LETTER TO THE SHAREHOLDERS

     

2

AUGUST, 2005

     Fellow Shareholders:

     In our last two Annual Report letters to you we wrote about the period of transition we were beginning to experience in our business. Fiscal 2005 was a year in which we encountered many of the symptoms of that transition. Our sales declined $5.3 million to $190.3 million, a 2.7% decline compared to last year. Net income for the year declined $2.2 million to $15 million, a 13.0% drop compared to last year. Despite the decline in net income, we generated $11.2 million in Economic Value Added, a figure which matches our second best year.

     This year’s financial results reflect a number of factors affecting our traditional lock products, including significant pricing pressures, a decline in the market share enjoyed by both we and our customers, and a drop in demand for light truck products due to fuel economy concerns. The light truck segment of the market is where we have had our greatest market share, so declining sales of these products has an adverse affect on us as our customers curtail production of these vehicles to balance their retail inventories. Increased sales of technology keys, particularly integrated keys, and sales to new ignition lock housing customers partially offset the declines affecting our traditional lock products. I am particularly pleased to report that our housing product line continues to develop nicely, with good customer acceptance and growth opportunities.

     Net income was affected in part by rising raw materials costs and declining production resulting from most of the factors affecting net sales. This year’s fourth quarter was also affected by some unusually high premium freight and overtime charges related to capacity issues with two customer-directed component suppliers. We expect to be reimbursed for a significant portion of these capacity related costs. We also recorded a one-time lump sum bonus paid to our represented hourly workers in Milwaukee resulting from a new 3-year labor contract ratified June 27th. The provisions of this new contract strike a good balance between fairness to our represented work force, and an operating structure that helps keep the Milwaukee manufacturing facility an economically viable operation. For more details on our fiscal 2005 performance, I recommend you read the “Management’s Discussion and Analysis” and “Financial Statements” sections of this report.

     Shortly after the close of our fiscal 2005, we entered into a successor Agreement with our Alliance partner, WITTE-Velbert GmbH. Although the formal signing of the successor Agreement took place in July of this year, the discussions with WITTE that brought us to a new agreement took place throughout fiscal 2005, and represent an important strategic development. The new Agreement builds upon our mutual experience over the five years since we signed our original Alliance Agreement in 2000. I believe it will enhance the overall effectiveness of this significant relationship.

     The structure of the Alliance, and the associated WITTE-STRATTEC LLC through which we have operations with local partners in Brazil and China, truly puts us in a position to operate globally. We and our partners are right where we want to be to take advantage of globally-sourced customer programs. We are currently jointly quoting a collection of

LETTER TO THE SHAREHOLDERS

     

3

components for a vehicle program that will be built in Europe, North America and China. This component collection includes locksets, ignition lock housings, rear compartment latches, hood latches, seat latches (sold to a Tier 1 seat manufacturer) and door handles. Clearly, if it were not for our Alliance, we would not be in a position to support such a global program, nor protect the potential STRATTEC North American content. Further, our new Alliance Agreement provides flexibility to consider additional creative ways to work together or in concert with other companies to provide a full spectrum of products and support to global customers.

     The global program we are quoting with WITTE also reflects the product line of rear compartment latches, seat latches and side door latches for passive entry that we at STRATTEC are developing to augment our traditional lock business and lock housing business in North America. The challenge is for us to make this product line transition smoothly, given the current pressures on our traditional products and the long lead times that are typical of new automotive product programs. Mindful of that challenge, we have been considering ways to “jump start” our new product offerings, including strategic partnering or acquisition. With our solid balance sheet and positive cash flow we are in a good position to not only take one or both of these initiatives, but do so in a selective manner to enhance the long-term future for the company and its product offerings.

     It is no secret that the whole automotive industry is in the midst of great change. The traditional North American manufacturers have seen their influence and their fortunes wane. To some extent, this is true of the traditional larger European manufacturers as well. Asian-based manufacturers, particularly the Japanese, have become the standard by which the rest of the industry is judged, and they are rapidly becoming the new global leaders. As I have reported to you in previous years, we are moving to reduce our dependence on our traditional customers as part of our own transition initiatives. While I would like to report significant progress in this regard, the process of becoming a supplier to a Japanese OEM is a years-long endeavor. We have not yet reached a point of complete acceptance by these OEMs, but we are making progress. We will continue placing resources on this effort, as I believe it is as important to the company’s future as our transitioning product line.

     As depicted in this year’s Report cover, 2005 was a milestone year for us as we completed our tenth year as an independent company on February 27th. Many of you reading this report have been long-term holders of STRATTEC SECURITY CORPORATION common stock. Some of you have been with us since 1995. To all of you, thank you for your support of this company. All of us at STRATTEC sincerely appreciate and value that support as we transition our business for a strong long-term future.

Sincerely,

Harold M. Stratton II
Chairman, President and Chief Executive Officer

FINANCIAL HIGHLIGHTS

(IN MILLIONS)

     

4

		2005				2004				2003
Net Sales		$	190.3			$	195.6			$	196.8
Gross Profit			42.7				47.5				45.4
Income from Operations			22.0				26.9				25.7
Net Income			15.0				17.3				16.4
Total Assets			138.1				137.2				118.1
Total Debt			—				—				—
Shareholders’ Equity			91.8				89.9				69.1

ECONOMIC VALUE ADDED (EVA^®)

     All U.S. associates, and many of our Mexico-based salaried associates, participate in incentive plans that are based upon our ability to add economic value to the enterprise. During 2005, $11.2 million of positive economic value was generated, a decrease of $1.8 million compared to the economic value the business generated in 2004 but equal to our second best year. We continue to believe that EVA^® represents STRATTEC’s ultimate measure of success and shareholder value.

Net Operating Profit After Cash-Basis Taxes						$	16.5
Average Net Capital Employed		$	47.9
Capital Cost			11	%
							5.3
Economic Value Added						$	11.2

     EVA^® is not a traditional financial measurement under U.S. GAAP and may not be similar to EVA^® calculations used by other companies. However, STRATTEC believes the reporting of EVA^® provides investors with greater visibility of economic profit. The following is a reconciliation of the relevant GAAP financial measures to the non-GAAP measures used in the calculation of STRATTEC’s EVA^®.

Net Operating Profit After Cash-Basis Taxes:

2005 Net Income as Reported		$	15.0
Deferred Tax Provision			2.3
Other			(.8	)
Net Operating Profit After Cash-Basis Taxes		$	16.5

Average Monthly Net Capital Employed:

Total Shareholders’ Equity as Reported at July 3, 2005		$	91.8
Current Interest Bearing Assets			(60.3	)
Long-Term Liabilities			16.3
Other			(1.8	)
Net Capital Employed at July 3, 2005			46.0
Impact of 12 Month Average			1.9
Average Monthly Net Capital Employed		$	47.9

EVA is a registered trademark of Stern, Stewart & Co.

COMPANY DESCRIPTION

     

5

BASIC BUSINESS

     STRATTEC SECURITY CORPORATION designs, develops, manufactures and markets mechanical locks, electro-mechanical locks, latches and related security/access control products for major North American and global automotive manufacturers. We also supply keys and lock repair components to the aftermarket through our Distributor network and through relationships with organizations supporting the dealerships and retail (hardware) channels. Through our alliance with WITTE-Velbert GmbH in Germany, both companies’ security/access control products are manufactured and marketed globally.

HISTORY

STRATTEC formerly was a division of Briggs & Stratton Corporation. In 1995, STRATTEC was spun off from Briggs & Stratton through a tax-free distribution to the then-existing Briggs & Stratton shareholders and has been an independent public company for ten years.      Our history in the automotive security business spans nearly 90 years. STRATTEC has been the world’s largest producer of automotive locks and keys since the late 1920s, and we currently maintain a dominant share of the North American markets for these products. PRODUCTS      Our traditional products are locks and keys for cars and light trucks. A typical new car uses a set of two to three locks. A typical 3-way lockset contains a steering column/ignition lock, a driver’s door lock and a rear compartment (trunk, hatch or liftgate) lock. Pickup trucks also use two to three locks, while sport utility

vehicles and vans use three to five locks. Some vehicles have additional locks for consoles, storage compartments or folding rear seats. Pick-up truck tailgate locks, spare tire locks and burglar alarm locks are offered as options. Usually, two keys are provided with each vehicle lockset. Most of the vehicles we currently supply are using keys with sophisticated radio frequency identification technology for theft prevention. However, keys with remote entry devices integrated into a single unit have been added to our product line.

