STRATTEC SECURITY CORP (STRT)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Discussion and Analysis should be read in conjunction with STRATTEC SECURITY CORPORATION’s accompanying Financial Statements and Notes thereto included in this Form 10-K. Unless otherwise indicated, all references to years or quarters refer to fiscal years or fiscal quarters of STRATTEC.

Executive Overview

Historically, traditional domestic automotive OEMs (General Motors, Ford and Stellantis) have comprised a majority of our total net sales. During the past two decades, these customers have lost North American market share to New Domestic automotive manufacturers (primarily Japanese and Korean automotive manufacturers). In addition, our financial performance depends in large part on conditions in the North American automotive industry, which in turn, are largely dependent upon the U.S. economy. During fiscal years 2024 and 2023, the traditional domestic automotive OEMs represented 66 percent of our total net sales.

Fiscal 2024 net sales were $537.8 million compared to $492.9 million in fiscal 2023. $32.7 million of the $44.9 million net sales increase was driven by net price increases to our major OEM customers. When excluding this pricing effect, underlying sales increased by $12.2 million, up 2.5% over the prior year, largely reflecting the launch of new customer programs in the latter half of the fiscal year. The $32.7 million of aforementioned net price increase was composed of $9.7 million one-time retroactive pricing that is not expected to recur, and $23.0 million in ongoing increases in current part prices to our customers. In addition, we settled negotiations with certain key suppliers and paid $5.7 million in higher prices during the year, of which $1.7 million relates to one-time retroactive pricing with the remaining $4.0 million attributable to higher supplier prices on an ongoing basis. The net margin result of both customer and supplier changes in price represented a $27.0 million net margin improvement in fiscal 2024, comprised of $8.0 million of nonrecurring one-time pricing and $19.0 million of ongoing pricing. These net margin improvements surpassed the higher end of our target ranges of $6.0 million and $15.0 million for one-time and ongoing net pricing respectively, which were provided in the fiscal 2024 Outlook in our 2023 Form 10-K.

During fiscal 2024, our cost of sales performance proved challenging. Despite favorability in our raw materials costs, which recovered from elevated levels in fiscal 2023, and improved efficiency of our Mexican operations through a salaried staff reduction in the first quarter and production efficiencies implemented throughout the year, our overall cost of sales performance deteriorated. Factors driving higher costs in our manufacturing operations were primarily:

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a weakened U.S. dollar against the Mexican peso, raising the cost of our Mexican operations

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higher Mexican labor wages due to government-mandated minimum wage increases

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higher shipping costs primarily due to expedited shipments related to the launch of new product programs

Sales, engineering and administrative expenses decreased in fiscal 2024, primarily due to historically high engineering cost reimbursements from our customers, offset by expenses related to the company bonus plan and the transition of our Chief Executive Officer position. Our improved operating performance enabled us to achieve net income attributable to STRATTEC of $16.3 million in fiscal 2024 compared with a net loss attributable to STRATTEC of $6.7 million in fiscal 2023.

Based on July 2024 projections from our third-party forecasting service, S&P Global, North American light vehicle production is forecasted to grow modestly between 2024 and 2028. Model year 2024 preliminary North American vehicle build was 15.8 million. S&P Global currently expects 2025 model year vehicle build to remain at 15.8 million vehicles, growing to 16.2 million vehicles in 2026 and then to 16.4 million vehicles for 2027 and 2028. The North American vehicle build forecasts for our primary customers (Ford, General Motors and Stellantis) project a modest decline from 6.7 million vehicles in 2024 to 6.5 million vehicles in 2025 and then an increase to 6.9 million vehicles in model year 2026, stabilizing at that level for model years 2027 and 2028. In an effort to increase our sales, we will continue pursuing opportunities to expand our offerings with existing and new customers. These forecasts are subject to variability based upon a number of factors, including the overall North American economy, current employment levels, availability and cost of consumer credit, home equity values, fuel prices, changes in customer vehicle and option preferences, product quality issues, including those related to recall and product warranty coverage issues, and other key factors that we believe could determine whether consumers can or will purchase new vehicles or particular brands.

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Results of Operations

2024 Compared to 2023

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

The year-over-year sales increase of $44.9 million reflects net price increases from our major OEM customers of $32.7 million of which $23.0 million is attributable to ongoing increases in current part prices and $9.7 million relates to one-time retroactive price increases for parts shipped in the prior year for which the net price increase was agreed to during the current year. In addition to the net price increases, the following items specifically impacted sales to the noted customer groups between years:

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Sales to General Motors Company were favorably impacted by new door handle business supplied on the Chevrolet Equinox EV.

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Sales to Ford Motor Company were positively impacted by added power end gate content we supply on the F-Series Super Duty Pickup and by new tailgate latch content supplied on the F-Series Pickups.

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Sales to Stellantis were negatively impacted by reduced customer vehicle production volumes as well as reduced content we supply for the Dodge Ram Pickup and several passenger car programs ending.

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Sales to Tier 1 Customers improved in the current year compared to the prior year due to new door hardware content on the F-Series Super Duty Pickup, which is sold to a Tier 1 customer.

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Sales to Commercial and Other OEM Customers, which are comprised of aftermarket products and vehicle access control products, such as latches, fobs, driver controls and door handles, were positively impacted by sales for new business awarded from Aston Martin.

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Sales to Hyundai / Kia were positively impacted by an overall increase in customer vehicle production volumes between years.

Cost of goods sold in the current year and prior year were as follows (millions of dollars):

Prior year reclassifications have been made for consistency with current year presentation.

Total cost of goods sold increased $21.5 million between years. The year-over-year increase in direct material costs of $6.1 million was the result of increases in sales volumes and content we supply, as discussed above, and $5.7 million of negotiated material price increases paid to key suppliers. Price increases paid to suppliers attributed to ongoing operations totaled $4.0 million while the remaining $1.7 million related to one-time retroactive price increases. The impact of content and material price increases was partially offset by reduced zinc costs of approximately $3.1 million in the current year as compared to the prior year. The year-over-year increase in labor and overhead costs of $15.4 million was impacted by the following:

Cost Increases:

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The U.S. dollar value of our Mexican operations was negatively impacted by approximately $8.5 million in the current year as compared to the prior year due to an unfavorable Mexican peso to U.S. dollar exchange rate between years. The

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average U.S. dollar / Mexican peso exchange rate decreased to approximately 17.13 pesos to the dollar for the year from approximately 18.98 pesos to the dollar in the prior year.

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Mexico wages and benefits increased $6.6 million in the current year as compared to the prior year as a result of annual wage increases, including January 1, 2024 and January 1, 2023 government mandated minimum wage increases.

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Freight costs increased $4.1 million between years due to an increase in shipments from foreign vendors, a change in shipping terms with a major supplier that occurred in June 2023, and an increase in expedited shipments.

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The current year includes expense provisions of $2.7 million under our incentive bonus plan. The prior year includes no bonus expense.

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The current year includes severance costs of $220,000 related to a realignment of our Mexican workforce.

Cost Decreases:

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Mexico wages and benefits decreased by $1.5 million due to a September 1, 2023 salaried staff reduction in Mexico and current year production efficiencies that controlled headcount and hours worked.

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Royalty costs paid on sales of certain aftermarket products decreased $0.9 million in the year as compared to the prior year due to lower volumes in these aftermarket products.

The net unfavorable impact of specific labor and overhead costs noted above was partially offset by more favorable absorption of our fixed overhead costs in the current year as compared to the prior year due to higher production volumes driven by an increase in finished goods inventory during the year and increased sales volumes.

Gross profit margin improvement between years was driven by pricing relief achieved during the current year as discussed above. The impact of one-time retroactive pricing in the current year increased the gross profit margin percentage by 1.3 percentage points. Additionally, favorable impacts of ongoing customer price increases, reduced zinc costs, favorable absorption, production efficiencies in Mexico and reduced royalty costs were partially offset by an unfavorable U.S. dollar to Mexican peso exchange rate, wage increases in Mexico, and increased freight, bonus, and severance costs, all as discussed above.

Engineering, Selling and Administrative Expenses in the current year and prior year were as follows:

Engineering, selling and administrative expenses were impacted by the following:

Cost Decrease:

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Current year costs decreased $3.2 million in comparison to the prior year due to an increase in customer billings for the reimbursement of engineering development costs.

Cost Increase:

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The current year includes one-time charges of $1.0 million associated with the transition of our Chief Executive Officer position.

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The current year includes expense provisions of $1.9 million under our incentive bonus plan. The prior year includes no bonus expense.

Income from operations in the current year was $17.8 million compared to loss from operations of $6.1 million in the prior year. This change between years was the result of an increase in sales in the current year as compared to the prior year along with a reduction in engineering, selling and administrative expenses partially offset by an increase in cost of goods sold, all as discussed above.

Effective June 30, 2023, STRATTEC sold its one-third interest in VAST LLC to WITTE. Refer to the discussion of the Equity Restructuring Agreement within Joint Ventures and Majority Owned Subsidiaries included in the Notes to Financial Statements within this Form 10-K for additional information regarding the sale. The equity loss of joint ventures was $331,000 in the current year compared to equity earnings of joint ventures of $1.6 million in the prior year. The current year loss was the result of additional professional fees incurred related to the sale of STRATTEC's investment in VAST LLC. The $331,000 loss is an adjustment to the gain on sale of VAST LLC, which was recorded in the prior year. Our adjusted loss to date on the sale of VAST LLC totals $221,000. Prior year equity earnings includes STRATTEC's one-third of a loss on disposal of VAST LLC's investment in Brazil of $531,000 and a gain on sale of STRATTEC's one-third share of VAST LLC of $110,000.

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Included in other income (expense), net in the current year and prior year were the following items (thousands of dollars):

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Foreign currency transaction gains and losses resulted from activity associated with foreign denominated assets and liabilities held by our Mexican subsidiaries.

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The Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in the Trust are considered trading securities.

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We entered into the Mexican peso currency forward contracts during fiscal 2024 and 2023 to reduce earnings volatility resulting from changes in exchange rates affecting the U.S. dollar cost of our Mexican operations. No peso forward currency contracts are outstanding as of June 30, 2024.

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Pension and postretirement plan costs include net periodic benefit cost other than the service cost component.

