Gentherm Incorporated (THRM) Q2 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Gentherm Inc. 2012 Second Quarter and 6 Months Results Conference Call. [Operator Instructions] Following the presentation, the conference will be open for questions. [Operator Instructions] At this time, I would like to turn the conference over to Jill Bertotti of Allen & Caron. Please go ahead.

Good morning, and thank you, everyone, for joining us today for the Gentherm Incorporated 2012 second quarter and 6 months results conference call. Before we start this morning's call, there are a few items I'd like to cover with you. First, in addition to disseminating through PR Newswire this morning's news release announcing Gentherm's results, an e-mail copy of the release was also sent to a number of conference calls participants. If any of you need a copy of the news release, you may download a copy from either the Gentherm website at www.Gentherm.com or the Allen & Caron website at www.AllenCaron.com. Additionally, a replay of this conference call will be available via a link provided on the events page of the investors section of Gentherm's website. Finally, I've been asked to make the following statements. Certain matters discussed on this conference call are forward-looking statements that involve risks and uncertainties, and actual results may be different. Important factors that could cause the Company's actual results to differ materially from its expectations on this call are risks that sales may not significantly increase; additional financing, if necessary, may not be available; new competitors may arise; and adverse conditions in the automotive industry may negatively affect its results. The liquidity and trading price of its common stock may be negatively affected by these and other factors. Please also refer to Gentherm's Securities and Exchange Commission filings and reports, including but not limited to Form 10-Q for the period ended June 30, 2012 and its Form 10-K for the year ended December 31, 2011. On the call today from Gentherm, 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 will be a question-and-answer period. I'd now like to turn the call over to Dan. Good morning, Dan.

And good morning, Jill. This is Dan Coker reporting in from Europe, so it's actually mid-afternoon for me here. And I would like to apologize for having to reshuffle the time of our call from our normal time, and I would also like to send best wishes from Bud Marx, who unfortunately has already caught a flight home and is unavailable for the call. We are in the, sorry, did I disconnect? Is everyone still there?

We are here.

Okay. Good. Sorry. There's a loud clicking on my end. We had a pretty good first half and a pretty good second quarter. We are pleased with the results. It is in keeping with our forecast for the year. We're very pleased with how things are going with the cooperation between the 2 teams from W.E.T. and Gentherm, and I think the results will speak for themselves, but we will ask Mr. Steele, our CFO to give us a few of the highlights from the operations for the second quarter and for the first half. Barry, are you still there?