     A relatively new and growing product line for us is ignition lock housings. These housings are the mating part for our ignition locks and typically are part of the steering column structure, although there are instrument-panel-mounted versions for certain vehicle applications. These housings are zinc or magnesium die castings and can include electronic components for theft deterrent systems.

     We are also developing business for additional access control products, including trunk latches, liftgate latches, tailgate latches, hood latches, side door latches and related hardware for this product category.

MARKETS

     We are a direct supplier to OEM auto and light truck manufacturers as well as other transportation-related manufacturers. For the 2005 model year, our lock and key products enjoyed a 53% market share in the North American automotive industry, supplying over

COMPANY DESCRIPTION

     

6

68% of General Motors’ production, over 70% of Ford’s, 97% of DaimlerChrysler’s and 100% of Mitsubishi’s production. Our growing ignition lock housing business captured an estimated 23% share in 2005. Our housings and OEM components are also sold to other “Tier 1” automotive suppliers and industrial manufacturers.

		Direct sales to various OEMs represent approximately 82% of total sales. The remainder of the company’s revenue is received primarily through sales to the OEM service channels, and the aftermarket.      Sales to our major automotive customers, both OEM and Tier 1, are coordinated through direct sales personnel located in our Detroit-area office. Sales are also facilitated through daily interaction between our application engineers located in Detroit and customer engineering departments. Sales to other OEM customers are accomplished through a combination of our own sales personnel and manufacturer representative agencies. STRATTEC’s products are supported by an extensive staff of experienced lock, housing and

latch engineers. This staff, which includes product design, quality and manufacturing engineers, is capable of providing complete design, development and testing services of new products for our customers. This staff also is available for customer problem solving, warranty analysis, and other activities that arise during a product’s life cycle. Our customers receive after-sales support in the form of special field service kits, service manuals, and specific in-plant production repair programs.

The majority of our OEM products are sold in North America. While a modest amount of exporting is done to automotive assembly plants in Europe and South America, we are in the process of expanding our presence in these markets and elsewhere through our alliance with WITTE-Velbert GmbH, which is described in more detail on page 8.      OEM service and replacement parts are sold to the OEM’s own service operations. In addition, we distribute our components and security products to the automotive aftermarket through approximately 50 authorized wholesale distributors, as well as other marketers and users of component parts, including export customers. Increasingly, our products find their way into the retail channel, specifically the hardware store channel. Our ability to provide a full line of keys to that channel has been accomplished through the introduction of the STRATTEC “XL” key line. This extension to our line includes keys that we currently do not supply on an OE basis, including keys for Toyota, Honda and other popular domestic and import vehicles. This extended line of keys is augmented by a variety of diagnostic programming tools. Together, the

diagnostic tools and our full line of keys enable automotive repair specialists to satisfy consumer needs for repair or replacement parts. These aftermarket activities are serviced through a warehousing operation integral to our Milwaukee headquarters and manufacturing facility.

COMPANY DESCRIPTION

     

7

CUSTOMER FOCUS

     To bring the proper focus to the relationships with our major customers, we have six customer-focused teams, each with a Customer Business Manager and one or two Engineering Program Managers. In addition to customer teams for General Motors, Ford and DaimlerChrysler/Mitsubishi, we have teams for Foreign-Owned North American Vehicle Manufacturers, Ignition Lock Housing customers, and for Service and Aftermarket customers.

		Each Customer Business Manager is responsible for the overall relationship between STRATTEC and a specific customer group. Engineering Program Managers report to their respective team Customer Business Manager and are responsible for coordinating engineering resources and managing new product programs for their customers. Customer Business Managers and Engineering Program Managers interface with our Detroit-based sales and application engineering personnel, who are also assigned to specific customer groups.

To serve our customers’ product needs, STRATTEC’s engineering resources are organized by product type. We have four product groups: Locks and Keys, Latches, Ignition Lock Housings and Electrical. Each group has an Engineering Manager and a complement of skilled engineers who design and develop products for specific applications. In doing this, each engineering group works closely with the Customer Business Managers, team Engineering Program Managers, sales personnel and application engineers.

     Underlying this organization is a formalized product development process to identify and meet customer needs in the shortest possible time. By following this streamlined development system, we shorten product lead times, tighten our response to market changes and provide our customers with the optimum value solution to their security/access control requirements. STRATTEC is also QS9000, ISO/TS 16949 and ISO 14001 certified. This means we embrace the philosophy that quality should exist not only in the finished product, but in every step of our processes as well.

		OPERATIONS      A significant number of the components that go into our products are manufactured at our main facility and headquarters in Milwaukee, Wisconsin. This facility produces zinc die cast components, stampings and key blanks. Key finishing takes place at

COMPANY DESCRIPTION

     

8

STRATTEC Componentes Automotrices in Juarez, Mexico along with some limited assembly activities. The majority of our assembly operations take place at STRATTEC de Mexico, also located in Juarez. Warehousing and distribution of service and aftermarket product is accomplished at the Milwaukee facility.

ADVANCED DEVELOPMENT

     Research and development activities are centered around a dedicated research engineering staff we call our Advanced Development Group. This group has the responsibility for developing future products and processes that will keep us in the forefront of the markets we serve. Projects we are pursuing focus on electronic and mechanical access control products, modularization of related access/security control components and new manufacturing processes to reduce costs for ourselves and our customers.

ALLIANCE

     In fiscal 2001, we entered into a formal alliance with WITTE-Velbert GmbH, a designer developer, manufacturer and marketer of automotive access control products for European-based customers. We recently renewed this important relationship with the signing of a successor Alliance agreement.

     Our alliance with WITTE consists of two main initiatives. The first is a set of cross-licensing agreements which allows STRATTEC to manufacture, market and sell WITTE products in North America, and allows WITTE to manufacture, market and sell STRATTEC products in Europe. In this way, both STRATTEC and WITTE have established international reach for their respective products and services, while capturing a financial benefit for those products sold outside of our respective home markets through a defined royalty structure.

     The second initiative is a 50-50 joint venture company, WITTE-STRATTEC LLC, which is the legal entity through which we and WITTE are pursuing emerging markets outside of Europe and North America. Our LLC has established joint ventures with local partners in China and Brazil. This Alliance Structure positions STRATTEC and our partner to take

COMPANY DESCRIPTION

     

9

advantage of emerging global supply opportunities. Additionally, the two companies jointly own intellectual property rights for any products resulting from the coordinated activities of our respective research and development resources.

CYCLICAL NATURE OF THE BUSINESS

     The manufacturing of components used in automobiles is driven by the normal peaks and valleys associated with the automotive industry. Typically, the months of July and August are relatively slow as summer vacation shutdowns and model year changeover occur at the automotive assembly plants. September volumes increase rapidly as the new model year begins. This volume strength continues through October and into early November. As the holiday and winter seasons approach, the demand for automobiles slows as does production. March usually brings a major sales and production increase, which then continues through most of June. This results in our first fiscal quarter (ending in September) sales and operating results typically being our weakest, with the remaining quarters being more consistent.

GLOBAL PARTNERS

ECONOMIC VALUE COMMITMENT

     The underlying philosophy of our business, and the means by which we measure our performance, is Economic Value Added (EVA^®). Simply stated, economic value is created when our business enterprise yields a return greater than the cost of capital we and our shareholders have invested in STRATTEC. The amount by which our return exceeds the cost of our capital is EVA^®. In line with this philosophy, EVA^® bonus plans are in effect for all our U.S. associates, outside directors and many of our Mexico-based salaried associates as an incentive to help positively drive the business.

     STRATTEC’s significant market presence is the result of a nine-decade-long commitment to creating quality products and systems that are responsive to changing needs. As technologies advance and markets grow, STRATTEC retains that commitment to meeting and exceeding the expectations of our customers, and providing economic value to our shareholders.

VEHICLE LIST

     

10

2006 VEHICLES      We are proud to be associated with many of the quality vehicles produced in North America. The following model year 2006 cars and light trucks are equipped with STRATTEC products.

