STRATTEC SECURITY CORPORATION Stock

Greetings. Welcome to the Strattec's First Quarter Fiscal Year 2027 Financial Results Conference Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to Deborah Pawlowski, Investor Relations for Strattec. Thank you, Deborah. You may begin.

Thank you, and good morning, everyone. We appreciate you joining us for Strattec's First Quarter Fiscal 2027 Financial Results Conference Call. Joining me on the call today are Jennifer Slater, our President and Chief Executive Officer; and Matthew Pauli, our Senior Vice President and Chief Financial Officer. Jen and Matt will review our first quarter financial results, the progress we are making in our transformation and our outlook for fiscal 2027. You can find a copy of the news 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 forward-looking statements during the formal discussion and 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 and in other documents filed by the company with the Securities and Exchange Commission. You can find those documents on our website as well.

I also want to point out that during today's call, we will discuss certain non-GAAP financial measures, which we believe are useful in evaluating our performance. You should not consider this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP measures with the most directly comparable GAAP measures in the tables accompanying the earnings release and in the supplemental slides.

So with that, I'll turn the call over to Jen, who will begin with Slide 3.

Thank you, Deb, and good morning, everyone. Our first quarter results reflect continued progress in transforming Strattec into a more resilient, higher-performing business. We generated $10.8 million in cash from operations, delivered gross margin of 16.5% on sales of $147.2 million and ended the quarter with $111.8 million in cash and no debt. We achieved these results against lower customer production volumes and continued inflation and foreign currency pressure. While sales and earnings declined from the prior year quarter, gross margin improved 90 basis points sequentially on lower sales and adjusted EBITDA increased to $13.5 million from $12.5 million in the fourth quarter. We believe this demonstrates the progress we are making in improving the underlying performance of the business.

We remain focused on the actions within our control: improving productivity, reducing our cost structure, serving our customers and allocating capital with discipline. As an example, during the quarter, we implemented additional restructuring actions in our Mexico operations that are expected to generate $1.3 million in annualized savings. Including these actions, the annualized savings associated with restructuring initiatives implemented since we began the transformation in fiscal '25 are over $10 million. It is worth highlighting that we believe there are meaningful additional opportunities to improve our cost position through supply chain improvements, automation, and more efficient manufacturing processes. These opportunities are important both to supporting margins in the current environment and to strengthen our long-term competitive position.

Our cash generation also gives us flexibility to advance our strategy while returning capital to shareholders. During the quarter, we repurchased approximately 68,000 shares for $5 million while continuing to build our cash balance. We also are investing in our strategic initiatives for future growth and the sustainability of the business.

Slide 4 highlights how our operating transformation and financial strength support the next phase of Strattec's development. We are continuing to develop plans for additional productivity enhancements and cost reductions. At the same time, we are engaging with more prospective customers and building the relationships needed to support longer-term growth.

Our commercial efforts remain centered on Permission, Motion, and Hold. Permission enables secure vehicle entry, Motion encompasses powered access systems, and Hold includes latching solutions designed for safety, strength, and durability. This framework aligns our commercial, innovation, and engineering teams around the access experience we deliver and the opportunities we see with customers.

Organic growth in automotive takes time. We are working to engage earlier in customers' development processes, increase our content on existing platforms, pursue new platforms, and expand our customer relationships. In parallel, we are evaluating acquisitions that could accelerate customer diversification, enhance our product offerings, and increase our scale. We have an active funnel of acquisition targets and incurred $2.4 million in business development expenses during the quarter, primarily related to advancing these opportunities. Our approach remains disciplined. We are evaluating acquisitions based on strategic fit, financial returns, capital requirements, and execution risk. Our strong balance sheet gives us the ability to pursue strategic growth, but we will remain mindful on how we deploy capital to create long-term shareholder value.

In addition, we will be balanced regarding growth and returning capital to shareholders. Importantly, pursuing strategic growth does not detract from our focus on improving the business we operate today. We will continue to invest in productivity, automation, and operational execution while maintaining the financial flexibility to navigate industry variability.

With that, I'll turn the call over to Matt to walk through the financial details.

Thanks, Jen, and good morning, everyone. Please turn to Slide 5. First quarter net sales were $147.2 million, a decrease of $5.2 million or 3.4% compared with $152.4 million in the prior year period. Lower customer production volumes reduced sales by $6.2 million, which was partially offset by $1 million in net pricing benefits. For context, North American automotive production declined 3.8% in the quarter, including production at our 3 largest customers declining 6.8%. Our results benefited somewhat from the production levels of the program mix for the customers we serve as well as the benefit of our pricing actions.

The charts on this slide show our sales across customers and product categories. While our business remains concentrated with our top 3 customers, we also serve other OEMs, Tier 1 suppliers, and commercial customers. Diversifying our customer and product base remains a critical element to our growth strategy.

Please turn to Slide 6. First quarter gross profit was $24.3 million compared with $26.3 million in the prior year period. Gross margin was 16.5%, down 80 basis points year-over-year. The comparison reflects lower production volumes and $1.4 million of unfavorable foreign currency effects. Foreign currency negatively impacted the year-over-year gross margin comparison by approximately 90 basis points. We also experienced elevated premium freight and overtime in the quarter as a result of supply chain challenges.

Partially offsetting these pressures were pricing benefits, $900,000 in restructuring savings, lower overhead costs, and favorable mix. Sequentially, gross margin improved from 15.6% in the fourth quarter to 16.5% despite lower sales. This improvement reflects continued progress with our transformation, although we recognize there is more work to improve the operating consistency and reduce costs.

Please turn to Slide 7. Selling, administrative, and engineering expenses were $17.9 million or 12.2% of sales compared with $15.9 million or 10.4% of sales in the prior year quarter. The increase primarily reflected $2.4 million in business development expenses. We also continue to invest in the talent and outside support needed to advance our transformation. These increases were partially offset by $1.2 million in incremental engineering and development cost recoveries.

Excluding business development, business transformation, and executive transition costs, adjusted SAE expenses declined $200,000 to $15 million or 10.2% of sales. On an adjusted basis, we are at the top end of our long-term target range of 10% to 11% of sales without the benefit from the engineering cost recoveries. Nonetheless, as revenue remains soft through the year, we expect near-term adjusted SAE to run somewhat above our longer-term range as we make selective investments, primarily headcount to support the transformation.

Please turn to Slide 8. Our transformation actions have enabled us to generate bottom line profit despite volume and cost headwinds and the investments we are making in the business. Net income attributable to Strattec was $4.8 million or $1.19 per diluted share compared with $8.5 million or $2.07 per diluted share in the prior year quarter. The decline primarily reflects lower volume, unfavorable foreign currency effects of approximately $2 million on a pretax basis and the business development expenses we discussed. Our effective tax rate was 26.2% compared with 21.6% in the prior year period. The current quarter rate included discrete tax items, including a $400,000 increase in reserves for uncertain tax positions.

On an adjusted basis, first quarter net income attributable to Strattec was $7.5 million or $1.85 per diluted share compared with $9.2 million or $2.22 per diluted share in the prior year quarter. Adjusted EBITDA was $13.5 million or 9.2% of sales compared with $15.6 million or 10.2% of sales in the prior year period.

Please turn to Slide 9. We generated $10.8 million in cash from operations during the quarter compared with $11.3 million in the prior year period. Cash generation remained strong despite lower net income and benefited from customer collections. During the quarter, we returned $5 million to shareholders through the repurchase of approximately 68,000 shares. We ended the quarter with no debt and $111.8 million in cash and cash equivalents, up from the $108.2 million at fiscal year-end. Our capital allocation priorities remain consistent. We will fund customer programs and organic growth, invest in automation and modernization, and maintain the flexibility to manage through automotive cycles. We will also return capital through opportunistic share repurchases and pursue disciplined acquisitions. We view these priorities as complementary. Improving the performance and cash generation of the existing business gives us the flexibility to invest in our future and pursue strategic growth while maintaining our commitment to a strong balance sheet.

Please turn to Slide 10. We continue to expect a challenging automotive environment in fiscal 2027. Current third-party forecasts indicate about a 2% decline in North American automotive production for our fiscal year, including production at the Detroit 3, down nearly 6%. We expect our second quarter to be similar to our expectations for the year. Lower volume is expected to be a headwind to gross margin for the balance of the fiscal year with material cost inflation being [indiscernible] offset by the benefit of foreign currency exchange based on what we've seen today. Given the current circumstances, we expect the gross margin should be in the range of 15% to 16% for the year. As we identify and implement further productivity enhancements, we will work towards improving that and continue towards our target gross margin of 18% to 20% in the long run. Our focus is on improving the underlying cost structure so that the business can perform better and more consistently across different production environments. Excluding unusual items, we expect SAE cost to be at a quarterly run rate of $16.5 million to $17 million in fiscal 2027 as we invest in the business. Longer term, however, we expect SAE expenses to run at 10% to 11% of sales. At the end of the quarter we had a $104 million outstanding in peso contracts that were locked in at an average exchange rate of MXN 18.15. From a currency perspective at the current peso to U.S. dollar exchange rate of MXN 18.67 we should not see the year-to-year headwind to gross margin in the second quarter we experienced in the first quarter. However, the mark-to-market on these hedges is reflected in other expense, and at the current rate becomes a larger expense. Because the contracts are marked on the last day of the quarter, the change in other expense will vary based on the peso to U.S. dollar currency at that point in time. We expect our normalized fiscal 2027 effective tax rate to be in the range of 23% to 25%. We also continue to expect normal operating cash flow run rate at approximately $10 million per quarter, subject to working capital variability. Our first quarter cash generation keeps us on track for approximately $40 million for the fiscal year. With that, I'll turn the call back to Jen to close with Slide 11.

