STRT - NASDAQ

Greetings. Welcome to Strattec Security Corporation's Second Quarter Fiscal Year 2026 Financial Results Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the call over to Deborah Pawlowski, Investor Relations. Thank you. You may begin.

Thank you, and good morning, everyone. We appreciate you joining us for Strattec's Second Quarter Fiscal 2026 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, progress being made to transform Strattec and our outlook. 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 those 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, 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 point out that during today's call, we will discuss some non-GAAP financial 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, let me turn it over to Jen, who will be referencing Slides 3 through 5.

Thank you, Deb, and welcome, everyone. We delivered a strong second quarter despite a challenging macro environment, which included some supply chain challenges for the industry, moderating automotive production and foreign exchange pressures. We believe our results further validate the effectiveness of our transformation actions and our focus on protecting profitability as we work to drive process improvement, institutionalize new practices and leverage the great team we have built. Sales grew 6%, driven by pricing, favorable sales mix, higher content value, new program launches and tariff recovery. We achieved gross margin in the quarter of 16.5% with margin expanding 330 basis points over last year. The transformation is translating to the bottom line and delivering improved returns for our investors. Net income nearly quadrupled year-over-year to $5 million or $1.21 per diluted share. On an adjusted basis, earnings per share grew 163% to $1.71. During the second quarter, we generated $14 million in cash from operations, bringing our year-to-date cash flow to $25 million. We have an exceptionally strong balance sheet with $99 million in cash and total debt of just $2.5 million. Our financial position gives us the flexibility to continue to invest in the business, manage through market volatility and explore strategic opportunities. We continue to drive actions to reduce costs and put talent in the right positions to deliver innovation and agility. During the quarter, we implemented a voluntary retirement program, which combined with other fiscal '26 restructuring actions should generate $3.4 million in annualized savings. This layers on top of the cost reductions completed in the prior fiscal year and demonstrates our focus on operational excellence and an appropriate cost structure. We have assembled a great team here at Strattec that is demonstrating the ability to collaborate to drive improvements across the organization. We will continue to invest in developing our employees, bringing in additional talent where needed and providing the tools to improve processes and provide the data required for nimble decision-making. Our strong balance sheet and positive momentum provide us confidence that we can continue to execute through this cycle and create meaningful value for our shareholders. With that, I'll turn it over to Matt to walk through the financial details.

