STRATTEC SECURITY CORP - Quarter Report: 2015 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

For the quarterly period ended March 29, 2015

or

For the transition period from                      to                     

Commission File Number 0-25150

STRATTEC SECURITY CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

3333 West Good Hope Road, Milwaukee, WI 53209

(Address of Principal Executive Offices)

(414) 247-3333

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     YES  x    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     YES  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     YES  ¨    NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

Common stock, par value $0.01 per share: 3,587,224 shares outstanding as of March 27, 2015 (which number includes all restricted shares previously awarded that have not vested as of such date).

STRATTEC SECURITY CORPORATION

FORM 10-Q

March 29, 2015

INDEX

PROSPECTIVE INFORMATION

A number of the matters and subject areas discussed in this Form 10-Q contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of forward-looking words or phrases such as “anticipate,” “believe,” “would,” “expect,” “intend,” “may,” “planned,” “potential,” “should,” “will,” and “could,” or the negative of these terms or words of similar meaning. These statements include expected future financial results, product offerings, global expansion, liquidity needs, financing ability, planned capital expenditures, management's or the Company’s expectations and beliefs, and similar matters discussed in this Form 10-Q. The discussions of such matters and subject areas are qualified by the inherent risks and uncertainties surrounding future expectations generally, and also may materially differ from the Company’s actual future experience.

The Company’s business, operations and financial performance are subject to certain risks and uncertainties, which could result in material differences in actual results from the Company’s current expectations. These risks and uncertainties include, but are not limited to, general economic conditions, in particular relating to the automotive industry, consumer demand for the Company’s and its customers’ products, competitive and technological developments, customer purchasing actions, foreign currency fluctuations, fluctuations in costs of operations (including fluctuations in the cost of raw materials), the volume and scope of product returns and warranty claims and other matters described in the section titled “Risk Factors” in the Company’s Form 10-K report filed on September 5, 2014 with the Securities and Exchange Commission for the year ended June 29, 2014.

Shareholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this Form 10-Q and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances occurring after the date of this Form 10-Q.

Item 1 Financial Statements

STRATTEC SECURITY CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Income and Comprehensive Income

(In Thousands, Except Per Share Amounts)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated statements of income and comprehensive income.

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STRATTEC SECURITY CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(In Thousands, Except Share Amounts)

The accompanying notes are an integral part of these condensed consolidated balance sheets.

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STRATTEC SECURITY CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(In Thousands)

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated statements of cash flows.

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STRATTEC SECURITY CORPORATION AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

Basis of Financial Statements

STRATTEC SECURITY CORPORATION designs, develops, manufactures and markets automotive access control products including mechanical locks and keys, electronically enhanced locks and keys, steering column and instrument panel ignition lock housings, latches, power sliding door systems, power lift gate systems, power deck lid systems, door handles and related products for primarily North American automotive customers. We also supply global automotive manufacturers through a unique strategic relationship with WITTE Automotive of Velbert, Germany, and ADAC Automotive of Grand Rapids, Michigan. Under this relationship, STRATTEC, WITTE and ADAC market the products of each company to global customers under the “VAST” brand name. STRATTEC products are shipped to customer locations in the United States, Canada, Mexico, Europe, South America, Korea and China, and we provide full service and aftermarket support for our products.

During 2013, we acquired a 51 percent ownership interest in NextLock LLC, a newly formed joint venture which will introduce a new generation of biometric security products based upon the designs of Actuator Systems LLC, our partner and the owner of the remaining ownership interest. Effective January 6, 2015, we changed the name of NextLock, LLC to STRATTEC Advanced Logic, LLC.

The accompanying condensed consolidated financial statements reflect the consolidated results of STRATTEC SECURITY CORPORATION, its wholly owned Mexican subsidiary, STRATTEC de Mexico, and its majority owned subsidiaries, ADAC-STRATTEC, LLC and STRATTEC POWER ACCESS LLC. STRATTEC SECURITY CORPORATION is located in Milwaukee, Wisconsin. STRATTEC de Mexico is located in Juarez, Mexico. ADAC-STRATTEC, LLC and STRATTEC POWER ACCESS LLC have operations in El Paso, Texas and Juarez, Mexico. Equity investments in Vehicle Access Systems Technology LLC (“VAST LLC”) and STRATTEC Advanced Logic, LLC (formerly known as NextLock, LLC) for which we exercise significant influence but do not control and are not the primary beneficiary, are accounted for using the equity method. VAST LLC consists primarily of three wholly owned subsidiaries in China and one in Brazil. STRATTEC Advanced Logic, LLC (formerly known as NextLock, LLC) is located in El Paso, Texas. We have only one reporting segment.