Thanks, Matt. We began fiscal '27 with continued progress in improving the business and generating cash. Our transformation is strengthening our underlying operating structure, while our balance sheet gives us the flexibility to invest in the next phase of Strattec's development.

Our priorities are clear: continue improving productivity and operational execution; pursue additional cost reductions through supply chain improvements and automation; build stronger and more diverse customer relationships to win future program opportunities around Permission, Motion, and Hold; evaluate acquisitions that can accelerate diversification and add scale; and allocate capital with discipline, including returning cash to shareholders through opportunistic repurchases. We recognize the challenges presented by lower industry production and the variability of foreign currency pressure. We also recognize that we have more work to do within our own operations. We will remain focused on serving customers, improving performance, and building a stronger business for the long term.

I want to thank our employees for their continued commitment and hard work and our shareholders for their support. With that, operator, we can open the call for questions.

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

I'd like to start with the guide. You just did a gross margin of 16.6% (sic) [ 16.5% ], but you're suggesting that there will be pressure on the year going forward. Even though you're suggesting that your FX benefits will offset higher material costs, what prompts you to have the outlook of a lower gross margin than you just recorded in the first quarter?

Thanks for the question, John. We just finished the first quarter roughly at 16.5% in gross margin. When we look forward, obviously, we've got lower volumes. That's the biggest reason for the range on the gross margin going forward of 15% to 16%. As you mentioned, we'll have a benefit from currency if the currency rates stay where they are, especially in the back half of the year. And then we are seeing some material cost inflation, not so much in the first quarter, but as we look forward, but we'll look to offset that internally.

And then the second option there on material cost is [indiscernible] is price increases or discussions with passing through inflation with our customers. And then obviously, there's the restructuring benefits that we implemented here in the first quarter that will benefit us in the second half of the year, but you've got the annual merit as well.

And John, that lower volume, obviously, is just related to North America production and the holiday schedules in Q2.

Yes. I mean I recognize that, like, we just had a quarter where we had lower volumes, not only the Big 3, but other North American production. So I kind of assume that was kind of embedded in the outlook.

Yes, it is.

Okay. Similar question on the SA&E number. it seems to me that if you kind of strip everything out in the quarter on a, call it, a recurring basis, you did about $15 million, but it also sounds like the E&D cost recoveries are also embedded in that number. Is that how I should be thinking about SA&E on a go-forward basis?

That's correct, John. So it's about $15 million of adjusted SAE costs in the quarter, but that included about $1.3 million of ED&D, which is kind of recoveries for our engineering efforts, which are very lumpy based on the projects. So if you adjust for that, it's probably $16.5 million.

How frequently do they occur, I guess?

I would say they're frequent, but not to the magnitude that we saw in the first quarter.

Got it. And it seems to me that M&A is becoming increasingly likely. Can you kind of give us a sense of size of an acquisition that you're looking at? It's been a while since you've done one. And given the charge that you took in the quarter, can we expect something by the end of this calendar year?

Yes. I think to your question on -- [Technical Difficulty] Sorry, John, I'm giving a little feedback. So on your question on size, there's not an exact formula because all acquisitions are not treated equal, and you can't buy what's not for sale, and that was part of the reason why that we advanced our framework early on. We are advancing, and some of the expense really is just related to, we don't want to take the prioritization off of the transformation of our core business.

And in some cases, we need supplemental capabilities. So that is really through advisers to help us with both those things so we can continue the progress on the transformation while we advance our thinking through M&A. And then your timing question, obviously, for all the things that I just talked about is hard to talk about what is the right timing there.

[Operator Instructions] Our next question is from Ethan Starr.

What progress have you made on getting more business for Strattec in future new models, including new content and innovations, please?

Ethan, thanks for the question. When we think about growth, we really complement what I had just answered on inorganic to organic. And as we've discussed, automotive is a long-cycle business. And so the next 2 years, we will follow North American production. We are actively engaged with our current customers and new customers to determine what opportunities and platforms we have confidence on. We're making great progress there. We really won't have line of sight to something beyond the next 2 years until probably the end of our fiscal year. What I want to make sure that we're doing, as you know, it is a bit of a technical sales, and because of the nature of long cycle, we want to make sure we have confidence in what we're seeing as future wins, and that takes time.

Sure. That's understandable. I appreciate that. That's very helpful. The only other comment I have is that considering where the stock is currently trading, I hope you will continue to repurchase shares.

Yes. As we talked about, Ethan, that is part of how we're thinking about deploying our capital. We're investing in our business. We're evaluating M&A and balancing that with return to shareholders.

[Operator Instructions] This now concludes our question-and-answer session. Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. Please disconnect your lines, and have a wonderful day.

Greetings. Welcome to Strattec's Fourth Quarter and Fiscal Year 2026 Financial Results Conference Call. [Operator Instructions] Please note, this conference is being recorded. At this time, I'll turn the conference over to Deborah Pawlowski, Investor Relations for Strattec. Thank you. You may begin.

Thank you, and good morning, everyone. We appreciate you joining us for Strattec's Fourth Quarter and Fiscal 2026 Financial Results Conference Call. Joining me on the call today are Jennifer Slater, our President and Chief Executive Officer; and Matthew Pauli, our Senior Vice President and Chief Financial Officer. Jen and Matt will review our fourth quarter and full year financial results, the progress we are making on our transformation and our outlook for fiscal 2027.

You can find a copy of the news 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 forward-looking statements during the formal discussion and during 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 and in other documents filed by the company with the Securities and Exchange Commission. You can find these documents on our website as well. I also want to point out that during today's call, we will discuss certain non-GAAP financial measures, which we believe are useful in evaluating our performance.

You should not consider this additional information in isolation or as a substitute for the results prepared in accordance with GAAP. We provided reconciliations of non-GAAP measures with the most directly comparable GAAP measures in the tables accompanying the earnings release and in the supplemental slides. So with that, I'll turn the call over to Jen, who will begin with Slide 3.

Thank you, Deb, and good morning, everyone. Fiscal '26 was a year of progress as we continue to reshape Strattec into a more resilient, higher-performing business. We delivered record annual revenue of $579.4 million, expanded full year gross margin by 150 basis points to 16.5%, generated $46.3 million in operating cash flow and ended the year with $108.2 million of cash and no debt.

In the fourth quarter, sales of $151.8 million were better than expected and essentially flat with the prior year period. These results were achieved in a dynamic automotive environment. Throughout the year, we managed fluctuating North American production levels, the evolving tariff environment, foreign exchange headwinds and customer cancellations of certain EV programs. We believe that our fiscal '26 results are an affirmation that the transformation is delivering, our teams are executing and we have the resiliency to offset a meaningful portion of these external pressures through pricing, cost actions and operational improvement.

During the year, we realized approximately $6 million of savings from restructuring actions. We also continue to invest in our commercial organization, innovation capabilities and the operating infrastructure needed to improve our margin profile. We are continuing to evolve our approach to growth. Automotive is a long cycle and cyclical industry, so it's critical that we engage customers earlier and more strategically in their development process.

This is relatively new concept for Strattec that historically did not have a process around a future-looking sales pipeline and only engaged with the customer when an RFQ was received. We have invested in our team and are in the early stages of developing the foundation around a future-looking development process with a focused product portfolio around 3 pillars: Permission, Motion and Hold. Permission includes secure vehicle entry technologies. Motion encompasses powered access systems and Hold includes latching products designed for safety, strength and durability.

This framework better aligns our commercial, innovation and engineering teams around customers' evolving access needs and future program opportunities. Our consistent cash generation also allowed us to return $7.4 million to shareholders in the form of share buybacks in the fourth quarter, and our Board of Directors has authorized a new $40 million stock repurchase program, which we intend to use to offset equity share dilution and opportunistically buy back shares.

Slide 4 highlights the disciplined execution of our transformation plan. We are working to improve how the business operates every day. Since fiscal '25, we have implemented restructuring actions that have delivered $9.5 million of savings. This past year, we consolidated our test lab operations in Auburn Hills and continue to invest in equipment and improve manufacturing flow at our Milwaukee operations. We also implemented new tools for sales pipeline management, financial consolidation, benefits administration and expense reporting.

These technology innovations help us make better decisions, enhance accountability, simplify processes and create a more scalable operating platform. In addition, we introduced culture pillars centered on innovation, collaboration and accountability, reinforced by a recognition program that highlights team members who put those values into action. The culture element of our transformation is critical to our success.

Our strong balance sheet and cash balance of $108.2 million give us the flexibility to invest in organic growth and modernization, maintain an appropriate cushion for industry variability, repurchase shares opportunistically and evaluate M&A opportunities that can provide scale and diversification. With that, I'll turn the call over to Matt to walk through the financial details.

Thanks, Jen, and good morning, everyone. Fourth quarter net sales were $151.8 million, essentially unchanged from the prior year period. This result was better than expected as we originally had estimated fourth quarter sales to be down 3% to 4% based on third-party estimates of OEM build rates at the time. Actual OEM production levels for the quarter came in down just 1.4%.