Our effective income tax rate for 2024 was 18.7 percent compared to (16.7) percent in 2023. Our 2024 effective tax rate was reduced by $1.2 million due to changes in the estimate of our 2023 foreign tax credits associated with the sale of our interest in VAST LLC. Our 2023 effective tax rate was impacted by $2.2 million in China non-resident capital gain tax resulting from the sale of our interest in VAST LLC, a valuation allowance of $1.4 million related to our assessment of the future realization of capital loss carryforwards generated from the sale of our interest in VAST LLC, a net Global Intangible Low Tax Income (GILTI) cost of $613,000 and the impact of available R&D and foreign tax credits on pre-tax book losses. Our income tax provision for each year 2024 and 2023 was affected by the non-controlling interest portion of our pre-tax income and R&D tax credit. The non-controlling interest impacts the effective tax rate as our ADAC-STRATTEC LLC entity was taxed as a partnership for U.S. tax purposes in 2024 and our ADAC-STRATTEC LLC and STRATTEC POWER ACCESS LLC entities were taxed as partnerships for U.S. tax purposes in 2023.

Liquidity and Capital Resources

Working Capital (millions of dollars)

Outstanding Receivable Balances from Major Customers

Our primary source of cash flow is from our major customers, which include Stellantis, General Motors Company and Ford Motor Company. As of the date of filing this Annual Report with the Securities and Exchange Commission, all of our 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 June 30, 2024 and July 2, 2023 was as follows (millions of dollars):

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Cash Balances in Mexico

We earn a portion of our operating income in Mexico. As of June 30, 2024, $1.4 million of our $25.4 million cash and cash equivalents balance was held in Mexico. These funds are available for repatriation as deemed necessary.

Cash Flow Analysis

Cash flow from operating activities increased $2.2 million between years as the impact of increased profitability between years, as previously discussed, was offset by a net increase in working capital. The net increase in our working capital included the following working capital changes (millions of dollars):

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Accounts receivable balances increased in both the current and prior year periods. The increase in the accounts receivable balance during 2024 reflects increased sales as of the end of our fiscal 2024 as compared to the end of our fiscal 2023 as well as an increase of $6.4 million in open customer billings for the reimbursement of customer tooling costs and engineering development costs. The increase in accounts receivable balances during 2023 reflects increased sales as of the end of our fiscal 2023 as compared to the end of our fiscal 2022.

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The change in inventory levels reflected an increase during the current year and a decrease during the prior year. The current year increase was driven by an increase in finished product inventory balances resulting from our long-term inventory reduction plan that looks to shift the composition of our inventory from purchased materials to finished production, improving responsiveness while reducing overall inventories. The prior year decrease was due to a reduction in inventory balances to align with historical customer production patterns, mostly offset by a change in inventory management and shipping terms with a significant vendor.

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The change in customer tooling balances, which consisted of costs incurred for the development of tooling that will be directly reimbursed by the customer whose parts are produced from the tool, was the result of the timing of tooling development spending required to meet customer production requirements and related billings for customer reimbursements.

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The current year increase in other assets is due to an $11.8 million increase in value added tax ("VAT") recoverable balances related to our Mexican operations. VAT recoverable balances increased due to a temporary issue with our Mexican tax certification. Although the certification issue was resolved during our December 2023 quarter, we were required to pay VAT on all parts temporarily imported into Mexico before seeking reimbursement for periods in which the certification issue was outstanding, which periods are now open to audit with the Mexican tax authority along with all periods subsequent to resolution of the certification issue. We believe temporary increases in the VAT recoverable balance will remain elevated until the periods under audit are closed.

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Accounts payable balances increased in both the current and prior year periods. The current year increase was due to the following:

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- Accrued salaries and benefits increased $6.3 million due to the accrual of $4.5 million under our incentive bonus plan as well as increased benefit accruals for our Mexican associates, which resulted from annual wage increases, including January 1, 2024 government mandated increases. There was no bonus accrual as of June 2023.

- VAT payable balances increased $3.5 million due to periods from 2024 being open to audit. Refer to the discussion of VAT recoverable balances and the VAT certification issue above.

- Income tax payable balances increased $2.5 million in 2024 based on the required income tax provision, the timing and amounts of federal, state and foreign tax payments made, and the timing of utilization of tax credits.

The prior year increase was due to the following:

- Accounts payable increased $14.0 million primarily due to a change in inventory management, shipping terms, and payment terms with a significant vendor and the temporary suspension of ADAC-STRATTEC LLC's payment of engineering, research and design fees and sales fees to ADAC in order to comply with ADAC-STRATTEC debt covenants.

- Accrued salaries and benefits increased $4.7 million due to increased salaries and benefits for our Mexican associates.

- Income taxes payable increased $2.4 million primarily due to the accrual of a China non-resident capital gain tax as a result of the sale of our interest in VAST LLC.

- Value added tax payable balances increased $3.0 million due to several periods being open to audit in Mexico.

Net cash used in investing activities of $7.8 million during 2024 included capital expenditures of $9.8 million in support of requirements for new product programs and the upgrade and replacement of existing equipment partially offset by additional proceeds from the sale of our interest in VAST LLC of $2.0. Net cash provided by investing activities of $8.9 million during 2023 included proceeds from the sale of our interest in VAST LLC of $26.2 million and a net increase in cash of $354,000 resulting from STRATTEC's purchase of the net assets of VAST Korea. The cash inflows were partially offset by capital expenditures of $17.4 million in support of requirements for new product programs and the upgrade and replacement of existing equipment and a $278,000 investment in VAST LLC for the purpose of funding general operating expenses for Sistema de Acesso Veicular Ltda, VAST LLC's Brazilian joint venture.

Net cash provided by financing activities of $72,000 during 2024 included additional borrowings under our credit facilities of $2.0 million and $72,000 received for purchases under our employee stock purchase plan. These cash inflows were partially offset by the repayment of borrowings under credit facilities of $2.0 million. Net cash used in financing activities of $7.4 million during 2023 included a payment of $9.0 million related to STRATTEC's purchase of the remaining non-controlling interest of STRATTEC POWER ACCESS LLC from WITTE Automotive, the repayment of borrowings under credit facilities of $15.0 million, and $600,000 of dividend payments to non-controlling interests in our subsidiaries. These cash outflows were partially offset by additional borrowings under our credit facilities of $17.0 million and $183,000 received for the exercise of stock options under our stock incentive plan and purchases under our employee stock purchase plan.

Cash Requirements

Dividends

On May 13, 2020, our Board of Directors took action to temporarily suspend payment of our quarterly dividend for the foreseeable future in order to conserve cash as a result of the economic downturn that began with COVID-19. No dividends were paid to shareholders during fiscal 2024 or fiscal 2023.

Future Capital Expenditures

We anticipate capital expenditures will be approximately $15.0 million in fiscal 2025 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 June 30, 2024. A total of 3,655,322 shares have been repurchased over the life of the program through June 30, 2024, at a cost of approximately $136.4 million. No shares were repurchased during fiscal 2024 or 2023. 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.

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Other Cash Requirements

In connection with the June 30, 2023 sale of our interest in VAST LLC to WITTE Automotive, we will be required to pay nonresident capital gain tax in China. The payment, which is expected to be made during our fiscal 2025, is expected to total approximately $1.9 million.

We anticipate payments of approximately $4.5 million to associates in connection with our incentive bonus plan during the first quarter of our fiscal 2025 related to bonuses earned in our fiscal 2024.

We also have an operating lease for our El Paso, Texas finished goods and service parts distribution warehouse, which has a term in excess of one year. We also have purchase commitments related to zinc and other purchased parts. Refer to required future payments under the lease and purchase commitments in the discussion of Leases under Organization and Summary of Significant Accounting Policies and in the discussion of Commitments and Contingencies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

Credit Facilities

STRATTEC has a $40 million secured revolving credit facility (the “STRATTEC Credit Facility”) with BMO Harris Bank N.A. ADAC-STRATTEC LLC has a $20 million secured revolving credit facility (the “ADAC-STRATTEC Credit Facility”) with BMO Harris Bank N.A., which is guaranteed by STRATTEC. The ADAC-STRATTEC Credit Facility borrowing limit decreases to $18 million on August 1, 2025. The credit facilities both expire August 1, 2026. 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 the STRATTEC Credit Facility were at varying rates based, at our option, on LIBOR plus 1.25 percent or the bank’s prime rate through February 22, 2023, SOFR plus 1.35 percent for the period February 23, 2023 through September 5, 2023, and SOFR plus 1.85 percent subsequent to September 5, 2023. Interest on borrowings under the ADAC-STRATTEC Credit Facility were at varying rates based, at our option, on the bank's prime rate with no interest rate margin through May 30, 2024 and a 2 percent interest rate margin subsequent to May 30, 2024 or LIBOR plus 1.25 percent through February 6, 2023, SOFR plus 1.35 percent for the period February 7, 2023 through May 30, 2024, and SOFR plus 3.10 percent subsequent to May 30, 2024. 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. As of June 30, 2024, we were in compliance with all financial covenants required by these credit facilities. There were no outstanding borrowings under the STRATTEC Credit Facility as of June 30, 2024 or July 2, 2023. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $33,000 and 8.5 percent, respectively, during 2024. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $15.4 million and 5.7 percent, respectively, during 2023. Outstanding borrowings under the ADAC-STRATTEC Credit Facility totaled $13 million at both June 30, 2024 and July 2, 2023. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $13.0 million and 6.8 percent, respectively, during 2024. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $12.4 million and 5.3 percent, respectively, during 2023. We believe that the credit facilities are adequate, along with existing cash flows from operations, to meet our anticipated capital expenditure, working capital, dividend, and operating expenditure requirements.

Joint Ventures and Majority Owned Subsidiaries

Refer to the discussion of Investment in Joint Ventures and Majority Owned Subsidiaries and discussion of Equity (Loss) Earnings of Joint Ventures included in the Notes to Financial Statements included within this Form 10-K.

