# STRATTEC SECURITY CORP (STRT) FY 2023 MD&A Verbatim Item 7 Management's Discussion and Analysis from STRATTEC SECURITY CORP's 10-K for fiscal year 2023. SEC filing source: https://www.sec.gov/Archives/edgar/data/933034/000095017023046852/strt-20230702.htm Accession: 0000950170-23-046852 Filing date: 2023-09-07 Report date: 2023-07-02 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture. Confidence: high Company profile: /company/STRT/ All MD&A years: /company/STRT/mda/ Previous year: /company/STRT/mda/fy2022/ (FY 2022) Next year: /company/STRT/mda/fy2024/ (FY 2024) ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Discussion and Analysis should be read in conjunction with STRATTEC SECURITY CORPORATION’s accompanying Financial Statements and Notes thereto included in this Form 10-K. Unless otherwise indicated, all references to years or quarters refer to fiscal years or fiscal quarters of STRATTEC. Executive Overview Historically, a significant portion of our total net sales have been to domestic automotive OEMs (General Motors, Ford and Stellantis). During the past two decades these customers lost North American market share to the New Domestic automotive manufacturers (primarily the Japanese and Korean automotive manufacturers). In addition to our dependence on our customers’ maintaining their market share, our financial performance depends in large part on conditions in the overall automotive industry, which in turn, are dependent upon the U.S. and global economies. During fiscal years 2023 and 2022, the above domestic automotive OEMs together represented each year 66 percent and 65 percent, respectively, of our total net sales. During fiscal years 2023 and 2022, we experienced strong sales demand for our components from our major North American customers noted above as it relates to light trucks and both sport utility and car-based utility vehicles in comparison to passenger cars, influenced by customer preferences. If gas prices were to rise substantially over the next several years, this consumer buying trend may not continue, which is approximately 90 percent light trucks and sport utility vehicles in comparison to 10 percent passenger car vehicle purchases today. During the last 3-5 years our major customers General Motors, Ford and Stellantis eliminated passenger car production on several models in North America as a strategy to improve their overall profitability going forward. Additionally, several of our significant customers have announced plans to increase production volumes for their models of Electric Vehicles. As these customers start migrating over to Electric Vehicles we believe a significant amount of our current and future product content will continue to be purchased by our major customers and will be adopted in this changeover (refer to vehicle list included at page 7 in this Form 10-K). Fiscal 2023 net sales were $492 million compared to $452 million in fiscal 2022. The net sales improvement in fiscal 2023 reflected an improvement in the global semiconductor chip shortage which had caused our OEM customers to temporarily shut down their assembly plants reducing our net sales during fiscal 2022. Despite higher sales in fiscal 2023, net income attributable to STRATTEC for fiscal 2023 was negative $6.7 million compared with the net income attributable to STRATTEC of $7.0 million in fiscal 2022. The deterioration in profitability was primarily driven by escalating manufacturing input costs for raw materials and purchased materials, higher shipping and Mexican labor wages, which increased on January 1 of both 2022 and 2023 as part of a Government mandated minimum wage increase of 22% and 20% respectively. In addition to the inflationary cost increases, the Mexican Peso strengthened against the U.S. Dollar throughout fiscal year 2023 negatively affecting the cost of our operations in Mexico. Seeking pricing recovery from our customers for the aforementioned inflationary costs was a prime focus of ours throughout fiscal year 2023. However, given the long-term nature of our supply agreements, such pricing concessions are not customary and, therefore, resulted in protracted rounds of negotiations with limited effect on our fiscal 2023 profitability. Despite the limited price concession results in fiscal 2023, we are committed to aggressively seeking a favorable resolution to these negotiations early in fiscal year 2024. As we look to the future, the June 2023 projections from our third-party forecasting service, S&P Global, indicate that North American light vehicle production will show an increase in demand