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Gentherm Incorporated (NASDAQ:THRM)

Q1 2017 Earnings Conference Call

April 27, 2017 8:00 AM ET

Executives

Kathleen Bentley – Prosek Partners

Dan Coker – President and Chief Executive Officer

Barry Steele – Chief Financial Officer

Analysts

Christopher Van Horn – FBR

Matthew Koranda – ROTH Capital Partners

Steven Dyer – Craig-Hallum

Gary Prestopino – Barrington Research

Operator

Greetings, and welcome to the Gentherm Incorporated First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer section will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Kathleen Bentley of Prosek Partners. Thank you. Ms. Bentley, you may begin.

Kathleen Bentley

Thank you, operator, and good morning everyone, and thank you for joining us today. Gentherm’s earnings results were released earlier this morning and a copy of the release is available at gentherm.com. Additionally, a webcast replay of today’s call will be available later today on the Investor Relations section of Gentherm’s Web site.

During this call, representatives of the company may make forward-looking statements within the meaning of Federal Securities laws. Statements reflect current views with respect to future events and financial performance, and actual results may materially differ. Please see the company’s SEC filings, including the latest 10-K and subsequent reports for discussions of various risk factors and uncertainties underlying such forward-looking statements.

During the call, the company may discuss non-GAAP financial measures as defined by SEC Regulation G. Reconciliations of these non-GAAP financial measures to the comparable GAAP financial measures are included in the company’s earnings release.

On the call, we have Dan Coker, President and Chief Executive Officer; and Barry Steele, Chief Financial Officer. Management will provide a review of the results, after which there will be a q-and-a period.

I would now like to turn the call over to Dan. Dan?

Dan Coker

Yes. Good morning and thank you. Thanks to everyone for joining us on our call. By every measure the first quarter 2017 for Gentherm was a success. We’re very pleased. All units are performing extremely well. Our operations have performed at an extremely high level of efficiency. Our margins were strong. Our revenues nearly reached the billion dollar annual run rate in the first quarter, at $249 million. And all units did well, particularly our CSZ medical line. They did an extremely good job, and are performing extremely well, and we saw a resurgence in the Global Power Technologies Group as well.

So, we’re going to go through our normal procedure. Barry is going to give you the intimate details in his presentation, and then we’ll open the floor for questions. Barry?

Barry Steele

Thanks Dan. Good morning everyone. Thanks for joining us today. Our quarterly results were positive, as Dan mentioned, in nearly all measures. Our quarterly revenue, for example, grew to $249.3 million, which is an increase of $33.6 million or about 16% [ph] compared with the prior year. This increase was partially due to the CSZ acquisition, although on a pro forma basis first quarter revenue represented a 26% increase for CSZ over its prior year revenue of about $16 [ph] million. Considering CSZ’s 2016 first quarter revenue with Gentherm on a combined pro forma basis, our organic revenue growth for the first quarter was nearly 8%. The revenue increase was also the result of growth in all our other products as well.

Automotive seat heaters and steering wheel heaters were particularly strong. In the case of seat heaters, our capabilities in electronic control — is adding to our product content. And steering wheel heaters are being driven by higher penetration on more and more vehicle programs. Even GPT, as Dan mentioned, which serves the energy market with its remote power generation products, mainly for gas pipeline, and which has had decreasing revenue for the past five quarters, contributed favorably to the strong quarterly revenue. We continue to forecast 2017 revenue growth of 5% to 10% despite a relatively flat automotive market, renewed headwinds from currency translation, and changes in our climate seat technology in a few vehicle models favoring the lower price heat-vent solutions.

The main drivers for growth will include continued organic growth for CSZ, continued penetration of our automotive products, some additional recovery for GPT, and the first very small amount of shipments of the new battery thermal management product at the very end of the year. Another positive was a nice improvement in our gross margin, which increased by almost $17 million, and the gross margin percent, which was 34%, a nearly 10-year high and an improvement of 2.6% over the prior year gross margin percent. This increase resulted mainly from the higher revenue for CSZ and GPT, which have higher revenue gross margins, but also was supported by better fixed cost coverage from the higher sales levels and currency-related benefit.