Critical Accounting Policies

We believe the following represents our critical accounting policies:

Liability for Uncertain Tax Positions – We are subject to income taxation in many jurisdictions around the world. Significant management judgment is required in the accounting for income tax contingencies because the outcomes are often difficult to determine. We are required to measure and recognize uncertain tax positions that we have taken or expect to take in our income tax returns. The benefit of an uncertain tax position can only be recognized in the financial statements if management concludes that it is more likely than not that the position will be sustained with the tax authorities. For a position that is likely to be sustained, the benefit recognized in the financial statements is measured at the largest amount that is greater than 50 percent likely of being realized. A reserve is established for the difference between a position taken in an income tax return and the amount recognized in the financial statements. The amount of unrecognized benefits, that if recognized, would affect the effective tax rate was $1.2 million at June 30, 2024 and $1.1 million at July 2, 2023. An increase or decrease in our assessment of the recorded amount of unrecognized benefits by

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10 percent would result in an increase or decrease in the reported tax provision, before the impact of interest and penalties, of $120,000 at June 30, 2024 and $110,000 at July 2, 2023. Refer to the discussion of Income Taxes included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

Warranty Reserve – We have a warranty reserve recorded related to our exposure to warranty claims in the event our products fail to perform as expected, and we may be required to participate in the repair costs incurred by our customers for such products. The recorded warranty reserve balance involves judgment and estimates. Our reserve estimate is based on an analysis of historical warranty data as well as current trends and information. Actual warranty costs might differ from estimates due to the level of actual claims varying from our claims experience and estimates and final negotiations and settlements reached with our customers. Therefore, future actual claims experience could result in changes in our estimates of the required reserve. Sensitivity of potential warranty or product recall claims is dependent on the respective customer platform, volumes, production years and product content. We have product recall insurance once a recall claim exceeds $2.5 million with a limit of $30 million. Refer to the discussion of Warranty Reserve under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

We believe the reserve discussed above is estimated using consistent and appropriate methods. However, changes to the assumptions could materially affect the recorded reserve amount.

New Accounting Standards

Refer to the discussion of New Accounting Standards under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Discussion and Analysis should be read in conjunction with STRATTEC SECURITY CORPORATION’s accompanying Financial Statements and Notes thereto included in this Form 10-K. Unless otherwise indicated, all references to years or quarters refer to fiscal years or fiscal quarters of STRATTEC.

Executive Overview

Historically, a significant portion of our total net sales have been to domestic automotive OEMs (General Motors, Ford and Stellantis). During the past two decades these customers lost North American market share to the New Domestic automotive manufacturers (primarily the Japanese and Korean automotive manufacturers). In addition to our dependence on our customers’ maintaining their market share, our financial performance depends in large part on conditions in the overall automotive industry, which in turn, are dependent upon the U.S. and global economies. During fiscal years 2023 and 2022, the above domestic automotive OEMs together represented each year 66 percent and 65 percent, respectively, of our total net sales.

During fiscal years 2023 and 2022, we experienced strong sales demand for our components from our major North American customers noted above as it relates to light trucks and both sport utility and car-based utility vehicles in comparison to passenger cars, influenced by customer preferences. If gas prices were to rise substantially over the next several years, this consumer buying trend may not continue, which is approximately 90 percent light trucks and sport utility vehicles in comparison to 10 percent passenger car vehicle purchases today. During the last 3-5 years our major customers General Motors, Ford and Stellantis eliminated passenger car production on several models in North America as a strategy to improve their overall profitability going forward. Additionally, several of our significant customers have announced plans to increase production volumes for their models of Electric Vehicles. As these customers start migrating over to Electric Vehicles we believe a significant amount of our current and future product content will continue to be purchased by our major customers and will be adopted in this changeover (refer to vehicle list included at page 7 in this Form 10-K).

Fiscal 2023 net sales were $492 million compared to $452 million in fiscal 2022. The net sales improvement in fiscal 2023 reflected an improvement in the global semiconductor chip shortage which had caused our OEM customers to temporarily shut down their assembly plants reducing our net sales during fiscal 2022. Despite higher sales in fiscal 2023, net income attributable to STRATTEC for fiscal 2023 was negative $6.7 million compared with the net income attributable to STRATTEC of $7.0 million in fiscal 2022. The deterioration in profitability was primarily driven by escalating manufacturing input costs for raw materials and purchased materials, higher shipping and Mexican labor wages, which increased on January 1 of both 2022 and 2023 as part of a Government mandated minimum wage increase of 22% and 20% respectively. In addition to the inflationary cost increases, the Mexican Peso strengthened against the U.S. Dollar throughout fiscal year 2023 negatively affecting the cost of our operations in Mexico. Seeking pricing recovery from our customers for the aforementioned inflationary costs was a prime focus of ours throughout fiscal year 2023. However, given the long-term nature of our supply agreements, such pricing concessions are not customary and, therefore, resulted in protracted rounds of negotiations with limited effect on our fiscal 2023 profitability. Despite the limited price concession results in fiscal 2023, we are committed to aggressively seeking a favorable resolution to these negotiations early in fiscal year 2024.

As we look to the future, the June 2023 projections from our third-party forecasting service, S&P Global, indicate that North American light vehicle production will show an increase in demand over the coming years. Model year 2023 preliminary North American vehicle build was 15.1 million. By model year, based on these projections we are expecting a 2024 vehicle build of 15.2 million vehicles, 16.1 million vehicles for 2025, and 16.6 million vehicles for 2026 and 2027. The North American vehicle build for Ford, General Motors and Stellantis reflects relative stability ranging between 6.7 million and 7.1 million vehicles each model year from 2024 through 2027 without much fluctuation between each customer. Of course, all of these forecasts are subject to variability based on what happens in the overall North American and global economies, the current levels of employment, availability of consumer credit, home equity values, fluctuating fuel prices, changes in customer vehicle and option preferences, product quality issues, including related to recall and product warranty coverage issues, and other key factors that we believe could determine whether consumers can or will purchase new vehicles or particular brands.

Fiscal 2024 Outlook

As stated above, we anticipate the 2024 North American light vehicle production, which closely aligns with our fiscal 2024 timing, to be relatively stable with a potential for modest growth. Similarly, we anticipate modest growth in our net sales on the basis of a stable industry and the launch of several new programs in the model year. From a cost of sales perspective, we anticipate some key challenges from fiscal 2023 will continue into fiscal 2024, notably a strong Mexican Peso relative to the U.S. Dollar, risk of another round of Mexican government mandated minimum wage increases in January 2024 affecting the cost of our Mexican operations, and increased purchased material costs from our suppliers. As for positive cost trends, we anticipate a continued recovery in the cost of some key raw materials, a trend which began in the second half of fiscal 2023.

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With a focus to offset the anticipated aforementioned cost challenges and to improve present profitability, management is targeting the following actions in fiscal 2024:

(1)
Successfully conclude price-concession negotiations with our key customers by the end of Q2 to achieve between $10 million and $15 million in present program pricing improvement for the fiscal year as well as receive one-time retroactive price adjustment payments totaling between $4 million and $6 million

(2)
Salaried staff reduction commencing in Q1 reducing annualized spending by approximately $2 million

(3)
Drive operational actions that reduce overhead in operations and purchase of materials by $3 million per year

(4)
Reduce fiscal year-end inventory levels by $10 million compared with that for fiscal 2023

We believe the successful execution of these actions together with that of our overall fiscal plan will considerably improve STRATTEC’s profitability in fiscal 2024, reestablishing a solid foundation from which to grow profitability thereafter.

Results of Operations

2023 Compared to 2022

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

The year-over-year sales increase of $40.6 million was due to improved global semiconductor chip availability in the current year period relative to the prior year period. Additionally, our 2023 fiscal year was 52 weeks while our 2022 fiscal year was 53 weeks. The impact of the additional week of sales during the prior year partially offset the lower net sales in the prior year from the semiconductor chip shortage and which extra week increased prior year sales by approximately $7.4 million. The following items further impacted sales to the noted customer groups between periods:

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Sales to General Motors Company, Ford Motor Company, and Hyundai/Kia were positively impacted in the current year due to higher vehicle production volumes resulting from improved global semiconductor chip availability relative to the prior year. Sales growth to General Motors Company in the current year was attributed to higher production volumes of their GMC and Chevrolet pickup trucks and certain SUVs for which we supply a wide range of components. Increased sales to Ford Motor Company in the current year were due to higher production volumes of their F-Series Pickups including the Super Duty Pickup, for which we supply a wide range of components, and an increased percentage of the F-Series Super Duty Pickup including our power end gate product option. Sales to Hyundai / Kia increased year-over-year due to higher levels of production of the Kia Carnival minivan in the current year period as compared to the prior year period.

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The decrease in net sales to Stellantis was driven primarily by its lower production volumes related to the Chrysler Pacifica minivan, the Jeep Wrangler, Jeep Gladiator, and Dodge Ram Truck for which we supply components.

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Sales to Tier 1 Customers improved in the current year compared to the prior year due to higher vehicle production volumes relating to the improvement in semiconductor chip availability referenced above.

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Sales to Commercial and Other OEM Customers, which are comprised of aftermarket products and vehicle access control products, such as latches, fobs, driver controls and door handles, declined in the current year as compared to the prior year due to the allocation of available semiconductor chips toward the production of components for production vehicles rather than aftermarket products.

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Total cost of goods sold increased $54.6 million between years primarily driven by higher sales volumes in the current year as compared to the prior year as discussed above, however, both direct material costs and labor and overhead costs increased as a percent of net sales, with direct material costs growing at a higher rate, explaining the increase in its percent of cost of goods sold shown above. The increase in direct material costs between years beyond the portion that was attributed to higher net sales was driven by escalating costs of raw material and purchased components as well as a shift toward products with a higher proportion of material costs as a percent of their total cost of goods related to the aforementioned prioritization of production vehicles over aftermarket products. It is worth noting that there was an improvement in the cost of raw materials in the latter half of the current fiscal year compared with the prior year, primarily driven by reduced supplier pricing on zinc and steel.

Labor and overhead costs increased $16.9 million between years. The variable portion of labor and overhead costs increased in the current year commensurate with the production volume increase required to support the increased sales volumes compared to the prior year. Apart from the improved fixed cost absorption associated with the higher sales compared with the prior year, labor and overhead costs were further impacted by the following:

Cost Increases:

-
Mexico wages and benefits increased $6.9 million in the current year as compared to the prior year as a result of January 1, 2022 and January 1, 2023 government mandated minimum wage increases.

-
The U.S. dollar value of our Mexican operations was negatively impacted by approximately $5.5 million in the year as compared to the prior year due to an unfavorable Mexican peso to U.S. dollar exchange rate between years. The average U.S. dollar / Mexican peso exchange rate decreased to approximately 18.98 pesos to the dollar for the year from approximately 20.33 pesos to the dollar in the prior year.