Thanks, Jen, and good morning, everyone. Let me walk through the second quarter financial results in detail. Looking at Slide 5, sales were $137.5 million in the quarter. We've demonstrated our ability to capture accretive pricing in a disciplined way, although we will lap some of the pricing benefits in the second half of the fiscal year. We also benefited from favorable sales mix, net new program launches and higher content value, including higher production volumes on the platforms we support. During the quarter, we also recovered $1.3 million of tariff costs, which show up in our net sales. As we've previously discussed, the tariff costs are recovered on a delayed basis and tend to not match up with the associated costs in any particular quarter. All of the positives we captured more than offset an overall weak automotive environment. Sequentially, we are expecting a slight improvement in sales in the third quarter as we begin to lap pricing and follow current automotive production forecasts. On a year-over-year basis, we expect the second half will be down approximately 3% to 4%. Turning to Slide 6. Gross margin increased $5.6 million to $22.7 million in the quarter. As Jen noted, gross margin expanded 330 basis points to 16.5%, driven by multiple favorable factors. Pricing actions contributed approximately $3.1 million of the improvement. Higher production volumes provided positive leverage as we built inventories by $7 million to provide better responsiveness to our customers and to help reduce expedited logistics costs. We also captured $1.7 million in restructuring savings from our cost optimization initiatives. These gains more than offset some headwinds. We had $1.2 million of higher labor costs in Mexico related to annual merit increases and incurred approximately $900,000 increase in tariff costs. We had approximately $1.6 million of negative foreign exchange impact and expect continued headwinds throughout the year. As a reminder, every 5% change in the dollar relative to the peso is an approximate $4 million annualized impact to our gross margin. Year-to-date, we've expanded gross margin 350 basis points to 16.9%. This reflects $8 million in cumulative pricing actions, including tariff recoveries, combined with higher production volumes and $3 million in restructuring savings. Offsetting these benefits were $2.3 million in elevated Mexico labor costs and $2.1 million in unfavorable foreign exchange. While we have much more work to be done, we believe we have raised the baseline of gross margin at the 15% to 16% level and are advancing towards our gross margin goal. Moving to Slide 7. Selling, administrative and engineering expenses, or SAE, increased $2.8 million (sic) [ $2.9 million ] year-over-year to $17.9 million or 13% of sales in the quarter. While the dollar increase appears significant, it's important to understand what's driving it. We incurred $1.7 million in expenses related to our voluntary retirement program, a onetime charge. We invested an additional $800,000 in business transformation costs, and we added $700,000 in talent investments to strengthen our capabilities and support our growth initiatives. These investments were partially offset by $1.1 million in lower executive transition costs compared with the prior year. Year-to-date, SAE remains controlled at 11.6% of sales, which, excluding the voluntary retirement charge, is within our expected long-term range of 10% to 11%. Interest income grew $500,000 on higher cash balances, reflecting our strong operating cash generation. Interest expense declined $200,000 on lower debt. and other income improved significantly due to the benefit of our peso hedging program. Let's move to Slide 8. Net income attributable to Strattec was $4.9 million for the quarter or $1.20 per diluted share compared with $1.3 million or $0.32 per share in the prior year. On an adjusted basis, net income was $7.1 million and adjusted diluted earnings per share grew 163% year-over-year to $1.71. We are also benefiting from our cash balances. We had interest income of $885,000 in the quarter. Our progress demonstrates that our transformation actions are flowing through to the bottom line. Adjusted EBITDA for the quarter was $12.3 million, representing an adjusted EBITDA margin of 8.9% compared with 6.1% in the prior year second quarter. Year-to-date, adjusted EBITDA was $27.8 million, up 55% versus the prior year with an adjusted EBITDA margin of 9.6%, up 290 basis points. Now let's turn to Slide 9, which highlights our cash position and capital flexibility. Operating cash flow for the second quarter was $13.9 million, up 48% compared to the prior year quarter. Year-to-date operating cash flow reached $25.2 million, up 21% versus the prior year. The improvement reflects higher net income that was somewhat offset with the investment in inventory that we made in the quarter to improve delivery times to customers. We expect the cash costs associated with restructuring and business transformation to impact the third quarter due to timing. We continue to expect to generate on an annual basis, about $40 million in cash from operations. Capital expenditures in the second quarter were $2.6 million, focused on new product programs and investments in new equipment. This resulted in free cash flow of $11.3 million for the quarter and year-to-date free cash flow of $21 million. Year-to-date, CapEx was $4.1 million (sic) [ $4.2 million ] and we expect that CapEx for the fiscal 2026 will be less than $10 million. We ended the quarter with a very healthy cash position of $99 million. We paid down another $2.5 million of debt in the quarter. Total debt, which is related to our joint venture is just $2.5 million, down from $8 million at the end of the prior fiscal year. We are consistent with our capital allocation priorities. First, we are prioritizing investments to support organic growth and new customer programs. Second, we are investing in process modernization and automation initiatives, which we expect to drive efficiencies and improve our manufacturing footprint. Third, we're preserving financial flexibility as we navigate the uncertain automotive market. And finally, we're evaluating M&A as a potential lever for longer-term growth. If you turn to Slide 10, I'll hand it back to Jen to review the conditions in the automotive industry and the actions we are taking.

Thanks, Matt. While North American automotive production is not looking as challenging as originally expected at the beginning of fiscal '26, industry forecasts still suggest a flat to moderate decline. While we have modest benefits from program launches and being on favored platforms this fiscal year, we are still subject to OEM production rates. To sum up, we are delivering on the transformation of Strattec. We've expanded margins significantly, nearly tripled net income and grown adjusted EBITDA by 55% year-to-date. We're building a stronger business with improved earnings power. We have a great balance sheet, giving us the capital to invest and the flexibility to manage through cycles While there are a number of obstacles we have yet to overcome, we believe our strategic focus on deepening our customer relationships and engineered access solutions, along with striving for operational excellence should enable sustainable profitable growth. We also have the opportunity to expand our customer set within North America by leveraging our technical expertise. We believe the talent we have invested in and the organizational muscle we are building are making meaningful contributions that are critical to the future of Strattec. We have good momentum heading into the second half of fiscal '26, and we're confident in the path that we are on.

[Operator Instructions] Our first question is from John Franzreb with Sidoti & Company.

Congratulations on another great quarter. I'd actually like to start with the just finished period. Jennifer, I know there was concerns that supply chain disruptions might be problematic. I'm curious, was there actual revenue pushed from Q2 into Q3? Or did your customers pretty much work around it and it was pretty much nonissue?

Yes. I think there were 2 things that we talked about. One was a fire with supplier for some of our customers. There was some slight impact from that on certain platforms that customers are looking to make up for the full year. And then the other one was the chip challenge. And I would say that customers with suppliers work to get through that with minimal impact to sales in the quarter.