I am here, and thank, you Dan. The second quarter 2012 represents the fourth quarter where the results of W.E.T. are included for the full period. Because the acquisition had such a dramatic effect on our statement of operations and balance sheet when compared to the prior year's second quarter, I'll keep my comments limited once again to observations related to the sequential comparisons of the second quarter of 2012 with the first quarter of 2012. Our product revenues for the second quarter of 2012 were $136.2 million, which represented an increase of $6.6 million, or 5% over the first quarter 2012 product revenue. The increase is due to higher revenues at Gentherm of $4.2 million and higher revenues of W.E.T. totaling $2.5 million. The higher revenues for Gentherm are primarily attributable to higher production orders from our customers based in Japan and Korea, which had experienced lower volumes during the first quarter due to orders that were pulled ahead to 2011. So in essence, we're back to our normal run rates with these customers in the second quarter. W.E.T. benefited from strong orders from its North American customers and steady revenues in Europe and Asia. However, due to the weakening of the European euro, W.E.T.’s euro-denominated revenue was lower when translated in U.S. dollars by approximately $500,000, when compared to the first quarter. So there was a bit of a deterioration just due to the euro weakening and that exposure. Our gross margin for the second quarter was the same as that of the first quarter. Our improved fixed-cost coverage was offset primarily by higher material costs during the quarter. Operating expenses were $25.4 million during the second quarter 2012, representing an increase of $1.3 million or 7% over the first quarter. This increase is primarily due to costs associated with our program to implement the requirements of the Sarbanes-Oxley Act at W.E.T., higher legal expenses, and higher research and development expenses. We expect our Sarbanes-Oxley Act implementation cost to the steady in the third quarter, but then go down as we go through the fourth quarter and beyond as we complete the implementation. Our adjusted EBITDA was $17.8 million during the second quarter, which was $2 million higher than that of the first quarter of 2012. This increase was primarily due to higher revenue, lower realized derivative losses, offset partially by the increase in operating expenses. Turning now to the balance sheet and primarily focusing on our cash. Our cash, which totaled $77.3 million at the end of the quarter, decreased by $23.3 million during the second quarter. We used some of our cash reserves for several items. These include, first, we repaid $11.8 million on our long-term debt facilities, which included a mandatory prepayment totaling approximately $8.3 million associated with W.E.T.'s sale of treasury shares. By the way, approximately $6.3 million of that expenditure was coming from Gentherm -- Gentherm acquired a significant stake of those shares. We also used $8.7 million of our pay, of our cash to pay our quarterly installment on our Series C convertible preferred stock. The remaining amounts due on the preferred stock after that payment are $41.2 million, including, which includes dividend payments. These amounts are due on a quarterly basis over the next 4 quarters. We also invested $7.8 million in a series of derivative securities designed to counterhedge W.E.T.'s cash-related swap, or CRS, exposure. This is a derivative that we acquired in the transaction that is an exposure to the Swiss franc as we put these derivatives in place to counterhedge any potential deterioration in that relationship. We also invested $5.0 million in capital expenditures a portion of which included the beginning of an expansion of the W.E.T. China manufacturing location. Our operating cash flow was $10.8 million for the quarter, which was reduced by approximately $4 million in working capital expansion, which was related to the higher revenue line. And that’s what I have Dan, back to you.

Okay, Barry, thank you very much for that comprehensive review of the facts of the second quarter. Operator, I think, we're ready to turn the call over and open for questions.

[Operator Instructions] Our first question is from the line of Michael Lew with Needham & Company.

You'd mentioned in the prepared remarks and the press release plans for expectations for moderately higher sales in 3Q. How should we think about that regionally? Is the right way to think about it, America and Asia up, Europe down, sequentially?

I think that everyone could agree that the North American market for our prime products are going very well. The European market is a little bit shaky, frankly. There's a lot of uncertainty in Europe these days. Our prime customers in Europe are the German automakers, and they have done fairly well and appear to be continuing to do fairly well. The Asian markets are fairly stable. So yes, I think your assessment is pretty close.

Okay, and on the quotation activity, increasing, same type of blend across the various geographic markets, given the various backdrops -- economic backdrops.

Yeah. I think that's pretty again, all of this activity, usually increased quotation activities has to do a lot with the economic activity, and I think those do parallel nicely.

Okay. And you also indicated that you expect new vehicle platforms launching this year. I mean, how many do you have in the pipeline?

Well, we don’t issue any specific information about that, but we do believe that there are additional platforms that will be introducing our products in the second half of this year.

Okay. And on the mattress front, what were sales in the quarter? Like how many markets are you currently in for Mattress Firm and what is the distribution strategy going forward?

I think they were somewhere around $200,000 to $250,000 of revenue in the second quarter, and we've been taking this time to get ourselves ready for a little bit better third and fourth quarter. We are introducing a new configuration of the product. We're also introducing the distribution lines into the Atlanta, Georgia, marketplace beginning in August, and they will continue a push through to where we'll be available in all, I think it's just under a 1,000 Mattress Firm stores nationwide by the end of the first quarter of 2013.

Do you know how many states that covers?

I do not, actually. All of their distribution is primarily in the Southeast and Southwest, but I have never really actually counted the states.

And last question is I think, Barry, you mentioned expansion in the China manufacturing facility. What kind of revenue capacity does that facility have?