In the opinion of management, the accompanying condensed consolidated balance sheet as of June 29, 2014, which has been derived from our audited financial statements, and the related unaudited interim condensed consolidated financial statements included herein contain all adjustments, consisting only of normal recurring items, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and in accordance with Rule 10-01 of Regulation S-X. All significant intercompany transactions have been eliminated.

Interim financial results are not necessarily indicative of operating results for an entire year. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis and the financial statements and notes thereto included in the STRATTEC SECURITY CORPORATION 2014 Annual Report, which was filed with the Securities and Exchange Commission as an exhibit to our Form 10-K on September 5, 2014.

New Accounting Standard

In May 2014, the FASB issued an update to the accounting guidance for the recognition of revenue arising from contracts with customers. The update supersedes most current revenue recognition guidance and outlines a single comprehensive model for revenue recognition based on the principle that an entity should recognize revenue in an amount that reflects the expected consideration to be received in the exchange of goods and services. The guidance update also required additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. The guidance update is effective for annual reporting periods beginning after December 15, 2016 and becomes effective for us at the beginning of our 2018 fiscal year. Early adoption is not permitted. We are currently assessing the impact that this guidance will have on our consolidated financial statements.

Subsequent Event

Effective April 30, 2015, the VAST LLC joint venture, which includes STRATTEC, WITTE Automotive (“WITTE”) of Velbert Germany and ADAC Automotive (“ADAC”) of Grand Rapids, Michigan, executed an agreement to become a 50:50 Joint Venture partner with Minda Management Services Limited an affiliate of both Minda Corporation Limited and Spark Minda, Ashok Minda Group of New Delhi, India (collectively “Minda”).  VAST acquired a fifty percent equity interest in the former Minda-Valeo Security Systems joint venture entity, based in Pune, India for approximately $12 million.  This joint venture entity will be renamed Minda-VAST Access Systems (“Minda-VAST”). The portion of the purchase price paid by each VAST LLC partner, STRATTEC, WITTE and ADAC, totaled $4 million. Minda-VAST will have operations in Pune and Delhi and is expected to have annual sales in excess of

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approximately $40 million. Minda and its affiliates cater to the needs of all major car, motorcycle, commercial vehicle, tractor and off-road vehicle manufacturers in India.  They are a leading manufacturer in the Indian marketplace of security & access products, handles, automotive safety, restraint systems, driver information and telematics systems for both OEMs and the aftermarket.

Fair Value of Financial Instruments

The fair value of our cash and cash equivalents, accounts receivable, accounts payable and borrowings under our credit facility approximated book value as of March 29, 2015 and June 29, 2014. Fair value is defined as the exchange price that would be received for an asset or paid for a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date.

The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of March 29, 2015 (in thousands):

The Rabbi Trust assets fund our amended and restated supplemental executive retirement plan and are included in Other Long-term Assets in the accompanying Condensed Consolidated Balance Sheets. There were no transfers between Level 1 and Level 2 assets during the three or nine month periods ended March 29, 2015.

Equity Earnings of Joint Ventures

We hold a one-third interest in a joint venture company, Vehicle Access Systems Technology LLC (“VAST LLC”), with WITTE Automotive of Velbert, Germany (“WITTE”), and ADAC Automotive of Grand Rapids, Michigan (“ADAC”). VAST LLC exists to seek opportunities to manufacture and sell all three companies’ products in areas of the world outside of North America and Europe. VAST LLC consists primarily of three wholly owned subsidiaries in China and one in Brazil. Our investment in VAST LLC, for which we exercise significant influence but do not control and are not the primary beneficiary, is accounted for using the equity method.

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The following are summarized statements of operations for VAST LLC (in thousands):  

During 2013, we acquired a 51% ownership interest in a newly formed joint venture company, STRATTEC Advanced Logic, LLC (formerly known as NextLock, LLC), which will introduce a new generation of biometric security products based upon designs of Actuator Systems LLC, our partner.