Our operating expenses were again higher with the prior year, and totaled $50.3 million, for a $12 million or 31% increase. However, they were almost $2 million or 4% lower than the prior sequential quarter, the fourth quarter of last year. Part of the year-over-year increase was due to the CSZ acquisition, which had operating expenses of about $7 million or just a little over half of the operating expense increase. And in the last three quarters, the rest of the increase comes in the form of investments or higher development costs for many new product initiatives, some of which we have announced, like the battery thermal management and electronics products, and some we have not announced yet or for strategic improvement to our business systems.

The sequential decrease is partly due to a $2 million management organization expense during the 2016 fourth quarter, which was a one-time cost and which also helped reduce recurring costs for the current and future quarters. Our net earnings of $25.4 million was about $0.59 per share. On a non-GAAP basis adjusting for acquisition-related amortization and unrealized currency losses, the earnings were about $0.70 per share. This compares to a similarly adjusted non-GAAP amount of $0.73 per share during the first quarter of 2016; the prior year amount also being adjusted for a one-time tax charge of about $10 million related to a reorganization of our North American operations under Gentherm Europe, formally known as W.E.T. Automotive.

During the first quarter we had negative operating cash flow of about $21 million. This negative amount was primarily due to tax payments made in conjunction with that same North American reorganization, totally $34 million. Without this unusual payment, our operating cash flow would have been favorable and about $10 million. Also because of this payment and due to about $8 million in debt repayments our cash, of $134 million, was $42 million lower at the end of the quarter as compared to the beginning. Outstanding debt was $153 million at the end of the quarter, which brings our net debt position to $29 million. Available borrowing capacity under revolving credit facility is now $203 million, which brings our total available liquidity, along with the cash, to $337 million, a quite nice quarter.

Dan, I turn it back to you.

Dan Coker

Thanks Barry, I appreciate it. And this was a very good quarter. And we did have an advantage in that the CSZ Group was not counted in last year’s 2016 first quarter numbers. So the strong 16% growth that you saw in our year-over-year revenue gain was partially due to that. We do not expect a 16% increase in revenues in the future quarters, although we do expect business to continue to grow and to be solid. But that does not mean that we’re going to continue seeing anything above 15% growth per quarter. It’s a good quarter. We think it’s a very good beginning to a year. And we’re very excited about the prospects.

So, for right now, we would like to open the floor for questions. Operator, we’re ready to address any questions anyone may have.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions] The first question is from Christopher Van Horn from FBR. Please go ahead.

Christopher Van Horn

Good morning. Thanks for taking the call, and congrats on quarter.

Dan Coker

Good morning.

Barry Steele

Thanks, Chris.

Christopher Van Horn

So just first on the gross margins, I mean, obviously I think there were some tailwinds here from the CSZ and GPT revenues. Could you give us an update on maybe your expectations on where you see margins in the latter half of the year?

Dan Coker

Well, as we’ve continually targeted, the low-30s are our target. We see variations from quarter-to-quarter. A lot of that’s based upon a group of variables, one of which is a very high revenue number is very good for our margins. And our operations are performing at pretty close to peak efficiencies right now. So we would still say that our gross margin target is in the low-30s. This quarter, we hit something closer to the mid-30s, but we would say somewhere between 32 and 34 is what you should plan for and see for the rest of the year.

Christopher Van Horn

Okay, great, got it. And then it seems like the rear seat penetration of heated seats has started to ramp a little bit. Could you just comment maybe a little bit on the pipeline or what the conversations you’re having the OEMs, because on our checks we obviously see a proliferation of more heated seats in the back, and just curious what your customers are kind of talking about in terms of the future pipeline there?

Dan Coker

Well, it’s a continuation of a comfort objective that the car companies have. They’re trying to put four seat positions into expand the ability to each passenger in a car to individually customize their position. So we do see a trend toward more rear seat applications per seat heaters. But we also, we’re seeing an increased revenue because of additional content. We’re beginning a few customers allow us to ship controlling devices for seat heaters of our production and that’s helping quite a bit as well in the revenue ramp for heated seat. So we’re getting additional positions and we’re getting the rear [ph] seats as well more and more, but we’re also getting additional content from the controller.

