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 2020 Form 10-K, which was filed with the Securities and Exchange Commission on September 3, 2020. Unless otherwise indicated, all references to quarters and years refer to fiscal quarters and fiscal years.

Outlook

Refer to discussion of Risks and Uncertainties included in the Notes to Condensed Consolidated Financial Statements beginning on page 6 of this Form 10-Q.

During the fourth quarter of our fiscal year ended June 2020, we responded to the COVID-19 pandemic and the temporary OEM customer plant shutdowns by implementing a permanent reduction in our salaried workforce, instituting temporary layoffs, reducing working hours, allowing (and in some cases encouraging) remote working from home, temporarily suspending our quarterly cash dividend, delaying capital expenditures and eliminating nonessential operating costs, all to preserve cash flow. In addition, during the fourth quarter of the prior fiscal year, we produced additional finished goods inventory in anticipation of our OEM customers pipeline fill to their dealers once vehicle production began starting up in June 2020.

During the first quarter ended September 2020, the Company experienced a strong sales recovery as our customers ramped up vehicle production as they restarted their assembly plant operations in order to replenish low inventory levels at the dealers. Likewise, our manufacturing operations in Milwaukee, WI and in Mexico ramped up production to meet this increased sales demand. However, these actions were, and continue to be hampered by, requirements imposed by the Mexican Government at our Mexican facilities that continue to limit operating capacity in Mexico due to COVID-19 which may in the future impact our ability to meet customer sales demand depending upon their order levels.

The sales outlook over the next few quarters appears strong as our customers continue to restock dealer inventories. However, this sales demand going forward is contingent on the impact and severity of the COVID-19 pandemic, including any potential worsening thereof, on the North American and overall global economy.

Analysis of Results of Operations



Three months ended September 27, 2020 compared to the three months ended
September 29, 2019



                                   Three Months Ended
                           September 27,        September 29,
                               2020                 2019
Net Sales (in millions)   $         126.2      $         120.0

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



                                              Three Months Ended
                                      September 27,        September 29,
                                          2020                 2019
General Motors Company               $          37.8      $          33.8
Fiat Chrysler Automobiles                       25.1                 25.5
Ford Motor Company                              15.8                 15.8
Commercial and Other OEM Customers              21.4                 21.4
Tier 1 Customers                                17.5                 17.8
Hyundai / Kia                                    8.6                  5.7
                                     $         126.2      $         120.0




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The increase in sales to General Motors Company in the current year quarter as compared to the prior year quarter was attributed to higher production volumes on models for which we supply components. The impact of the UAW strike reduced net sales by an estimated $3.0 million in the prior year quarter. Sales to Fiat Chrysler Automobiles decreased slightly in the current year quarter as compared to the prior year quarter due to lower vehicle production volumes on the FCA minivans for which we supply components. The Dodge Grand Caravan minivan went out of production during July 2020. Sales to Ford Motor Company, Tier 1 Customers and Commercial and Other OEM Customers were flat in the current year quarter compared to the prior year quarter. Sales to Tier 1 Customers, Commercial and Other OEM Customers primarily represent purchasers of vehicle access control products, such as latches, key fobs, driver controls, steering column locks and door handles, that we have developed in recent years to complement our historic core business of locks and keys. The increased sales to Hyundai / Kia in the current year quarter as compared to the prior year quarter were due to higher levels of production on their new, recently launched Kia Sedona minivan for which we supply components.





                                            Three Months Ended
                                    September 27,        September 29,
                                        2020                 2019

Cost of Goods Sold (in millions) $ 103.7 $ 104.1

Direct material costs are the most significant component of our cost of goods sold and comprised $70.5 million or 68.0 percent of our cost of goods sold in the current year quarter compared to $68.5 million or 65.8 percent of our cost of goods sold in the prior year quarter. The increase in our direct material costs between these quarters of $2.0 million or 2.9 percent was due to increased sales volumes in the current year quarter as compared to the prior year quarter and increased obsolescence costs in the current year quarter resulting from the discontinuance of a customer program. The increase in our direct material costs as a percentage of our cost of goods sold in the current year quarter as compared to the prior year quarter was due to reduced labor and overhead costs between periods as discussed below.

The remaining components of our cost of goods sold consist of labor and overhead costs which decreased $2.4 million or 6.7 percent to $33.2 million in the current year quarter from $35.6 million in the prior year quarter. The prior year quarter costs included a $1.4 million non-cash compensation expense charge related to the transfer of excess Qualified Pension Plan assets as described under Pension and Postretirement Benefits within Notes to Condensed Consolidated Financial Statement included herein. Additionally, labor and overhead costs in the current year quarter were favorably impacted by cost improvements implemented at our Milwaukee, WI and Mexico facilities, along with a favorable Mexican peso to U.S. dollar exchange rate affecting our operations in Mexico, which favorable impacts were partially offset by an increase in the variable portion of our labor and overhead costs as a result of the increase in sales volumes in the current year quarter as compared to the prior year quarter. The U.S. dollar value of our Mexican operations was favorably impacted by approximately $2.0 million in the current year quarter as compared to the prior year quarter due to a favorable Mexican peso to U.S. dollar exchange rate between these quarterly periods. The average U.S. dollar / Mexican peso exchange rate increased to approximately 22.21 pesos to the dollar in the current year quarter from approximately 19.61 pesos to the dollar in the prior year quarter.