CARS

Buick Allure		Chrysler Pacifica		Ford Mustang
(Canadian only vehicles)		Chrysler PT Cruiser		Ford Taurus
Buick LaCrosse		Chrysler Sebring		Lincoln LS
Buick Lucerne		Dodge Magnum		Lincoln Town Car
Cadillac XLR		Dodge Stratus		Mercury Grand Marquis
Cadillac DTS		Dodge Viper		Mercury Montego
Chevrolet Corvette		Ford Five Hundred		Mitsubishi Eclipse/
Chevrolet Impala		Ford Crown Victoria		Eclipse Spyder
Chevrolet Monte Carlo		Ford Freestyle		Mitsubishi Galant
Chrysler 300/300C		Ford GT		Saturn Ion

LIGHT TRUCKS, VANS AND SPORT UTILITY VEHICLES

Buick Rainier		Dodge Dakota Pickup		Hummer H2
Buick Rendezvous		Dodge Durango		Isuzu Ascender
Buick Terraza		Dodge Ram Pickup		Jeep Commander
Cadillac Escalade		Ford Expedition		Jeep Grand Cherokee
Cadillac Escalade ESV		Ford Explorer		Jeep Liberty
Cadillac Escalade EXT		Ford Explorer Sport Trac		Jeep Wrangler/Wrangler
Chevrolet Avalanche		Ford F-Series Pickup		Unlimited
Chevrolet Express Van		Ford F-Series Supercrew		Lincoln Mark LT Pickup
Chevrolet Silverado Pickup		Ford F-Series Super Duty		Lincoln Navigator
Chevrolet SSR		Ford Heritage F-Series		Mazda B-Series Pickup
Chevrolet Suburban		Ford Ranger Pickup		Mercury Mountaineer
Chevrolet Tahoe		GMC Envoy/Envoy XL		Mitsubishi Endeavor
Chevrolet		GMC Envoy XUV		Mitsubishi Raider
Trailblazer/Trailblazer EXT		GMC Savana		Nissan Titan
Chevrolet Uplander		GMC Sierra Pickup		Pontiac Montana
Chrysler Town & Country		GMC Yukon		Saturn Relay
Dodge Caravan/Grand Caravan		GMC Yukon XL

MANAGEMENT’S DISCUSSION AND ANALYSIS

     

11

     The following Discussion and Analysis should be read in conjunction with the Company’s Financial Statements and Notes thereto. Unless otherwise indicated, all references to years refer to fiscal years.

RESULTS OF OPERATIONS

     Net sales were $190.3 million in 2005 compared to $195.6 million in 2004. The current year included one additional shipping week, which increased sales by approximately $2.9 million. Sales to the Company’s largest customers overall declined in the current year as compared to the prior year. Sales to DaimlerChrysler Corporation increased to $51.5 million in 2005 from $42.0 million in 2004. The sales increase was primarily the result of content changes on existing products the Company supplies. Sales to General Motors Corporation, Delphi Corporation, Ford Motor Company and Mitsubishi Motor Manufacturing of America, Inc. decreased in 2005 compared to 2004. Sales to General Motors decreased to $43.2 million from $52.2 million, Delphi sales decreased to $29.6 million from $30.2 million, Ford sales decreased to $32.0 million from $34.7 million and Mitsubishi sales decreased to $4.5 million from $7.0 million. The decrease in sales to these customers was primarily the result of lower customer vehicle production on vehicles the Company supplies, and to a lesser degree, discontinued models and pre-programmed price decreases. As discussed in the 2004 Annual Report, Mitsubishi informed the Company that due primarily to economic pressures impacting Mitsubishi they intend to consolidate the purchase of their lockset requirements with their Japanese supplier for the 2007 model year. This will effectively end the Company’s supply of production requirements to Mitsubishi by the start of its 2007 fiscal year. Mitsubishi represented approximately 2.4 percent of the Company’s fiscal 2005 sales. Sales to Auto Alliance International, Ford Motor Company’s joint venture assembly plant with Mazda, were $2.2 million in the current year and represents new lockset content related to the Ford Mustang. Decreased aftermarket sales of approximately $2.2 million also contributed to the overall reduction in sales.

     Gross profit as a percentage of net sales was 22.4 percent in 2005 compared to 24.3 percent in 2004. The lower gross margin in the current year was primarily the result of lower production volumes, which resulted from lower customer vehicle production on vehicles the Company supplies as discussed above, changes in customer product content with lower margins and higher purchased material costs for brass, zinc and magnesium. A lump sum bonus of approximately $217,000 paid to the Company’s Milwaukee represented hourly workers resulting from a new three-year labor contract ratified June 27, 2005 and $580,000 of premium freight and overtime charges related to capacity issues with two customer directed component suppliers also reduced the current year margin. The average per pound price of brass increased to $1.94 in 2005 from $1.63 in 2004. The average per pound price of zinc increased to $.54 in 2005 from $.46 in 2004. The Company uses an average of approximately 170,000 pounds per month of brass and approximately 770,000 pounds per month of zinc. Increased magnesium costs resulted in increased purchased component costs of approximately $420,000 in 2005.

     The Company is required under Statement of Financial Accounting Standard (SFAS) 123(R) to recognize stock-based compensation expense in its financial statements beginning in fiscal 2006. The adoption of SFAS 123(R)’s fair value method will have an impact on the Company’s results of operations, although it will not have an impact on the overall financial position. The impact of the adoption of SFAS 123(R) will depend on levels of share-based

MANAGEMENT’S DISCUSSION AND ANALYSIS

     

12

payments granted in the future and is expected to reduce pre-tax earning by approximately $1.1 million in fiscal 2006.

     Engineering, selling and administrative expenses were $20.7 million in 2005, compared to $20.6 million in 2004. Increases in payroll related costs resulting from the August 2004 human resources realignment, which shifted resources to the engineering and sales areas to support new product development and aftermarket sales, were mostly offset by reduced costs for bonuses to be paid to eligible associates.

     Income from operations was $22.0 million in 2005, compared to $26.9 million in 2004, reflecting the decreased sales and profitability as discussed above.

     The effective income tax rate was 36.0 percent in 2005 compared to 37.5 percent in 2004. The current year income tax provision includes a state refund claim recovery. The claim recovery, net of the federal income tax impact, was $162,000. The overall effective tax rate differs from the federal statutory tax rate primarily due to the effects of state income taxes.

RESULTS OF OPERATIONS

     Net sales were $195.6 million in 2004 compared to $196.8 million in 2003. Sales to DaimlerChrysler Corporation and Delphi Corporation increased in 2004 compared to 2003 with DaimlerChrysler at $42.0 million compared to $34.6 million and Delphi at $30.2 million compared to $28.9 million. The sales increase to DaimlerChrysler Corporation was primarily the result of content changes on existing products. The sales increase to Delphi Corporation was primarily the result of sales for new product programs, which were partially off-set by lower customer vehicle production on vehicles the Company supplied, discontinued models and pre-programmed price reductions. Sales to General Motors Corporation, Ford Motor Company and Mitsubishi Motor Manufacturing of America, Inc. decreased in 2004 compared to 2003 with General Motors at $52.2 million compared to $61.0 million, Ford at $34.7 million compared to $39.3 million and Mitsubishi at $7.0 million compared to $9.4 million. The decrease in sales to these customers was primarily the result of lower customer vehicle production, and to a lesser degree, discontinued models and pre-programmed price decreases. Increased aftermarket sales substantially offset the overall reduction in sales to the Company’s largest customers.

     Continuing a trend experienced during 2002 and 2003, the Company’s sales to Mitsubishi Motor Manufacturing of America, Inc. declined $2.4 million in 2004 due to their reduced production volumes. On July 22, 2004 Mitsubishi publicly announced the discontinuation of second shift operations at their Normal, Illinois assembly plant by October 2004, thereby further reducing their production volumes to approximately 140,000 vehicles annually in North America. This will result in reduced Company sales to Mitsubishi in future fiscal years. In addition, due primarily to the economic pressures affecting Mitsubishi, they informed the Company that they intend to consolidate the purchase of their lockset requirements with their Japanese supplier for the 2007 model year. This will effectively end the Company’s supply of production requirements to Mitsubishi by the start of its 2007 fiscal year. Mitsubishi represented approximately 3.5 percent of the Company’s fiscal 2004 sales.