-
Freight costs increased $2.3 million between years due to an increase in fuel costs and supply chain disruptions.

-
Warranty costs increased by $2.1 million in the year as compared with the prior year due to specific warranty claims involving our product.

Cost Decreases:

-
Production efficiencies that controlled headcount at our Mexico facilities combined with having one less operational week in the current fiscal year resulted in reduced labor and benefit costs of approximately $2.1 million in the current year as compared to the prior year.

-
Royalty costs paid on sales of certain aftermarket products decreased $0.9 million in the year as compared to the prior year due to lower volumes in these aftermarket products stemming from the current semiconductor chip shortage.

Gross profit dollars in the current year decreased $13.8 million as compared to the prior year driven by the aforementioned inflationary pressures on direct material and labor and overhead costs as well as by the strengthening of the Mexican peso against the U.S. dollar. The resulting decrease in gross profit as a percentage of net sales was 3.8 percentage points from the prior year to the current year.

Engineering, Selling and Administrative Expenses in the current year and prior year were as follows:

Engineering, selling and administrative expenses were impacted by the following:

Cost Increases:

-
The current year includes higher outside expenditures on new product development costs associated with utilizing third party vendors for a portion of our development work.

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-
The current year includes an increase in engineering costs related to our ADAC-STRATTEC LLC door handle and exterior trim products. Such expenses are based on a percentage of ADAC-STRATTEC LLC net sales.

-
The current year includes increased salary costs and increased recruiting costs for new and replacement positions.

Cost Decrease:

-
The prior year included an additional week of expense as our fiscal 2022 was a 53 week year and our fiscal 2023 was a 52 week year.

Loss from operations in the current year was $6.1 million compared to income from operations of $8.9 million in the prior year. This change between years was the result of an increase in cost of goods sold and increased engineering, selling and administrative expenses, which were partially offset by an increase in sales in the current year as compared to the prior year, all as discussed above.

Equity earnings of joint ventures during the fiscal years ending July 2, 2023 and July 3, 2022 were $1.6 million and $177,000 respectively. Current year equity earnings of joint ventures includes STRATTEC's one-third of a loss on disposal of VAST LLC's investment in Brazil of $531,000 and a gain on sale of STRATTEC's one-third share of VAST LLC of $110,000. Effective June 30, 2023, STRATTEC entered into and completed transactions contemplated by an Equity Restructuring Agreement between STRATTEC and WITTE. Accordingly, effective as of June 30, 2023, STRATTEC sold its one-third interest in VAST LLC to WITTE. Refer to the discussion of "VAST, LLC, SPA, LLC and SPA de Mexico Equity Restructuring Agreement" above and the Equity Restructuring Agreement in Joint Ventures and Majority Owned Subsidiaries included in the Notes to Financial Statements included within this Form 10-K for additional information regarding the sale of STRATTEC's VAST LLC interest to WITTE Automotive.

Improved profitability from our VAST LLC joint venture resulted from increased net sales and increased profitability in VAST China’s operations between fiscal years. VAST China’s sales and profitability improved in the current year due to an improved semiconductor chip availability environment compared with that of the prior year. Additionally, during the prior year, VAST China experienced a fire at their Taicang plant. As a result, certain door handle and painting operations were temporarily transferred to their Jingzhou facility and another supplier. The transfer of production negatively impacted VAST China's profitability in the prior year. Due to a limited amount of business in both India and Brazil during fiscal 2023 the VAST LLC joint venture in India continued to have break-even operating results and the VAST LLC joint venture in Brazil continued to report losses.

Included in other (expense) income, net in the current year and prior year were the following items (thousands of dollars):

-
Foreign currency transaction gains and losses resulted from activity associated with foreign denominated assets and liabilities held by our Mexican subsidiaries.

-
The Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in the Trust are considered trading securities.

-
We entered into the Mexican peso currency forward contracts during fiscal 2023 and 2022 to reduce earnings volatility resulting from changes in exchange rates affecting the U.S. dollar cost of our Mexican operations. No peso forward currency contracts are outstanding as of July 2, 2023.

-
Pension and postretirement plan costs include net periodic benefit cost other than the service cost component.

Our effective income tax rate for 2023 was (16.7) percent compared to 4.5 percent in 2022. Our 2023 effective tax rate was impacted by $2.2 million in China non-resident capital gain tax resulting from the sale of our interest in VAST LLC, a valuation allowance of $1.4 million related to our assessment of the future realization of capital loss carryforwards generated from the sale of our interest in VAST LLC, and the impact of available R&D and foreign tax credits on pre-tax book losses. Our 2022 effective tax rate was impacted by adjustments made to the amount of our 2021 estimated foreign tax credits and estimated tax impacts associated with our investment in VAST LLC. These true-up adjustments resulted from the filing of our 2021 U.S. income tax returns during 2022 and were attributable to actual results included in non-U.S. income tax returns, which are filed on a calendar year basis, and which differ from estimates included in our 2021 tax provision. The adjustment amounts recorded during 2022 totaled $1.0 million. Our effective tax rate for 2022 excluding these adjustments was 15.6 percent. These adjustments were not material to our previously issued financial statements. Our income tax provision for each year 2023 and 2022 was affected by the non-controlling interest portion

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of our pre-tax income, Global Intangible Low Taxed Income (GILTI) provisions and R&D tax credit. The non-controlling interest impacts the effective tax rate as our ADAC-STRATTEC LLC and STRATTEC POWER ACCESS LLC entities are taxed as partnerships for U.S. tax purposes.

Liquidity and Capital Resources

Working Capital (millions of dollars)

Outstanding Receivable Balances from Major Customers

Our primary source of cash flow is from our major customers, which include Stellantis, General Motors Company and Ford Motor Company. As of the date of filing this Annual Report with the Securities and Exchange Commission, all of our 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 July 2, 2023 and July 3, 2022 was as follows (millions of dollars):

Cash Balances in Mexico

We earn a portion of our operating income in Mexico. As of July 2, 2023, $2.2 million of our $20.6 million cash and cash equivalents balance was held in Mexico. These funds are available for repatriation as deemed necessary.

Cash Flow Analysis

Cash flow from operating activities was consistent between years as the impact of the reduction in profitability between years, as previously discussed, was offset by a net decrease in working capital requirements. The net decrease in our working capital requirements included the following working capital changes (millions of dollars):

-
Accounts receivable balances increased in both the current and prior year periods. The increase in the accounts receivable balance during the current year reflect increased sales as of the end of our fiscal 2023. The increase in accounts receivable balances during the prior year was mostly due to payments from a specific customer being made in advance of the payment

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term due dates in the prior year while current year payments from that customer were made according to the planned payment term due dates.

-
The change in inventory levels reflected a decrease during the current year and an increase during the prior year. The current year decrease was due to a reduction in inventory balances to align with historical customer production patterns, mostly offset by a change in inventory management and shipping terms with a significant vendor. The prior year increase was due to an inventory build-up while our OEM customers experienced reduced production schedules due to certain part shortages, including for semiconductor chips.

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The change in customer tooling balances, which consisted of costs incurred for the development of tooling that will be directly reimbursed by the customer whose parts are produced from the tool, was the result of the timing of tooling development spending required to meet customer production requirements and related billings for customer reimbursements.

-
The change in other assets was relatively consistent between years. The increase in value added tax recoverable balances in the current year due to several periods being open to audit in Mexico was mostly offset by a reduction in our Rabbi Trust assets of $863,000 resulting from a current year SERP settlement and a $627,000 reduction in our Mexico peso forward contract asset.

-
The current year increase in accounts payable and other liabilities is due to the following:

- Accounts payable increased approximately $14.0 million in the current year primarily due to a change in inventory management, shipping terms, and payment terms with a significant vendor and the suspension of ADAC-STRATTEC LLC's payment of engineering, research and design fees as well as a sales fees to ADAC in order to comply with ADAC-STRATTEC debt covenants.

- Accrued salaries and benefits increased approximately $4.7 million in the current year resulting from increased salaries and benefits for our Mexican associates.

- Income taxes payable increased $2.4 million in the current year primarily due to the accrual of a China non-resident capital gain tax as a result of the sale of our interest in VAST LLC.

- Value added tax payable balances increased $3.0 million in the current year due to several periods being open to audit in Mexico.

Net cash provided by investing activities of $8.9 million during 2023 included proceeds from the sale of our interest in VAST LLC of $26.2 million and a net increase in cash of $354,000 resulting from STRATTEC's purchase of the net assets of VAST Korea. The cash inflows were partially offset by capital expenditures of $17.4 million in support of requirements for new product programs and the upgrade and replacement of existing equipment and a $278,000 investment in VAST LLC for the purpose of funding general operating expenses for Sistema de Acesso Veicular Ltda, VAST LLC's Brazilian joint venture. Net cash used by investing activities of $14.3 million during 2022 included capital expenditures of $14.2 million, which were made in support of requirements for new product programs and the upgrade and replacement of existing equipment. Net cash used by investing activities during 2022 also included an investment in VAST LLC of $150,000 for the purpose of funding general operating expenses for Sistema de Acesso Veicular Ltda.

Net cash used in financing activities of $7.4 million during 2023 included a payment of $9.0 million related to STRATTEC's purchase of the remaining non-controlling interest of STRATTEC POWER ACCESS LLC from WITTE Automotive, the repayment of borrowings under credit facilities of $15.0 million, and $600,000 of dividend payments to non-controlling interests in our subsidiaries. These cash outflows were partially offset by additional borrowings under our credit facilities of $17.0 million and $183,000 received for the exercise of stock options under our stock incentive plan and purchases under our employee stock purchase plan. Net cash used in financing activities of $1.9 million during 2022 included repayments of borrowings under credit facilities of $14.0 million and $1.8 million of dividend payments to non-controlling interests in our subsidiaries, partially offset by borrowings under credit facilities of $13 million and $908,000 received for the exercise of stock options under our stock incentive plan and purchases under our employee stock purchase plan.

Cash Requirements

Dividends

On May 13, 2020, our Board of Directors took action to temporarily suspend payment of our quarterly dividend for the foreseeable future in order to conserve cash as a result of the economic downturn that began with COVID-19. No dividends were paid to shareholders during fiscal 2023 and fiscal 2022.