Compared with the prior year period, we had $3.2 million lower sales from OEM canceled EV programs, which offset $1.4 million in pricing benefits and certain customer inventory builds. For the full year, net sales increased to $579.4 million from $565.1 million in the prior year, which represents a 2.5% increase. Pricing contributed 2% with volume growth being less than 1%, consistent with the overall North American automotive market.

Sales growth was stronger in the first half of the fiscal year as macroeconomic conditions, reduced OEM production builds and EV program shifts weighed on second half sales. Our customer and product mix remains diversified across leading OEMs, Tier 1 customers and commercial accounts as well as across our various product lines.

Please turn to Slide 6. Fourth quarter gross profit was $23.6 million compared with $25.4 million in the prior year period, and gross margin was 15.6%. The fourth quarter comparison was affected by unfavorable foreign exchange rates and lower tooling gains. On a constant currency basis, gross margin improved, reflecting lower tariff costs, pricing and restructuring savings, partially offset by higher cost of quality.

For the full year, gross profit increased to $95.4 million from $84.6 million in fiscal 2025, and gross margin expanded 150 basis points to 16.5%. Importantly, this demonstrates the continued progress we are making in improving the underlying cost structure of the business even while managing external headwinds.

Please turn to Slide 7. Selling, Administrative and Engineering expenses were $17.5 million in the fourth quarter or 11.5% of sales compared with $16.9 million or 11.1% of sales in the prior year quarter. The increase primarily reflected business transformation costs as well as higher salaries and benefits. These expenses were partially offset by lower engineering and professional fees and restructuring savings.

Higher business transformation costs in the quarter primarily related to the use of outside advisers to advance strategic initiatives, including the transformation of our Milwaukee operations and advancing our focus on M&A alternatives that could deliver shareholder value. For fiscal 2026, SAE expenses were $68.8 million or 11.9% of sales compared with $61.8 million or 10.9% of sales in fiscal 2025.

The full year increase includes investments in salaries and benefits, business transformation, restructuring and executive transitions. It also reflects targeted investments in commercial, innovation, quality, procurement, supply chain, IT and program management capabilities. We remain focused on managing expenses with discipline. Excluding unusual items, our longer-term objective is to operate SAE in a range of approximately 10% to 11% of revenue. In the near term, we will continue to make selective investments that support our transformation and position Strattec for future growth.

Please turn to Slide 8. Net income attributable to Strattec in the fourth quarter was $3.9 million or $0.95 per diluted share compared with $8.3 million or $2.01 per diluted share in the prior year quarter. Fiscal 2026 fourth quarter GAAP earnings reflected incremental business transformation and executive transition costs as well as $2.9 million of discrete income tax adjustments associated with changes in tax regulations.

On an adjusted basis, fourth quarter net income attributable to Strattec was $8.4 million and adjusted diluted earnings per share was $2.06, unchanged from the prior year period. Adjusted EBITDA was $12.5 million compared with $13 million in the prior year quarter, with adjusted EBITDA margin affected principally by foreign exchange.

For fiscal 2026, earnings per share grew 9% to $5, validating the impact of our transformation actions against the macro headwinds discussed today. We believe we have built a stronger business that can be more durable through the automotive cycles. Full year adjusted EBITDA increased to $50.5 million, up 15% from fiscal 2025, and adjusted EBITDA margin was 8.7%. Our fiscal year financial performance, which includes a 100-basis-point improvement in adjusted EBITDA margins, illustrates an improved earnings base.

Please turn to Slide 9. We continue to demonstrate our strong cash generation capabilities with $9.7 million in cash from operations during the fourth quarter and $46.3 million for the full year. As a reminder, fiscal 2025 cash flow benefited from a significant reduction in working capital and preproduction balances as we worked to release value that have been dormant on our balance sheet. Nevertheless, the company generated substantial cash in fiscal 2026 while continuing to invest in the business.

We also returned $7.4 million to shareholders through the repurchase of approximately 110,000 shares during the fourth quarter, which was about 2% of our outstanding shares. We accomplished that under a previous share repurchase authorization. As Jen mentioned, the Board approved a new authorization under which $40 million is available for future share repurchases.

Our capital allocation priorities are straightforward. We will support organic growth and new customer programs, invest in automation and process modernization and preserve flexibility to manage cyclical industry conditions. Depending on the market, we will also repurchase shares opportunistically and evaluate M&A opportunities that can add scale and diversify our customer, product and program base. We will remain disciplined in how we evaluate and deploy capital.

Please turn to Slide 10. As we look ahead to fiscal 2027, we expect the automotive environment to remain challenging. Based on current third-party forecasts, we expect softer industry production in fiscal 2027, including an approximately 2% decline in North American production and a nearly 6% decline at our 3 largest customers. Our revenue will continue to be influenced principally by production levels at those customers, along with program mix, pricing and aftermarket demand. We also expect typical second quarter seasonality.

We believe the actions that we have taken and transformation progress expected in fiscal '27 will help to offset our typical 30% decremental impact to gross profit on lower sales. However, we will face headwinds from foreign currency. For example, had the peso been at its 5-year average or $19.50 to the U.S. dollar, our gross margin would have been about 100 basis points better in fiscal '26. The peso has already started the year at $16.90 compared with last year's average of $18.

For perspective, based on our foreign currency exposure, a 5% change in the U.S. dollar relative to the Mexican peso could affect annual manufacturing costs by approximately $4 million before the impact of any hedging activity. Over the next few years, we continue to target gross margins of 18% to 20%, assuming the peso returns to its 5-year average. We demonstrated the ability to generate gross margins at 16.5% this past year, and we believe our ongoing productivity, pricing and cost actions can support continued improvement.

As I mentioned, we are targeting longer-term SAE to run at approximately 10% to 11% of revenue, excluding unusual items. In the near term, it will likely be slightly higher than our stated range as we continue to make investments that support the transformation amidst a weakening automotive market. Our effective tax rate for fiscal '27 is expected to be approximately 24% to 25%. We also expect a normalized operating cash flow run rate of approximately $10 million per quarter, subject to typical working capital variability. We are planning about $12 million in capital expenditures for the year. With that, I'll turn the call back to Jen to close with Slide 11.

Thanks, Matt. Let me review the progress we made in fiscal '26 with our transformation actions. We rebranded the company and created 3 focus pillars for our product lines: Permission, Motion and Hold. We injected new talent throughout the organization. We advanced engagement with current customers and began conversations with prospective customers as we work to institutionalize a future-looking pipeline development process.

We captured $11 million in pricing. We moved the test lab from Milwaukee to our Auburn Hills location. We added 16 new automated assembly stations, which brings our total number of automated stations to 9%. This, of course, means we have a lot more opportunity in front of us. We freed up 91,000 square feet or about 26% of production space in our Milwaukee facility. We rightsized our manufacturing operations by reducing headcount by an additional 7%.

We automated our commercial pipeline management system, financial consolidation, employee benefits and expense reporting. We generated $46 million in cash from operations and ended the year with $108 million in cash. We returned $7.1 million of cash to our shareholders and paid down $8 million in debt. I want to thank all of our employees for their dedication and hard work. Without them, we would not have accomplished as much as we did.

We enter fiscal '27 with a stronger operating foundation and improved earnings base and a balance sheet that provides meaningful flexibility. We recognize that we have more work to do, particularly as we pursue future vehicle programs and navigate the challenging automotive environment. We will execute on the actions within our control, serving customers, improving operations, innovating new products, advancing future programs and allocating capital with discipline. With that, operator, we can open the call for questions.

[Operator Instructions] And our first question comes from the line of John Franzreb with Sidoti.

Congratulations on a good quarter in a tough environment. I'd like to start with your outlook for the year. You talked about down 2% in production. I'm kind of curious about the timing, what you're hearing out there. Is that going to be a first half of fiscal year '27 event? Or is it more towards the second half of the year?

Yes, John, this is Matt. I think the overall North American automotive production is down 2% or projected to be down 2% in fiscal '27. However, our top 3 customers, that being Ford, Stellantis and GM are projected to be down slightly more than that, around 6%. But when you think about it from a calendarization perspective, it's fairly consistent throughout our fiscal '27. Obviously, you've got some seasonality there in the second quarter just with the holiday shutdowns, but it's fairly consistent as we look forward to fiscal '27.

Okay. Got you, Matt. And you mentioned about some of the cost savings that you realized in the past 2 years, I think, $9.5 and $6 last year, not compared total since '25 and $6 last year. Can you talk about what major program initiatives that still remains to be done? Or is the heavy lifting kind of already happened?

Yes. Thanks for the question. I think what we touched on in some of the areas, we still feel there's still opportunity in the business. I talked about our automation being at 9% of our assembly stations. So I think the team has been making really good progress in how they're looking at that, but I think there's a lot of opportunity to continue there.

As we continue to look at our supply chain processes, getting more stability across our supply chain is something that we haven't talked about, and it takes a little bit longer to start delivering, but there's continued opportunity there. And then as we make improvements in those areas, continuing to look and make sure that we're constantly rightsizing our cost structure.

Matt and I are really working on laying out what that is going to look at because I think as we've talked about in prior calls, a lot of our work has been about prioritization. There's been so much to do and getting the low-hanging fruit and the easiest to deliver first. And now it's about making sure we've got good plans for the rest of the opportunity and alignment with the organization on what those priorities are.