     Gross profit as a percentage of net sales was 24.3 percent in 2004 compared to 23.0 percent in 2003. The gross margin improvement was attributed primarily to the Company’s on-going manufacturing process improvement initiatives, a more positive sales mix, and a favorable Mexican peso to U.S. dollar exchange rate. The inflation rate in Mexico for the 12 months ended June 2004 was approximately 4 percent while the U.S. dollar/Mexican peso

MANAGEMENT’S DISCUSSION AND ANALYSIS

     

13

exchange rate increased to approximately 11.15 pesos to the dollar in 2004 from approximately 10.35 pesos to the dollar in 2003. These favorable items were partially offset by higher purchased raw material costs for brass and zinc.

     Engineering, selling and administrative expenses were $20.6 million or 10.5 percent of net sales in 2004, compared to $19.6 million or 10.0 percent of net sales in 2003. The increase was primarily the result of the April 2003 human resources realignment in which resources were shifted to the engineering area to support new product development.

     Income from operations was $26.9 million in 2004, compared to $25.7 million in 2003, reflecting the increased profitability as discussed above.

     The effective income tax rate was 37.5 percent in 2004 compared to 37.0 percent in 2003. The overall effective tax rate differs from the federal statutory tax rate primarily due to the effects of state income taxes.

LIQUIDITY AND CAPITAL RESOURCES

     The Company generated cash from operating activities of $15.8 million in 2005 compared to $29.4 million in 2004. The decreased generation of cash between periods of $13.6 million is the result of a reduction of $2.2 million in net income and changes in accounts payable and accrued liabilities, accounts receivable and inventory levels.

     Accounts payable and accrued liabilities decreased $12.6 million in the current year while increasing $954,000 in the prior year and was impacted by accounts payable balances, bonus accruals, income tax balances and contributions to the Company’s qualified pension fund. Accounts payable decreased $1.6 million in the current year compared to an increase of $4.8 million in the prior year. The current year decrease is based on the timing of purchases from suppliers and normal payment terms. The prior year increase was due to lengthening payment terms with a significant supplier as well as the timing of payments in accordance with normal payment terms. The bonus accrual, which is based on financial results and is payable to all eligible associates, decreased $3.2 million in 2005. The 2004 bonus accrual was consistent with the 2003 bonus accrual. In 2005 the income tax payable balance decreased $963,000 compared to an increase of the same amount in 2004. The changes in the income tax balances are based on the amount and timing of estimated federal and state income tax payments. In 2005 there was an $8.0 million contribution to the Company’s qualified pension fund, compared to a $7.0 million contribution in 2004.

     Accounts receivable balances decreased $4.9 million in 2005 and $122,000 in 2004. The current year decrease is primarily the result of the normal timing of the scheduled July 2005 payment from two major customers. These payments were received in fiscal 2005 and reduced the July 3, 2005 receivables balance. The July 2004 payments from these customers were not received in fiscal 2004. The LIFO inventory balance increased $3.3 million in 2005 and $477,000 in 2004. The increased inventory at July 3, 2005 is primarily due to the build-up of inventory banks in preparation of a potential strike by the Company’s unionized associates at the Milwaukee facility. The contract with the unionized associates expired June 26, 2005. A new contract was ratified and is effective through June 29, 2008.

     Capital expenditures were $5.5 million in both 2005 and 2004. Expenditures were primarily in support of requirements for new product programs and the upgrade and replacement of existing equipment. The Company anticipates that capital expenditures will be approximately $7 million in fiscal 2006, primarily in support of requirements for new product programs and the upgrade and replacement of existing equipment.

     The Board of Directors of the Company has authorized a stock repurchase program to

MANAGEMENT’S DISCUSSION AND ANALYSIS

     

14

buy back up to 3,439,395 outstanding shares. Over the life of the repurchase program through July 3, 2005, a total of 3,127,492 shares have been repurchased at a cost of approximately $116.7 million. Additional repurchases may occur from time to time. Funding for the repurchases was provided by cash flow from operations.

     The Company has a $50.0 million unsecured line of credit (the “Line of Credit”), which expires October 31, 2005. There were no outstanding borrowings under the Line of Credit at July 3, 2005 or at June 27, 2004. Interest on borrowings under the Line of Credit are at varying rates based, at the Company’s option, on the London Interbank Offering Rate or the bank’s prime rate. The Line of Credit contains various restrictive non-financial covenants. The Company believes that the Line of Credit is adequate, along with cash flow from operations, to meet its anticipated capital expenditure, working capital and operating expenditure requirements.

     The Company has not been significantly impacted by inflationary pressures over the last several years, except for rising health care costs which have increased the Company’s cost of employee medical coverage, fluctuations in the market price of zinc, brass, aluminum and magnesium, and inflation in Mexico, which impacts the U.S. dollar costs of the Mexican operations. The Company does not hedge the peso exposure.

CONTRACTUAL OBLIGATIONS

The contractual obligations of the Company are as follows as of July 3, 2005 (thousands of dollars):

		Payments Due By Period
						Less Than												More Than
Contractual Obligation		Total				1 Year				1-3 Years				3-5 Years				5 Years
Operating Leases		$	1,903			$	595			$	1,037			$	271			$	—
Purchase Obligations			1,251				1,251				—				—				—
Pension and Postretirement Obligations (a)			6,589				6,589				—				—				—
Total		$	9,743			$	8,435			$	1,037			$	271			$	—

(a) As disclosed in Notes to Financial Statements, estimated cash funding related to the Company’s pension and postretirement benefit plans totals $6.6 million in 2006. Because the timing of funding related to these plans beyond 2006 is uncertain, and is dependent on future movements in interest rates and investment returns, changes in laws and regulations, and other variables, pension and postretirement outflows beyond 2006 have not been included in the table above.

JOINT VENTURES

     On November 28, 2000, the Company signed certain alliance agreements with E. WITTE Verwaltungsgesellschaft GmbH, and its operating unit, WITTE-Velbert GmbH & Co. KG (“WITTE”). WITTE, of Velbert, Germany, is a privately held, ISO/TS 16949 and VDA 6.1 certified automotive supplier. WITTE designs, manufactures and markets components including locks and keys, hood latches, rear compartment latches, seat back latches, door handles and specialty fasteners. WITTE’s primary market for these products has been Europe. The WITTE-STRATTEC alliance provides a set of cross-licensing agreements for the manufacture, distribution and sale of WITTE products by the Company in North America, and the manufacture, distribution and sale of the Company’s products by WITTE in Europe. Additionally, a joint venture company (“WITTE-STRATTEC LLC”) — in which each company holds a 50 percent interest — has been established to seek opportunities to manufacture and sell both companies’ products in areas of the world outside of North America and Europe.

     In November 2001, WITTE-STRATTEC do Brasil, a joint venture formed between WITTE-

MANAGEMENT’S DISCUSSION AND ANALYSIS

     

15

STRATTEC LLC and Ifer Estamparia e Ferramentaria Ltda. was formed to service customers in South America. On March 1, 2002, WITTE-STRATTEC China was formed and in April 2004, WITTE-STRATTEC Great Shanghai Co. was formed. WITTE-STRATTEC China and WITTE-STRATTEC Great Shanghai Co. are joint ventures between WITTE-STRATTEC LLC and a unit of Elitech Technology Co. Ltd. of Taiwan and are the base of operations to service the Company’s automotive customers in the Asian market.

     The investments are accounted for using the equity method of accounting. The activities related to the joint ventures resulted in a loss of approximately $70,000 in 2005 and a gain of approximately $72,000 in 2004. A capital contribution of $125,000 was made to the joint ventures in both 2005 and 2004 primarily in support of general operating expenses.

CRITICAL ACCOUNTING POLICIES

The Company believes the following represent its critical accounting policies:

     Pension and Postretirement Health Benefits — The determination of the obligation and expense for pension and postretirement health benefits is dependent on the selection of certain assumptions used by actuaries in calculating such amounts. Those assumptions are described in the Notes to Financial Statements and include, among others, the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation and health care costs. In accordance with United States generally accepted accounting principles, actual results that differ from these assumptions are accumulated and amortized over future periods. While the Company believes that the assumptions used are appropriate, significant differences in the actual experience or significant changes in the assumptions may materially affect the pension and postretirement health obligations and future expense.

     Other Reserves — The Company has reserves such as an environmental reserve, an incurred but not reported claim reserve for self-insured health plans, a worker’s compensation reserve, and a repair and maintenance supply parts reserve. These reserves require the use of estimates and judgment with regard to risk exposure, ultimate liability and net realizable value. The Company believes such reserves are estimated using consistent and appropriate methods. However, changes to the assumptions could materially affect the recorded reserves.