Christopher Van Horn

Okay. Just a follow on to that, because the thing you know the controllers obviously very interesting part of the story, is that is that a market share gain for you or is that you know is did the OEMs in-source some of that before like how is it you know what is where were you standing in the kind of the competitive space around the controllers?

Daniel Coker

For us in places where we’re now selling the controller we work obviously it’s penetration gain and the customers a few of them do provide from their own internal sources, but most of them buy from other sources, so we’re allowed now to sell a complete heater system including the controller, yes that’s a penetration gain and then we settled for that.

Christopher Van Horn

Okay, great. Thanks for the time.

Daniel Coker

Thank you.

Operator

Thank you. The next question is from the line of Matthew Koranda from ROTH Capital. Please go ahead.

Matthew Koranda

Hi guys. Good morning. Nice quarter in terms of gross margins just want to touch on that one more time, so if I try to back in a gross margins for CSC and GPT and I assume automotive revenue is tracking kind of at your historical corporate average in the low 30s and I guess the something in the mid-40s for CSC and GPT so one is that a fair assumption and two do you think you can sustain those levels through the remainder of 2017?

Daniel Coker

Well, we won’t be speculating on your assumptions and you’re backing around into our P&L but you are essentially correct in that our group objectives are to achieve a 32%, low 30s, 32% minimum type of gross profit in occasional quarter we have business units or product mixes that shift, in some cases dramatically. The businesses we have diversified into typically have higher gross margin percentages than the traditional automotive businesses have. So for us it is a matter of mix as well and efficiency when we look at our gross margins.

Matthew Koranda

Okay. And then fair way to quantify was I think Barry mentioned there might have been an FX benefit or small one in the margin if you help us understand?

Barry Steels

It was fairly small at top line we gave up about $2 million in revenue year-over-year but the gross margin is probably increase at the lower but maybe $500,000 or so just because of currency benefit and mix primarily.

Matthew Koranda

Okay, got it. And then just following up on the seat heater discussion that you guys had, maybe just digging into it little bit more was kind of curious if you could maybe quantify for us what percentage of your currency programs are using your electronic controllers currently?

Barry Steels

I have no clue to be honest with you but I’m not sure we would announce that publicly anyway but more and more of our seat heater are allowing us to shift both systems.

Matthew Koranda

Okay. Well, yes, maybe the other way to ask it is on the incremental when you win a new program is there way to kind of think about the attach rate for your controllers there?

Barry Steels

We are getting a significant amount of traction with our new electronics divisions being able to support a broader range of activities in the electric controllers, electronics controllers are big target segment for us, it adds additional content and it allows us to control more precisely our product or complete product up and down the line and of course it allows us to make fair profit on that.

Daniel Coker

Matt maybe I could help a little bit by pointing out that you would say there is growth potentially in our future, because it was continued penetration electronics for seat heaters, it won’t necessarily come on one quarter but it is a one of the many ways we will continue to grow faster than the industry. They are not just for the seat heaters, although that’s a key significant factor in the seat heater business, but yes that’s true.

Matthew Koranda

Okay. Got it and just last one and that I would assume as you alluded to that mix is up the margin profile of the seat heaters as well, does that bring it up sort of towards that corporate average is that a fair assumption?

Daniel Coker

Everything helps.

Matthew Koranda

Got it. Okay. Maybe just one more from me and then I will jump back in queue, do you guys have any updated view on when you might expect to see that CCS category kind of growth kick back in there or you getting any better visibility from customers on program launches in the coming quarters or we still kind of in the period of stays this year?

Daniel Coker

Nothing happens in the auto industry in a blink of an eye and so there’s going to be a long period of time where the transition occurs, where we’re seeing some transition from heat cool to heat vent and that’s beginning to happen now, it will happen for a period of years actually it’s as the car company platforms age out but we’re as we had indicated, we see a very big opportunity for CCS in many of the markets especially the European market that’s the area where we’re going to see the growth in the heat and cool seats begin to take off again to levels that we’re more satisfied with. Initially that will probably start off in the form of heat vent systems and then as customers decide to upgrade for their luxury brands they’ll add heat cool as well.