over the coming years. Model year 2023 preliminary North American vehicle build was 15.1 million. By model year, based on these projections we are expecting a 2024 vehicle build of 15.2 million vehicles, 16.1 million vehicles for 2025, and 16.6 million vehicles for 2026 and 2027. The North American vehicle build for Ford, General Motors and Stellantis reflects relative stability ranging between 6.7 million and 7.1 million vehicles each model year from 2024 through 2027 without much fluctuation between each customer. Of course, all of these forecasts are subject to variability based on what happens in the overall North American and global economies, the current levels of employment, availability of consumer credit, home equity values, fluctuating fuel prices, changes in customer vehicle and option preferences, product quality issues, including related to recall and product warranty coverage issues, and other key factors that we believe could determine whether consumers can or will purchase new vehicles or particular brands. Fiscal 2024 Outlook As stated above, we anticipate the 2024 North American light vehicle production, which closely aligns with our fiscal 2024 timing, to be relatively stable with a potential for modest growth. Similarly, we anticipate modest growth in our net sales on the basis of a stable industry and the launch of several new programs in the model year. From a cost of sales perspective, we anticipate some key challenges from fiscal 2023 will continue into fiscal 2024, notably a strong Mexican Peso relative to the U.S. Dollar, risk of another round of Mexican government mandated minimum wage increases in January 2024 affecting the cost of our Mexican operations, and increased purchased material costs from our suppliers. As for positive cost trends, we anticipate a continued recovery in the cost of some key raw materials, a trend which began in the second half of fiscal 2023. 20 With a focus to offset the anticipated aforementioned cost challenges and to improve present profitability, management is targeting the following actions in fiscal 2024: (1) Successfully conclude price-concession negotiations with our key customers by the end of Q2 to achieve between $10 million and $15 million in present program pricing improvement for the fiscal year as well as receive one-time retroactive price adjustment payments totaling between $4 million and $6 million (2) Salaried staff reduction commencing in Q1 reducing annualized spending by approximately $2 million (3) Drive operational actions that reduce overhead in operations and purchase of materials by $3 million per year (4) Reduce fiscal year-end inventory levels by $10 million compared with that for fiscal 2023 We believe the successful execution of these actions together with that of our overall fiscal plan will considerably improve STRATTEC’s profitability in fiscal 2024, reestablishing a solid foundation from which to grow profitability thereafter. Results of Operations 2023 Compared to 2022 [[GREPCENT_TABLE]] [["","","Years Ended"],["","","July 2, 2023","","","July 3, 2022"],["Net Sales (millions of dollars)","","$","492.9","","","$","452.3"]] [[/GREPCENT_TABLE]] Net Sales to each of our customers or customer groups in the current year and prior year were as follows (millions of dollars): [[GREPCENT_TABLE]] [["","","Years Ended"],["","","July 2, 2023","","","July 3, 2022"],["General Motors Company","","$","150.3","","","$","130.2"],["Ford Motor Company","","","96.6","","","","79.7"],["Stellantis","","","78.1","","","","83.3"],["Tier 1 Customers","","","73.3","","","","59.3"],["Commercial and Other OEM Customers","","","56.3","","","","65.0"],["Hyundai / Kia","","","38.3","","","","34.8"],["Total","","$","492.9","","","$","452.3"]] [[/GREPCENT_TABLE]] The year-over-year sales increase of $40.6 million was due to improved global semiconductor chip availability in the current year period relative to the prior year period. Additionally, our 2023 fiscal year was 52 weeks while our 2022 fiscal year was 53 weeks. The impact of the additional week of sales during the prior year partially offset the lower net sales in the prior year from the semiconductor chip shortage and which extra week increased prior year sales by approximately $7.4 million. The following items further impacted sales to the noted customer groups between periods: - Sales to General Motors Company, Ford Motor Company, and Hyundai/Kia were positively impacted in the current year due to higher vehicle production volumes resulting from improved global semiconductor chip availability relative to the prior year. Sales