Strattec Security Corporation (STRT) Earnings Call Transcript & Summary

Greetings, and welcome to the Strattec Security Corporation Fourth Quarter Fiscal Year 2025 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Deb Pawlowski, investor Relations for Strattec. Thank you. You may begin.

Thank you, and good morning, everyone. We greatly appreciate you joining us for Strattec's Fourth Quarter and Fiscal '25 Year-end Financial Results Conference Call. Joining me on the call this morning are Jennifer Slater, President and CEO; and Mathew Pauli, Vice President and Chief Financial Officer. Jen and Matt will review our financial results, the progress being made to transform Strattec and our expectations for fiscal 2026. You can find a copy of the press release and the slides that accompany our conversation today on the Investor Relations section of the company's website. If you are reviewing these slides, please turn to Slide 2 for the safe harbor statement. As you are aware, we may make some forward-looking statements on this call during the formal discussion as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is stated on today's call. These risks and uncertainties and other factors are discussed in the earnings release as well as with other documents filed by the company with the Securities and Exchange Commission. You can find these documents on our website as well. I want to also point out that during today's call, we will discuss some non-GAAP measures, which we believe will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP to comparable GAAP measures in the tables accompanying the earnings release and slides. So with that, if you would please turn to Slide 3, I will turn it over to Jen to begin. Jen?

Thank you, Deb, and welcome, everyone. We ended fiscal 2025 on a strong note with solid sales growth, expanded margins, strong cash generation and a much better business from where we were at the beginning of the fiscal year when I joined the company as CEO. Our success was a result of our team, whom I want to thank for their energy, perseverance and hard work. We covered a lot of ground and underwent significant change in fiscal '25. We have a refreshed and energized executive team. We added critical talent throughout the organization and continue to do so. We simplified our operations and reduced headcount by 15%. We implemented an operating cadence and created communication channels that had not existed in the organization before. We also began the work to reshape our product portfolio, and we advanced our plans to modernize our manufacturing operations. These efforts were clearly demonstrated in our financial results, which I will now touch on for the quarter and the year. We delivered very strong cash generation as we generated $30 million (sic) [ $30.2 million ] in cash from operations for the quarter and $71 million (sic) [ $71.7 million ] for the fiscal year. In addition to achieving stronger cash earnings, we improved our working capital velocity and benefited from some onetime opportunities to unlock value from the balance sheet that Matt will discuss later. Revenue grew 6% in the quarter and 5% for the year. Higher sales and favorable foreign currency exchange, combined with the initial benefits from our restructuring efforts helped to drive 370 basis points of gross margin expansion for the quarter as well as 280 basis points of margin improvement for the year. Fourth quarter EBITDA margin of 8.5% also demonstrated our continued progress through the year but was up against a tough comparator in the prior year that benefited from a onetime engineering cost recovery of $4.8 million. Our efforts resulted in EBITDA margin expansion of 220 basis points for the year to 7.7%. Please turn to Slide 4. Our priorities for fiscal 2025 were to create shareholder value, which we believe our transformation actions to date have accomplished across key focus areas of the business. This is demonstrated by the significant progress we have made to improve our underlying operations, unlock working capital and build a strong team. As we move into fiscal year '26, we will continue to focus on these same priorities. While we did unlock most of the low-hanging fruit, we still believe we have opportunity to improve our margin profile. We are also focusing on leveraging our product expertise in key areas of the business such as digital key and power access to expand our customer base and facilitate growth. Our healthy balance sheet will help us weather any weakening market condition and continue to invest in the growth of the business and create value for our shareholders. If you will turn to Slide 5, you can see that there were a number of drivers to sales growth in both the quarter and the year. The fourth quarter benefited from our strategic pricing initiatives as well as higher demand. Throughout the year, we have had the advantage of several new program launches as well as being well positioned on better selling platforms. We are expecting our growth from new vehicle launches to moderate as we are in between significant launch cycles with our existing customers. Due to the long-cycle nature of our business, we are actively working today to be included on model year '29 and '30 platforms. We are also working to broaden our reach to a larger customer set than we have addressed historically. We are excited about the future for Strattec and expect that over the long term, we can continue to drive a growing stronger margin profile business with greater predictability and earnings power. Let me now turn it over to Matt.