Matthew Koranda

And just clarifying that you are talking kind of over a period of multiple years though and you are not just this year in particular?

Daniel Coker

It is a long term.

Matthew Koranda

All right I will jump in queue guys. Thank you.

Daniel Coker

Thanks Matt.

Operator

Thank you. The next question is from the line of Steven Dyer from Craig-Hallum. Please go ahead.

Steven Dyer

Thanks good morning, Dan. Good morning, Barry.

Daniel Coker

Thanks, good morning; just kind of following up on Matt’s question.

Operator

Sorry to interrupt, Mr. Dyer. This is the conference moderator, sir. Mr. Dyer, maybe I request you to speak up a bit loud as your voice is a bit low.

Steven Dyer

Perfect. Is it better?

Operator

Perfect, sir. You may proceed.

Steven Dyer

Thank you. Just following up on Matt’s question, as it relates to heat cool you know that was obviously on the scene I think even earlier 15, 20 years ago than heat vent, I guess what is what is sort of changed such that heat vent has become it seems like other than you know a little bit lower price tag but you know is there is there still opportunity it sounds like for growth there or is heat cold sort of becoming the facto standard I guess for CCS products?

Daniel Coker

Well, there is couple factors that that would lead a OEM to decide to use heat vent or heat cool, the main advantage over heat cool is that the system is independent of the HVAC system and allows a very rapid response, it particularly in a warm condition when you’re adding cooling unit energy to the occupants through the seat a independent thermo electric device creates cool air and directs it to the human very, very quickly, so time to comfort is our biggest advantage with the heat cool system, the luxury market was the target of this all along and continues to be our target and there are plenty of luxury vehicles specifically the European luxury vehicles that have yet to introduce this even to the high end customers.

So the opportunity for CCS remained strong, we’re in a period right now where we’re not seeing the type of growth we like part of that is being impacted by some of the previous customers who have been using the heat cool systems that are mid-range vehicles are now converting over to the heat vent system which has advantages itself, it is less power to drive the system and it costs slightly less than the heat cool system.

So, we released a heat vent system targeting specifically the mid-range vehicles around the world now there are many times more mid-range vehicles built than luxury vehicles obviously, so the market opportunity for heat vent is extremely large and is relatively untapped at this moment, so we see a big opportunity for new penetration in the heat vent systems in the mid-market and there will be some continued migration from heat cool to heat vent for those customers who had adopted heat cooling systems for their mid-range vehicles in the past. So I think that they’re still good strong growth for both categories but we see in particular a lot a longer term of growth for the heat vent systems as that penetration into the mid-range market begins and pushes out over the next few years.

Steven Dyer

Okay, thanks. And then in your press release you had mentioned some opportunities for standalone electronic production being kind of a early 2019 event, did that slip at all I guess I have sort of anticipated maybe we see something a bit sooner, but I’m not sure if I misread things at some point?

Dan Coker

No. Actually, I think we’ve been saying early ’19 all along there. They may have used some indications at some point that might have been late ’18, but it’s pretty well right on target, we are quite pleased with the team’s response to our customers demands, it’s a new category for us and it’s a new classification of qualification for our factory, so it’s a big step up for us to become a electronic control supplier to an OEM and that takes a lot of time to get ready, it take a lot of time on the OEM spaces to properly evaluate and test to make sure we are ready to join the very select maternity of people who are allowed to connect in for their networks on the cause.

Steven Dyer

Yes, got it. And then, as it relates to your – sort of rest of your guidance, I’m assuming that that sort of takes into consideration all of the downtime at GM for the K2 program in the back half for the year. So that implies you know, pretty flat not year-over-year, but just a level similar to Q1 revenues, is that sort of how you see it and then also OpEx seems to have sort of found a comfortable level, is that a good number to use give or take going forward for the rest of the year.