growth to General Motors Company in the current year was attributed to higher production volumes of their GMC and Chevrolet pickup trucks and certain SUVs for which we supply a wide range of components. Increased sales to Ford Motor Company in the current year were due to higher production volumes of their F-Series Pickups including the Super Duty Pickup, for which we supply a wide range of components, and an increased percentage of the F-Series Super Duty Pickup including our power end gate product option. Sales to Hyundai / Kia increased year-over-year due to higher levels of production of the Kia Carnival minivan in the current year period as compared to the prior year period. - The decrease in net sales to Stellantis was driven primarily by its lower production volumes related to the Chrysler Pacifica minivan, the Jeep Wrangler, Jeep Gladiator, and Dodge Ram Truck for which we supply components. - Sales to Tier 1 Customers improved in the current year compared to the prior year due to higher vehicle production volumes relating to the improvement in semiconductor chip availability referenced above. - Sales to Commercial and Other OEM Customers, which are comprised of aftermarket products and vehicle access control products, such as latches, fobs, driver controls and door handles, declined in the current year as compared to the prior year due to the allocation of available semiconductor chips toward the production of components for production vehicles rather than aftermarket products. 21 [[GREPCENT_TABLE]] [["","","Years Ended"],["","","July 2, 2023","","","July 3, 2022"],["","","Millions of Dollars","","","Percent of Cost of Goods Sold","","","Millions of Dollars","","","Percent of Cost of Goods Sold"],["Direct Material Costs","","$","298.5","","","","66.2","%","","$","260.8","","","","65.8","%"],["Labor and Overhead Costs","","","152.3","","","","33.8","%","","","135.4","","","","34.2","%"],["Total Cost of Goods Sold","","$","450.8","","","","","","$","396.2"]] [[/GREPCENT_TABLE]] Total cost of goods sold increased $54.6 million between years primarily driven by higher sales volumes in the current year as compared to the prior year as discussed above, however, both direct material costs and labor and overhead costs increased as a percent of net sales, with direct material costs growing at a higher rate, explaining the increase in its percent of cost of goods sold shown above. The increase in direct material costs between years beyond the portion that was attributed to higher net sales was driven by escalating costs of raw material and purchased components as well as a shift toward products with a higher proportion of material costs as a percent of their total cost of goods related to the aforementioned prioritization of production vehicles over aftermarket products. It is worth noting that there was an improvement in the cost of raw materials in the latter half of the current fiscal year compared with the prior year, primarily driven by reduced supplier pricing on zinc and steel. Labor and overhead costs increased $16.9 million between years. The variable portion of labor and overhead costs increased in the current year commensurate with the production volume increase required to support the increased sales volumes compared to the prior year. Apart from the improved fixed cost absorption associated with the higher sales compared with the prior year, labor and overhead costs were further impacted by the following: Cost Increases: - Mexico wages and benefits increased $6.9 million in the current year as compared to the prior year as a result of January 1, 2022 and January 1, 2023 government mandated minimum wage increases. - The U.S. dollar value of our Mexican operations was negatively impacted by approximately $5.5 million in the year as compared to the prior year due to an unfavorable Mexican peso to U.S. dollar exchange rate between years. The average U.S. dollar / Mexican peso exchange rate decreased to approximately 18.98 pesos to the dollar for the year from approximately 20.33 pesos to the dollar in the prior year. - Freight costs increased $2.3 million between years due to an increase in fuel costs and supply chain disruptions. - Warranty costs increased by $2.1 million in the year as compared with the prior year due to specific warranty claims involving our product. Cost Decreases: - Production efficiencies that controlled headcount at our Mexico facilities combined with having one less operational week in the current fiscal year resulted in reduced labor and benefit costs of approximately $2.1 million in the current