Thanks, Jen, and good morning, everyone. Let's begin with Slide 6. Fourth quarter gross profit increased to $25.4 million and gross margin expanded by 370 basis points to 16.7%. Gross profit improvement was the result of a $3 million benefit from a stronger U.S. dollar, strategic pricing actions, $1.7 million in tooling gains, higher production volumes and $1.3 million of restructuring savings. These gains more than offset $1.6 million of net tariff expenses stemming from recent changes in U.S. trade policy and higher labor costs in Mexico, albeit on a lower headcount. Based on the currently enacted tariff rates, we estimate that the annual cost increase is between $5 million to $7 million before any mitigation efforts. However, we have taken steps to change our logistic routes, review our supply chain and implement price increases or tariff recoveries from customers. Our tariff mitigation efforts have continued after our fiscal year-end. And as of today, we have line of sight to recover the majority of the cost, but the recovery of tariff costs will lag the associated expenses. For the full fiscal year, gross margin improved by 280 basis points, reflecting these same drivers, pricing actions, cost optimization and FX, partially offset by elevated labor costs in Mexico and ongoing tariff headwinds. Turning to Slide 7. Selling, administration -- administrative and engineering expenses or SAE, was $16.9 million. Prior year SAE benefited from $4.8 million of onetime engineering recoveries that makes the year-over-year comparison difficult. What's important to take away is that we are holding our SAE steady at about 11% of sales. The absolute spend reflects deliberate investments in our transformation initiatives as well as a $2.2 million increase related to incentive compensation and bonus expense that were the result of strong financial performance for the year. For the fiscal year, our SAE included $6.7 million of incremental incentive compensation costs given our financial performance, $1 million in additional executive transition costs and $1 million of business transformation costs. Let's move to Slide 8, where we summarize our profitability. Net income attributable to Strattec for the quarter on both a GAAP and an adjusted basis declined primarily due to the prior year's engineering recovery benefit that I mentioned earlier and the increase in bonus provision this year on improved performance. Adjusted EBITDA was $13 million, representing an adjusted EBITDA margin of 8.5%. Our results reflect the team's commitment to delivering sustainable margin improvement. Let me point out that over the long term, we believe the business model would suggest a low-teen EBITDA margin. Now turning to Slide 9, which highlights our cash flow, balance sheet and capital priorities. Operating cash flow was strong for the quarter at $30.2 million, a 55% improvement over the same period last year. This reflects higher cash earnings, disciplined working capital management, the collection of about $5 million of historical VAT balances in Mexico and the benefit of timing on receivables. During the quarter, we also had an $11 million reduction in inventory levels, partially attributable to reduced in-transit inventory. While this benefited working capital, I should point out that we will need to increase some inventory to maintain timely deliveries to our customers. For the year, operating cash flow reached $71.7 million, a record for the company. We had the onetime opportunities captured during the year that I mentioned earlier, which makes repeating this performance a challenge until we gain more scale. Year-to-date, capital expenditures totaled $7.2 million, consistent with our focus on new product programs, productivity enhancements and IT infrastructure upgrades. This resulted in free cash flow for the year of $64.5 million. We ended the year with a very healthy cash position of $84.6 million. We also have approximately $52 million available under our revolving credit facilities. Our capital priorities in the near term are to create organic growth through investment in our commercial initiatives, drive operational improvements through modernization and continue new product innovation. We are also being conservative with our cash through these uncertain times, including moderated market conditions. Over the longer term, once we've established a greater amount of predictability in the business, we'll be in a better position to consider shareholder distributions as well as M&A. If you turn to Slide 10, I'll outline in general, our expectations for fiscal 2026, given our perspective on our end markets as we know it today. As most of you are aware, we are a very long-cycle business and the work we are doing today, as Jen mentioned, will be apparent in our model years 2029 and beyond. In the meantime, our sales will generally follow North American OEM production volumes given that we will lap several key launches that we benefited from in fiscal '25. Current third-party industry projections estimate that North American automotive production for our fiscal 2026 will be lower by about 5% to 6%, with softness more prevalent in the second half of the fiscal year. We expect that we will still benefit from our recent pricing actions, especially in the first half of the year. We believe the business over the longer term and with sufficient volume is capable of achieving gross margins in the 18% to 20% range. Until then, we will continue to focus on what we can control with margins, productivity, working capital and cash generation. As I mentioned earlier, we had a very robust year from a cash generation that was boosted by several onetime opportunities. For 2026 and beyond, we expect to continue to generate solid cash from operations but at a more normalized rate. In summary, we are pleased with our solid financial progress and the momentum we are building through our strategic execution. With that, operator, we're ready to open the line for questions.

