s cost of employee medical coverage, fluctuations in the market price of zinc and brass, and inflation in Mexico, which impacts the U.S. dollar costs of the Mexican operations. The Company has entered into purchase commitments for a percentage of its zinc requirements through June 2005 and for a percentage of its brass requirements through March 2005. These commitments will reduce the financial impact of future price fluctuations. The Company does not hedge the peso exposure.
Joint Ventures
On November 28, 2000, the Company signed certain alliance agreements with E. WITTE Verwaltungsgesellschaft GmbH, and its operating unit, WITTE-Velbert GmbH & Co. KG ("WITTE"). WITTE, of Velbert, Germany, is a privately held, QS 9000 and VDA 6.1 certified automotive supplier. WITTE designs, manufactures and markets 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. The WITTE-STRATTEC alliance provides a set of cross-licensing agreements for the manufacture, distribution and sale of WITTE products by the Company in North America, and the manufacture, distribution and sale of the Company’s products by WITTE in Europe. Additionally, a joint venture company ("WITTE-
STRATTEC LLC") - in which each company holds a 50 percent interest - has been established to seek opportunities to manufacture and sell both companies’ products in areas of the world outside of North America and Europe.
In November 2001, WITTE-STRATTEC do Brasil, a joint venture formed between WITTE-STRATTEC LLC and Ifer Estamparia e Ferramentaria Ltda. was formed to service customers in South America. On March 1, 2002, WITTE-STRATTEC China was formed and in April 2004, WITTE-STRATTEC Great Shanghai Co. was formed. WITTE-STRATTEC China and WITTE-STRATTEC Great Shanghai Co. are joint ventures between WITTE-STRATTEC LLC and a unit of Elitech Technology Co. Ltd. of Taiwan and are the base of operations to service the Company’s automotive customers in the Asian market.
The investments are accounted for using the equity method of accounting. The activities related to the joint ventures resulted in a loss of approximately $55,000 in the six month period ended December 26, 2004 and a gain of approximately $110,000 in the prior year period.
Critical Accounting Policies
The Company believes the following represents its critical accounting policies:
Pension and Post-Retirement Health Benefits - The determination of the obligation and expense for pension and post-retirement health benefits is dependent on the selection of certain assumptions used by actuaries in calculating such amounts. Those assumptions are described in the Notes to Financial Statements in the Company’s 2004 Annual Report and include, among others, the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation and health care costs. In accordance with accounting principles generally accepted in the United States of America, actual results that differ from these assumptions are accumulated and amortized over future periods. While the Company believes that the assumptions
used are appropriate, significant differences in the actual experience or significant changes in the assumptions may materially affect the pension and post-retirement health obligations and future expense.
Other Reserves - The Company has reserves such as an environmental reserve, an incurred but not reported claim reserve for self-insured health plans, a worker’s compensation reserve, and a repair and maintenance supply parts reserve. These reserves require the use of estimates and judgement with regard to risk exposure, ultimate liability and net realizable value. The Company believes such reserves are estimated using consistent and appropriate methods. However, changes to the assumptions could materially affect the recorded reserves.
Risk Factors
The Company understands it is subject to the following risk factors based on its operations and the nature of the automotive industry in which it operates:
Loss of Significant Customers, Vehicle Content and Market Share - Sales to General Motors Corporation, Ford Motor Company, DaimlerChrysler Corporation and Delphi Corporation represent approximately 81 percent of the Company’s annual sales. The contracts with these customers provide for supplying the customer’s requirements for a particular model. The contracts do not specify a specific quantity of parts. The contracts typically cover the life of a model, which averages approximately four to five years. Certain customer models may also be market tested annually. Therefore, the loss of any one of these customers, the loss of a contract for a specific vehicle model, reduction in vehicle content, technological changes or a significant re
duction in demand for certain key models could have a material adverse effect on the Company’s existing and future revenues and net income.
The Company’s major customers also have significant underfunded legacy liabilities related to pension and post-retirement health care obligations. The future impact of these items along with a continuing decline in their North American automotive market share to the Foreign-Owned North American Automotive Manufacturers (primarily the Japanese Automotive Manufacturers) may have a significant impact on the Company’s future sales and collectibility risks.
Cost Reduction - There is continuing pressure from the Company’s major customers to reduce the prices the Company charges for its products. This requires the Company to generate cost reductions, including reductions in the cost of components purchased from outside suppliers. If the Company is unable to generate sufficient production cost savings in the future, to offset programmed price reductions, the Company’s gross margin and profitability will be adversely affected.
Cyclicality and Seasonality in the Automotive Market - The automotive market is highly cyclical and is dependent on consumer spending and to a certain extent on customer sales incentives. Economic factors adversely affecting consumer demand for automobiles and automotive production could adversely impact the Company’s revenues and net income. The Company typically experiences decreased revenue and operating income during the first fiscal quarter of each year due to the impact of scheduled customer plant shut-downs in July and new model changeovers.