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Future Capital Expenditures

We anticipate capital expenditures will be approximately $14.0 million in fiscal 2024 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 July 2, 2023. A total of 3,655,322 shares have been repurchased over the life of the program through July 2, 2023, at a cost of approximately $136.4 million. No shares were repurchased during fiscal 2023 or 2022. 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. At this time, we anticipate minimal or no stock repurchase activity in fiscal year 2024.

Other Cash Requirements

In connection with the June 30, 2023 sale of our interest in VAST LLC to WITTE Automotive, we will be required to pay nonresident capital gain tax in China. The payment, which will be made during our fiscal 2024, is expected to total approximately $2.2 million.

We also have an operating lease for our El Paso, Texas finished goods and service parts distribution warehouse, which has a term in excess of one year. We also have purchase commitments related to zinc and other purchased parts. Refer to required future payments under the lease and purchase commitments in the discussion of Leases under Organization and Summary of Significant Accounting Policies and in the discussion of Commitments and Contingencies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

Credit Facilities

STRATTEC has a $40 million secured revolving credit facility (the “STRATTEC Credit Facility”) with BMO Harris Bank N.A. ADAC-STRATTEC LLC has a $25 million secured revolving credit facility (the “ADAC-STRATTEC Credit Facility”) with BMO Harris Bank N.A., which is guaranteed by STRATTEC. The credit facilities expire on August 1, 2024. 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 the STRATTEC Credit Facility were at varying rates based, at our option, on LIBOR plus 1.25 percent or the bank’s prime rate through February 22, 2023. Interest on borrowings under the ADAC-STRATTEC Credit Facility were at varying rates based, at our option, on LIBOR plus 1.25 percent or the bank’s prime rate through February 6, 2023. Subsequent to these dates, interest on borrowings under both credit facilities were at varying rates based, at our option, on SOFR plus 1.35 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. As of July 2, 2023, we were in compliance with all financial covenants required by these credit facilities. There were no outstanding borrowings under the STRATTEC Credit Facility as of July 2, 2023 or July 3, 2022. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $15.4 million and 5.7 percent, respectively, during 2023. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $332,000 and 2.0 percent, respectively, during 2022. Outstanding borrowings under the ADAC-STRATTEC Credit Facility totaled $13 million at July 2, 2023 and $11 million at July 3, 2022. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $12.4 million and 5.3 percent, respectively, during 2023. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $14.2 million and 1.5 percent, respectively, during 2022. We believe that the credit facilities are adequate, along with existing cash flows from operations, to meet our anticipated capital expenditure, working capital, dividend, and operating expenditure requirements.

On August 22, 2023, STRATTEC entered into an agreement, which is effective September 6, 2023, with BMO Harris Bank N.A. to renew the term of its current $40 million secured credit facility until August 1, 2026. The two parties are working on a renewal of the $25 million secured credit facility for ADAC-STRATTEC LLC, which is guaranteed by STRATTEC, for completion in fiscal year 2024.

Joint Ventures and Majority Owned Subsidiaries

Refer to the discussion of Investment in Joint Ventures and Majority Owned Subsidiaries and discussion of Equity Earnings of Joint Ventures included in the Notes to Financial Statements included within this Form 10-K.

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Critical Accounting Policies

We believe the following represents our critical accounting policies:

Liability for Uncertain Tax Positions – We are subject to income taxation in many jurisdictions around the world. Significant management judgment is required in the accounting for income tax contingencies because the outcomes are often difficult to determine. We are required to measure and recognize uncertain tax positions that we have taken or expect to take in our income tax returns. The benefit of an uncertain tax position can only be recognized in the financial statements if management concludes that it is more likely than not that the position will be sustained with the tax authorities. For a position that is likely to be sustained, the benefit recognized in the financial statements is measured at the largest amount that is greater than 50 percent likely of being realized. A reserve is established for the difference between a position taken in an income tax return and the amount recognized in the financial statements. The amount of unrecognized benefits, that if recognized, would affect the effective tax rate was $1.1 million at July 2, 2023 and $1.0 million at July 3, 2022. An increase or decrease in our assessment of the recorded amount of unrecognized benefits by 10 percent would result in an increase or decrease in the reported tax provision, before the impact of interest and penalties, of $110,000 at July 2, 2023 and $100,000 at July 3, 2022. Refer to the discussion of Income Taxes included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

Warranty Reserve – We have a warranty reserve recorded related to our exposure to warranty claims in the event our products fail to perform as expected, and we may be required to participate in the repair costs incurred by our customers for such products. The recorded warranty reserve balance involves judgment and estimates. Our reserve estimate is based on an analysis of historical warranty data as well as current trends and information. Actual warranty costs might differ from estimates due to the level of actual claims varying from our claims experience and estimates and final negotiations and settlements reached with our customers. Therefore, future actual claims experience could result in changes in our estimates of the required reserve. Sensitivity of potential warranty or product recall claims is dependent on the respective customer platform, volumes, production years and product content. We have product recall insurance once a recall claim exceeds $2.5 million with a limit of $30 million. Refer to the discussion of Warranty Reserve under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

We believe the reserve discussed above is estimated using consistent and appropriate methods. However, changes to the assumptions could materially affect the recorded reserve amount.

New Accounting Standards

Refer to the discussion of New Accounting Standards under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Discussion and Analysis should be read in conjunction with STRATTEC SECURITY CORPORATION’s accompanying Financial Statements and Notes thereto included in this Form 10-K. Unless otherwise indicated, all references to years or quarters refer to fiscal years or fiscal quarters of STRATTEC.

Executive Overview

Historically, a significant portion of our total net sales have been to domestic automotive OEMs (General Motors, Ford and Stellantis (formerly Fiat Chrysler)). During the past two decades these customers lost North American market share to the New Domestic automotive manufacturers (primarily the Japanese and Korean automotive manufacturers). In addition to our dependence on our customers’ maintaining their market share, our financial performance depends in large part on conditions in the overall automotive industry, which in turn, are dependent upon the U.S. and global economies. During fiscal years 2022 and 2021, the above domestic automotive OEMs together represented each year 65 percent and 62 percent, respectively, of our total net sales.

During fiscal years 2022 and 2021, we experienced stronger sales demand for our components from our major North American customers noted above as it relates to light trucks and both sport utility and car based utility vehicles in comparison to passenger cars, which was likely influenced by customer preferences and gas prices. If gas prices continue to rise over the next several years, this consumer buying trend may not continue, which is approximately 80 percent light trucks and sport utility vehicles in comparison to 20 percent passenger car vehicle purchases today. During the last 3-5 years our major customers General Motors, Ford and Stellantis eliminated passenger car production on several models in North America as a strategy to improve their overall profitability going forward. Additionally, several of our significant customers have announced plans to increase production volumes for their models of Electric Vehicles.  As these customers start migrating over to Electric Vehicles we believe a significant amount of our current and future product content will continue to be purchased by our key customers and will be adopted in this changeover (refer to vehicle list included at page 7 in this Form 10-K).

Fiscal 2022 net sales were $452 million compared to $485 million in 2021. Both the fiscal 2022 and 2021 net sales were negatively impacted by the global semiconductor chip shortage which caused our OEM customers to temporarily shut down their assembly plants and which ultimately reduced our net sales and profitability during each of these years. In addition, we see these supply chain shortages continuing into fiscal year 2023. Net income attributable to STRATTEC for fiscal 2022 was $7.0 million and the Net income attributable to STRATTEC in fiscal 2021 was $22.5 million. In addition, during fiscal years 2022 and 2021 the Company produced additional finished goods inventory in anticipation of our OEM customers coming out of the temporary shutdowns from the impact of the COVID-19 pandemic and other supply chain shortages to fill their dealer pipelines which are at historic low levels. Also impacting profitability in fiscal year 2022 were increased costs for purchased raw materials relating to zinc, steel, nickel silver, brass, aluminum and plastic resins.  In most cases we were not able to pass along all these increased costs to our customers through pricing increases. Another factor impacting our profitability is our U.S. Dollar and Mexican Peso exchange rate that affects our operations in Mexico. In the case of the Mexican Peso, the Company does have certain hedging strategies to offset the impact of the exchange rate effects on profitability. Finally, on each of January 1, 2022 and 2021, the Mexican Government mandated minimum wage increases of 22% and 15%, respectively which also negatively impacted our overall profitability.

As we look out into the future, the July 2022 projections from our third-party forecasting service indicate that North American light vehicle production will show a significant increase in demand in vehicle production build for the next four years from our original 2022 forecast which was originally set lower due to the expected lingering effects of the COVID-19 pandemic and the ongoing global semiconductor chip shortage. By model year, based on these projections we are expecting a 2022 vehicle build of 13.4 million vehicles, 15.8 million vehicles for 2023, 16.8 million vehicles for 2024, 16.8 million vehicles for 2025 and 16.5 million vehicles for 2026. These vehicle production estimates going forward were significantly increased due to the impact of COVID-19 that lowered vehicle production in late fiscal 2020 and the global semiconductor chip shortage in late fiscal 2021 and 2022 which also continues to negatively impact vehicle production levels. As part of this third party projection, the Ford Motor Company, General Motors and Stellantis are expected to experience increased vehicle production volumes in their production levels during this time period.  Of course, all of these forecasts are subject to variability based on what happens in the overall North American and global economies, especially as it relates to the world wide status of the global semiconductor chip and other supply chain shortages and the lingering impacts of the  COVID-19 pandemic that may shut down our customers' assembly facilities and further disrupt supply chains in the foreseeable future, potential tariff enactment by the United States Government or other foreign countries, the current levels of employment, availability of consumer credit, home equity values, fluctuating fuel prices, changes in customer vehicle and option preferences, product quality issues, including related to recall and product warranty coverage issues, and other key factors that we believe could determine whether consumers can or will purchase new vehicles or particular brands.

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Focus and Strategy Going Forward

STRATTEC’s long-term strategy is focused on maximizing long-term shareholder value by driving profitable growth. Our management believes productivity improvements and cost reductions are critical to our competitiveness, while enhancing the value we deliver to our customers. In order to accomplish this, we have been pursuing, and we intend to continue to pursue over the foreseeable future, the following objectives as summarized below:

We use several key performance indicators to gauge progress toward achieving these objectives. These indicators include net sales growth, operating margin improvement, return on capital employed and cash flow from operations.