RISK FACTORS

     The Company understands it is subject to the following risk factors based on its operations and the nature of the automotive industry in which it operates:

     Loss of Significant Customers, Vehicle Content and Market Share — Sales to General Motors Corporation, Ford Motor Company, DaimlerChrysler Corporation and Delphi Corporation represent approximately 82 percent of the Company’s annual sales. The contracts with these customers provide for supplying the customer’s requirements for a particular model. The contracts do not specify a specific quantity of parts. The contracts typically cover the life of a model, which averages approximately four to five years. Certain customer models may also be market tested annually. Therefore, the loss of any one of these customers, the loss of a contract for a specific vehicle model, reduction in vehicle content, technological changes or a significant reduction in demand for certain key models could have a material adverse effect on the Company’s existing and future revenues and net income.

     The Company’s major customers also have significant under funded legacy liabilities related to pension and postretirement health care obligations. The future impact of these items — along with a continuing decline in their North American automotive market share to the New Domestic Automotive Manufacturers (primarily the Japanese Automotive Manufacturers) — may have a significant impact on the Company’s future sales and collectibility risks.

     Cost Reduction — There is continuing pressure from the Company’s major customers to reduce the prices the Company charges for its products. This requires the Company to

MANAGEMENT’S DISCUSSION AND ANALYSIS

     

16

generate cost reductions, including reductions in the cost of components purchased from outside suppliers. If the Company is unable to generate sufficient production cost savings in the future to offset programmed price reductions, the Company’s gross margin and profitability will be adversely affected.

     Cyclicality and Seasonality in the Automotive Market — The automotive market is highly cyclical and is dependent on consumer spending and to a certain extent on customer sales incentives. Economic factors adversely affecting consumer demand for automobiles and automotive production could adversely impact the Company’s revenues and net income. The Company typically experiences decreased revenue and operating income during the first fiscal quarter of each year due to the impact of scheduled customer plant shut-downs in July and new model changeovers.

     Foreign Operations — As discussed under Joint Ventures, the Company has joint venture investments in both Brazil and China. These operations are currently not material. However, as these operations expand, their success will depend, in part, on the Company’s and its partners’ ability to anticipate and effectively manage certain risks inherent in international operations including: enforcing agreements and collecting receivables through certain foreign legal systems, payment cycles of foreign customers, compliance with foreign tax laws, general economic and political conditions in these countries, and compliance with foreign laws and regulations.

     Currency Exchange Rate Fluctuations — The Company incurs a portion of its expenses in Mexican pesos. Exchange rate fluctuations between the U.S. dollar and the Mexican peso could have an adverse effect on financial results.

     Sources of and Fluctuations in Market Prices of Raw Materials — The primary raw materials used by the Company are high-grade zinc, brass, magnesium, aluminum, steel and plastic resins. These materials are generally available from a number of suppliers, but the Company has chosen to concentrate its sourcing with one primary vendor for each commodity or purchased component. The Company believes its sources of raw materials are reliable and adequate for its needs. However, the development of future sourcing issues related to the availability of these materials as well as significant fluctuations in the market prices of these materials may have an adverse affect on the Company’s financial results.

     Disruptions Due to Work Stoppages and Other Labor Matters — The Company’s major customers and many of their suppliers have unionized work forces. Work stoppages or slow-downs experienced by the Company’s customers or their suppliers could result in slow-downs or closures of assembly plants where the Company’s products are included in assembled vehicles. For example, strikes by the United Auto Workers led to a shut-down of most of General Motors Corporation’s North American assembly plants in June and July of 1998. A material work stoppage experienced by one or more of the Company’s customers could have an adverse effect on the Company’s business and its financial results. In addition, all production associates at the Company’s Milwaukee facility are unionized. A sixteen-day strike by these associates in June 2001 resulted in increased costs by the Company as all salaried associates worked with additional outside resources to produce the components necessary to meet customer requirements. The current contract with the unionized associates is effective through June 29, 2008. The Company may encounter further labor disruption after the expiration date of this contract and may also encounter unionization efforts in its other plants or other types of labor conflicts, any of which could have an adverse effect on the Company’s business and its financial results.

     Environmental and Safety Regulations — The Company is subject to federal, state, local and foreign laws and other legal requirements related to the generation, storage, transport, treatment and disposal of materials as a result of its manufacturing and assembly operations. These laws include the Resource Conservation and Recovery Act (as amended), the Clean Air Act (as amended) and the Comprehensive Environmental Response, Compensation and Liability Act (as amended). The Company has an environmental management system that is

MANAGEMENT’S DISCUSSION AND ANALYSIS

     

17

ISO-14001 certified. The Company believes that its existing environmental management system is adequate and it has no current plans for substantial capital expenditures in the environmental area. An environmental reserve was established in 1995 for estimated costs to remediate a site at the Company’s Milwaukee facility. The site was contaminated by a former above-ground solvent storage tank, located on the east side of the facility. The contamination occurred in 1985. This is being monitored in accordance with federal, state and local requirements. The Company does not currently anticipate any material adverse impact on its results of operations, financial condition or competitive position as a result of compliance with federal, state, local and foreign environmental laws or other legal requirements. However, risk of environmental liability and changes associated with maintaining compliance with environmental laws is inherent in the nature of the Company’s business and there is no assurance that material liabilities or changes could not arise.

     Highly Competitive Automotive Supply Industry — The automotive component supply industry is highly competitive. Some of the Company’s competitors are companies, or divisions or subsidiaries of companies, that are larger than the Company and have greater financial and technology capabilities. The Company’s products may not be able to compete successfully with the products of these other companies, which could result in loss of customers and, as a result, decreased revenues and profitability. In addition, the Company’s competitive position in the North American automotive component supply industry could be adversely affected in the event that it is unsuccessful in making strategic acquisitions, alliances or establishing joint ventures that would enable it to expand globally. The Company principally competes for new business at the beginning of the development of new models and upon the redesign of existing models by its major customers. New model development generally begins two to five years prior to the marketing of such new models to the public. The failure to obtain new business on new models or to retain or increase business on redesigned existing models could adversely affect the Company’s business and financial results. In addition, as a result of relatively long lead times for many of its components, it may be difficult in the short-term for the Company to obtain new sales to replace any unexpected decline in the sale of existing products. Finally, the Company may incur significant product development expense in preparing to meet anticipated customer requirements which may not be recovered.

     Program Volume and Pricing Fluctuations — The Company incurs costs and makes capital expenditures for new program awards based upon certain estimates of production volumes over the anticipated program life for certain vehicles. While the Company attempts to establish the price of its products for variances in production volumes, if the actual production of certain vehicle models is significantly less than planned, the Company’s revenues and net income may be adversely affected. The Company cannot predict its customers’ demands for the products it supplies either in the aggregate or for particular reporting periods.

     Investments in Customer Program Specific Assets — The Company makes investments in machinery and equipment used exclusively to manufacture products for specific customer programs. This machinery and equipment is capitalized and depreciated over the expected useful life of each respective asset. Therefore, the loss of any one of the Company’s major customers or specific vehicle models could result in impairment in the value of these assets and have a material adverse effect on the Company’s financial results.

CONSOLIDATED STATEMENTS OF INCOME

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

     

18

		Years Ended
		July 3, 2005				June 27, 2004				June 29, 2003
NET SALES		$	190,314			$	195,646			$	196,827
Cost of goods sold			147,618				148,159				151,468
GROSS PROFIT			42,696				47,487				45,359
Engineering, selling, and administrative expenses			20,688				20,624				19,613
INCOME FROM OPERATIONS			22,008				26,863				25,746
Interest income			1,169				426				369
Interest expense			—				—				—
Other income (expense), net			320				362				(156	)
INCOME BEFORE PROVISION FOR INCOME TAXES			23,497				27,651				25,959
Provision for income taxes			8,459				10,369				9,605
NET INCOME		$	15,038			$	17,282			$	16,354
EARNINGS PER SHARE:
BASIC		$	3.97			$	4.56			$	4.32
DILUTED		$	3.94			$	4.49			$	4.24
AVERAGE SHARES OUTSTANDING:
BASIC			3,790				3,788				3,788
DILUTED			3,816				3,849				3,855

The accompanying notes to financial statements are an integral part of these consolidated statements.