Dan Coker

Generally speaking, I think you are right on all of those points. Yes we see — in the automotive sector we see a similar growth patterns of what we have seen in the first quarter. We will see continued strength particularly CSC, we think they are performing very, very well and their market is receptive to products that we are offering there, we have taken steps to add our own direct sales force and technical field sales support and that’s been continued to perform well during the year, but I think we are going to have a good year but we still maintain that we will be growing somewhere between 5% and 10% for the full year on the revenue line.

Steven Dyer

Okay. Great. Thank you.

Operator

Thank you. [Operator Instructions] The next question is from the line of Gary Prestopino from Barrington Research. Please go ahead.

Dan Coker

Hello.

Gary Prestopino

A couple of questions. Can you hear me?

Dan Coker

Yes, yes. You were a little far from your phone there.

Gary Prestopino

Okay. Can you hear me now?

Dan Coker

Yes, I can hear you now.

Gary Prestopino

Okay, great. A couple of questions here, I would assume that you know, solid results in Cincinnati Sub-Zero, you haven’t got the full sales force as a full infrastructure yet, correct?

Dan Coker

That is correct. It’s a building process; we suspect that we will have everybody in place and train probably by second half of this year. The training part is what takes the most effort, make sure that these folks are ready go out and represent our products.

Gary Prestopino

Okay. And historically Dan has Cincinnati Sub-Zero had you know, strong first quarters and strong fourth quarters. I just try to get an idea of how that would shake out?

Dan Coker

Yes, I don’t — there is a lot of seasonality to their product lines. Although I would say probably the industrial environmental chamber business is somewhat affected by capital purchasing strategies as people push, so that would indicate just probably a bigger chance for a stronger fourth quarter than first quarter. But in general I don’t think that there is a lot of seasonality to their business.

Gary Prestopino

Okay. And then, there is a lot of questions around electronic controllers on your [indiscernible] that obviously you don’t want to answer in terms of percentage. But maybe you could help about and just talk about how much do those controllers drive an increase in your content or vehicle, can you help us out with that?

Dan Coker

Well, because it vary with complexity, there can be anything from a few dollars to $10 and that’s a significant piece of some of the cost of resistant heater but if for us it’s an opportunity to provide an additional service to our customers. We provide a full system without been having to have additional vendors qualified and supplied to be able to deliver a product and that’s a good thing for us but does it allows us to have complete control and match pay controller with a device and if we know it’s going to perform exactly as designed and that also provides a lot of comfort for the OEM as well.

Gary Prestopino

Okay. I mean, I’m trying to recall, this is the first time you’ve really called that out on an earnings release or not but it seems to me that this is really the first time there should be a solid runway here as we go forward.

Dan Coker

It’s not the first time that we call that out that’s actually the region that we died into the electronic business to be able to provide full system content and additional content and get better control of our systems overall, but this particular quarter there was a significant increase in some of the businesses and we’ve seen growth in the heater business in the past and part of that has been the addition of new content in the form of electronic controls press.

Gary Prestopino

Okay. Thank you.

Dan Coker

Thank you.

Operator

Thank you.

Dan Coker

Okay. Operator, it looks like…

Operator

As there are no questions at this time, I would like to turn the floor back to Mr. Dan Coker for closing comments; over to you.

Dan Coker

Thank you, and thank you everyone for joining us for our first quarter review. Again by all measures, it was a very solid quarter and a great beginning to a year. We don’t believe that the revenue growth percentages are going to continue, but we believe that the revenues themselves will continue to be strong throughout the year and we have great confidence that we will be able to achieve our projection of 5% to 10% revenue growth and a very solid earnings performance for all of our businesses.

We have lots of exciting things coming in the future we’ve been very hard at work for the past couple of years really but really last year or so getting ready for the launches of some very significant new products including battery thermal management systems that we think are going to really change the way that our businesses operate and provide new opportunities and new pass for growth for us.

So again, we thank everyone for your time and attention, we’d like to congratulate our team on a global basis for a great first quarter, and thank you everyone, and good bye.

Operator

Thank you very much. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you all for your participation.

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