Effective February 16, 2015, STRATTEC Advanced Logic, LLC entered into a $1.5 million revolving credit facility (the “STRATTEC Advanced Logic Credit Facility’) with BMO Harris Bank N.A., which is fully guaranteed by STRATTEC. Interest on borrowings under the STRATTEC Advanced Logic Credit Facility is at varying rates based, at STRATTEC Advanced Logic, LLC’s option, on LIBOR plus 1.0 percent or the bank’s prime rate. The STRATTEC Advanced Logic Credit Facility currently has a maturity date of February 16, 2016. Outstanding borrowings under the STRATTEC Advanced Logic Credit Facility as of March 29, 2015 totaled $750,000. STRATTEC Advanced Logic, LLC is considered a variable interest entity based on the STRATTEC guarantee. STRATTEC is not the primary beneficiary and does not control the entity. Accordingly, our investment in STRATTEC Advanced Logic, LLC is accounted for using the equity method. As of March 29, 2015, STRATTEC has a recorded a liability related to the guarantee of $750,000, which amount is equal to the outstanding borrowings on the STRATTEC Advanced Logic Credit Facility as of March 29, 2015, and which amount is also equal to the estimated fair value of the guarantee as of the March 29, 2015 balance sheet date. The liability is included in Other Current Liabilities in the accompanying Condensed Consolidated Balance Sheets. STRATTEC’s proportionate share of the guarantee based on our ownership percentage in STRATTEC Advanced Logic, LLC totals $383,000, and accordingly, we have increased our investment in STRATTEC Advanced Logic, LLC as of March 29, 2015 by this amount. Our joint venture partner did not guarantee their proportionate share of the STRATTEC Advanced Logic Credit Facility. As a result, STRATTEC recorded a loss of $367,000 which is equal to our partner’s proportionate share, based upon their ownership interest in the joint venture, of the fair value of the STRATTEC guarantee. This loss is included in Equity Loss (Earnings) of Joint Ventures for the three and nine month periods ended March 29, 2015 in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income.

The following are summarized statements of operations for STRATTEC Advanced Logic, LLC (in thousands):

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We have sales of component parts to VAST LLC and STRATTEC Advanced Logic, LLC, purchases of component parts from VAST LLC, expenses charged to VAST LLC for engineering and accounting services and expenses charged to us from VAST LLC for general headquarters expenses.  The following table summarizes these related party transactions with VAST LLC and STRATTEC Advanced Logic, LLC for the periods indicated below (in thousands):

Credit Facilities and Guarantees

STRATTEC has a $25 million secured revolving credit facility (the “STRATTEC Credit Facility”) with BMO Harris Bank N.A. ADAC-STRATTEC LLC has a $5 million secured revolving credit facility (the “ADAC-STRATTEC Credit Facility”) with BMO Harris Bank N.A, which is guaranteed by STRATTEC. The credit facilities both expire August 1, 2016. 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 ADAC-STRATTEC Credit Facility for periods prior to January 22, 2014 was at varying rates based, at our option, on LIBOR plus 1.75 percent or the bank’s prime rate.  Interest on borrowings under the STRATTEC credit facility and effective on or after January 22, 2014 under the ADAC-STRATTEC Credit Facility is at varying rates based, at our option, on LIBOR plus 1.0 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 March 29, 2015, we were in compliance with all financial covenants.

Outstanding borrowings under the credit facilities were as follows (in thousands):

Average outstanding borrowings and the weighted average interest rate under each credit facility were as follows for each period presented (in thousands):

Effective February 16, 2015, STRATTEC Advanced Logic, LLC entered into a $1.5 million revolving credit facility (the “STRATTEC Advanced Logic Credit Facility’) with BMO Harris Bank N.A., which is fully guaranteed by STRATTEC. Interest on borrowings under the STRATTEC Advanced Logic Credit Facility is at varying rates based, at STRATTEC Advanced Logic, LLC’s option, on LIBOR plus 1.0 percent or the bank’s prime rate. The STRATTEC Advanced Logic Credit Facility currently has a maturity date of February 16, 2016. Outstanding borrowings under the STRATTEC Advanced Logic Credit Facility as of March 29, 2015 totaled $750,000. As of March 29, 2015, STRATTEC has recorded a liability related to the guarantee of $750,000, which amount is equal to the outstanding borrowings on the STRATTEC Advanced Logic Credit Facility as of March 29, 2015, and which amount is also equal to the estimated fair value of the guarantee as of the March 29, 2015 balance sheet date. See further discussion under Equity Earnings of Joint Ventures included herein.