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AMOUNTS AND PER SHARE AMOUNTS)

     

19

		July 3, 2005				June 27, 2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	56,950			$	54,231
Receivables, less allowance for doubtful accounts of $250 at July 3, 2005 and June 27, 2004			26,053				30,931
Inventories			11,654				8,361
Customer tooling in progress			1,295				679
Deferred income taxes			1,594				1,959
Income taxes refundable			214				—
Other current assets			6,927				7,805
Total current assets			104,687				103,966
DEFERRED INCOME TAXES			1,796				—
INVESTMENT IN JOINT VENTURES			1,412				1,336
OTHER LONG-TERM ASSETS			603				460
PROPERTY, PLANT, AND EQUIPMENT, NET			29,592				31,428
		$	138,090			$	137,190
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	17,218			$	18,787
Accrued liabilities:
Payroll and benefits			7,679				11,067
Environmental			2,701				2,710
Commitments and Contingencies—see note
Income taxes			—				963
Other			2,470				1,757
Total current liabilities			30,068				35,284
BORROWINGS UNDER LINE OF CREDIT			—				—
DEFERRED INCOME TAXES			—				543
ACCRUED PENSION OBLIGATIONS			11,191				6,487
ACCRUED POSTRETIREMENT OBLIGATIONS			5,080				5,024
SHAREHOLDERS’ EQUITY:
Common stock, authorized 12,000,000 shares $.01 par value, issued 6,856,237 shares at July 3, 2005 and 6,754,892 shares at June 27, 2004			69				68
Capital in excess of par value			74,924				70,415
Retained earnings			145,268				130,230
Accumulated other comprehensive loss			(12,047	)			(5,385	)
Less: Treasury stock at cost (3,113,004 shares at July 3, 2005 and 2,926,687 shares at June 27, 2004)			(116,463	)			(105,476	)
Total shareholders’ equity			91,751				89,852
		$	138,090			$	137,190

The accompanying notes to financial statements are an integral part of these consolidated statements.

     

20

														Accumulated
						Capital in								Other
		Common				Excess of				Retained				Comprehensive				Treasury				Comprehensive
		Stock				Par Value				Earnings				Loss				Stock				Income
BALANCE JUNE 30, 2002		$	65			$	59,425			$	96,594			$	(2,440	)		$	(78,977	)
Net Income			—				—				16,354				—				—			$	16,354
Translation adjustments			—				—				—				(153	)			—				(153	)
Minimum pension liability, net of tax of $2,634			—				—				—				(4,298	)			—				(4,298	)
Comprehensive income																						$	11,903
Purchase of common stock			—				—				—				—				(21,897	)
Exercise of stock options and employee stock purchases, including tax benefit of $766			1				4,405				—				—				16
BALANCE JUNE 29, 2003			66				63,830				112,948				(6,891	)			(100,858	)
Net Income			—				—				17,282				—				—				17,282
Translation adjustments			—				—				—				(270	)			—				(270	)
Minimum pension liability, net of tax of $1,088			—				—				—				1,776				—				1,776
Comprehensive income																						$	18,788
Purchase of common stock			—				—				—				—				(4,633	)
Exercise of stock options and employee stock purchases, including tax benefit of $1,368			2				6,585				—				—				15
BALANCE JUNE 27, 2004			68				70,415				130,230				(5,385	)			(105,476	)
Net Income			—				—				15,038				—				—				15,038
Translation adjustments			—				—				—				283				—				283
Minimum pension liability, net of tax of $4,257			—				—				—				(6,945	)			—				(6,945	)
Comprehensive income																						$	8,376
Purchase of common stock			—				—				—				—				(10,999	)
Exercise of stock options and employee stock purchases, including tax benefit of $956			1				4,509				—				—				12
BALANCE JULY 3, 2005		$	69			$	74,924			$	145,268			$	(12,047	)		$	(116,463	)

The accompanying notes to financial statements are an integral part of these consolidated statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

     

21

		Years Ended
		July 3, 2005				June 27, 2004				June 29, 2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income		$	15,038			$	17,282			$	16,354
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			7,225				7,704				7,854
Loss on disposition of property, plant and equipment			190				116				227
Deferred income taxes			2,282				1,393				1,229
Tax benefit from options exercised			956				1,368				766
Change in operating assets and liabilities:
Receivables			4,943				122				(3,350	)
Inventories			(3,293	)			(477	)			358
Other assets			748				1,047				(1,141	)
Accounts payable and accrued liabilities			(12,621	)			954				(4,757	)
Other, net			285				(144	)			65
Net cash provided by operating activities			15,753				29,365				17,605
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in joint ventures			(125	)			(125	)			(876	)
Additions to property, plant, and equipment			(5,498	)			(5,523	)			(3,772	)
Proceeds received on sale of property, plant, and equipment			22				12				230
Net cash used in investing activities			(5,601	)			(5,636	)			(4,418	)
CASH FLOWS FROM FINANCING ACTIVITIES
Purchase of common stock			(10,999	)			(4,633	)			(21,897	)
Exercise of stock options			3,566				5,233				3,656
Net cash (used in) provided by financing activities			(7,433	)			600				(18,241	)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			2,719				24,329				(5,054	)
CASH AND CASH EQUIVALENTS
Beginning of year			54,231				29,902				34,956
End of year		$	56,950			$	54,231			$	29,902
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid		$	6,696			$	5,950			$	9,899
Interest paid			—				—				—

The accompanying notes to financial statements are an integral part of these consolidated statements.

NOTES TO FINANCIAL STATEMENTS

     

22

ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     STRATTEC SECURITY CORPORATION (the “Company”) designs, develops, manufacturers and markets mechanical locks, electro-mechanical locks, latches and related security/access control products for global automotive manufacturers. The accompanying financial statements reflect the consolidated results of the Company, located in Milwaukee, Wisconsin, and its wholly owned Mexican subsidiaries, STRATTEC de Mexico and STRATTEC Componentes Automotrices, both located in Juarez, Mexico. The Company has only one reporting segment.

     The significant accounting policies followed by the Company in the preparation of these financial statements, as summarized in the following paragraphs, are in conformity with United States generally accepted accounting principles.

     Principles of Consolidation and Presentation: The accompanying financial statements reflect the consolidated results of the Company and its wholly owned Mexican subsidiaries. All intercompany accounts have been eliminated.

     Reclassifications: Certain reclassifications have been made to the 2004 financial statements to conform to the 2005 presentation.

     Fiscal Year: The Company’s fiscal year ends on the Sunday nearest June 30. The years ended July 3, 2005, June 27, 2004, and June 29, 2003 are comprised of 53, 52 and 52 weeks, respectively.

     Use of Estimates: The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

     Fair Value of Financial Instruments: The fair value of financial instruments does not materially differ from their carrying values.

     Cash and Cash Equivalents: Cash and cash equivalents include all short-term investments with an original maturity of three months or less due to the short-term nature of the instruments. Excess cash balances are placed in a money market account at a high quality financial institution and in short-term commercial paper.

     Receivables: Receivables consist primarily of trade receivables due from Original Equipment Manufacturers in the automotive industry and locksmith distributors relating to our service and aftermarket business. The Company evaluates the collectibility of its receivables based on a number of factors. An allowance for doubtful accounts is recorded for significant past due receivable balances based on a review of the past due items, general economic conditions and the industry as a whole. Changes in the Company’s allowance for doubtful accounts are as follows (thousands of dollars):

		Balance,				Provision								Balance,
		Beginning				Charged to				Accounts				End of
		of Year				Expense				Written Off				Year
Year ended July 3, 2005		$	250			$	80			$	80			$	250
Year ended June 27, 2004		$	250			$	26			$	26			$	250
Year ended June 29, 2003		$	250			$	53			$	53			$	250

     Inventories: Inventories are stated at cost, which does not exceed market. The last-in, first-out (LIFO) method is used for determining the cost of the inventories at the end of each period.