I think the other thing to add, John, is we've been fairly measured in the actions that we've taken just to try and make sure that we've got good delivery with our customers. So we still think there's an opportunity. The team has done a nice job around kind of transportation costs, the automation that Jen mentioned, but there still is an opportunity to continue to improve our margins. We've said kind of longer term, we want to be in the 18% to 20%, and we see a path to get to there.

Okay. And just one more quick question. Can you talk a little bit about the $1.4 million in cost of quality? I don't remember hearing that last quarter. What is that item?

Yes. I think the first thing to make sure you understand is it's not the quality of our products. We make sure through our end-of-line process checks and everything else that we're delivering good quality products to our customers. And sometimes to do that, that we will find in our processes issues that we have in the supply base that then turn into expedited freight and other things to make sure we're getting good quality parts to our customers on time.

We -- one of the things that we've been focusing on the last 2 years is understanding our supplier base and making sure we've got good suppliers who are aligned with their strategies and our strategies going forward. And our purchasing director, who's relatively new to the organization has done a really nice job in balancing and working through some suppliers that have had exits for financial issues, some suppliers that haven't had the right quality for our expectations. And all of that gets put into that cost of quality bucket.

Our next question comes from the line of [ Ethan Star ], private investor.

Nice year. So I'm wondering, are you seeing more opportunities to innovate and add content to vehicles in future model years that are still on the drawing board?

[ Ethan ], thanks for the question. I talked a bit about what we have done with our branding of our products and focusing on our pillars with our Permission, Hold and Motion pillars. And the reason why we organized our pillars that way and aligned them to access is we feel with our existing products, we still have a lot of opportunity to work with our customers and get more content and proliferation on a larger set of platforms.

We're continuing to work on our innovation process around those products and working with our customers much more upfront than we have in the past to understand what problems they have and make sure that we're designing our product road maps to differentiate and provide value to our customers. So I think it's really a new approach here for the team that we've been focusing on. And I'm feeling really good about the progress the team has made that with those 3 pillars, we will be able to address a much larger set of customers. And then it's just about the time it takes to do that for the long-cycle business.

Great. So are you making efforts to add new automaker customers in North America?

Yes. Our commercial team has definitely -- we've brought in some new talent there that's leveraging some of the prior relationships that they've had with other automakers. Our focus really is first on automotive transportation. And then we think about extending it to a broader base of mobility where you've got off-road and ag customers and commercial truck.

But we're starting in automotive and our customer team is making really good groundwork in developing some new relationships. And then I just always have to add the reminder of the time length that, that takes to turn into revenue because of the long-cycle nature of the business. We're typically working 5-plus years out to when a start of production would happen and when we would realize that revenue.

Okay. How much money do the automated manufacturing and assembly stations save? And what plans are there to add more such stations?

So it's typically less than a year payback in how we're looking at it. What we're looking right now in our manufacturing is the simple automation where we can do more simple automation to replace a station at a line. As we're engaging with new customers and new products, we look at more transformational automation where we'll have fully automated lines. And I'll let Matt add on to that question a little bit.

Yes. The CapEx has not been significant, [ Ethan ]. We -- our CapEx in total was only about $7 million for the fiscal year, and that included the automation that we wanted to do, which is primarily around assembly, as Jen mentioned, but we are rethinking other avenues for automation as well.

Okay. Great. That's helpful. And last question, what, if anything, is happening with the potential sale of the Milwaukee facility?

Yes. I think we've talked in the past, we had the building for sale, and we've decided that we are going to continue to manufacture here in Milwaukee at our current facility. But the facility is still too large for what we need for operations. And so we'll likely pursue a sale and a leaseback a portion of the building that we need to continue to operate here in Milwaukee.

[Operator Instructions] Our next questions are from the line of Kanagat Yertay with Freedom Broker.

Congratulations on a strong quarter. So my first question is going to be about outlook on the gross margin. So on the outlook slide, you say gross margin is challenged by FX and the volume in the next year. So should we be modeling margin down year-over-year? And if so, where does that leave the 18% to 20% target?

Yes. So I think from a gross margin perspective, obviously, we've provided some comments on the revenue and the revenues being down on a year-over-year basis. Fundamentally, I think we've got a stronger business heading into '27 than we did in fiscal '25 or '26. So there will be pressure on the margins from the volume and the other portion there is FX.

So FX is a headwind on a year-over-year basis from where the peso is today versus the average in fiscal '26 was about 18. But we've got the offsets to that. We don't know that we'll offset all of it, but we'll offset a good portion of it based on some pricing actions not to the level that we saw this past year and also some continuous improvement actions that we have. So we've been very measured on the restructuring that we've done in the past. There still is opportunities to take further costs out of the business, and we'll work on those in fiscal '27.

Got it. And my next question is about CapEx. So CapEx was $7 million this year against $15 million of depreciation and the net PE came down. But Slide 4 is about upgraded equipment and assembly automation. So is the automation work generally that capital light? Or is there spend that's been deferred and that comes back in the next fiscal year?

Our estimate for next year is still around $12 million, which is a little less than 2% of sales for CapEx.

And I would say our business generally is more CapEx light even for some of the simple automation that we've been talking about.

Got it. And one more question. So Detroit 3 is about 2/3 of your revenue. So -- and over the next 3 or 4 years, roughly how much of that content comes up for resourcing as platforms reach end of life? And on the ones that have already been re-bid, have you retained the content?

Yes. I talked a bit about all the work that we've been doing with our pipeline business. Matt and I have been clear that over the next 2 years, we are going to follow the automotive production. And then past that, we've been working to understand what -- with some of the opportunities that the team has worked on and as you pointed out, some platforms that are being renewed, some that are falling off, where do we feel confident our revenue will be longer term.

I don't think we're going to have a good level of confidence until the end of our fiscal year to give any longer-term guidance past what we have done as far as these fiscal year '27 and fiscal year '28 following typical North America production.

The next questions are from the line of John Franzreb with Sidoti.

Yes. Just a question about the revenue outlook. You talked a little bit about canceled EV programs. Has that kind of all been flushed out? Or is that something we have to be cognizant about in the year ahead revenue profile?

That's kind of all flushed out in our fiscal '26, John. It's about -- it was about a $10 million headwind from fiscal '25 to '26.

Got it. And just one point of clarification. In the slide, you talked about cash flow. Is that an operating cash flow number? Or is that a free cash flow number?

That's an operating cash flow number of about $10 million a quarter.

Perfect. And the major automotive producers are now getting their tariff refunds. How does that flow down to you if it does at all?

Yes. So we filed for certain tariff recoveries from IEEPA claims. But a lot of our agreements with our customers would require us to reimburse the customers to the extent they previously had compensated us for the tariffs. So it's not -- it's essentially neutral for Strattec.

That's good to hear. And I guess I asked this question before. I'm going to ask it again or can you talk a little bit about maybe the willingness to reinstate the dividend? And also at this level, given your cash position and everything else, also maybe a stock split, I mean, increase the float there.

Yes, John, I think we've talked about in the past, we're currently not contemplating a dividend, but I think we've laid out kind of our capital allocation priorities in the presentation material. So we want to continue to invest in the business, first and foremost. And then we've got other alternatives to drive shareholder value, which is really around exploring M&A, which will help us from a scale and a diversification perspective and also opportunistically buying back shares with the new authorization.

Okay. And let's press that button. When you're talking about M&A, can you give us a sense of what kind of businesses you're targeting, maybe size and scale? I mean you have a clean balance sheet, so you can borrow rather significantly. Maybe give us some thoughts about the dynamics as far as M&A is concerned.

Yes. What I would say to that, John, is the easiest thing for us, knowing we still have transformation here to do at this business is to stay in the industry that we're in. It's important that we're diversifying our customer base. So an opportunity that would help us diversify our customer base would be helpful to build those relationships faster than I said we can do organically.

And then scale in this business is very important. If you look at our competitors, they have more scale, substantially more scale than we do. And so continuing to build scale faster than we can organically would be also important for M&A. And then finally, as we've better defined what our product pillars are, something that fits in those product pillars so that we're not going too far out of our core is also important.

And I think we talked about M&A before that we were in the early stages of developing a framework for our M&A, and we have worked with some third parties, and we're continuing to be active in that thinking. And because there's a lot of dynamics right now in the industry, and we want to be ready if something comes to us that we thought through what works for us and what doesn't work for us, to your point on what are we thinking about.

[Operator Instructions] Ladies and gentlemen, this will conclude today's question-and-answer session. We'll also conclude today's teleconference. Thank you for your participation, and have a wonderful day.

Greetings, and welcome to the Strattec Third Quarter Fiscal Year 2026 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Deborah Pawlowski, Investor Relations for Strattec. Please go ahead.

Thank you, and good morning, everyone. We appreciate you joining us for Strattec's Third Quarter Fiscal 2026 Financial Results Conference Call. Joining me on the call today are Jennifer Slater, our President and Chief Executive Officer, and Mathew Pauli, our Senior Vice President and Chief Financial Officer. Jen and Matt will review our financial results, the progress we are making on our transformation and our outlook. You can find a copy of the news 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 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. We believe these 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.

With that, I'll turn the call over to Jen, who will begin with Slide 3.

Thank you, Deb, and good morning, everyone. We delivered another solid quarter and continued to make progress on our transformation despite a challenging automotive environment. Our previously completed restructuring actions delivered $1.9 million in savings this quarter. This is a peak level as we lap some of the benefits from the prior year restructuring actions.