Results of Operations

2022 Compared to 2021

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

Current year sales were adversely impacted by the global semiconductor chip shortage that temporarily closed several of our customers’ assembly plants, caused production schedule reductions for all of our customers and, as a result, reduced orders for our products and our net sales to all customer groups (other than Ford Motor Company as noted below) in the current year period as compared to the prior year period. Our 2022 fiscal year was 53 weeks while our 2021 fiscal year was 52 weeks. The impact of the additional week of sales during the current year partially offset the reduction in net sales resulting from the semiconductor chip shortage and increased current year sales by approximately $7.4 million. The following items further impacted sales to the noted customer groups between periods:

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The direct material cost decrease was due to reduced sales volumes between years, as discussed above, which more than offset an increase in direct material costs in the current year as compared to the prior resulting from higher raw material and purchased component costs. In the current year period as compared to the prior year period, our direct material costs decreased as a percent of cost of goods sold while our labor and overhead costs increased as a percent of cost of goods sold. This shift was due to our material costs varying with the sales volume reduction between years while our labor and overhead cost reduction, as discussed below, did not keep pace with the sales reduction between years.

Labor and overhead costs decreased between years. The variable portion of our labor and overhead costs decreased due to lower levels of production at our facilities in the current year as compared to the prior year and production efficiencies at our Milwaukee and Mexico facilities, which reduced labor and overhead costs in the current year as compared to the prior year. This impact was partially offset by less favorable absorption of our fixed overhead costs in the current year as compared to the prior year resulting from the production volume reduction between years and an additional week of expense in the current year as compared to the prior year as our fiscal 2022 was a 53 week year and our fiscal 2021 was a 52 week year. Labor and overhead costs were further impacted by the following:

-Cost Increases:

Cost Decreases:

The decrease in gross profit dollars in the current year as compared to the prior year was attributed to the decrease in net sales between years, partially offset by the decrease in cost of goods sold as discussed above. Gross profit as a percentage of net sales decreased between years due to reduced sales, which resulted in less favorable absorption of our fixed costs, and due to increased direct material costs between periods, which negatively impacted the gross profit margin percentage by 210 basis points between years, as discussed above.

Engineering, Selling and Administrative Expenses in the current year and prior year were as follows:

Engineering, selling and administrative expenses were impacted by the following:

Cost Increases:

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Cost Decrease:

Income from operations in the current year was $8.9 million compared to income from operations of $33.9 million in the prior year. This change between years was the result of decreased sales and increased engineering, selling and administrative expenses, which were partially offset by a decrease in cost of goods sold in the current year as compared to the prior year, all as discussed above.

Equity earnings of joint ventures during the fiscal years ending July 3, 2022 and June 27, 2021 were $181,000 and $2.6 million respectively.  Lower profitability during fiscal 2022 from our VAST LLC joint venture resulted from reduced net sales and reduced profitability in our VAST China operation between years. The reduced profitability in our VAST China operation stemmed from the current global semiconductor chip shortage described above and Chinese Government mandated temporary facility shutdowns due to COVID-19. VAST China’s profitability in the current year was also partially offset with continued startup losses related to their new plant in Jingzhou, China. Additionally, during the current year, VAST China experienced a fire at their Taicang plant. As a result, certain door handle and painting operations were subsequently transferred to their new Jingzhou facility and another supplier. The transfer of production negatively impacted VAST China’s profitability during the second half of our fiscal 2022. We currently believe a presence in the Asian market is a key component of our global strategy. We anticipate that it will contribute to our overall long-term market and financial strength as the Asian market continues to expand and as it seeks to rebound from the ongoing impacts of the COVID-19 pandemic and resulting supply chain shortages of critical electronic component parts. Due to our limited amount of business in both India and Brazil as well as the impact of COVID-19 and the global semiconductor chip shortage described above, our VAST LLC joint venture in India continues to have break-even operating results and our VAST LLC joint venture in Brazil continues to report losses.

Included in other income (expense), net in the current year and prior year were the following items (thousands of dollars):

Our effective income tax rate for 2022 was 4.5 percent compared to 14.6 percent in 2021. The reduction in our effective tax rate in 2022 as compared to 2021 was due to adjustments made to the amount of our 2021 estimated foreign tax credits and estimated tax impacts associated with our investment in VAST LLC. These true-up adjustments resulted from the filing of our 2021 U.S. income tax returns during 2022 and were attributable to actual results included in non-U.S. income tax returns, which are filed on a calendar year basis, and which differ from estimates included in our 2021 tax provision. The adjustment amounts recorded during 2022 totaled $1.0 million. Our effective tax rate for 2022 excluding these adjustments was 15.6 percent. These adjustments were not material to our previously issued financial statements. Additionally, effective July 20, 2020, the U.S. Treasury Department finalized and enacted previously proposed regulations regarding Global Intangible Low Taxed Income (GILTI) tax provisions of the Tax Cuts and Jobs Act of 2017 (TCJA). Prior to this enactment, GILTI represented a significant U.S. income tax on our foreign earnings during 2020. With the enactment of these final regulations, we became eligible for an exclusion from GILTI since we met provisions for the GILTI High-Tax exception included in the final regulations. The enactment of these new regulations and our eligibility for the GILTI High-Tax exception was retroactive to the original enactment of the GILTI tax provision, which included our fiscal 2020. As a result, we

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recorded an income tax benefit of $675,000 during 2021. Our income tax provision for each year 2022 and 2021 was affected by the non-controlling interest portion of our pre-tax income, GILTI provisions and R&D tax credit. The non-controlling interest impacts the effective tax rate as our ADAC-STRATTEC LLC and STRATTEC POWER ACCESS LLC entities are taxed as partnerships for U.S. tax purposes.

Liquidity and Capital Resources

Working Capital (millions of dollars)

Outstanding Receivable Balances from Major Customers

Our primary source of cash flow is from our major customers, which include Stellantis (formerly Fiat Chrysler Automobiles), General Motors Company and Ford Motor Company. As of the date of filing this Annual Report with the Securities and Exchange Commission, all of our 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 July 3, 2022 and June 27, 2021 was as follows (millions of dollars):

Cash Balances in Mexico

We earn a portion of our operating income in Mexico. As of July 3, 2022, $2.2 million of our $8.8 million cash and cash equivalents balance was held in Mexico. These funds are available for repatriation as deemed necessary.

Cash Flow Analysis

The decrease in cash provided by operating activities between 2021 and 2022 was due to a reduction in operating income as previously discussed. The decrease in operating income was slightly offset by a net decrease in working capital requirements between these years of $1.3 million, with the net decrease in our working capital requirements being made up of the following working capital changes (millions of dollars):

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Net cash used by investing activities of $14.3 million during 2022 and $9.0 million during 2021 included capital expenditures of $14.2 million and $8.9 million, respectively. Capital expenditures during each year were made in support of requirements for new product programs and the upgrade and replacement of existing equipment. Net cash used by investing activities during 2022 and 2021 also included an investment in our VAST LLC joint venture of $150,000 and $100,000, respectively. The investments were made for the purpose of funding general operating expenses for Sistema de Acesso Veicular Ltda, our Brazilian joint venture.

Net cash used in financing activities of $1.9 million during 2022 included repayments of borrowings under credit facilities of $14.0 million and $1.8 million of dividend payments to non-controlling interests in our subsidiaries, partially offset by borrowings under credit facilities of $13 million and $908,000 received for the exercise of stock options under our stock incentive plan and purchases under our employee stock purchase plan. Net cash used in financing activities of $22.9 million during 2021 included repayments of borrowings under credit facilities of $23.0 million and $490,000 of dividend payments to non-controlling interests in our subsidiaries, partially offset by $604,000 received for the exercise of stock options under our stock incentive plan and purchases under our employee stock purchase plan.

Cash Requirements

Dividends

On May 13, 2020, our Board of Directors took action to temporarily suspend payment of our quarterly dividend for the foreseeable future in order to conserve cash as a result of the economic downturn caused by COVID-19. No dividends were paid to shareholders during fiscal 2022 and fiscal 2021.

VAST LLC Cash Requirements

We currently anticipate that VAST China has adequate debt facilities in place over the next fiscal year to cover the future operating and capital requirements of its business. During 2022, capital contributions totaling $450,000 were made to VAST LLC for purposes of funding operations in Brazil. STRATTEC’s portion of the capital contribution totaled $150,000. During 2021, capital contributions totaling $300,000 were made to VAST LLC for purposes of funding operations in Brazil. STRATTEC’s portion of the capital contribution totaled $100,000.  Due to economic conditions in Brazil, we anticipate Sistema de Acesso Veicular Ltda may require an additional capital contribution of approximately $300,000 collectively by all VAST LLC partners to fund operations during our fiscal year 2023. STRATTEC’s portion of these capital contributions is anticipated to be $100,000. During 2022 and 2021, VAST LLC made no capital contributions to Minda-VAST Access Systems. We currently anticipate no required future capital contributions to Minda-VAST Access Systems for fiscal year 2023.

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Future Capital Expenditures

We anticipate capital expenditures will be approximately $13.0 million in fiscal 2023 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 July 3, 2022. A total of 3,655,322 shares have been repurchased over the life of the program through July 3, 2022, at a cost of approximately $136.4 million. No shares were repurchased during fiscal 2022 or 2021. 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. At this time, we anticipate minimal or no stock repurchase activity in fiscal year 2023.