year as compared to the prior year. - Royalty costs paid on sales of certain aftermarket products decreased $0.9 million in the year as compared to the prior year due to lower volumes in these aftermarket products stemming from the current semiconductor chip shortage. [[GREPCENT_TABLE]] [["","","Years Ended"],["","","July 2, 2023","","","July 3, 2022"],["Gross Profit (millions of dollars)","","$","42.2","","","$","56.0"],["Gross Profit as a percentage of net sales","","","8.6","%","","","12.4","%"]] [[/GREPCENT_TABLE]] Gross profit dollars in the current year decreased $13.8 million as compared to the prior year driven by the aforementioned inflationary pressures on direct material and labor and overhead costs as well as by the strengthening of the Mexican peso against the U.S. dollar. The resulting decrease in gross profit as a percentage of net sales was 3.8 percentage points from the prior year to the current year. Engineering, Selling and Administrative Expenses in the current year and prior year were as follows: [[GREPCENT_TABLE]] [["","","Years Ended"],["","","July 2, 2023","","","July 3, 2022"],["Expenses (millions of dollars)","","$","48.2","","","$","47.1"],["Expenses as a percentage of net sales","","","9.8","%","","","10.4","%"]] [[/GREPCENT_TABLE]] Engineering, selling and administrative expenses were impacted by the following: Cost Increases: - The current year includes higher outside expenditures on new product development costs associated with utilizing third party vendors for a portion of our development work. 22 - The current year includes an increase in engineering costs related to our ADAC-STRATTEC LLC door handle and exterior trim products. Such expenses are based on a percentage of ADAC-STRATTEC LLC net sales. - The current year includes increased salary costs and increased recruiting costs for new and replacement positions. Cost Decrease: - The prior year included an additional week of expense as our fiscal 2022 was a 53 week year and our fiscal 2023 was a 52 week year. Loss from operations in the current year was $6.1 million compared to income from operations of $8.9 million in the prior year. This change between years was the result of an increase in cost of goods sold and increased engineering, selling and administrative expenses, which were partially offset by an increase in sales in the current year as compared to the prior year, all as discussed above. Equity earnings of joint ventures during the fiscal years ending July 2, 2023 and July 3, 2022 were $1.6 million and $177,000 respectively. Current year equity earnings of joint ventures includes STRATTEC's one-third of a loss on disposal of VAST LLC's investment in Brazil of $531,000 and a gain on sale of STRATTEC's one-third share of VAST LLC of $110,000. Effective June 30, 2023, STRATTEC entered into and completed transactions contemplated by an Equity Restructuring Agreement between STRATTEC and WITTE. Accordingly, effective as of June 30, 2023, STRATTEC sold its one-third interest in VAST LLC to WITTE. Refer to the discussion of "VAST, LLC, SPA, LLC and SPA de Mexico Equity Restructuring Agreement" above and the Equity Restructuring Agreement in Joint Ventures and Majority Owned Subsidiaries included in the Notes to Financial Statements included within this Form 10-K for additional information regarding the sale of STRATTEC's VAST LLC interest to WITTE Automotive. Improved profitability from our VAST LLC joint venture resulted from increased net sales and increased profitability in VAST China’s operations between fiscal years. VAST China’s sales and profitability improved in the current year due to an improved semiconductor chip availability environment compared with that of the prior year. Additionally, during the prior year, VAST China experienced a fire at their Taicang plant. As a result, certain door handle and painting operations were temporarily transferred to their Jingzhou facility and another supplier. The transfer of production negatively impacted VAST China's profitability in the prior year. Due to a limited amount of business in both India and Brazil during fiscal 2023 the VAST LLC joint venture in India continued to have break-even operating results and the VAST LLC joint venture in Brazil continued to report losses. Included in other (expense) income, net in the current year and prior year were the following items (thousands of dollars): [[GREPCENT_TABLE]] [["","","Years Ended"],["","","July 2, 2023","","","July 3, 2022"],["Foreign currency transaction (loss) gain","","$","(2,935",")","","$","237"],["Rabbi Trust Assets gain (loss)","","","202","","","","(304",")"],["Unrealized gain on Mexican peso forward contracts","","","\u2014","","","","384"],["Realized gain on Mexican peso forward contracts, net","","","1,022","","","","361"],["Pension and postretirement plans cost","","","(722",")","","","(505",")"],["Other","","","255","","","","233"],["","","$","(2,178",")","","$","406"]] [[/GREPCENT_TABLE]] - Foreign currency transaction gains and losses resulted from activity associated with foreign denominated assets and liabilities held by our Mexican subsidiaries. - The Rabbi Trust assets fund our amended and restated supplemental executive retirement plan. The investments held in the Trust are considered trading securities. - We entered into the Mexican peso currency forward contracts during fiscal 2023 and 2022 to reduce earnings volatility resulting from changes in exchange rates affecting the U.S. dollar cost of our Mexican operations. No peso forward currency contracts are outstanding as of July 2, 2023. - Pension and postretirement plan costs include net periodic benefit cost other than the service cost component. Our effective income tax rate for 2023 was (16.7) percent compared to 4.5 percent in 2022. Our 2023 effective tax rate was impacted by $2.2 million in China non-resident capital gain tax resulting from the sale of our interest in VAST LLC, a valuation allowance of $1.4 million related to our assessment of the future realization of capital loss carryforwards generated from the sale of our interest in VAST LLC, and the impact of available R&D and foreign tax credits on pre-tax book losses. Our 2022 effective tax rate was impacted by adjustments made to the amount of our 2021 estimated foreign tax credits and estimated tax impacts associated with our investment in VAST LLC. These true-up adjustments resulted from the filing of our 2021 U.S. income tax returns during 2022 and were attributable to actual results included in non-U.S. income tax returns, which are filed on a calendar year basis, and which differ from estimates included in our 2021 tax provision. The adjustment amounts recorded during 2022 totaled $1.0 million. Our effective tax rate for 2022 excluding these adjustments was 15.6 percent. These adjustments were not material to our previously issued financial statements. Our income tax provision for each year 2023 and 2022 was affected by the non-controlling interest portion 23 of our pre-tax income, Global Intangible Low Taxed Income (GILTI) provisions and R&D tax credit. The non-controlling interest impacts the effective tax rate as our ADAC-STRATTEC LLC and STRATTEC POWER ACCESS LLC entities are taxed as partnerships for U.S. tax purposes. Liquidity and Capital Resources Working Capital (millions of dollars) [[GREPCENT_TABLE]] [["","","July 2, 2023","","","July 3, 2022"],["Current Assets","","$","225.8","","","$","188.2"],["Current Liabilities","","","109.0","","","","81.5"],["Working Capital","","$","116.8","","","$","106.7"]] [[/GREPCENT_TABLE]] Outstanding Receivable Balances from Major Customers Our primary source of cash flow is from our major customers, which include Stellantis, General Motors Company and Ford Motor Company. As of the date of filing this Annual Report with the Securities and Exchange Commission, all of our customers are making payments on their outstanding accounts receivable in accordance with the payment terms included on their purchase orders. A summary of our outstanding receivable balances from our major customers as of July 2, 2023 and July 3, 2022 was as follows (millions of dollars): [[GREPCENT_TABLE]] [["","","July 2, 2023","","","July 3, 2022"],["General Motors Company","","$","27.5","","","$","24.6"],["Ford Motor Company","","","17.4","","","","10.6"],["Stellantis","","","14.1","","","","12.8"],["","","$","59.0","","","$","48.0"]] [[/GREPCENT_TABLE]] Cash Balances in Mexico We earn a portion of our operating income in Mexico. As of July 2, 2023, $2.2 million of our $20.6 million cash and cash equivalents balance was held in Mexico. These funds are available for repatriation as deemed necessary. Cash Flow Analysis [[GREPCENT_TABLE]] [["","","Years Ended"],["","","July 2, 2023","","","July 3, 2022"],["Cash Flows from (millions of dollars):"],["Operating Activities","","$","10.1","","","$","10.4"],["Investing Activities","","","8.9","","","","(14.3",")"],["Financing Activities","","","(7.4",")","","","(1.9",")"],["","","$","11.6","","","$","(5.8",")"]] [[/GREPCENT_TABLE]] Cash flow from operating activities was consistent between years as the impact of the reduction in profitability between years, as previously