[Operator Instructions] Thank you. Our first question comes from the line of John Franzreb with Sidoti.

Congratulations on another great quarter. I'd like to start with the transformation process, Jen. I'm curious how far along do you think you are in it? And how long do you think it will take before you're satisfied with the majority of it being completed?

Thanks for the question, John. I would say we're still in the early innings of the transformation. We did have the opportunity this past fiscal year to address a lot of the low-hanging fruit. And now as we focus on further transformation items, they'll be more longer term in nature than what we were able to see in fiscal year '25.

Okay. And when I look at that slide on Slide Page 4, I was wondering, does that mean you're considering exiting or divesting product lines? Is that a possibility in that process?

I think I can give one example. We had some products really our switch product line. And when we look at that market, there's less and less switches in the vehicle today. It's already a crowded market. We have other areas of our business like our power access products and our Digital Keyfobs that we feel we have a lot of opportunity. So we're still supporting our customers that we have in production, but we're really refocusing our engineering efforts around those products that we feel have more growth and provide more value to our customers.

And I guess the other side of that question on the same slide is the larger customer set. I mean I assume that means outside the automotive market. Can you give some examples of how you -- any hits yet or what you'd be looking at?

Yes. It doesn't necessarily mean outside of the automotive market, John. If you look at our customer concentration, we've been pretty concentrated around some of the larger North American customers. So we feel we have opportunity within automotive. And then the second layer of that is if you think about transportation, heavy vehicle off-road, there's opportunity for us there, too. But our priority really is to continue to start within automotive.

Okay. And I guess one last question, I'll get back into queue. On the gross margins, 2 great quarters of above 16%. I believe Matt said the long-term target is in the 18% to 20% range. What should we think about in fiscal 2026 is -- kind of a sustainable range for gross margin?

Yes, John, this is Matt. I think we finished the year at 15% gross margin for the fiscal year. We provided a little bit of a view on what we see on a go-forward basis on Slide 10, but revenues will be down to flattish in fiscal '26. So we do have the tailwinds in the first half of '26 around the pricing that we implemented in January, which is about $8 million and some of the restructuring actions. But on the flip side, we also have incremental costs around Mexico labor inflation, which we'll see in the back half of the year.

I guess, Matt, I'm curious, this might be too soon to ask this question, but do you have a sense of what the incremental/decremental margins of the company are going to look like after some of these actions are completed?

Yes. We generally see incremental/decremental margins in kind of the 25% to 30% range.

Our next question comes from the line of Brian Sponheimer with Gabelli.

Congratulations. A couple of questions on the balance sheet and then just a couple on operations and product. So you mentioned that you want to invest organically, invest in new products, but it's $21 a share, $22 a share and $21.5 a share in cash. To what extent are you willing to hold that substantial amount of cash where -- basically, what's your cushion given the uncertain times? And then what is in excess of what you would consider to be the appropriate cushion for this business and then how you would think about the excess cash on the balance sheet?

Yes. Thanks for the question, Brian. And Matt and I were expecting to get this question. Really where we are right now, the good thing is that we're not worried day-to-day about liquidity, which is really helping us focus on driving the improvement in the underlying business. There's a lot of uncertainty still in North America production. And as you heard Matt say, we really are following what those productions, what North America production schedule is. So when we have this market uncertainty, we feel very comfortable that we've got the cash that we have to help us continue to focus on the transformation of the business. So I think as we think about it, we really look to make sure that we've got stability in the underlying business, continuing to focus on the transformation and then get through a little bit more certainty on what's going to happen in the market before we can get to a point where we're thinking about what is that cash cushion and how do we want to allocate longer-term shareholder value.

Okay. Understood. You mentioned investing in new products with Digital Keyfob as an area for growth. I'm curious how you see that Digital Keyfob balancing with potentially the secular decline of more of the physical keyfob business that you had and whether it's kind of a net neutral for the overall business and whether there's any sort of subscription revenue that could come from a Digital Keyfob product?