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Environmental Reserve

In 1995, we recorded a provision of $3 million for estimated costs to remediate an environmental contamination site at our Milwaukee facility. The site was contaminated by a solvent spill, which occurred in 1985, from a former above ground solvent storage tank located on the east side of the facility. The reserve was originally established based on third party estimates to adequately cover the cost for active remediation of the contamination. Due to changing technology and related costs associated with active remediation of the contamination, an updated analysis and estimate was obtained during fiscal 2010. As a result of this analysis, the reserve was reduced by approximately $1.1 million, to $1.5 million in 2010, to reflect the revised monitoring and remediation cost estimate. From 1995 through March 29, 2015, costs of approximately $490,000 have been incurred related to the installation of monitoring wells on the property and ongoing monitoring costs. We continue to monitor and evaluate the site with the use of these groundwater monitoring wells. An environmental consultant samples these wells one or two times a year to determine the status of the contamination and the potential for remediation of the contamination by natural attenuation, the dissipation of the contamination over time to concentrations below applicable standards. If such sampling evidences a sufficient degree of and trend toward natural attenuation of the contamination at the site, we may be able to obtain a closure letter from the regulatory authorities resolving the issue without the need for active remediation. If a sufficient degree and trend toward natural attenuation is not evidenced by sampling, a more active form of remediation beyond natural attenuation may be required. The sampling has not yet satisfied all of the requirements for closure by natural attenuation. As a result, sampling continues and the reserve remains at an amount to reflect the estimated cost of active remediation. The reserve is not measured on a discounted basis. We believe, based on findings-to-date and known environmental regulations, that the remaining environmental reserve of $1.4 million at March 29, 2015 is adequate.

Shareholders’ Equity

A summary of activity impacting shareholders’ equity for the nine month period ended March 29, 2015 was as follows (in thousands):

Other Income, net

Net other income included in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income primarily included foreign currency transaction gains and losses and Rabbi Trust gains and losses. Foreign currency transaction gains and losses resulted from activity associated with foreign denominated assets held by our Mexican subsidiaries. The Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in this Trust are considered trading securities.

The impact of these items for each of the periods presented was as follows (in thousands):

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Income Taxes

The income tax provisions for the three and nine month periods ended March 29, 2015 and March 30, 2014 were affected by the non-controlling interest portion of our pre-tax income and a lower statutory tax rate for income subject to tax in Mexico as compared to the statutory tax rate for income subject to tax in the U.S.  Moreover, our income tax provision included a reduction in our liability for unrecognized tax benefits and related interest of approximately $936,000 for the three and nine month periods ended March 29, 2015 and $307,000 for the three and nine month periods ended March 30, 2014 due to tax years that closed during such periods.

Earnings Per Share (EPS)

Basic earnings per share is computed on the basis of the weighted average number of shares of common stock outstanding during the applicable period. Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock plus the potential dilutive common shares outstanding during the applicable period using the treasury stock method. Potential dilutive common shares include outstanding stock options and unvested restricted stock awards.

A reconciliation of the components of the basic and diluted per-share computations follows (in thousands, except per share amounts):

We consider unvested restricted stock that provides the holder with a non-forfeitable right to receive dividends to be a participating security.

As of March 29, 2015, options to purchase 9,010 shares of common stock were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive.  As of March 30, 2014, options to purchase 49,340 shares of common stock were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive.

Stock-based Compensation

We maintain an omnibus stock incentive plan. This plan provides for the granting of stock options, shares of restricted stock and stock appreciation rights. As of March 29, 2015, the Board of Directors had designated 1,850,000 shares of common stock available for the grant of awards under the plan. Remaining shares available to be granted under the plan as of March 29, 2015 were 253,339. Awards that expire or are canceled without delivery of shares become available for re-issuance under the plan. We issue new shares of common stock to satisfy stock option exercises.

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Nonqualified and incentive stock options and shares of restricted stock have been granted to our officers, outside directors and specified employees under our stock incentive plan. Stock options granted under the plan may not be issued with an exercise price less than the fair market value of the common stock on the date the option is granted. Stock options become exercisable as determined at the date of grant by the Compensation Committee of the Board of Directors. The options expire 5 to 10 years after the grant date unless an earlier expiration date is set at the time of grant. The options vest 1 to 4 years after the date of grant. Shares of restricted stock granted under the plan are subject to vesting criteria determined by the Compensation Committee of the Board of Directors at the time the shares are granted and have a minimum vesting period of three years from the date of grant. Restricted shares granted have voting rights, regardless if the shares are vested or unvested. Restricted shares granted prior to August 2014 have dividend rights, regardless if the shares are vested or unvested. Commencing in August 2014 and thereafter, shares of restricted stock awarded to participants are not entitled to receive any cash dividends if they are unvested as of the record date. The restricted stock grants issued to date vest 3 years after the date of grant.

The fair value of each stock option grant was estimated as of the date of grant using the Black-Scholes pricing model. The resulting compensation cost for fixed awards with graded vesting schedules is amortized on a straight line basis over the vesting period for the entire award. The fair value of each restricted stock grant was based on the market price of the underlying common stock as of the date of grant. The resulting compensation cost is amortized on a straight line basis over the vesting period.