We generated $11.4 million of operating cash flow in the quarter and ended the third quarter with $107 million of cash on hand. That liquidity gives us flexibility to continue investing in the business, support customers and navigate a dynamic industry backdrop. While sales were down from prior year, the decline was in line with expectations, and we continue to improve profitability, generate strong cash flow and maintain a very strong balance sheet.

Despite lower revenue and ongoing foreign exchange headwinds, gross margin expanded to 16.5%, supported by restructuring savings, recoveries tied to canceled customer programs and continued operational focus.

As highlighted on Slide 4, our priority remains the execution of our transformation plan with discipline and consistency. We are working to build a more predictable, higher-performing company, and that means staying focused on daily operational execution while continuing to put the right processes, talent and systems in place.

During the quarter, we made additional changes within our Mexico operations that are expected to provide $800,000 in incremental annualized savings beginning in the fourth quarter. More broadly, the actions we have taken over the last several quarters helped to improve the way the business operates and better aligns our cost structure with the business we have today.

Equally as important as our focus on improving our cost structure is a transformation for how we approach growth. As you know, the automotive industry is long cycle and cyclical with intense competition and more recently, there have also been challenging external factors such as tariffs and supply chain challenges within our business and the broader industry.

As a result, our strategic growth initiatives are centered on how we build a sustainable business that can deliver resilient and predictable growth even in a challenging industry. From a commercial standpoint, we are focused on capturing additional content with our current customers by deepening our relationships and being involved in advanced development on new platforms.

In addition, we are starting to develop relationships with a more diverse set of customers that have U.S. production sites and looking to source locally. We are also focused on innovation and a product strategy that is anchored to engineering-led access systems, organized into 3 core product categories of permission, motion and hold.

The team is busy defining technical product road maps that are aligned with customer requirements and current and future technologies. We are very early in our execution on these growth initiatives. Importantly, we have the balance sheet and financial flexibility to support our efforts and the broader transformation of Strattec.

With that, I'll turn the call over to Matt to walk through the financial details.

Thanks, Jen, and good morning, everyone. Please turn to Slide 5. As Jen pointed out, sales in the quarter were down 4.5% as lower volume and EV program cancellations were only partially offset by pricing benefits and tariff recoveries. The annual impact of the customer cancellations on reduced EV platforms is about $9 million, of which about 2/3 we have already seen in our year-to-date fiscal 2026 results.

Our largest declines by customer were with Ford and Hyundai/Kia, which were both down a little over 10% year-over-year in the quarter. During the quarter, we did see higher sales to Tier 1 customers and Stellantis as they increased production. By product, door handles and keys and lock sets were steady, while power access and latches were down year-over-year.

Please turn to Slide 6. Gross profit for the quarter was $22.7 million, compared with $23.1 million in the prior year period. While gross profit dollars were modestly down on lower sales, gross margin improved by 50 basis points year-over-year to 16.5%, reflecting the value of our transformation actions. The quarter benefited from restructuring savings of approximately $1.7 million as well as recoveries related to canceled customer programs. Those benefits were partially offset by higher labor and benefit costs, incremental tariff costs and a meaningful foreign exchange headwind.

As we previously communicated, the annual cost of incremental tariffs has been approximately $5 million to $7 million, of which about half were IEEPA tariffs. We have recovered a majority of the tariff costs on a delayed basis through price increases or pass-throughs to OEMs and will now pursue past IEEPA tariff recoveries from the government, which we will have to then pass back to our customers.

On a year-to-date basis, we continue to see the benefits of pricing actions, operational improvements and restructuring savings come through in our margins, although foreign exchange remains an ongoing headwind. Overall, we believe these results show that we are improving the underlying earnings power of the business even in a softer production environment.

Please turn to Slide 7. Selling, administrative and engineering expenses were $17.6 million in the quarter or 12.8% of sales, compared with $16 million or 11.1% of sales in the prior year period. The increase reflects continued business transformation activity, executive transition costs, higher salaries and benefits and third-party engineering support. At the same time, these expenses also reflect investments we are making to strengthen the business.

As Jen mentioned, we are continuing to upgrade talent, improve internal capabilities and support the systems and processes needed to create a more effective and scalable operating model. We remain focused on cost discipline. And over time, we still expect SAE to move closer to our targeted operating range. For now, the reported expense level reflects both the work required to transform the business and the near-term investments needed to support that effort.

Please turn to Slide 8. Net income attributable to Strattec in the third quarter was $3.2 million or $0.78 per diluted share compared with $5.4 million or $1.32 per diluted share in the prior year quarter. On an adjusted basis, net income was $3.7 million or $0.90 per diluted share. The year-over-year decline in quarterly earnings was primarily driven by unfavorable changes in foreign exchange, which was a headwind in both cost of goods sold and other income and expense.

Nonoperating other income and expense in the prior year included a $235,000 foreign currency gain, while the current year included a $900,000 currency loss, the majority of which is unrealized losses on peso forward contracts, driven by the sudden and short-lived strengthening of the U.S. dollar at the end of the quarter.

The currency loss had a $0.16 negative impact on earnings per share. Based on the accounting mark-to-market requirements for the forward contracts, this could reverse at the end of the fourth quarter given where the peso is trading today.

On a year-to-date basis, earnings per share was up 46% over the prior year period, reflecting the cumulative benefits of cost reduction actions, productivity improvements and stronger underlying operating performance. Adjusted EBITDA was $10.1 million in the quarter compared to $12.5 million in the prior year period. FX was the primary reason for the decline. On a year-to-date basis, adjusted EBITDA was $37.9 million, a 23% increase over the prior year period.

Turning to Slide 9. The business continues to demonstrate that it is a strong cash generator with cash from operations in the third quarter of $11.4 million. We ended the quarter with $107 million in cash and cash equivalents. We also continued to reduce debt associated with the joint venture credit facility. And subsequent to quarter end, that facility was replaced with a new revolving credit agreement that extended the maturity and eliminated the Strattec guarantee on borrowings.

Our balance sheet remains a significant strength. It supports investments in organic growth, continued process modernization and automation, the flexibility needed to manage through cyclical industry conditions and enables us to execute on our plans for growth.

Please turn to Slide 10. As we look ahead, we continue to expect a moderate market environment, including the impact of canceled EV programs and lower production on certain key platforms. At the same time, we believe the business is better positioned than it was a year ago with a stronger operating foundation and clearer priorities. We expect revenue in the fourth quarter will be down 3% to 4% year-over-year, reflecting the same dynamics that we saw in the third quarter.

As we've mentioned before, over the next few years, we are targeting gross margin of 18% to 20%, which assumes the peso at its 5-year average of $19.50. We are currently operating in the 16-plus range. Over the next several years, we are targeting SAE of approximately 10% to 11% of revenue, excluding unusual items. Our focus remains on continuing to improve operational performance, maintaining cost discipline, supporting customers effectively and generating cash.

Over time, we remain focused on building a stronger and more consistently profitable business through a combination of cost improvements, modernization efforts and more effective positioning for future customer awards.

With that, I'll turn it back to Jen to cover Slide 11.

Thanks, Matt. We presented our vision last quarter, which reflects the broader transformation taking place at Strattec and the role we aim to play in safe and secure access solutions. Our vision is to be the most trusted global leader in safe and secure access solutions for the automotive and mobility industries by creating the ultimate access experience for consumers.

As we discussed previously, we have been working to sharpen how we align internally around a common purpose and how we present these changes externally. This work supports our internal culture and organizational alignment, so the team is engaged with the direction of the company and the role that they play in that future. It also reinforces the importance of innovation, collaboration and accountability as we continue to transform the business.

We believe the actions we are taking are building a stronger company with improved resilience, better earnings power and a clearer path to long-term value creation. We have a strong balance sheet and engaged leadership team and sharper strategic focus. We are confident in the progress we are making and the opportunities ahead. With that, operator, we can open the call for questions.

The first question comes from John Franzreb with Sidoti & Company.

I'd like to start with the $600,000 in canceled programs. I'm curious if those are programs that you walked away from or if those are programs that the customer canceled.

Yes. I'll let Matt talk a little bit more about the financials. But the canceled programs are really what you've seen in the headlines from our customers on a shift of EV programs back to ICE in North America. And so that's really just the impact of those decisions that the customer made.

Yes. And John, it's about $1.3 million of a benefit in our results. About half of it is in cost of goods sold and the other half is within SAE. And it's really recovery of costs that we previously had expensed for the development on those programs.

Okay. I guess the reason I phrased the question the way I did was that I know that there's a review of unprofitable or less profitable programs. So I'm curious where you stand in that evaluation.

Yes. We did a portfolio review first, and that's why we made the decision not to continue to invest in our switch portfolio. And then we continue, obviously, to look at opportunities for cost optimization versus pricing opportunities. So that's an ongoing effort for us, John, but nothing in this quarter related to that.

Got it. And since we're talking about particular product lines, I saw in the presentation that power access was down. Maybe can we talk to why that was the case?

Yes. That really was just timing of builds from our customers between Hyundai/Kia and Ford. So we don't see that impacting long term. That's really more just of a timing of a build impact.

All right. Fair enough. I guess I'll ask one more question, I'll get back into queue. What is needed to move the gross margin from the 16% threshold to the 18% target range? What are the levers you need to pull still?