Inventories consist of the following (thousands of dollars):

		July 3, 2005				June 27, 2004
Finished products		$	3,691			$	2,659
Work in process			5,171				4,620
Purchased materials			6,287				4,441
LIFO reserve			(3,495	)			(3,359	)
		$	11,654			$	8,361

     Customer Tooling in Progress: The Company incurs costs related to tooling used in component production and assembly. The Company accumulates its costs for development of certain tooling which will be directly reimbursed by the customer whose parts are produced from the tool. These costs are accumulated on the Company’s balance sheet and are then billed to the customer upon formal acceptance by the customer of products produced with the individual tool. Other tooling costs are not directly reimbursed by the customer. These costs are capitalized and amortized over the life of the related product based on the fact that the Company will use the related tool over the life of the supply arrangement.

NOTES TO FINANCIAL STATEMENTS

     

23

     Repair and Maintenance Supply Parts: The Company maintains an inventory of repair and maintenance supply parts in support of operations. This inventory includes critical repair parts for all production equipment as well as general maintenance items. The inventory of critical repair parts is required to avoid disruptions in the Company’s customers’ just-in-time production schedules due to a lack of spare parts when equipment breakdowns occur. All required critical repair parts are on hand when the related production equipment is placed in service and maintained to satisfy the customer model life production and service requirements, which may be 12 to 15 years. As repair parts are used, additional repair parts are purchased to maintain a minimum level of spare parts inventory. Depending on maintenance requirements during the life of the equipment, excess quantities of repair parts arise. Excess quantities are kept on hand and are not disposed of until the equipment is no longer in service. A repair and maintenance supply parts reserve is maintained to recognize the normal adjustment of inventory for obsolete and slow moving supply and maintenance parts. The adequacy of the reserve is reviewed by the Company periodically in relation to the repair parts inventory balances. The gross balance of the repair and maintenance supply parts inventory was approximately $1.9 million, $2.2 million and $2.4 million in 2005, 2004 and 2003, respectively. These assets are included in other current assets in the Consolidated Balance Sheets. The activity related to the repair and maintenance supply parts reserve is as follows (thousands of dollars):

		Balance,				Provision								Balance,
		Beginning				Charged to				Balances				End of
		of Year				Expense				Written Off				Year
Year ended July 3, 2005		$	750			$	(24	)		$	76			$	650
Year ended June 27, 2004		$	810			$	27			$	87			$	750
Year ended June 29, 2003		$	810			$	75			$	75			$	810

     Property, Plant, and Equipment: Property, plant, and equipment are stated at cost, and depreciation is computed using the straight-line method over the following estimated useful lives:

Classification		Expected Useful Lives
Land improvements		20 years
Buildings and improvements		20 to 35 years
Machinery and equipment		3 to 10 years

Property, plant, and equipment consist of the following (thousands of dollars):

		July 3, 2005				June 27, 2004
Land		$	1,431			$	1,410
Buildings and improvements			12,549				11,987
Machinery and equipment			91,956				89,213
			105,936				102,610
Less: accumulated depreciation			(76,344	)			(71,182	)
		$	29,592			$	31,428

     The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured by the excess of the carrying amount of the assets over the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less estimated costs to sell.

     Expenditures for repairs and maintenance are charged to expense as incurred. Expenditures for major renewals and betterments, which significantly extend the useful lives of existing plant and equipment, are capitalized and depreciated. Upon retirement or disposition of plant and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in income.

     Supplier Concentrations: During 2005 approximately 33 percent of all inventory purchases were made from three major suppliers. During 2004 approximately 28 percent of all inventory purchases were made from two major suppliers. During 2003 approximately 19 percent of all inventory purchases were made from one major supplier. The Company does have long-term contracts or arrangements with most of its suppliers to guarantee the availability of merchandise.

     Labor Concentrations: The Company had approximately 1,935 full-time employees of which approximately 293 or 15 percent were represented by a labor union at July 3, 2005. The employees represented by a labor union accounts for all production associates at the Company’s Milwaukee facility. The current contract with the unionized associates is effective through June 29, 2008.

NOTES TO FINANCIAL STATEMENTS

     

24

     Revenue Recognition: Revenue is recognized upon the shipment of products, which is when title passes, payment terms are final, the Company has no remaining obligations, and the customer is required to pay, net of estimated returns and allowances.

     Research and Development Costs: Expenditures relating to the development of new products and processes, including significant improvements and refinements to existing products, are expensed as incurred. Research and development expenditures were approximately $1.7 million in 2005, $1.6 million in 2004 and $2.4 million in 2003.

     Self Insurance and Loss Sensitive Plans: The Company has self-insured medical and dental plans covering all eligible U.S. associates. The claims handling process for the self-insured plans is managed by a third party administrator. Stop-loss insurance coverage limits the Company’s liability on a per individual per calendar year basis and an aggregate per calendar year basis. The per individual per calendar year stop-loss limit was $150,000 in 2005 and 2004 and $125,000 in 2003. The aggregate stop-loss limit per calendar year was approximately $6.1 million, $6.3 million and $5.7 million in calendar year 2005, 2004 and 2003, respectively. Each covered individual can receive up to $2 million in total benefits during his or her lifetime. Once an individual’s medical claims reach $2 million, the Company is no longer liable for any additional claims for that individual.

     The Company maintains an insured workers compensation program covering all U.S. associates. The insurance is renewed annually, with a renewal date of February 27. The policy may be a guaranteed cost policy or a loss sensitive policy. Under a guaranteed cost policy, the ultimate cost is known at the beginning of the policy period and is subject to change only as a result of changes in payroll. Under a loss sensitive policy, the ultimate cost is dependent upon losses incurred during each policy period. The incurred loss amount for loss sensitive policies will continue to change as claims develop and are settled in future reporting periods.

     The expected ultimate cost for claims incurred under the self-insured medical and dental plans and loss sensitive workers compensation plan as of the balance sheet date is not discounted and is recognized as an expense. The expected ultimate cost of claims is estimated based upon the aggregate liability for reported claims and an estimated liability for claims incurred but not reported, which is based on analysis of historical data, current trends and information available from the insurance carrier. The expected ultimate cost for claims incurred under the self-insured medical and dental plans that has not been paid as of the balance sheet date is reflected as a liability in accrued payroll and benefits liabilities in the Consolidated Balance Sheets. The schedule of premium payments due under the workers compensation plan requires a larger percentage of the estimated premium dollars to be paid during the beginning of the policy period. The excess of the premium payments over the expected ultimate cost for claims incurred as of the balance sheet date is reflected as an asset in other current assets in the Consolidated Balance Sheets.

     Changes in the balance sheet amounts for self-insured and loss sensitive plans are as follows (thousands of dollars):

		Balance,				Provision								Balance,
		Beginning				Charged to								End of
		of Year				Expense				Payments				Year
Year ended July 3, 2005
Incurred but not reported claim reserve for self-insured plans		$	600			$	3,460			$	3,560			$	500
Workers Compensation			(202	)			672				672				(202	)
Year ended June 27, 2004
Incurred but not reported claim reserve for self-insured plans		$	550			$	3,778			$	3,728			$	600
Workers Compensation			(59	)			476				619				(202	)
Year ended June 29, 2003
Incurred but not reported claim reserve for self-insured plans		$	650			$	3,748			$	3,848			$	550
Workers Compensation			(194	)			326				191				(59	)

NOTES TO FINANCIAL STATEMENTS

     

25

     Product Warranty: The Company provides a specific accrual for known product issues. Historical activity for product issues has not been significant.

     Foreign Currency Translation: Since December 28, 1998, the functional currency of the Mexican operation has been the Mexican peso. Assets and liabilities of subsidiaries and equity investees outside of the United States with a functional currency other than the U.S. dollar are translated into U.S. dollars using exchange rates at the end of the respective period. Sales, costs and expenses are translated at average exchange rates effective during the respective period. Foreign currency translation gains and losses are included as a component of other accumulated comprehensive loss. Foreign currency transaction gains and losses are not significant for any period presented.

     Accumulated Other Comprehensive Loss: Accumulated other comprehensive loss is comprised of the following (thousands of dollars):

		July 3, 2005				June 27, 2004				June 29, 2003
Minimum pension liability, net of tax		$	9,467			$	2,522			$	4,298
Foreign currency translation			2,580				2,863				2,593
		$	12,047			$	5,385			$	6,891

Deferred taxes have not been provided for the translation adjustments in accordance with Statement of Financial Accounting Standards (‘SFAS’) No. 109, “Accounting for Income Taxes.”