A summary of stock option activity under our stock incentive plan for the nine months ended March 29, 2015 was as follows:

The intrinsic value of stock options exercised and the fair value of stock options vesting during the three and nine month periods presented below was as follows (in thousands):

The grant date fair value and assumptions used to determine compensation expense for the options granted during each period presented below were as follows:

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A summary of restricted stock activity under our omnibus stock incentive plan for the nine months ended March 29, 2015 was as follows:

As of March 29, 2015, there was $558,000 of total unrecognized compensation cost related to outstanding stock options granted under our omnibus stock incentive plan. This cost is expected to be recognized over a remaining weighted average period of 0.9 years. As of March 29, 2015, there was approximately $1.5 million of total unrecognized compensation cost related to unvested restricted stock grants outstanding under the plan. This cost is expected to be recognized over a remaining weighted average period of 1.1 years. Total unrecognized compensation cost will be adjusted for any future changes in estimated and actual forfeitures of awards granted under our omnibus stock incentive plan.

Pension and Postretirement Benefits

We have a qualified, noncontributory defined benefit pension plan (“Qualified Pension Plan”) covering substantially all U.S. associates. Benefits are based on years of service and final average compensation. Our policy is to fund at least the minimum actuarially computed annual contribution required under the Employee Retirement Income Security Act of 1974 (ERISA). Plan assets consist primarily of listed equity and fixed income securities. Effective December 31, 2009, an amendment to the Qualified Pension Plan discontinued the benefit accruals for salary increases and credited service rendered after that date.  On April 2, 2014, our Board of Directors approved a resolution to terminate the Qualified Pension Plan.  The termination of the Qualified Pension Plan is subject to the Internal Revenue Service’s (“IRS”) determination that the Qualified Pension Plan is qualified on termination.  We believe it will take 18 to 24 months to finalize the complete termination of the Qualified Pension Plan after obtaining IRS approval.  We have not yet received IRS approval that the qualified plan is qualified on termination. Additionally, we have amended the Qualified Pension Plan to provide that participants are 100 percent vested in their accrued benefits as of the effective date of the plan termination, to adopt a new standard for disability benefits that will apply when the plan’s assets are distributed due to the termination, to add a lump sum distribution for employees and terminated vested participants who are not in payment status when Qualified Pension Plan assets are distributed due to the termination and to make certain other conforming amendments to the Qualified Pension Plan to comply with applicable laws that may be required by the IRS or may be deemed necessary or advisable to improve the administration of the Qualified Pension Plan or facilitate its termination and liquidation.  We also intend to make contributions to the Trust Fund for the Qualified Pension Plan to ensure that there are sufficient assets to provide all Qualified Pension Plan benefits as of the anticipated distribution date.  The financial impact of the plan termination will be recognized as a settlement of the Qualified Pension Plan liabilities.  The settlement date and related financial impact have not yet been determined.

We have historically had in place a noncontributory supplemental executive retirement plan (“SERP”), which was a nonqualified defined benefit plan that essentially mirrored the Qualified Pension Plan, but provided benefits in excess of certain limits placed on our Qualified Pension Plan by the Internal Revenue Code.  We froze our Qualified Pension Plan effective as of December 31, 2009 and the SERP provided benefits to participants as if the Qualified Pension Plan had not been frozen.  Because the Qualified Pension Plan was frozen and because new employees were not eligible to participate in the Qualified Pension Plan, our Board of Directors adopted amendments to the SERP on October 8, 2013 that were effective as of December 31, 2013 to simplify the SERP calculation.  The SERP is funded through a Rabbi Trust with BMO Harris Bank N.A.  Under the amended SERP, participants received an accrued lump-sum benefit as of December 31, 2013 which was credited to each participant’s account.  Going forward, each eligible participant will receive a supplemental retirement benefit equal to the foregoing lump-sum benefit, plus an annual benefit accrual equal to 8 percent of the participant’s base salary and cash bonus, plus annual credited interest on the participant’s account balance.  All current participants are fully vested in their account balances with any new individuals participating in the SERP effective on or after January 1, 2014 being subject to a five year vesting schedule.  The SERP, which is considered a defined benefit plan under applicable rules and regulations, will continue to be funded through the use of a Rabbi Trust to hold investment assets to be used in part to fund any future required lump sum benefit payments to participants.  The foregoing amendments to the SERP did not have a material effect on our financial statements.  The Rabbi Trust assets had a value of $2.3 million at March 29, 2015 and $2.2 million at June 29, 2014, respectively, and are included in Other Long-Term Assets in the accompanying Condensed Consolidated Balance Sheets.

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We also sponsor a postretirement health care plan for all of our U.S. associates hired prior to June 2, 2001. The expected cost of retiree health care benefits is recognized during the years that the associates who are covered under the plan render service. Effective January 1, 2010, an amendment to the postretirement health care plan limited the benefit for future eligible retirees to $4,000 per plan year and is subject to a maximum five year coverage period based on the associate’s retirement date and age. The postretirement health care plan is unfunded.