Yes. I think we're pleased with the progress that we've made so far on gross margin. We've talked about the fact that we still feel early in the transformation, and there's still a lot of work to do on cost optimization.

So we'll continue to have very granular focus on further cost opportunities that will help that gross margin. The other piece is, as you mentioned, the portfolio review on pricing. We talked about in the past that we had really taken the low-hanging fruit, but we're continuing to look at where there's further opportunities on pricing. And then longer term, volume is important. So I think at this volume level, we're confident we can get to the 18% to 20%, but volume always matters longer term.

Yes. The only thing I'd add, John, is if you look at our gross margin, your last fiscal year, it was 15%. If I look at it on a trailing 12-month basis kind of at the end of the third quarter here, it's just north of 16.5% on a trailing 12-month basis.

So we are seeing improvement in our gross margins. The actions that we've taken to kind of rightsize the cost structure and improve the margin. So we feel comfortable, kind of, with the target. Kind of the items we have line of sight to get to the 18% to 20%.

And I think it also is a proof point for our cash generation because we've continued to have stable cash generation from the improvements that we've put into the fundamentals of the business.

All right. I [indiscernible] then. What were the changes that you made in Mexico that would benefit you?

We implemented additional restructuring action in Mexico. That's driving the additional savings that you'll see starting here in the fourth quarter. It's about $800,000.

And I think, John, that's where we continue to have opportunity. What we're balancing is making sure that as we optimize the business, we don't impact delivery or quality for our customers.

So it's a measured approach of getting our cost structure in the right way. Part of it is just looking at the way we do our business and improving processes. Part of it is the automation activities, the simple automation activities that we've talked about and continuing to look at benchmark cost structures against where we're at.

So this is where we think there's continued opportunity, but it's really in a balanced measure to make sure that we are not impacting our customers from a quality and a delivery standpoint while we rightsize our cost structure.

[Operator Instructions] At this time, there are no further questions. I would like to thank everyone for their participation in today's conference. You may disconnect your lines at this time. Have a great day.

Greetings. Welcome to Strattec Security Corporation's Second Quarter Fiscal Year 2026 Financial Results Call. 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. helped 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 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, 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 suggests 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. With that, operator, we're ready to open the line for questions.

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

Congratulations on another great quarter. I 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, where is the actual revenue push from Q2 into Q3? Or do your customers pretty much work around it and it was pretty much a 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 1 was the chip challenge. And I would say that customers with suppliers work to get through that with minimum 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 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 see, 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 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. So 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 and merits 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.

Got it. 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 saw -- only saw about $400,000 of a benefit in the current quarter, and we'll kind of get fully phased in roughly around $800,000 a quarter by the time we get to the fourth quarter.

Perfect. I guess just 1 more question, and then I'll get back into queue. Regarding the free cash flow, I mean you've had a great bunch of quarters. What did the -- 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 -- we expensed in the second quarter will impact cash flow in the third quarter.

[Operator Instructions] 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 the potential new customers in North America, mention 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 specking 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 1 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 is we provide mechanical locking mechanisms as well as -- it's just reinforcing that while technology is changing, there still is a need for a secondary mechanical locking mechanism to untrended 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 or what you're finding as you go through a product line or 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 have 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 latch mechanisms, store 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 fobs 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.

There are no further questions at this time. So this will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.

Good day, and welcome to the IAccess Alpha Virtual Best Ideas Winter Investment Conference of 2025. The next presenting company is Strattec Security Corp. [Operator Instructions] I'd now like to turn the floor over to today's host, Jennifer Slater, President and CEO of Strattec Security Corp. The floor is yours.

Thank you. Good morning, everyone. I'm Jennifer Slater, President and CEO of Strattec. I'm here today with our CFO, Matt Pauli, and we're excited to tell you more about Strattec.

Before we begin, as you are aware, we may make some forward-looking statements during this presentation as well as during our Q&A. As noted here, these statements are covered under a safe harbor.

First, for those of you who may not be familiar with Strattec, we were founded in 1908 and became public in 1995. We're an automotive supplier that provides highly engineered and innovative solutions across a wide range of products that you can find on your vehicle from powered tailgates to front latches and key fobs.

Our customer mix has been historically concentrated across the North American original equipment customers with General Motors, Ford and Stellantis. Our product portfolio is relatively balanced, while the majority of our products serve directly those original equipment customers, we do have about 8% of our business that is sold into the aftermarket.

Our footprint is concentrated in North America with our Headquarters in Milwaukee, Wisconsin, a Customer Center in Michigan, a Distribution Center in El Paso, and then the majority of our assembly operations are in Mexico.

Beyond our strong development and testing capability, we also have strong manufacturing capabilities from a component standpoint with die cast, stamping, injection molding and PCBA manufacturing capabilities, but we also have strong system assembly manufacturing.

I joined the company last July. And since then, we've been singularly focused on transforming the business across four strategic initiatives.

Starting with making sure we have the right capabilities, culture and alignment. We have a full new executive team and have been making progress with key capabilities throughout the other layers of the organization. We're keenly focused on increasing communication and expectations on our culture pillars to drive increased innovation, improve collaboration, breaking down silos and driving for results. From an innovation standpoint, this is not just a -- at a product level, but we are also looking at new ways to enable our business processes.

We're also refocusing on the customer to make sure we have the appropriate external view of our business, which is fundamental to our growth. Clear and consistent communication goal alignment and prioritization has been key in our culture and our leadership transformation.

Secondly, to make sure we're driving results on the key priorities, we instituted a strong business operating system, this has allowed us to make the improvement in our margin cash flow and helps us continuously evaluate and address our cost structure. We're still making progress here, but I'm proud of the team has, the work the team has done to drive more stability in the business.

As we think about our revenue growth, we took a strong look at our pricing opportunities, and we were able to capitalize on short-term opportunities. While I fell we primarily address the low-hanging fruit in the business, we continue to build the capability to think about our pricing in a more strategic manner.

Finally, but extremely important. We've been on a journey to modernize our business. Our starting point was very low. So there's been very simple things like automating our benefits, moving from paper expense report and building other basic business processes, but they've really been critical in our transformation to help enable our teams to focus on the more critical items that drive the business.

I'm extremely proud of the progress the team has made. We've navigated a significant amount of change in the business, but there's still a significant amount of work to be done on our underlying operations and continuing to lay the groundwork for our long-term growth.

This slide really translates the actions from our transformation into the results. we've been able to improve our margins and cash balance steadily over the past 5 quarters. As I mentioned, we definitely have more to do, but I'm pleased that our transformation actions are delivering bottom line results.

Shifting to our future. Our products have historically been categorized in three areas: our security and authorization products are a traditional lockset, key and key fob products. We've continued to drive innovation here with our digital key technology, which I'll cover in a couple of slides.

Next, the company acquired a division at Delphi in 2008, which includes our power access products and also contains all of our other access products, including door handles, which are supported by our joint venture partners.

Our engineers did a great job taking what we historically did in our security and authorization business and what capabilities we gained in our vehicle access business to create a new product portfolio with select user interface controls. This created new customers and new products. But as we've continued to look at the market, there's less and less switches going in consumer vehicles. The market is already served, so we will continue to support the customers we have in this space with legacy continuity but are more focused on our growth in our security and authorization and vehicle access business.

Diving into our power access products a bit more. These products have a strong depth of technical expertise to provide strong value for our customers. Our products combine the electronics engineering, software engineering and manufacturing expertise to drive seamless system performance to the end item customer.

Historically, we've had strong relationships with the North American OEMs, and we feel as access proliferates throughout the vehicle, we have opportunities to provide increased content across a wider subset of customers starting in North America where we have a strong supply chain.

As a reminder, in automotive, it's a very long-cycle business. So laying the groundwork today translates to longer-term revenue growth.

Moving on to our digital key product. This is the next generation of a key fob for your vehicle that integrates seamlessly with your phone using Bluetooth and Ultra-wide Band Connection technology. While there are advancements made in vehicle access, we feel strongly that key fob will still be an important part of the majority of vehicles over the next 10 years. We're also finding that customers that were going away from the mechanical lock in key fob are looking to put these back into their product planning for transferability, safety and security.

Our products are uniquely positioned based on our long-standing history to provide software and electronics packaging that meets customer requirements along with our USMCA manufacturing footprint.

To sum things up before I hand it over to Matt, we expect our revenue to closely follow North American production in '26. We are proud of the margin improvements and cash generation that we delivered from our transformation actions and are working through several near-term supply challenges in the market that impact vehicle production and efficiency. We will continue to be focused on our transformation. With some of the big rocks dealt with operationally, we're now providing a heavier focus on our products and our growth. And with that, I'll turn it over to Matt.

Thanks, Jen. Before we open it up for Q&A, I'll review our most recent financial results. As a reminder for everyone, we are a June 30 fiscal year-end. So our most recently completed quarter ended September 30.

Our first quarter results, we ended with $152.4 million in sales, so it's up about 9.6% on a year-over-year basis. That's on a back of the North American automotive production that was up about 4% to 5% in the same period. So our performance in the first quarter outperformed the market, largely driven by pricing benefits for some pricing actions that we implemented in 2025, favorable sales mix and we also had some new program launches that benefited us. As we look forward, we would assume that the program launches will level out here in the back half of fiscal '26.

On the right-hand side of the slide, you see our annual revenue numbers from fiscal '22 through fiscal '25, on a trailing 12-month basis, we're at about $578 million in sales. It's about a 4% growth rate over the last 4 years, a combination of both pricing actions as well as additional volumes.