Always seems to be a chip challenge out there.

Yes.

Regarding the selling and administrative expenses in the second half, with the change in compensation, with new people coming on board, with early retirement plan, how should we think about that line item? Is that going to be closer to the second quarter's 13%? Or is it more of the first half's 11.8%, 11.6%? How should we think about how that line item plays out for the year?

I think maybe I'll start with a little bit of context on how we're evaluating that investment, and then Matt can talk a little bit more on the target. This is an area, John, we're continuously looking at where do we need to invest in continuing the progress on the transformation. So there's a lot of puts and takes in there, but we also want to make sure that we're not starving the long term for where we need to be with the business as we think through the investment. But I think we've set where we think the target of the business is, and that's where we're continuing to work through, and I'll let Matt answer more specifically.

Yes, we still expect it to be in the 10% to 11% in the back half of the year, John. And we've talked about merit, especially in Mexico in the past. What I think we'll see going forward in merit is it will be a little bit less than what we've had to do historically. So I think 2 years ago, it was kind of 20%, 12% this past year, but it will be a little bit less than that on a go-forward basis. So expect 10% to 11% from an SAE perspective in the back half of the year.

And regarding the $3.4 million in savings from the early retirement plan, when does that hit the bottom line? Is that immediately in the third quarter? I saw that you took the $1.7 million against that. How does that play out?

Yes. Just to clarify, the $3.4 million is the annual benefit for the restructuring actions and the voluntary retirement program that we did in fiscal '26. So we only saw about $400,000 of a benefit in the current quarter, and it will kind of get fully phased in roughly around $800,000 a quarter by the time we get to the fourth quarter.

Perfect. Regarding the free cash flow, you've had a great bunch of quarters. What's the pushback that's going to draw down the cash flow? It sounds almost like there's an inventory build going on, but I'm not sure if I just misheard that in the presentation.

Yes. I think we've talked about it in the past, we were intentionally building inventories, finished good inventories in the quarter just to improve our service delivery to our customers. So that was a headwind in the quarter. But also some of the restructuring costs and the business transformation costs that we incurred in -- or we expensed in the second quarter will impact cash flow in the third quarter.

Our next question is from Brian Sponheimer with Gabelli Funds.

Could you just talk a little bit about maybe some of the conversations you're having with potential new customers in North America? You mentioned that as a source of growth. And obviously, that's not a fiscal '26 or potentially '27 item, but maybe just where some of those conversations are going and what products they're centering on?

Yes. So we are focused on our access products and our digital key as we're talking to our existing customers and prospective customers. As you know, Brian, the sales cycle in automotive is a long sales cycle. So starting the discussions right now to get our customers comfortable with our product portfolio, the value we can provide and lining those up to timing of their model year launches. The very earliest it would be is '29, but it's more likely to be longer term as they're going through their product plans, qualifying us as a supplier and then specing those into the platforms. Once we are spec-ed into the platforms, we are on for the life of the platform, which is typically 5 to 7 years.

Okay. One other one for me. Tesla had a very high-profile issue with the door handle that you're not on. But does this call -- does this impact you from a technology perspective on any prospective platforms that you had coming out in the next couple of years with a similar mechanism on proximity handles?

Yes. For door handles, it doesn't impact us for what we had planned for the future. But I would say that the benefit to us as we provide mechanical locking mechanisms as well is it's just reinforcing that while technology is changing, there still is a need for a secondary mechanical locking mechanism to enter into vehicles. So I see this as continued strength for our product offerings to the customers.

[Operator Instructions] We do have a follow-up question from John Franzreb with Sidoti.

Jennifer, I'd be remiss not to ask this question every quarter. Just regarding the -- your product review, can you give us any kind of update of what you're finding as you go through a product line by product line review of the company's offerings?

Yes. That's a good question, John. And we talked about earlier in the year that we did have a product line, which was our switch business that we deprioritized because while we had some good technology there, it wasn't the right fit from a profit and the value that we could supply to our customers. We still are heavily focused on our power access products, which is our drive units, our latching mechanisms, door handles as well as our digital key technology, which is the next-generation technology of a traditional key fob. So when I talk about digital key, it's the actual key fob's next-generation technology.

Got it. And just a point of clarification, Matt. I think you said that you expect revenue to be up 3% to 4% in the second half. I'm not sure if you're referencing year-over-year or sequentially.

Yes. Just to clarify, the expectation is it will be down 3% to 4% on a year-over-year basis.

Okay. And that's year-over-year. Okay.