Net periodic benefit costs under these plans are allocated between Cost of Goods Sold and Engineering, Selling and Administrative Expenses in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income.

The following tables summarize the net periodic benefit cost recognized for each of the periods indicated under these plans (in thousands):

No contributions were made to the Qualified Pension Plan during the nine month period ended March 29, 2015. Contributions of $1.5 million were made to the Qualified Pension Plan during the nine month period ended March 30, 2014. Voluntary contributions of $3.0 million are anticipated to be made during the remainder of fiscal 2015.

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Accumulated Other Comprehensive Loss

The following table summarizes the changes in accumulated other comprehensive loss (“AOCL”) for each period presented (in thousands):

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Item 2

STRATTEC SECURITY CORPORATION AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis should be read in conjunction with STRATTEC SECURITY CORPORATION’s accompanying Condensed Consolidated Financial Statements and Notes thereto and its 2014 Annual Report which was filed with the Securities and Exchange Commission as an exhibit to its Form 10-K on September 5, 2014. Unless otherwise indicated, all references to years refer to fiscal years.

Outlook

Chrysler commenced their planned shutdown of their Windsor, Canada Assembly Plant effective February 9, 2015 in preparation of their changeover to the production of the new Chrysler minivan. The impact to STRATTEC’s current year quarter and nine month period ended March 29, 2015 were lost sales of approximately $8 million. This Windsor, Canada Assembly Plant shutdown is scheduled to continue through May 24, 2015. In the event this shutdown does continue through the above time period, we estimate this will result in lost power access and lockset product sales of approximately $8 million to $9 million during our fiscal 2015 fourth quarter.

Analysis of Results of Operations

Three months ended March 29, 2015 compared to the three months ended March 30, 2014

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

The decrease in sales to Chrysler Group LLC in the current year quarter was due to Chrysler’s temporary shutdown of its Windsor, Canada assembly plant to re-tool the facility for the production of the new Chrysler minivan. The negative effect of the shutdown was partially offset by increased service sales to Chrysler in the current year quarter over the prior year quarter. The decrease in sales to General Motors Company in the current year quarter related to a $3.3 million sales concession that we granted to General Motors during the current year quarter, which decrease was partially offset by higher vehicle production volumes and greater product content on vehicle models for which we supply components that were introduced for the 2015 model year. Decreased sales to Ford Motor Company in the current year quarter were attributed to lower vehicle production volumes on models for which we supply components and in particular for components we supply on the F-150 pick-up trucks, which decrease was partially offset by higher latch product sales in the current year quarter. Sales to Tier 1 Customers during the current year quarter increased in comparison to the prior year quarter. These customers primarily represent purchasers of vehicle access control products, such as latches, fobs, and driver controls, that we have developed in recent years to complement our historic core business of locks and keys.  The increase in sales to Hyundai / Kia in the current year quarter was due to the continued ramp-up of the new Kia Sedona minivan for which we supply components.

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Direct material costs are the most significant component of our cost of goods sold and comprised $47.9 million or 65.6 percent of cost of goods sold in the current year quarter compared to $45.6 million or 64.8 percent of cost of goods sold in the prior year quarter. The increase in material costs of $2.3 million, or 5.0 percent, was due to increased sales volumes in the current year quarter over the prior year quarter as discussed above. The increase in material costs as a percent of cost of goods sold is the result of the increased sales of product with higher purchased part content in the current year quarter as compared to the prior year quarter.  

The remaining components of our cost of goods sold consist of labor and overhead costs which increased $400,000 or 1.6 percent in the current year quarter over the prior year quarter as the variable portion of these costs increased due to the increase in sales volumes during the current year quarter over the prior year quarter. The impact of the increase in the variable portion of these costs was partially offset by the benefits of favorable absorption of the fixed portion of our labor and overhead costs resulting from increased sales volumes between periods, a reduction of $780,000 in expense provisions for the accrual of bonuses under our incentive bonus plans for the current year quarter as compared to the prior year quarter and a favorable Mexican Peso to U.S. dollar exchange rate affecting the U.S. dollar cost of our Mexican operations. The average U.S. dollar/Mexican Peso exchange rate increased to approximately 14.96 in the current year quarter from approximately 13.22 in the prior year quarter, which resulted in decreased U.S. dollar costs related to our Mexican operations of approximately $1.3 million in the current year quarter compared to the prior year quarter.