Next, if we look at our cost structure, both gross margin and our SAE, from a gross margin perspective, our gross margin was 17.3% for the first quarter, which was up about 370 basis points year-over-year. The improvement in gross profit was due driven by increased volumes restructuring savings for actions that we took in 2025 and also the pricing actions.

Jen mentioned our footprint. We do have operations both here in Milwaukee as well as in Mexico. And in Mexico, we do have the headwind from increased labor costs on a year-over-year basis, just given government -- just given increased labor driven by the government-mandated increases and we also have a headwind from FX.

From an SAE standpoint, we expect our SAE to be in the 10% to 11% range, and it's the increase on a year-over-year basis was driven by higher equity compensation costs and some investments in the business.

Next, if we look at our bottom line results on Slide 14, whether it's net income, adjusted net income or adjusted EBITDA, you'll see the improvement in our results over the last 5 quarters. Highlight for first quarter is we delivered $9.2 million in adjusted net income or $2.22 per share, and we delivered $15.6 million in adjusted EBITDA or roughly 10%.

Next, if we look at our balance sheet and kind of cash generation and capital flexibility. At the end of the first quarter, we had $90 million of cash on the balance sheet and only $5 million of debt outstanding. The outstanding debt relates to a revolver on our joint venture. We also have a Strattec revolver of $40 million that we recently extended the maturity for an additional 3 years.

During the first quarter, we generated $11 million of cash from operations, which is consistent on a year-over-year basis. From a CapEx standpoint, think about our CapEx as roughly 2% to 2.5% of sales on an annual basis.

When we think about our capital priorities, our capital priorities in the near term are more internally focused. We'll continue to generate cash and add it to the balance sheet. We do acknowledge we're in North American automotive. It's a cyclical business. There's some uncertainties regarding the supply chain, tariffs. And so we'll be conservative on our cash but also use some of that cash to drive organic growth as well as some of the operating improvements for the transformation. On a longer-term basis, we'll consider M&A, but obviously, that's a longer-term process. We're in the early innings of defining what that framework would look like for Strattec.

And lastly, just to leave you with kind of the Strattec investment rationale. These are hopefully points that Jen and I covered this morning. The Strattec story is a transformation story. We're in the early innings of that transformation. And it's a combination of both driving additional sales growth as well as improving our operating efficiency and our cost structure. We've got a new executive team that's excited about the opportunity. And lastly, we've got a strong balance sheet to support us in those transformation efforts.

With that, I'll open it up for Q&A.

[Operator Instructions] Well, we have one question. What are the main drivers behind the improving gross margin trend this year?

Yes. So the improvement in gross margin is really -- there's kind of three key drivers. First off, it's the additional volumes. So as you saw in our first quarter with over $150 million in revenue, the volume definitely helped us from a gross margin perspective. We also implemented pricing and then we did some restructuring actions in '25. So you see the benefit of those three things really driving the margin improvement on a year-over-year basis.

The next question in the queue is where are supply chain costs and logistics trending compared to last year?

Yes. First on the supply chain cost. We haven't necessarily seen significant inflationary cost increases in the business. There's obviously some pockets with certain individual suppliers. But on a broader perspective, we haven't seen significant increases in supply chain costs.

Logistics, I would say, is similar. Obviously, the biggest challenge we face right now in kind of the supply chain logistics is the tariffs and mitigating the tariffs and working with our supply chain team there.

Yes, I do think that there are things happening also in the environment with the Novelis fire, the Nexperia chip issue. There's been some recent border issues that also impact supply chain because it's our goal just to make sure that we're meeting on-time delivery. And whenever you have unpredictability in -- where the North America production is and blips that impact your supply chain, it drives inefficiencies into the business.

The next question is, are you seeing any signs of stabilization or recovery in North American auto production schedules?

I would say, in this quarter, like we talked about, there was the Novelis fire that impacted some of our customers. They're really working to build back what any softening that they've had in the quarter longer term. I think the market projections, external market projections every quarter and every month that they are published, they are lifting a bit. But I think there is still quite a bit going on in the environment. So there still is a bit of uncertainty on what North America production is going to look like versus last year and any softening impact.

The next question is, do you expect working capital needs to increase as new project programs launch in 2026?

Yes. From a working capital perspective, our working capital is about 17% of sales. Our longer-term target is to be closer to 15%. We don't have significant new program launches in the back half of fiscal '26. But I think the team has done a nice job in reducing our working capital over the last 5 quarters. So I don't see a significant increase in working capital as we look forward in the back half of the year.

Yes. And I think just to add on to Matt's point about launches, for our addressable customers who we've historically supported, they're actually in a lull of launches as well, while they transition their thinking with some of the regulation changes that are changing the balance of their electric vehicles and internal combustion engines. So it's more of just an output of where our customers are with their vehicle launches as well.

The next question is where do you see gross margins on new projects you are bidding on?

Yes. From a gross margin perspective, just to put our fiscal '25, we ended at about 15% gross profit. In the first quarter here, we ended at 17% gross profit. Our longer-term expectation is to be in the 18% to 20% for a gross profit percentage. That's where the business has been in the past. And it's a combination of additional volume pricing and then some improvements in operational efficiencies. We're in the early innings of some of those opportunities, especially around automation on the shop floor.

The next question is, can you expand on how the mix shift toward higher value lock and ignition products impact profitability?

I think from that, we are still doing quite a bit of work on kind of operational improvements and strategic pricing. So as we continue to improve the business and look at where the value is for our customers from a value-based pricing model, we're still working through where we think the opportunity will be. I think we've given some expectation on what our target margins are, but not necessarily at a product level.

The next question is shift back to internal combustion engines. What impact will that mix shift have on your business?

The advantage for our product portfolio is we really are powertrain agnostic. So our products support both internal combustion engines and hybrid and electric vehicles. The impact that we do have is once we're sourced on a platform, were sourced on that platform typically through the life of the platform. So as our customers are making changes in their platform mix, we may see some sensitivity based on the amount of content we have on one platform versus another, but there is not an impact of our product portfolio between internal combustion engines, hybrid and electric vehicles.

The next question is our European manufacturers and opportunity for growth. In the presentation, when I talked about traditionally, our customers have been the North American OEMs with a strong supply chain in North America and more focus from our customers on local supply for local manufactured platforms. we really are taking an approach to say where do our products have a fit across all customers.

As I said, the life cycle in automotive is long. Right now laying the foundation of what products would apply to those customers that we haven't necessarily addressed to get into their vehicle platforms in '29 and beyond. So we're really taking a holistic view of the customer set and where our products will be a good fit for those customers.

Just to add to that, roughly 60% of our volume gets shipped to a U.S. production facility. The other 40% is to Mexico, Canada, Korea and to various European production sites.

The next question is, can you provide more detail on new business wins this year and how they contribute in fiscal year '26. .

I think for this, I'd really reiterate the long-cycle business in automotive. So typically, when you're looking at getting introduced on a new platform, you start pretty early before a request for quotation comes out. That's usually 1 to 2 years before an RFQ. When customers do sourcing in North America, once they release an RFQ, that platform then launches 3 to 4 years after that time frame.

So as I talked about, we're really balancing on improving the business as well as driving new customer relationships to support our growth, but we really see that as a longer-term growth opportunity.

The next question is, how should we think about volume expectations from your EV and next-gen platform programs.

I think I mentioned that our products are powertrain agnostic. We see that as an advantage as mix shifts change. We have a product portfolio that meets all powertrain types. And it's really just working with our customers on what platforms they're releasing in the market and when.

The next question is how our conversations with OEMs evolving around pricing and cost sharing? I would say that, that becomes more critical for us has been more critical for us as we've navigated tariffs with our customers. Most of our customers, this is facing their entire supply base. So they've worked with suppliers to make sure that they've got a process for reimbursement. And obviously, also working with the supply base to make sure that long term, suppliers have a plan to reduce any tariff impact.

The fact that we are majority USMCA certified helps us with that because we don't have a tariff impact on our final assemblies from USMCA. We do have some components that come from other regions, and we're working longer term with our customers on what that -- how we would support a transition to more local supply.

So with that, I appreciate everybody's time this morning. Hopefully, you have a better understanding of where we are on this transformation journey. As Matt said, we're still in early innings, but we're really proud of the team and the work and the progress that we've had over this past year. And we're looking forward to continuing to build on that progress as we move forward. I hope everybody has a great day, and thank you for your time.

Thank you. That does conclude Strattec Security Corp.'s presentation. You may now disconnect. Please consult the conference agenda for the next presenting company.

Greetings, and welcome to the Strattec Security Corporation's First Quarter Fiscal Year 2026 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Deborah 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 First 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, the progress being made to transform Strattec and our outlook. You can find a copy of the news 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 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.

With that, let me turn it over to Jen, who will be referencing Slides 3 through 5.

Thank you, Deb, and welcome, everyone. We started fiscal 2026 in a solid position, and our financial results are a direct testament to the actions we have been taking to transform the underlying operations of Strattec to improve our earnings profile. The progress reflects the significant effort by our team and the magnitude of change we have been implementing.

Revenue grew nearly 10% in the quarter, while gross profit margin expanded 370 basis points and EBITDA margin expanded 310 basis points to 10.2%. Margin improvements are a result of higher sales, pricing actions and cost reduction activities. We continue to actively manage our cost structure and implemented an additional restructuring action during the quarter that is expected to provide approximately $1 million in annualized savings that will be fully realized in the third quarter of this fiscal year.