Other Cash Requirements

We have an operating lease for our El Paso, Texas finished goods and service parts distribution warehouse, which has a term in excess of one year. We also have purchase commitments related to zinc and other purchased parts. Refer to required future payments under the lease and purchase commitments in the discussion of Leases under Organization and Summary of Significant Accounting Policies and in the discussion of Commitments and Contingencies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

Credit Facilities

STRATTEC has a $40 million secured revolving credit facility (the “STRATTEC Credit Facility”) with BMO Harris Bank N.A. ADAC-STRATTEC LLC has a $25 million secured revolving credit facility (the “ADAC-STRATTEC Credit Facility”) with BMO Harris Bank N.A., which is guaranteed by STRATTEC. The credit facilities expire August 1, 2024. 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 the STRATTEC Credit Facility through May 31, 2021 was at varying rates based, at our option, on the London Interbank Offering Rate (“LIBOR”) plus 1.0 percent or the bank’s prime rate. Interest on borrowings under the ADAC-STRATTEC Credit Facility through May 31, 2021 was at varying rates based, at our option, on LIBOR plus 1.25 percent or the bank’s prime rate. Effective June 1, 2021 interest on borrowings under both credit facilities were at varying rates based, at our option, on the London Interbank Offering Rate (“LIBOR”) plus 1.25 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. As of July 3, 2022, we were in compliance with all financial covenants required by these credit facilities. There were no outstanding borrowings under the STRATTEC Credit Facility as of July 3, 2022 or June 27, 2021. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $332,000 and 2.0 percent, respectively, during 2022. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $8.8 million and 1.2 percent, respectively, during 2021. Outstanding borrowings under the ADAC-STRATTEC Credit Facility totaled $11 million at July 3, 2022 and $12 million at June 27, 2021. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $14.2 million and 1.5 percent, respectively, during 2022. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $14.3 million and 1.4 percent, respectively, during 2021. We believe that the credit facilities are adequate, along with existing cash flows from operations, to meet our anticipated capital expenditure, working capital, dividend, and operating expenditure requirements.

Joint Ventures and Majority Owned Subsidiaries

Refer to the discussion of Investment in Joint Ventures and Majority Owned Subsidiaries and discussion of Equity Earnings of Joint Ventures included in the Notes to Financial Statements included within this Form 10-K.

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Critical Accounting Policies

We believe the following represents our critical accounting policies:

Liability for Uncertain Tax Positions – We are subject to income taxation in many jurisdictions around the world. Significant management judgment is required in the accounting for income tax contingencies because the outcomes are often difficult to determine. We are required to measure and recognize uncertain tax positions that we have taken or expect to take in our income tax returns. The benefit of an uncertain tax position can only be recognized in the financial statements if management concludes that it is more likely than not that the position will be sustained with the tax authorities. For a position that is likely to be sustained, the benefit recognized in the financial statements is measured at the largest amount that is greater than 50 percent likely of being realized. A reserve is established for the difference between a position taken in an income tax return and the amount recognized in the financial statements. The amount of unrecognized benefits, that if recognized, would affect the effective tax rate was $1.0 million at July 3, 2022 and $1.1 million at June 27, 2021. An increase or decrease in our assessment of the recorded amount of unrecognized benefits by 10 percent would result in an increase or decrease in the reported tax provision, before the impact of interest and penalties, of $100,000 at July 3, 2022 and $110,000 at June 27, 2021. Refer to the discussion of Income Taxes included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

Warranty Reserve – We have a warranty liability recorded related to our exposure to warranty claims in the event our products fail to perform as expected, and we may be required to participate in the repair costs incurred by our customers for such products. The recorded warranty liability balance involves judgment and estimates. Our liability estimate is based on an analysis of historical warranty data as well as current trends and information, including our customers’ recent extension or expansion of their warranty programs. Actual warranty costs might differ from estimates due to the level of actual claims varying from our claims experience and estimates and final negotiations and settlements reached with our customers. Therefore, future actual claims experience could result in changes in our estimates of the required liability. Sensitivity of potential warranty or product recall claims is dependent on the respective customer platform, volumes, production years and product content. We have product recall insurance once a recall claim exceeds $5 million with a limit of $35 million. Refer to the discussion of Warranty Reserve under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

We believe the reserve discussed above is estimated using consistent and appropriate methods. However, changes to the assumptions could materially affect the recorded reserve amount.

New Accounting Standards

Refer to the discussion of New Accounting Standards under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Discussion and Analysis should be read in conjunction with STRATTEC SECURITY CORPORATION’s accompanying Financial Statements and Notes thereto included in this Form 10-K. Unless otherwise indicated, all references to years or quarters refer to fiscal years or fiscal quarters of STRATTEC.

Executive Overview

Historically, a significant portion of our total net sales have been to domestic automotive OEMs (General Motors, Ford and Fiat Chrysler). During the past two decades these customers lost North American market share to the New Domestic automotive manufacturers (primarily the Japanese and Korean automotive manufacturers). In addition to our dependence on our customers’ maintaining their market share, our financial performance depends in large part on conditions in the overall automotive industry, which in turn, are dependent upon the U.S. and global economies. During fiscal years 2021 and 2020, the above domestic automotive OEMs together represented each year 62 percent, respectively, of our total net sales.

During fiscal years 2021 and 2020, we experienced stronger sales demand for our components from our major North American customers noted above as it relates to light trucks and both sport utility and car based utility vehicles in comparison to passenger cars, which was likely influenced by customer preferences and gas prices. If gas prices continue to remain flat or slightly higher over the next several years, we anticipate this consumer buying trend will continue, which is approximately 77 percent light trucks and sport utility vehicles in comparison to 23 percent passenger car vehicle purchases today. During the last 3-5 years our major customers General Motors, Ford and Fiat Chrysler eliminated passenger car production on several models in North America as a strategy to improve their overall profitability going forward.

Fiscal 2021 net sales were $485 million compared to $385 million in 2020. The fiscal 2021 net sales were impacted by the global semiconductor chip shortage that reduced net sales and profitability primarily in the fourth quarter of fiscal 2021 and we see these shortages continuing into fiscal year 2022. The reduced sales in fiscal year 2020 was attributed to the General Motors labor strike with the United Auto Workers in September and October 2019 which reduced net sales to General Motors by approximately $10 million and as a result of the COVID-19 pandemic. During March, April and May 2020, the North American OEM assembly plant operations were shut down for the COVID-19 pandemic reducing our net sales to our customers by approximately $78 million during that period. Net income attributable to STRATTEC for fiscal 2021 was $22.5 million and the Net loss attributable to STRATTEC in fiscal 2020 was $7.6 million (which included a $3.7 million non-cash compensation expense charges net of tax), which as noted above was primarily attributed to the lost net sales previously described above. In response to the COVID -19 pandemic in the fourth quarter of fiscal 2020, the Company implemented temporary layoffs of production workers in our Milwaukee, WI and Mexico plant operations, reduced the US Salaried workforce by ten percent, reduced salaried working hours by ten percent, allowed remote working from home, significantly reduced nonessential operating costs, delayed capital expenditures and temporarily suspended the quarterly cash dividend to preserve cash flow during the fourth quarter of fiscal year 2020. In addition, during fiscal year 2021 the Company produced additional finished goods inventory in anticipation of our OEM customers pipeline fill to their dealers once vehicle production began starting up in July, 2020 coming out of the temporary shutdowns from the impact of the COVID-19 pandemic. We continued to build inventory as it relates to the global chip shortage and low inventory levels at the dealers today. Also impacting profitability in late fiscal year 2021 were increased costs for purchased raw materials relating to zinc, steel, nickel silver, brass, aluminum and plastic resins that in most cases we were not able to pass along all these increased costs to our customers. Another factor impacting our profitability is our U.S. Dollar and Mexican Peso exchange rate that affects our operations in Mexico. In the case of the Mexican Peso, the Company does have certain hedging strategies to offset the impact of the exchange rate effects on profitability.

As we look out into the future, the July 2021 projections from our third-party forecasting service indicate that North American light vehicle production will show a significant increase in demand in vehicle production build for the next four years from our original 2021 forecast which was originally set lower due to the expected lingering effects of the COVID-19 pandemic and the ongoing global semiconductor chip shortage. By model year, based on these projections we are expecting a 2021 vehicle build of 14.7 million vehicles, 17.1 million vehicles for 2022, 17.0 million vehicles for 2023, 16.6 million vehicles for 2024 and 16.8 million vehicles for 2025. These vehicle production estimates going forward were significantly increased due to the impact of COVID-19 that lowered vehicle production in late fiscal 2020 and the global semiconductor chip shortage in late fiscal 2021. As part of this third party projection, the Ford Motor Company, General Motors and Fiat Chrysler are expected to experience slightly decreased vehicle production volumes in their production levels during this time period. Of course, all of these forecasts are subject to variability based on what happens in the overall North American and global economies, especially as it relates to the world wide status of the global semiconductor chip shortage and the lingering impacts of the COVID-19 pandemic that may shut down our customers assembly facilities and supply chains in the foreseeable future, potential tariff enactment by the United States Government or other foreign countries, the current levels of employment, availability of consumer credit, home equity values, fluctuating fuel prices, changes in customer vehicle and option preferences, product quality issues, including related to recall and product warranty coverage issues, and other key factors that we believe could determine whether consumers can or will purchase new vehicles or particular brands.

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Focus and Strategy Going Forward

STRATTEC’s long-term strategy is focused on maximizing long-term shareholder value by driving profitable growth. Our management believes productivity improvements and cost reductions are critical to our competitiveness, while enhancing the value we deliver to our customers. In order to accomplish this, we have been pursuing, and we intend to continue to pursue over the foreseeable future, the following objectives as summarized below:

We use several key performance indicators to gauge progress toward achieving these objectives. These indicators include net sales growth, operating margin improvement, return on capital employed and cash flow from operations.

Results of Operations

2021 Compared to 2020

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

Current year sales were adversely impacted by the global semiconductor chip shortage, and prior year sales were significantly and negatively impacted by the decision of our OEM customers to fully close their assembly plants in April and May 2020 due to the COVID-19 pandemic.  The impact of these production schedule reductions reduced our net sales in the prior year by approximately $78.0 million. Sales to all customer groups in the current year were higher in comparison to the prior year due to the foregoing impact of the COVID-19 virus disruption on our operations. The following items further impacted sales to the noted customer groups between years:

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The direct material cost increase was due to increased sales volumes between years, as discussed above, and increased purchased costs for certain raw materials and purchased components in the current year as compared to the prior year. The impact of increased zinc, brass, and nickel silver costs increased current year material costs by approximately $1.3 million as compared to the prior year. The increase in our direct material costs as a percentage of our cost of goods sold was due to the increased raw material costs as previously discussed and due to a reduction in our labor and overhead costs as a percentage of our cost of goods sold, as discussed below.

Labor and overhead costs increased between years, yet these costs decreased as a percentage of our cost of goods sold as a result of favorable absorption of fixed overhead costs resulting from production volume increases and cost improvement initiatives at our Milwaukee and Mexico facilities. Labor and overhead costs were impacted by the following:

Cost Increases:

Cost Decreases:

The increase in gross profit dollars in the current year as compared to the prior year was attributed to the increase in net sales between years, partially offset by the increase in cost of goods sold as discussed above. Gross profit as a percentage of net sales improved between years due to the increase in net sales as discussed above, which resulted in more favorable absorption of our fixed costs and due to cost improvement initiatives at our Milwaukee and Mexico facilities.