     Accounting For Stock Based Compensation: The Company accounts for its stock-based compensation plans under the intrinsic value recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” As the exercise price of all options granted under this plan was equal to or exceeded the market price of the underlying stock on the grant date, no stock-based employee compensation cost related to these plans was charged against earnings in 2005, 2004, and 2003. Had compensation cost for these plans been determined consistent with SFAS No. 123, the pro forma impact on earnings per share would have been as follows (thousands of dollars except per share amounts):

		Year Ended
		July 3, 2005				June 27, 2004				June 29, 2003
Net Income
As reported		$	15,038			$	17,282			$	16,354
Pro forma compensation expense, net of tax			514				889				735
Pro forma		$	14,524			$	16,393			$	15,619
Basic earnings per share
As reported		$	3.97			$	4.56			$	4.32
Pro forma		$	3.83			$	4.33			$	4.12
Diluted earnings per share
As reported		$	3.94			$	4.49			$	4.24
Pro forma		$	3.82			$	4.30			$	4.04

The fair value of each option grant was estimated as of the date of grant using the Black-Scholes pricing model. The resulting pro forma compensation cost for fixed awards with graded vesting schedules was amortized on a straight line basis over the vesting period for the entire award. Effective June 17, 2005, 58,040 options were voluntarily terminated by the associates who received the awards. The options were previously issued in August 2004 at an exercise price of $76.70. No form of compensation was provided to the associates as a result of the terminations, and no compensation cost related to these terminated options is included in the presentation above.

NOTES TO FINANCIAL STATEMENTS

     

26

The grant date fair values and assumptions used to determine such impact are as follows:

Options Granted During		2005				2004				2003
Weighted average grant date fair value:
Options issued at grant date market value		$	18.56			$	16.29			$	19.92
Options issued above grant date market value			n/a			$	8.06			$	14.68
Assumptions:
Risk free interest rates			3.69	%			2.42	%			3.01	%
Expected volatility			24.64	%			17.57	%			39.97	%
Expected term (in years)			5.00				4.67				5.75

No dividends were assumed in the grant date fair value calculations as the Company does not intend to pay cash dividends on the Company’s common stock in the foreseeable future.

The range of options outstanding as of July 3, 2005, is as follows:

Number of Options

Weighted Average Exercise

Weighted Average Remaining

Outstanding/Exercisable

Price Outstanding/Exercisable

Contractual Life (In Years)

$17.05

5,000/5,000

$ 17.05 /$17.05

1.9

$31.95-$37.58

5,400/5,400

$ 34.04 /$34.04

6.1

$43.07-$45.85

49,630/49,630

$ 44.37 /$44.37

1.2

Over $45.85

221,830/35,500

$ 58.49 /$53.51

5.9

$ 54.80 /$45.75

Recent Accounting Pronouncements:

     In December 2004, the Financial Accounting Standards Board (‘FASB’), issued SFAS No. 123(R), “Share-Based Payment,” which changed the accounting for equity compensation programs. Under SFAS No. 123(R), companies that award share-based payments to employees, including stock options, must begin to recognize the expense of these awards in the financial statements at the time the employee receives the award. As allowed by SFAS 123 and SFAS 148, the Company has elected to follow APB Opinion No. 25 in accounting for its stock option plan until the effective date of SFAS 123(R). The accounting as provided by SFAS 123(R) will be effective for the Company beginning July 4, 2005, which is the beginning of the Company’s next fiscal year.

     Under APB 25’s intrinsic value method, no compensation cost for employee stock options is recognized. Accordingly, the adoption of SFAS 123(R)’s fair value method will have an impact on the Company’s results of operations, although it will not have an impact on the overall financial position. The impact of the adoption of SFAS 123(R) will depend on levels of share-based payments granted in the future and is expected to reduce pre-tax earning by approximately $1.1 million in fiscal 2006. SFAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under the current standards. This requirement will reduce the net cash provided by operating activities and increase the net cash from financing activities in periods after adoption. While the Company cannot estimate what these amounts will be in the future because it will depend on, among other things, when employees exercise stock options, the amount of cash flows from operating activities in prior periods for such excess tax deductions were approximately $138,000, $427,000 and $127,000 in 2005, 2004 and 2003, respectively.

     In May 2004, the FASB issued Financial Staff Position No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the Act), which provides guidance on accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) for employers that sponsor postretirement health care plans that provide prescription drug coverage that is at least actuarially equivalent to that offered by Medicare Part B. The Act provides a prescription drug benefit for Medicare eligible employees starting in 2006. The impact of the Act on the Company is not expected to be material.

NOTES TO FINANCIAL STATEMENTS

     

27

INVESTMENT IN JOINT VENTURES

     The Company has entered into a joint venture with E. WITTE Verwaltungsgesellschaft GmbH, and its operating unit, WITTE-Velbert GmbH & Co. KG (“WITTE”), WITTE-STRATTEC LLC, in which each company holds a 50 percent interest. The joint venture was established to seek opportunities to manufacture and sell both companies’ products in areas of the world outside of North America and Europe.

     In November 2001, WITTE-STRATTEC do Brasil, a joint venture formed between WITTE-STRATTEC LLC and Ifer Estamparia e Ferramentaria Ltda. was formed to service customers in South America. On March 1, 2002, WITTE-STRATTEC China was formed and in April 2004, WITTE-STRATTEC Great Shanghai Co. was formed. WITTE-STRATTEC China and WITTE-STRATTEC Great Shanghai Co. are joint ventures between WITTE-STRATTEC LLC and a unit of Elitech Technology Co. Ltd. of Taiwan and will be the base of operations to service the Company’s automotive customers in the Asian market.

     The investments are accounted for using the equity method of accounting. The activities related to the joint ventures resulted in a loss of approximately $70,000 in 2005, a gain of approximately $72,000 in 2004 and a loss of approximately $99,000 in 2003. A capital contribution of $125,000 was made to the joint ventures in both 2005 and 2004 primarily in support of general operating expenses.

LINE OF CREDIT

     The Company has a $50.0 million unsecured line of credit (the “Line of Credit”), which expires October 31, 2005. Interest on borrowings under the Line of Credit are at varying rates based, at the Company’s option, on the London Interbank Offering Rate or the bank’s prime rate. There were no outstanding borrowings at July 3, 2005 or June 27, 2004. There were no borrowings under the Line of Credit during 2005, 2004 or 2003.

     The Line of Credit contains various restrictive non-financial covenants. As of July 3, 2005, the Company was in compliance with all debt covenants.

COMMITMENTS AND CONTINGENCIES

     In 1995, the Company recorded a provision of $3.0 million for estimated costs to remediate a site at the Company’s Milwaukee facility. The site was contaminated by a solvent spill, which occurred in 1985, from a former above-ground solvent storage tank located on the east side of the facility. The reserve was established based on third party estimates to adequately cover the cost for active remediation of the contamination. The Company continues to monitor and evaluate the site with the use of groundwater monitoring wells that are installed on the property. An environmental consultant samples these wells one to two times a year to determine the status of the contamination and the potential for remediation of the contamination by natural attenuation, the dissipation of the contamination over time to concentrations below applicable standards. If such sampling evidences a sufficient degree of and trend toward natural attenuation of the contamination, the Company may be able to obtain a closure letter from the regulatory authorities resolving the issue without the need for active remediation. If a sufficient degree and trend toward natural attenuation is not evidenced by sampling, a more active form of remediation beyond natural attenuation may be required. The sampling has not yet satisfied all of the requirements for closure by natural attenuation. As a result sampling continues and the reserve remains. The reserve is not measured on a discounted basis. Management believes, based upon findings-to-date and known environmental regulations, that the environmental reserve at July 3, 2005, is adequate to cover any future developments.

     At July 3, 2005, the Company had purchase commitments for aluminum of approximately $1.3 million payable in 2006. Minimum rental commitments under all non-cancelable operating leases with a term in excess of one year are payable as follows: 2006-$595,000; 2007-$594,000; 2008-$443,000; 2009-$271,000. Rental expense under all non-cancelable operating leases totaled approximately $611,000, $607,000 and $574,000 in 2005, 2004 and 2003, respectively.

INCOME TAXES

The provision for income taxes consists of the following (thousands of dollars):

		2005				2004				2003
Currently payable:
Federal		$	4,780			$	6,882			$	6,344
State			766				1,496				1,409
Foreign			631				598				623
			6,177				8,976				8,376
Deferred tax provision			2,282				1,393				1,229
		$	8,459			$	10,369			$	9,605