We also had solid cash generation of $11 million and ended the quarter with just over $90 million of cash on the balance sheet. We believe this provides us the capital to continue to execute on our transformation plans while providing a cushion during these rather turbulent times for the automotive industry. I'll talk more about the short-term automotive industry headwinds that have been layered on top of the impact of tariffs after Matt covers the details of the quarter results.

Thanks, Jen, and good morning, everyone. Let's begin with Slide 6. First quarter gross profit increased $7.4 million or approximately 40% on 10% sales growth, while gross margin expanded by 370 basis points to 17.3%. Gross profit improvement was a result of strategic pricing actions, higher production volumes, some modest contributions from tooling and $1.3 million of restructuring savings. These gains more than offset $500,000 in unfavorable foreign currency, $200,000 in net tariff expenses and $1.1 million increase in statutory labor rates in Mexico.

Sequentially, gross margin improved 60 basis points on relatively similar revenue as bonus accruals normalized and tariff recoveries helped to offset the unfavorable impact of foreign currency and higher warranty reserves. Selling, administrative and engineering expenses, or SAE, were $15.9 million, a $2 million increase year-over-year, reflecting the investments in the business transformation. As a percentage of sales, SAE was 10.4%, somewhat similar to the prior year and within our expected long-term range of 10% to 11%.

Let's move to Slide 7, where we summarize our profitability. Net income attributable to Strattec for the quarter on both a GAAP and an adjusted basis was up meaningfully year-over-year, reflecting the progress we've been making with the transformation even as we invest to drive the progress. Adjusted EBITDA was $15.6 million, representing an adjusted EBITDA margin of 10.2%. Our results reflect the team's commitment to delivering sustainable margin improvement. As I've noted before, over the long term, we believe the business model would suggest low teen EBITDA margins. Reaching the double-digit level, we believe, demonstrates the validity of this expectation.

Now turning to Slide 8, which highlights our cash flow, balance sheet and capital priorities. Operating cash flow was more normalized, $11.3 million for the quarter, coincidentally similar to the first quarter of the prior year. We had capital expenditures of $1.5 million in the quarter or about 1% of sales. While we are investing in the business, we tend to not be capital intensive. We expect CapEx to be higher over the next several quarters as we advance our plans to accommodate the changes we are making to modernize the business.

We now have $90 million of cash and approximately $53 million available under our revolving credit facilities. Subsequent to the end of the first quarter, we did enter into an amended and restated $40 million revolving credit facility, which extended the maturity until October 2028. We believe we are in a secure position with our cash balance to continue to advance our transformation plans as well as begin to investigate what M&A may look like for us.

I'll caution that we are in the very early stages of this discussion internally about what that scenario could be. Right now, we won't have much more to add to the conversation, but we believe acquisitions could be a part of our longer-term future growth.

If you turn to Slide 9, I'll hand it back to Jen to review the conditions in the automotive industry and the actions we're taking.

Thanks, Matt. As you know, we are heavily dependent on volume to deliver profit. I am sure you are all aware of 2 significant events that have impacted auto production. First, an aluminum supplier had a fire in its facility, which will impact production levels for some of our major customers during our second quarter and potentially into our third fiscal quarter. The return to full production and restocking dealer inventory levels for our customers can take months to make up for lost time.

The second major event is the result of international trade restrictions on a chip supplier that has caused shortages of semiconductor chips to the automotive industry. At this time, we do not know the full impact to how our OEM customers will respond as the industry looks for alternative sources. We will use this time to build finished-good inventories to be able to better serve our OEM and aftermarket customers, reduce expedite costs and be prepared for anticipated demand rebound as OEM customers catch up for lost production time. Importantly, we will continue to monitor demand signals and take appropriate actions to align our cost structure as needed.

Despite these constant industry macros that disrupt progress, we are in a better position to manage the current issues facing our major customers than we would have been last year.

Let me update you on our transformation plan. We have started modernizing our operations with automation. While some of the improvements we are making may seem menial, each one makes a difference. For example, we are starting to automate certain manual assembly stations in our Mexico operations. These relatively simple automation projects have been validated, and we are applying this automation process to other production lines.

Our commercial efforts are centered on gaining new customers as well as capturing future vehicle platforms with existing customers. To do this well requires a deep understanding of our products, cost structure and where our value add is generated. We still have more work to do on this front, but we are continually assessing our operations and product portfolio to drive value.

Regarding the sale of our Milwaukee facility and the modernization program, we have come to the conclusion that our best route is a sale leaseback. This should provide us a better return on the building, reduce the challenges of moving production operations, allow us to rightsize our floor space requirement and redesign production flow. In conjunction with this decision, we will be consolidating our test lab to Auburn Hills, Michigan. This will put it closer to the customer and the commercial team for greater collaboration and oversight.

We also plan to move the corporate offices to a more modernized facility to advance our culture and enable better productivity. We have been producing results that demonstrate the effectiveness of our efforts to drive profitability, and we believe we have a great foundation upon which to grow. I'd be remiss not to thank the team that has made this happen.

With that, operator, we're ready to open the line for questions.

[Operator Instructions]

Our first question comes from the line of John Franzreb with Sidoti.

Congratulations on another good quarter. Jen, I'd like to start with your ongoing review of operations. What can you share with us that's new compared to what we discussed in fourth quarter results?

John, thanks for your question. I touched a bit on some of the automation work we're doing. And I think as we go through this transformation, and we really started with the basics, we're now moving on to where there are simple processes that we can leverage automation. And then for new -- for future products, we'll look at are there more transformational ways to automate our manufacturing. So it's really just a progression of our thinking as we're stabilizing the underlying operations and moving to the next phase of modernization.

And how should we think about the change in CapEx as you start to automate? What does the CapEx budget, say, for 2026 look like versus 2025?

John, it's Matt. On a full year basis, our CapEx budget is about $12.5 million. So it's about 2% of our sales. But the automation -- the cost of automation has come down over the years. So it's not a significant investment from a CapEx standpoint.

And I'll maybe just add on to that, John, just to give you an example. There's really simple automation processes that we're starting with. So where you're manually putting a screw into a part, we've proven that, that's an easy thing to automate. Automation costs really have come down. And so they're quick payback to look at those simple ways to automate our processes.

You want to talk on the Mexico restructuring too, the most recent...

Yes. I think we also talked about that. We did do -- we continue to look at our cost structure, John. And so we have done another look at our Mexico operations. We continue to drive efficiency in Mexico. And so we will see in our Q3 more favorability from further restructuring that we've done in Mexico.

And actually, that kind of dovetails nicely into maybe you looking at the footprint of the company, relocating the labs, changing corporate offices and now going to a sale leaseback in the Milwaukee facility. Can you just talk about your thought process and some of the moves you're making here? And does that maybe optimize what you think the manufacturing and the corporate footprint should look like on a go-forward basis?

Yes. I think it gives us flexibility. So we're optimizing for what we have today, making sure we're utilizing the space, getting a better process flow, moving the things and consolidating where we're closer to the customer like the test lab and then driving our continued culture change. So it's an ongoing process, John, to make sure that we're leveraging the footprint that we have to where our business is today, but where we think we're going to be in the future, along with providing ourselves flexibility.

Okay. And in Slide #9, you're signaling a cautionary outlook, certainly next quarter and change. Can you talk about the potential impact to the company on the fire and the semiconductor production, I don't know, disruption. Can you kind of quantify what you are thinking and the timing of all this become -- normalizing against?

Yes. When we started the year, John, we said that we would really be in line with North America production because we would be lapping some of our launches and the pricing actions that we had last fiscal year. And with that in line, we thought we would be modestly flat -- or flat to modestly down. That didn't anticipate the supplier issue or the chip shortage. So we do see that, that will be an impact here in the quarter because our customers have already announced some time out. I know our customers will work like they always do to make as much of that up as they can, and it will be a timing issue. But right now, there's too much uncertainty to say what the full impact of those will be for the full year for us.

We have no further questions at this time. I'd like to turn the call back over to management -- I'm sorry, I would like to turn the call back over to management for closing comments.

No, I just saw that we had an investor hop into the queue, Christine. Maybe we can take them.

Our next question is from [ Ethan Star ], a private investor.

Great quarter. And my question is regarding the automation products that -- to further improve gross margins, what types of return on investments do you expect from those? And when might such returns show up in quarterly results?

Yes. It's less than a 1-year payback, [ Ethan ], and I think we'll start to see some of those results in the second half of this fiscal year.

Okay. Great. And then on Page 4 of the slide deck, it says that Strattec is developing relationships with other North American vehicle manufacturers. Are you able to tell us anything about this at present?

No, not specifics, [ Ethan ], but we have talked about that we've had a pretty limited customer reach with the North American OEs and our products can add value to other customers in the region. And so as we start thinking about where do we have opportunity with our power access products and our digital key, we're looking to support the customers we have today, but also expand our customer base.

We have no further questions at this time. I'd like to turn the floor back over to management for closing comments.

Thank you very much, everybody, for joining us here today. We will be presenting Monday at the Gabelli Automotive Symposium in Las Vegas. So we will be posting the presentation associated with that on our website Monday. And in the meantime, if you have any questions, my contact information is on the website, and I look forward to talking with you. Have a great day. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.