Engineering, Selling and Administrative Expenses in the current year and prior year were as follows:

Engineering, selling and administrative expenses were impacted by the following:

Cost Increases:

Cost Decreases:

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Income from operations in the current year was $33.9 million compared to loss from operations of $8.7 million in the prior year. This change was the result of increase sales, which were partially offset by an increase in cost of goods sold in the current year as compared to the prior year, all as discussed above.

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

Higher profitability from our VAST LLC joint venture was due to higher net sales and improved profitability in our VAST China operation between years. The improved profitability in our VAST China operation between years stemmed from the extended OEM customer plant shutdowns associated with the COVID-19 pandemic in the prior year. VAST China’s profitability in the current year was also partially offset by startup costs for their new plant in Jingzhou, China and by costs associated with the closure of our VAST China plant in Fuzhou, China, which operations were consolidated into the new Jingzhou facility. We continue to believe these actions related to the changes in facilities, will give VAST China added capacity, greater operating efficiencies and a broader geographic footprint in the China market going forward. VAST LLC, including VAST China, is a crucial part of our global strategy and we anticipate that it will contribute to our overall long term sales growth as the China market continues to expand. Our VAST LLC joint ventures in India and Brazil continue to report losses due to our limited amount of business in both regions as well as the impact of COVID-19. SAL LLC was dissolved during fiscal 2020. Our 2020 equity earnings of SAL LLC included a gain on dissolution of $342,000.

Included in other (expense) income, net in the current year and prior year were the following items (thousands of dollars):

Our effective income tax rate for 2021 was 14.6 percent compared to 27.9 percent in 2020. Our effective tax rate for 2020 was higher due to our pre-tax book loss and the beneficial carry-back of losses. Additionally, our income tax provision for each year 2021 and 2020 was affected by the non-controlling interest portion of our pre-tax income, GILTI provisions and R&D tax credit. The non-controlling interest impacts the effective tax rate as our ADAC-STRATTEC LLC and STRATTEC POWER ACCESS LLC entities are taxed as partnerships for U.S. tax purposes.

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Liquidity and Capital Resources

Working Capital (millions of dollars)

Outstanding Receivable Balances from Major Customers

Our primary source of cash flow is from our major customers, which include Fiat Chrysler Automobiles LLC, General Motors Company and Ford Motor Company. As of the date of filing this Annual Report with the Securities and Exchange Commission, all of our 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 June 27, 2021 and June 28, 2020 was as follows (millions of dollars):

Reduced accounts receivable balances as of June 28, 2020 was primarily due to reduced sales levels from the end of March 2020 through June 2020 as a result of our OEM customers reducing production schedules and closing their assembly plants, which reduced orders for our products, due to the COVID-19 outbreak.

Cash Balances in Mexico

We earn a portion of our operating income in Mexico. As of June 27, 2021, $2.3 million of our $14.5 million cash and cash equivalents balance was held in Mexico. These funds are available for repatriation as deemed necessary.

Cash Flow Analysis

The increase in cash provided by operating activities between 2020 and 2021 was due to an increase in operating income as previously discussed. The increase in operating income was partially offset by a net increase in working capital requirements between these years of $28.7 million, with the net increase in our working capital requirements being made up of the following working capital changes (millions of dollars):

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Net cash used by investing activities of $9.0 million during 2021 and $12.3 million during 2020 included capital expenditures of $8.9 million and $12.4 million, respectively. Capital expenditures during each year were made in support of requirements for new product programs and the upgrade and replacement of existing equipment. Net cash used by investing activities during 2021 also included an investment in our VAST LLC joint venture of $100,000. The investment was made for the purpose of funding general operating expenses for Sistema de Acesso Veicular Ltda, our Brazilian joint venture.

Net cash used in financing activities of $22.9 million during 2021 included repayments of borrowings under credit facilities of $23.0 million and $490,000 of dividend payments to non-controlling interests in our subsidiaries, partially offset by $604,000 received for the exercise of stock options under our stock incentive plan and purchases under our employee stock purchase plan. Net cash used in financing activities of $9.0 million during 2020 included repayments of borrowings under credit facilities of $15.0 million, $1.6 million of regular quarterly dividend payments to shareholders and $980,000 of dividend payments to non-controlling interests in our subsidiaries, partially offset by $8 million in additional borrowings under credit facilities as well as $560,000 received for the exercise of stock options under our stock incentive plan and purchases under our employee stock purchase plan.

Dividends

On May 13, 2020, our Board of Directors took action to temporarily suspend payment of our quarterly dividend for the foreseeable future in order to conserve cash as a result of the economic downturn caused by COVID-19. During the first nine months of fiscal 2020, prior to the suspension of dividend payments as discussed above, approximately $1.6 million of cash dividends were paid to our shareholders. No dividends were paid to shareholders during fiscal 2021.

VAST LLC Cash Requirements

We currently anticipate that VAST China has adequate debt facilities in place over the next fiscal year to cover the future operating and capital requirements of its business. During 2021, capital contributions totaling $300,000 were made to VAST LLC for purposes of funding operations in Brazil. STRATTEC’s portion of the capital contribution totaled $100,000.  No capital contributions were made to VAST LLC in 2020. Due to economic conditions in Brazil, we anticipate Sistema de Acesso Veicular Ltda may require an additional capital contribution of approximately $300,000 collectively by all VAST LLC partners to fund operations during our fiscal year 2022. STRATTEC’s portion of these capital contributions is anticipated to be $100,000. During 2021 and 2020, VAST LLC made no capital contributions to Minda-VAST Access Systems. Due to Minda-VAST Access System recently experiencing losses and due to the COVID-19 outbreak, future capital contributions may be required by the partners in this joint venture.

Future Capital Expenditures

We anticipate capital expenditures will be approximately $13 million in fiscal 2022 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 June 27, 2021. A total of 3,655,322 shares have been repurchased over the life of the program through June 27, 2021, at a cost of approximately $136.4 million. No shares were repurchased during fiscal 2021 or 2020. 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. At this time, we anticipate minimal or no stock repurchase activity in fiscal year 2022.

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Credit Facilities

STRATTEC has a $40 million secured revolving credit facility (the “STRATTEC Credit Facility”) with BMO Harris Bank N.A. ADAC-STRATTEC LLC has a $25 million secured revolving credit facility (the “ADAC-STRATTEC Credit Facility”) with BMO Harris Bank N.A., which is guaranteed by STRATTEC. The credit facilities were extended during June 2021 and both expire August 1, 2024. 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 the STRATTEC Credit Facility through May 31, 2021 was at varying rates based, at our option, on the London Interbank Offering Rate (“LIBOR”) plus 1.0 percent or the bank’s prime rate. Interest on borrowings under the ADAC-STRATTEC Credit Facility through May 31, 2021 was at varying rates based, at our option, on LIBOR plus 1.25 percent or the bank’s prime rate. Effective June 1, 2021 interest on borrowings under both credit facilities were at varying rates based, at our option, on the London Interbank Offering Rate (“LIBOR”) plus 1.25 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. As of June 27, 2021, we were in compliance with all financial covenants required by these credit facilities. There were no outstanding borrowings under the STRATTEC Credit Facility as of June 27, 2021. Outstanding borrowings under the STRATTEC Credit Facility totaled $18 million at June 28, 2020. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $8.8 million and 1.2 percent, respectively, during 2021. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $13.8 million and 2.6 percent, respectively, during 2020. Outstanding borrowings under the ADAC-STRATTEC Credit Facility totaled $12 million at June 27, 2021 and $17 million at June 28, 2020. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $14.3 million and 1.4 percent, respectively, during 2021. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $19.1 million and 2.9 percent, respectively, during 2020. We believe that the credit facilities are adequate, along with existing cash flows from operations, to meet our anticipated capital expenditure, working capital, dividend, and operating expenditure requirements.

Inflation and Other Changes in Prices

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, steel, brass, nickel silver, and aluminum as well as 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 own and operate manufacturing operations in Mexico.  As a result, a portion of our manufacturing costs are incurred in Mexican pesos. We have from time to time entered into 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 to minimize our earnings volatility resulting from changes in exchange rates affecting the U.S. dollar cost of our Mexican operations. Refer to the discussion of Derivative Instruments under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

Joint Ventures and Majority Owned Subsidiaries

Refer to the discussion of Investment in Joint Ventures and Majority Owned Subsidiaries and discussion of Equity Earnings (Loss) of Joint Ventures included in the Notes to Financial Statements included within this Form 10-K.

Critical Accounting Policies

We believe the following represents our critical accounting policies:

Liability for Uncertain Tax Positions – We are subject to income taxation in many jurisdictions around the world. Significant management judgment is required in the accounting for income tax contingencies because the outcomes are often difficult to determine. We are required to measure and recognize uncertain tax positions that we have taken or expect to take in our income tax returns. The benefit of an uncertain tax position can only be recognized in the financial statements if management concludes that it is more likely than not that the position will be sustained with the tax authorities. For a position that is likely to be sustained, the benefit recognized in the financial statements is measured at the largest amount that is greater than 50 percent likely of being realized. A reserve is established for the difference between a position taken in an income tax return and the amount recognized in the financial statements. Refer to the discussion of Income Taxes included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

Warranty Reserve – We have a warranty liability recorded related to our exposure to warranty claims in the event our products fail to perform as expected, and we may be required to participate in the repair costs incurred by our customers for such products. The recorded warranty liability balance involves judgment and estimates. Our liability estimate is based on an analysis of historical

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warranty data as well as current trends and information, including our customers’ recent extension or expansion of their warranty programs. Actual warranty costs might differ from estimates due to the level of actual claims varying from our claims experience and estimates and final negotiations and settlements reached with our customers. Therefore, future actual claims experience could result in changes in our estimates of the required liability. Refer to the discussion of Warranty Reserve under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.

We believe the reserve discussed above is estimated using consistent and appropriate methods. However, changes to the assumptions could materially affect the recorded reserve amount.

New Accounting Standards

Refer to the discussion of New Accounting Standards under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.