discussed, was offset by a net decrease in working capital requirements. The net decrease in our working capital requirements included the following working capital changes (millions of dollars): [[GREPCENT_TABLE]] [["","","Increase (Decrease) in Working Capital Requirements"],["","","2023","","","2022","","","Change"],["Accounts Receivable","","$","13.7","","","$","5.9","","","$","7.8"],["Inventories","","","(2.9",")","","","9.6","","","","(12.5",")"],["Customer Tooling","","","10.0","","","","3.3","","","","6.7"],["Other Assets","","","0.5","","","","(0.2",")","","","0.7"],["Accounts Payable and Other Liabilities","","","(24.0",")","","","(1.8",")","","","(22.2",")"],["","","$","(2.7",")","","$","16.8","","","$","(19.5",")"]] [[/GREPCENT_TABLE]] - Accounts receivable balances increased in both the current and prior year periods. The increase in the accounts receivable balance during the current year reflect increased sales as of the end of our fiscal 2023. The increase in accounts receivable balances during the prior year was mostly due to payments from a specific customer being made in advance of the payment 24 term due dates in the prior year while current year payments from that customer were made according to the planned payment term due dates. - The change in inventory levels reflected a decrease during the current year and an increase during the prior year. The current year decrease was due to a reduction in inventory balances to align with historical customer production patterns, mostly offset by a change in inventory management and shipping terms with a significant vendor. The prior year increase was due to an inventory build-up while our OEM customers experienced reduced production schedules due to certain part shortages, including for semiconductor chips. - The change in customer tooling balances, which consisted of costs incurred for the development of tooling that will be directly reimbursed by the customer whose parts are produced from the tool, was the result of the timing of tooling development spending required to meet customer production requirements and related billings for customer reimbursements. - The change in other assets was relatively consistent between years. The increase in value added tax recoverable balances in the current year due to several periods being open to audit in Mexico was mostly offset by a reduction in our Rabbi Trust assets of $863,000 resulting from a current year SERP settlement and a $627,000 reduction in our Mexico peso forward contract asset. - The current year increase in accounts payable and other liabilities is due to the following: - Accounts payable increased approximately $14.0 million in the current year primarily due to a change in inventory management, shipping terms, and payment terms with a significant vendor and the suspension of ADAC-STRATTEC LLC's payment of engineering, research and design fees as well as a sales fees to ADAC in order to comply with ADAC-STRATTEC debt covenants. - Accrued salaries and benefits increased approximately $4.7 million in the current year resulting from increased salaries and benefits for our Mexican associates. - Income taxes payable increased $2.4 million in the current year primarily due to the accrual of a China non-resident capital gain tax as a result of the sale of our interest in VAST LLC. - Value added tax payable balances increased $3.0 million in the current year due to several periods being open to audit in Mexico. Net cash provided by investing activities of $8.9 million during 2023 included proceeds from the sale of our interest in VAST LLC of $26.2 million and a net increase in cash of $354,000 resulting from STRATTEC's purchase of the net assets of VAST Korea. The cash inflows were partially offset by capital expenditures of $17.4 million in support of requirements for new product programs and the upgrade and replacement of existing equipment and a $278,000 investment in VAST LLC for the purpose of funding general operating expenses for Sistema de Acesso Veicular Ltda, VAST LLC's Brazilian joint venture. Net cash used by investing activities of $14.3 million during 2022 included capital expenditures of $14.2 million, which were made in support of requirements for new product programs and the upgrade and replacement of existing equipment. Net cash used by investing activities during 2022 also included an investment in VAST LLC of $150,000 for the purpose of funding general operating expenses for Sistema de Acesso Veicular Ltda. Net cash used in financing activities of $7.4 million during 2023 included a payment of $9.0 million related