Foreign Operations - As discussed under Joint Ventures, the Company has joint venture investments in both Brazil and China. These operations are currently not material. However, as these operations expand, their success will depend, in part, on the Company’s and its partners’ ability to anticipate and effectively manage certain risks inherent in international operations including: enforcing agreements and collecting receivables through certain foreign legal systems, payment cycles of foreign customers, compliance with foreign tax laws, general economic and political conditions in these countries, and compliance with foreign laws and regulations.
Currency Exchange Rate Fluctuations - The Company incurs a portion of its expenses in Mexican pesos. Exchange rate fluctuations between the U.S. dollar and the Mexican peso could have an adverse effect on financial results.
Sources of and Fluctuations in Market Prices of Raw Materials - The primary raw materials used by the Company are high-grade zinc, brass, magnesium, aluminum, steel and plastic resins. These materials are generally available from a number of suppliers, but the Company has chosen to concentrate its sourcing with one primary vendor for each commodity or purchased component. The Company believes its sources of raw materials are reliable and adequate for its needs. However, the development of future sourcing issues related to the availability of these materials as well as significant fluctuations in the market prices of these materials may have an adverse affect on the Company’s financial results.
Disruptions Due to Work Stoppages and Other Labor Matters - The Company’s major customers and many of their suppliers have unionized work forces. Work stoppages or slow-downs experienced by the Company’s customers or their suppliers could result in slow-downs or closures of assembly plants where the Company’s products are included in assembled vehicles. For example, strikes by the United Auto Workers led to a shut-down of most of General Motors Corporation’s North American assembly plants in June and July of 1998. A material work stoppage experienced by one or more of the Company’s customers could have an adverse effect on the Company’s business and its financial results. In addition, all production associates at the Company’s Milwaukee facility are unionized. A sixteen-day strik
e by these associates in June 2001 resulted in increased costs by the Company as all salaried associates worked with additional outside resources to produce the components necessary to meet customer requirements. The current contract with the unionized associates is effective through June 26, 2005. The Company may encounter further labor disruption after the expiration date of this contract and may also encounter unionization efforts in its other plants or other types of labor conflicts, any of which could have an adverse effect on the Company’s business and its financial results.
Environmental and Safety Regulations - The Company is subject to federal, state, local and foreign laws and other legal requirements related to the generation, storage, transport, treatment and disposal of materials as a result of its manufacturing and assembly operations. These laws include the Resource Conservation and Recovery Act (as amended), the Clean Air Act (as amended) and the Comprehensive Environmental Response, Compensation and Liability Act (as amended). The Company has an environmental management system that is ISO-14001 certified. The Company believes that its existing environmental management system is adequate and it has no current plans for substantial capital expenditures in the environmental area. An environmental reserve was established in 1995 for estimated costs to remediate a site at the Co
mpany’s Milwaukee facility that was contaminated by a former above-ground solvent storage tank, located on the east side of the facility. The contamination occurred in 1985. This is being monitored in accordance with federal, state and local requirements.
The Company does not currently anticipate any material adverse impact on its results of operations, financial condition or competitive position as a result of compliance with federal, state, local and foreign environmental laws or other legal requirements. However, risk of environmental liability and changes associated with maintaining compliance with environmental laws is inherent in the nature of the Company’s business and there is no assurance that material liabilities or changes could not arise.
Highly Competitive Automotive Supply Industry - The automotive component supply industry is highly competitive. Some of the Company’s competitors are companies, or divisions or subsidiaries of companies, that are larger than the Company and have greater financial and technology capabilities. The Company’s products may not be able to compete successfully with the products of these other companies, which could result in loss of customers and, as a result, decreased revenues and profitability. In addition, the Company’s competitive position in the North American automotive component supply industry could be adversely affected in the event that it is unsuccessful in making strategic acquisitions, alliances or establishing joint ventures that would enable it to expand globally. The Company principally co
mpetes for new business at the beginning of the development of new models and upon the redesign of existing models by its major customers. New model development generally begins two to five years prior to the marketing of such new models to the public. The failure to obtain new business on new models or to retain or increase business on redesigned existing models could adversely affect the Company’s business and financial results. In addition, as a result of relatively long lead times for many of its components, it may be difficult in the short-term for the Company to obtain new sales to replace any unexpected decline in the sale of existing products. Finally, the Company may incur significant product development expense in preparing to meet anticipated customer requirements which may not be recovered.
Program Volume and Pricing Fluctuations - The Company incurs costs and makes capital expenditures for new program awards based upon certain estimates of production volumes over the anticipated program life for certain vehicles. While the Company attempts to establish the price of its products for variances in production volumes, if the actual production of certain vehicle models is significantly less than planned, the Company’s revenues and net income may be adversely affected. The Company cannot predict its customers’ demands for the products it supplies either in the aggregate or for particular reporting periods.