The improvement in gross profit in the current year quarter over the prior year quarter was the result of the increase in sales, partially offset by the increase in cost of goods sold as discussed above. Gross profit as a percentage of net sales in the current year quarter was relatively consistent with the prior year quarter as the unfavorable impacts of increased sales of products with higher purchased part content, which have lower overall profit margins, and a General Motors sales concession that we agreed to provide in the current year quarter were offset by the favorable impacts of increased customer production volumes resulting in more favorable absorption of our fixed manufacturing costs, a reduction in expense provisions for the accrual of bonuses under our incentive bonus plans for the current year quarter as compared to the prior year quarter and a favorable Mexican Peso to U.S. dollar exchange rate affecting the U.S. dollar cost of our Mexican operations, all as discussed above.

Engineering, selling and administrative expenses in the current year quarter and prior year quarter were as follows:

Engineering, selling and administrative expenses remained consistent between periods while decreasing as a percentage of net sales. Higher costs in support of our new Auburn Hills, Michigan sales and engineering facility and higher engineering and selling costs associated with current product programs as well as new product programs under development were offset by a reduction of $630,000 in expense provisions for the accrual of bonuses for the current year quarter as compared to the prior year quarter under our incentive bonus plans.

Income from operations in the current year quarter was $5.9 million compared to $5.1 million in the prior year quarter. This increase was the result of the increased sales in the current year quarter over the prior year quarter, partially offset by an increase in cost of goods sold, all as discussed above.  

Equity loss of joint ventures was $207,000 during the current year quarter compared to equity earnings of joint ventures of $267,000 in the prior year quarter. The activities related to the STRATTEC Advanced Logic, LLC joint venture are included in equity (loss) earnings of joint ventures and resulted in equity loss of joint ventures to STRATTEC of $508,000 in the current year quarter and $98,000 in the prior year quarter. The equity loss of joint ventures for the current year quarter included a loss of $367,000 related to STRATTEC’s guarantee of the STRATTEC Advanced Logic, LLC revolving credit facility. Our joint venture partner did not guarantee their proportionate share of the STRATTEC Advanced Logic credit facility. As a result, we recorded a loss equal to our partner’s proportionate share, based on their ownership percentage, of the fair value of the STRATTEC guarantee. The activities related to the VAST LLC joint venture are also included in equity (loss) earnings of joint ventures and resulted in equity earnings of joint ventures of $301,000 in the current year quarter and $365,000 in the prior year quarter.

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

Foreign currency transaction gains during the current year quarter resulted from activity associated with foreign denominated assets held by our Mexican subsidiaries. Our Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in the Trust are considered trading securities.  

Our income tax provision for each of the three month periods ended March 29, 2015 and March 30, 2014 was affected by the non-controlling interest portion of our pre-tax income and a lower effective tax rate for income subject to tax in Mexico as compared to the statutory tax rate for income subject to tax in the U.S. Moreover, our income tax provision included a reduction in our liability for unrecognized tax benefits and related interest of approximately $936,000 for the three month period ended March 29, 2015 and $307,000 for the three month period ended March 30, 2014 due to tax years that closed during these periods. Our effective tax rate was 16.5 percent for the current year quarter as compared to 23.4 percent for the prior year quarter. The reduction in the effective rate between quarters was the result of a larger reduction in the liability for unrecognized tax benefits in the current year quarter as compared to the prior year quarter.

Nine months ended March 29, 2015 compared to the nine months ended March 30, 2014

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

The increase in sales to General Motors Company in the current year period was attributed to incremental service parts sales during the six months ended December 28, 2014 of $34.0 million related to a recall campaign. The incremental sales adjusted to more normal levels during the quarter ended March 29, 2015 and are expected to remain at normal levels going forward. Sales to General Motors were also impacted by higher vehicle production volumes and greater product content on vehicle models for which we supply components that were introduced for the 2015 model year and a $3.3 million sales concession we granted to General Motors which negatively impacted the quarter ended March 29, 2015. Increased sales to Chrysler Group LLC in the current year period were the result of higher customer vehicle production volumes and increased content on models for which we supply components and increased service sales to Chrysler during the quarter ended March 29, 2015, which were partially offset by decreased sales resulting from Chrysler’s temporary shutdown of its Windsor, Canada assembly plant, which began in February 2015, to re-tool the facility for the production of the new Chrysler minivan. Decreased sales to Ford Motor Company in the current year period were attributed lower vehicle production volumes on models for which we supply components and in particular for components we supply on the F-150 pick-up trucks, which were partially offset by higher latch product sales in the current year period.   Sales to Tier 1 Customers during the current year period increased in comparison to the prior year period. These customers primarily represent purchasers of vehicle access control products, such as latches, fobs, and driver controls, that we have developed in recent years to complement our historic

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core business of locks and keys.  The increase in sales to Hyundai / Kia in the current year period was due to the ramp-up of the new Kia Sedona minivan for which we supply components.