to STRATTEC's purchase of the remaining non-controlling interest of STRATTEC POWER ACCESS LLC from WITTE Automotive, the repayment of borrowings under credit facilities of $15.0 million, and $600,000 of dividend payments to non-controlling interests in our subsidiaries. These cash outflows were partially offset by additional borrowings under our credit facilities of $17.0 million and $183,000 received for the exercise of stock options under our stock incentive plan and purchases under our employee stock purchase plan. Net cash used in financing activities of $1.9 million during 2022 included repayments of borrowings under credit facilities of $14.0 million and $1.8 million of dividend payments to non-controlling interests in our subsidiaries, partially offset by borrowings under credit facilities of $13 million and $908,000 received for the exercise of stock options under our stock incentive plan and purchases under our employee stock purchase plan. Cash Requirements Dividends On May 13, 2020, our Board of Directors took action to temporarily suspend payment of our quarterly dividend for the foreseeable future in order to conserve cash as a result of the economic downturn that began with COVID-19. No dividends were paid to shareholders during fiscal 2023 and fiscal 2022. 25 Future Capital Expenditures We anticipate capital expenditures will be approximately $14.0 million in fiscal 2024 in support of requirements for new product programs and the upgrade and replacement of existing equipment. Stock Repurchase Program Our Board of Directors has authorized a stock repurchase program to buy back outstanding shares of our common stock. Shares authorized for buy back under the program totaled 3,839,395 at July 2, 2023. A total of 3,655,322 shares have been repurchased over the life of the program through July 2, 2023, at a cost of approximately $136.4 million. No shares were repurchased during fiscal 2023 or 2022. Additional repurchases may occur from time to time and are expected to continue to be funded by cash flow from operations and current cash balances. At this time, we anticipate minimal or no stock repurchase activity in fiscal year 2024. Other Cash Requirements In connection with the June 30, 2023 sale of our interest in VAST LLC to WITTE Automotive, we will be required to pay nonresident capital gain tax in China. The payment, which will be made during our fiscal 2024, is expected to total approximately $2.2 million. We also have an operating lease for our El Paso, Texas finished goods and service parts distribution warehouse, which has a term in excess of one year. We also have purchase commitments related to zinc and other purchased parts. Refer to required future payments under the lease and purchase commitments in the discussion of Leases under Organization and Summary of Significant Accounting Policies and in the discussion of Commitments and Contingencies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K. Credit Facilities STRATTEC has a $40 million secured revolving credit facility (the “STRATTEC Credit Facility”) with BMO Harris Bank N.A. ADAC-STRATTEC LLC has a $25 million secured revolving credit facility (the “ADAC-STRATTEC Credit Facility”) with BMO Harris Bank N.A., which is guaranteed by STRATTEC. The credit facilities expire on August 1, 2024. Borrowings under either credit facility are secured by our U.S. cash balances, accounts receivable, inventory, and fixed assets located in the U.S. Interest on borrowings under the STRATTEC Credit Facility were at varying rates based, at our option, on LIBOR plus 1.25 percent or the bank’s prime rate through February 22, 2023. Interest on borrowings under the ADAC-STRATTEC Credit Facility were at varying rates based, at our option, on LIBOR plus 1.25 percent or the bank’s prime rate through February 6, 2023. Subsequent to these dates, interest on borrowings under both credit facilities were at varying rates based, at our option, on SOFR plus 1.35 percent or the bank's prime rate. Both credit facilities contain a restrictive financial covenant that requires the applicable borrower to maintain a minimum net worth level. The ADAC-STRATTEC Credit Facility includes an additional restrictive financial covenant that requires the maintenance of a minimum fixed charge coverage ratio. As of July 2, 2023, we were in compliance with all financial covenants required by these credit facilities. There were no outstanding borrowings under the STRATTEC Credit Facility as of July 2, 2023 or July 3, 2022. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $15.4 million and 5.7 percent, respectively, during 2023. The average outstanding borrowings and weighted average interest rate on the STRATTEC Credit Facility loans were approximately $332,000 and 2.0 percent, respectively, during 2022. Outstanding borrowings under the ADAC-STRATTEC Credit Facility totaled $13 million at July 2, 2023 and $11 million at July 3, 2022. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $12.4 million and 5.3 percent, respectively, during 2023. The average outstanding borrowings and weighted average interest rate on the ADAC-STRATTEC Credit Facility loans were approximately $14.2 million and 1.5 percent, respectively, during 2022. We believe that the credit facilities are adequate, along with existing cash flows from operations, to meet our anticipated capital expenditure, working capital, dividend, and operating expenditure requirements. On August 22, 2023, STRATTEC entered into an agreement, which is effective September 6, 2023, with BMO Harris Bank N.A. to renew the term of its current $40 million secured credit facility until August 1, 2026. The two parties are working on a renewal of the $25 million secured credit facility for ADAC-STRATTEC LLC, which is guaranteed by STRATTEC, for completion in fiscal year 2024. Joint Ventures and Majority Owned Subsidiaries Refer to the discussion of Investment in Joint Ventures and Majority Owned Subsidiaries and discussion of Equity Earnings of Joint Ventures included in the Notes to Financial Statements included within this Form 10-K. 26 Critical Accounting Policies We believe the following represents our critical accounting policies: Liability for Uncertain Tax Positions – We are subject to income taxation in many jurisdictions around the world. Significant management judgment is required in the accounting for income tax contingencies because the outcomes are often difficult to determine. We are required to measure and recognize uncertain tax positions that we have taken or expect to take in our income tax returns. The benefit of an uncertain tax position can only be recognized in the financial statements if management concludes that it is more likely than not that the position will be sustained with the tax authorities. For a position that is likely to be sustained, the benefit recognized in the financial statements is measured at the largest amount that is greater than 50 percent likely of being realized. A reserve is established for the difference between a position taken in an income tax return and the amount recognized in the financial statements. The amount of unrecognized benefits, that if recognized, would affect the effective tax rate was $1.1 million at July 2, 2023 and $1.0 million at July 3, 2022. An increase or decrease in our assessment of the recorded amount of unrecognized benefits by 10 percent would result in an increase or decrease in the reported tax provision, before the impact of interest and penalties, of $110,000 at July 2, 2023 and $100,000 at July 3, 2022. Refer to the discussion of Income Taxes included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K. Warranty Reserve – We have a warranty reserve recorded related to our exposure to warranty claims in the event our products fail to perform as expected, and we may be required to participate in the repair costs incurred by our customers for such products. The recorded warranty reserve balance involves judgment and estimates. Our reserve estimate is based on an analysis of historical warranty data as well as current trends and information. Actual warranty costs might differ from estimates due to the level of actual claims varying from our claims experience and estimates and final negotiations and settlements reached with our customers. Therefore, future actual claims experience could result in changes in our estimates of the required reserve. Sensitivity of potential warranty or product recall claims is dependent on the respective customer platform, volumes, production years and product content. We have product recall insurance once a recall claim exceeds $2.5 million with a limit of $30 million. Refer to the discussion of Warranty Reserve under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K. We believe the reserve discussed above is estimated using consistent and appropriate methods. However, changes to the assumptions could materially affect the recorded reserve amount. New Accounting Standards Refer to the discussion of New Accounting Standards under Organization and Summary of Significant Accounting Policies included in the Notes to Financial Statements included as part of Item 8 within this Form 10-K.