                                                     Three Months Ended
                                             September 27,         September 29,
                                                 2020                  2019
Gross Profit (in millions)                  $          22.5       $          15.9
Gross Profit as a percentage of net sales              17.8 %                13.2 %

Gross profit dollars increased in the current year quarter as compared to the prior year quarter as a result of both an increase in sales and an increase in cost of goods sold between periods, as discussed above. Gross profit as a percentage of net sales increased between periods. The increase was due to the prior year quarter non-cash compensation expense charge as well as cost improvements implemented at our Milwaukee and Mexico production facilities in the current year quarter as compared to the prior year quarter and a favorable Mexican peso to U.S. dollar exchange rate affecting our operations in Mexico as discussed above.

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





                                                 Three Months Ended
                                         September 27,         September 29,
                                             2020                  2019
Expenses (in millions)                  $          11.3       $          13.0
Expenses as a percentage of net sales               9.0 %                10.8 %

The decrease in engineering, selling and administrative expenses in the current year quarter decreased in comparison to the prior year quarter due to lower new product development costs, a temporary reduction in salary work force wages, permanent layoffs, and improved operating expense management in the current year quarter as compared to the prior year quarter. Additionally, the prior year quarter costs included an $862,000 non-cash compensation expense charge related to the transfer of excess Qualified Pension



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Plan assets as described under Pension and Postretirement Benefits within Notes to Condensed Consolidated Financial Statement included herein.

Income from operations was $11.2 million in the current year quarter compared to $2.9 million in the prior year quarter due to an increase in gross profit margin dollars and a decrease in engineering, selling and administrative expenses between quarters, all as discussed above.

The equity earnings of joint ventures was $825,000 in the current year quarter compared to $484,000 in the prior year quarter. Higher profitability from our Vehicle Access Systems Technology LLC ("VAST LLC") joint ventures is due to higher profitability in our VAST China operation between periods. Our VAST LLC joint ventures in India and Brazil continue to report losses due to our limited amount of business in both regions.

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



                                                     Three Months Ended
                                             September 27,         September 29,
                                                 2020                  2019
Foreign Currency Transaction Loss           $          (399 )     $           (85 )
Unrealized Gain on Peso Forward Contracts               335                     -
Realized Loss on Peso Forward Contracts                 (59 )                   -
Pension and Postretirement Plans Cost                  (105 )                (117 )
Rabbi Trust Loss                                        (57 )                  (2 )
Other                                                    25                   107
                                            $          (260 )     $           (97 )

Foreign currency transaction losses during the current year quarter and prior year quarter resulted from activity associated with foreign denominated assets held by our Mexican subsidiaries. We entered into the Mexican peso currency forward contracts to minimize earnings volatility resulting from changes in exchange rates affecting the U.S. dollar cost of our Mexican operations. Unrealized gains and losses on the peso forward contracts recognized as a result of mark-to-market adjustments as of September 27, 2020 may or may not be realized in future periods, depending on actual Mexican peso to U.S. dollar exchange rates experienced during the balance of the contract period. Pension and postretirement plan impacts include the components of net periodic benefit cost other than the service cost component. Our Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in the Trust are considered trading securities.

Our effective tax rate was 13.5% and 10.0% for the three months ended September 27, 2020 and September 29, 2019, respectively. Effective July 20, 2020, the U.S Treasury Department finalized and enacted previously proposed regulations regarding the 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 fiscal 2020. With the enactment of these final regulations, we are now eligible for an exclusion from GILTI since we meet the provisions for the GILTI High-Tax exception included in the final regulations. In addition, the enactment of the new regulations and our eligibility for the GILTI High-Tax exception are retroactive to the original enactment of the GILTI tax provision, which includes our 2020 fiscal year. As a result of the newly enacted regulations, we recorded an income tax benefit of $675,000 during the three month period ended September 27, 2020. During the three month period ended September 29, 2019, our effective tax rate was impacted by the discrete impact of the non-cash compensation expense, as discussed under Pension and Postretirement Benefits below. Our effective tax rate differs from the statutory tax rate due to the GILTI provisions, our available R&D tax credit and the non-controlling interest portion of our pre-tax income. The non-controlling interest impacts the effective tax rate as ADAC-STRATTEC LLC and STRATTEC POWER ACCESS LLC entities are taxed as partnerships for U.S. tax purposes.

Liquidity and Capital Resources

Working Capital (in millions)



                       September 27,       June 28,
                           2020              2020

Current Assets        $         160.9     $    125.4
Current Liabilities              76.3           48.1
Working Capital       $          84.6     $     77.3





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Outstanding Receivable Balances from Major Customers

Our primary source of cash flow is from our major customers, which include Fiat Chrysler Automobiles, General Motors Company and Ford Motor Company. As of the date of filing this Form 10-Q with the Securities and Exchange Commission, all of our major 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 September 27, 2020 was as follows (in millions):





General Motors Company      $ 23.2
Fiat Chrysler Automobiles   $ 16.2
Ford Motor Company          $  7.6




Cash Balances in Mexico

We earn a portion of our operating income in Mexico. As of September 27, 2020, $4.2 million of our $12.0 million cash and cash equivalents balance was held in Mexico. These funds are available for repatriation as deemed necessary.

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