Direct material costs are the most significant component of our cost of goods sold and comprised $163.7 million or 65.3 percent of cost of goods sold in the current year period compared to $131.5 million or 65.4 percent of cost of goods sold in the prior year period. The increase in material costs of $32.2 million, or 24.5 percent, was due to increased sales volumes in the current year period over the prior year period as discussed above. While material costs as a percent of cost of goods sold was relatively consistent between periods, the favorable impact to material costs resulting from increased sales of service parts as discussed above, which typically have lower material cost percentages as compared to parts sold for new vehicle production, was offset by the impact of increased sales of product with higher purchased part content in the current year period as compared to the prior year period.

The remaining components of cost of goods sold consist of labor and overhead costs which increased $17.6 million or 25.3 percent in the current year period over the prior year period as the variable portion of these costs increased due to the increase in sales volumes during the current year period over the prior year period. In addition, the current year period includes benefits from the favorable absorption of the fixed portion of our labor and overhead costs resulting from increased sales volumes between periods and a favorable Mexican Peso to U.S. dollar exchange rate affecting the U.S. dollar cost of our Mexican operations, which were partially offset by higher costs associated with new product launches, higher costs to meet expedited customer timelines, an increase of $2.6 million in expense provisions for the accrual of bonuses under our incentive bonus plans as a result of improved financial results for fiscal 2015 to date and a lump sum bonus totaling $311,000 paid to the Company’s Milwaukee represented hourly workers resulting from a new 4-year labor contract ratified on September 18, 2014. The average U.S. dollar/Mexican Peso exchange rate increased to approximately 13.97 in the current year period from approximately 13.11 in the prior year period, which resulted in decreased U.S. dollar costs related to our Mexican operations of approximately $2.1 million in the current year period compared to the prior year period.

The improvement in gross profit in the current year period over the prior year period was the result of the increase in sales, which was partially offset by the increase in cost of goods sold as discussed above. The improvement in gross profit as a percentage of net sales in the current year period as compared to the prior year period was the result of increased sales of service parts related to the General Motors recall campaign described above, which sales typically have higher gross profit margins as compared to gross profit margins on parts sold for new vehicle production, increased customer production volumes resulting in more favorable absorption of our fixed manufacturing costs and a favorable Mexican Peso to U.S. dollar exchange rate affecting the U.S. dollar cost of our Mexican operations. These favorable impacts to the gross profit margin as a percentage of net sales were partially offset by increased sales of product with higher purchased part content in the current year period as compared to the prior year period, higher costs associated with new product launches, higher costs to meet expedited customer timelines, the General Motors sales concession that we granted in fiscal 2015, an increase in expense provisions for the accrual of bonuses under our incentive bonus plans as a result of improved financial results for fiscal 2015 to date and a lump sum bonus paid to the Company’s Milwaukee represented hourly workers resulting from the ratification of a new 4-year labor contract, all as discussed above.

Engineering, selling and administrative expenses in the current year period and prior year period were as follows:

Engineering, selling and administrative increased approximately $5.0 million between periods while decreasing as a percentage of net sales. The increase in these costs in the current year period over the prior year period was due to an increase of $2.1 million in expense provisions for the accrual of bonuses under our incentive bonus plans as a result of improved financial results for fiscal 2015 to date, higher outside service costs to support sales and engineering activities for current product programs as well as new product

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programs under development and higher outside service costs in support of our new Auburn Hills, Michigan sales and engineering facility.

Income from operations in the current year period was $28.7 million compared to $16.9 million in the prior year period. This increase was the result of the increased sales and improved gross profit margins in the current year period over the prior year period, partially offset by an increase in engineering, selling and administrative expenses between periods, all as discussed above.  

Equity loss of joint ventures was $138,000 during the current year period compared to equity earnings of joint ventures of $858,000 in the prior year period. The activities related to the STRATTEC Advanced Logic, LLC joint venture are included in equity loss and earnings of joint ventures and resulted in equity loss of joint ventures to STRATTEC of $957,000 in the current year period and $249,000 in the prior year period. The equity loss of joint ventures for the current year period included a loss of $367,000 related to STRATTEC’s guarantee of the STRATTEC Advanced Logic, LLC revolving credit facility. Our joint venture partner did not guarantee their proportionate share of the STRATTEC Advanced Logic credit facility. As a result, we recorded a loss equal to our partner’s proportionate share, based on their ownership percentage, of the fair value of the STRATTEC guarantee. The activities related to the VAST LLC joint venture are also included in equity (loss) earnings of joint ventures and resulted in equity earnings of joint ventures of $819,000 in the current year period and $1.1 million in the prior year period.

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