Investments in Customer Program Specific Assets - The Company makes investments in machinery and equipment used exclusively to manufacture products for specific customer programs. This machinery and equipment is capitalized and depreciated over the expected useful life of each respective asset. Therefore, the loss of any one of the Company’s major customers or specific vehicle models could result in impairment in the value of these assets and have a material adverse effect on the Company’s financial results.
Prospective Information
A number of the matters and subject areas discussed in this Form 10-Q contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of forward-looking words or phrases such as "anticipate," "believe," "would," "expect," "intend," "may," "planned," "potential," "should," "will," and "could." These include expected future financial results, product offerings, global expansion, liquidity needs, financing ability, planned capital expenditures, management's or the Company's expectations and beliefs, and similar matters discussed in the Company’s Management's Discussion and Analysis. The discussions of such matters and subject areas are qualified by the inherent risks and uncertainties surrounding future expectations ge
nerally, and also may materially differ from the Company's actual future experience.
The Company's business, operations and financial performance are subject to certain risks and uncertainties, which could result in material differences in actual results from the Company's current expectations. These risks and uncertainties include, but are not limited to, general economic conditions, in particular relating to the automotive industry, customer demand for the Company’s and its customers’ products, competitive and technological developments, customer purchasing actions, foreign currency fluctuations, costs of operations and other matters described under "Risk Factors" above.
Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this Form 10-Q and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances occurring after the date of this Form 10-Q.
The Company does not utilize financial instruments for trading purposes and holds no derivative financial instruments which would expose the Company to significant market risk. The Company has not had outstanding borrowings since December 1997. The Company has been in an investment position since this time and expects to remain in an investment position for the foreseeable future. There is therefore no significant exposure to market risk for changes in interest rates.
The Company is subject to foreign currency exchange rate exposure related to the Mexican operations.
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective in timely alerting them to material information relating to the Company required to be included in the Company's periodic filings with the Securities and Exchange Commission. 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. The Company has designed its disclosure controls and procedures to reach a level of reasonable assurance of achieving the desired control objectives and, based on the evaluation described above, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective at reaching that level of reasonable assurance.
There was no change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during the Company's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
Part II
Other Information
In the normal course of business, the Company may be involved in various legal proceedings from time to time. The Company does not believe it is currently involved in any claim or action the ultimate disposition of which would have a material adverse effect on the Company’s financial statements.
Issuer Purchases of Equity Securities
|
Period |
|
Total Number Of Shares Purchased |
|
Average Price
Paid Per Share |
|
Total Number Of Shares Purchased As Part of Publicly Announced Program |
|
Maximum Number
Of Shares that May Yet be Purchased Under the Program |
|
|
September 27, 2004-October 31, 2004 |
|
|
- |
|
|
- |
|
|
- |
|
|
- |
|
|
November 1, 2004-November 28, 2004 |
|
|
8,500 |
|
$ |
62.95 |
|
|
8,500 |
|
|
202,803 |
|
|
November 29, 2004-December 26, 2004 |
|
|
4,000 |
|
$ |
62.90 |
|
|
4,000 |
|
|
198,803 |
|
|
Total |
|
|
12,500 |
|
$ |
62.94 |
|
|
12,500 |
|
|
198,803 |
|
The Company’s Board of Director’s authorized a stock repurchase program on October 16, 1996, and the program was publicly announced on October 17, 1996. The Board of Director’s has periodically increased the number of shares authorized under the program, most recently in October 2003. The program currently authorizes the repurchase of up to 3,239,395 shares of the Company’s common stock from time to time, directly or through brokers or agents, and has no expiration date.
At the Company’s Annual Meeting held on October 5, 2004, the shareholders voted to elect Frank J. Krejci as director for a term to expire in 2007. The number of votes cast for and withheld in the election were 3,526,133 and 2,907, respectively. Directors whose term continued after the meeting include Michael J. Koss with a term expiring in 2005, and Harold M. Stratton and Robert Feitler each with a term expiring in 2006.
(a) Exhibits
31.1 Rule 13a-14(a) Certification for Harold M. Stratton II, Chairman and Chief
Executive Officer
31.2 Rule 13a-14(a) Certification for Patrick J. Hansen, Chief Financial Officer
32 (1) 18 U.S.C. Section 1350 Certifications
____________
(1) This certification is not "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
STRATTEC SECURITY CORPORATION (Registrant)
Date: February 2, 2005 By /s/ Patrick J. Hansen
Patrick J. Hansen
Vice President,
Chief Financial Officer,
Treasurer and Secretary
(Principal Accounting and Financial Officer)