Yes. We've done a lot of third-party market studies on what does it look like for a Digital Keyfob longer term. And we still see that there's both a consumer drive and the customer drive to have the physical keyfob, which helps us get our confidence around having a Digital Keyfob that's connecting to the car and the phone for the consumer. As far as subscription services, a lot of the customers are holding that opportunity. So I think it's premature, Brian, with where we are in our product development to think about where we have further subscription opportunity. But obviously, that's something we'll continue to understand as we work with our customers and see what their needs are for themselves and the consumers.

Okay. Great. And last one for me. You talked about next year being more of a flattish year, but if you were to take $2 in earnings for the quarter in what traditionally hasn't been -- you traditionally haven't been the most seasonal businesses. But obviously, you extrapolate that out to $7.5, $8 a share. How much do you think the performance of this $2 a share earnings is repeatable? And how many -- how much potentially were some more onetime items that you think we shouldn't be considering if we're thinking about an earnings number for 2026, 2027?

I think I'm just going to frame that a little bit with the market again, Brian, because I think as we talked about, it will be connected to where the North America production market is. And if you were to look at third-party projections earlier in this calendar year versus later in the calendar year, production levels dropped 10% to what they were projecting earlier from a third-party standpoint. I'll let Matt add on from his perspective.

Yes. It really comes down to volume. I think we've done a good job over the past year of the things that we can control. So we've been more aggressive on pushing pricing where we have the opportunity and also on the cost takeout, which is what you see kind of in the back half of the year. We'll balance that with some of the inflationary pressures that we see on a go-forward basis as well as kind of the headwinds from volume and some of the investments we still need to make in the business.

Understood. Well, clearly, you're on an excellent track and we look forward to seeing what's ahead.

Our next question comes from the line of Dennis Scannell with Rutabaga Capital.

Congratulations on a great quarter and a great finish to the year. Just a couple of quick things. To follow up on the margin question, to get to that low teens EBITDA margin potential, is that just volume growth? Or will that take -- how do I want to put it, kind of like the new programs that you're targeting in the, say, the '29, '30 model year in terms of achieving that kind of margin improvement?

Yes. So the margin improvement really comes at the gross margin line. And I think it's -- there's kind of 3 drivers there that will help us get to those longer-term margins. So first off, it's pricing. So we've demonstrated the ability to get price. I think we'll continue to drive pricing where we command a premium. The second piece is around volume, which is the new model year launches. And then the third is really around operational improvements. And so there's a funnel of continuous improvement, ideas around both the 4-wall costs as well as supply chain. And we've added 2 new leaders to help us there in identifying kind of the opportunity set. And then longer term, there's obviously kind of structural changes we could make around our footprint on a go-forward basis.

Yes. And I think I would just add on to that. Matt touched on the 2 new leaders. So we've recently added a Vice President of Operations. He's hit the ground running and helping us, as Matt said, look at our 4-wall costs and making sure that we're implementing standard operating procedures and understanding what the opportunity is on that side of the business. We also added supply chain talent for us to look at logistics and our overall supply chain. And as we talked about our low-hanging fruit that we addressed last year, we've done some cost efficiency opportunities, but we haven't really looked at that longer-term structural changes.

Got it. Great. Just a couple of other quick things. So obviously, a great year in terms of cash flow and some benefiting from some onetime items. So Matt, when you said that you expect free cash flow to return to more normalized levels, again, I feel like you guys have changed the business a lot. So what do you see as normalized levels? Is that kind of $20 million to $30 million free cash flow per year? Or how do we think about that?

Yes. So I'd referenced our results in '25. We delivered $71 million of cash from operations. I'd say about half of that is kind of the normal and the other half was kind of recovery of some preproduction balances, which we reduced by about 50% during the year and then also a $25 million reduction in working capital, which I'd categorize that as kind of low-hanging fruit. So I'm encouraged by the efforts the team has made around our working capital. At the beginning of the year, it was roughly 22% of our sales. And at the end of the year here, it's a little over 16%. We've stated kind of our longer-term target around primary working capital, that being receivables, inventory and payables is 15%. So we've made a nice move here in the fiscal year.