We don't express it in terms of revenue, but I can tell you that their square footage will roughly double.

Square footage doubles? Okay.

Our next question comes from the line of Steve Dyer, Craig-Hallum.

Just how should we think about, Barry, gross margins, I guess, going into the back half of the year? I would expect that on a higher revenue base and a little bit of tellurium help, even though I know that's not super meaningful at this point, that they'd be up a bit. Is that fair?

As we see revenue grow, we should see a little bit of an increase, although materials do continue to be a cost issue for us across all platforms and products. So I would say pretty standard, flat to maybe slightly up.

And how about operating expense, just in general?

I think we'll still have sort of these lumpy costs that kind of come through that are sort of reverberations of the original acquisition. There'll be a point, I think, that we'll see some decrease, although I'll point out that there are currency effects built into this line item that can affect us as well. If the euro starts to recover, we might see a little bit higher SG&A from that.

Okay. I'm wondering if you could give us an update on the minority interest situation, if there's anything new to report?

From our view, there's nothing new to report. We are pursuing legal remedies through the German court system. The next stage for us is an appeal process. That's being worked through -- by our lawyers in Europe, and they, we're not really expecting any answers or any action on that until late this year, probably in the fourth quarter of this year.

Okay. And then, Barry, what was cup holder revenue in the quarter?

I'll have that before the end of the call. I have to look it up.

Okay. And then, I guess, just lastly, a bigger-picture question, where are you seeing, I guess, the most interest from new customers? Is it heated and ventilated, heated and cooled, plain old heated? Anything of note there as to areas you're really encouraged about?

The thing that's, I think, we predicted for years, I think more and more people are looking for thermal comfort in the seat these days, and we are beginning to see more people in the entry-level and mid-range vehicles start to pick up on the heated and ventilated solution, and that's encouraging for us. It's primarily focused in the Asian markets, but again, it’s a big growth opportunity for us in terms of the sheer magnitude of the size of the entry-level and lower mid-range. So that, I think, is going to be key to us for the long term. We still can see a pretty strong demand for heated and cooled, and of course the heated demand is very steady worldwide.

Cup holder revenue was approximately $2 million.

Our next question comes from the line of Anthony Deem, KeyBanc Capital Markets.

So you had very nice year-over-year pro-forma revenue growth relative to the first quarter. And it looks like 14% versus about 2.5% in the first quarter, and based on your 10% guidance looks like you are implying 12% back-half growth and your third-quarter guidance definitely lines up with that. And I'm just under the impression that your revenue growth would accelerate in the second half, driven by program launches, improving take rates for your heating and cooling applications. So as I think about that 14% this quarter versus the 12% outlook, would you say that your 10% guidance just might be conservatism on your part, maybe given some of the currency headwinds, the production outlook, or anything else we should be thinking about as to why maybe the second half might be lower relative to the second quarter.

Well, actually, I think that the second- quarter results kind of proved our point. We are pretty much on plan and on target to where we thought we'd be when we gave the original guidance for the year. So I don't think you should over-read much into this. I think the first quarter was a bit of an unusual circumstance because of some shifting in orders on the Gentherm side. The second quarter showed very good strength on both sides of our business, and I think you're going to see that kind of steady results throughout the year. The only thing that could cause us any concerns or issues, if there is a further deterioration in the European marketplace and that actually sags into the German auto market as well. I think that, generally speaking, we're very happy with how things are positioned and we think the second half is going to be right on target.

Okay. And then, your margins, your operating margins have been tracking within that 6% to 7% bandwidth over the past 3 quarters, and Barry, you covered this somewhat in a prior question. But as we think about the next 12 to 18 months, what are the major puts and takes you're thinking about internally? Is it sort of fair to assume that the operating margins might stay within that range going forward or is there anything that could materially change the outlook, in your view, above and beyond production?

This is Barry. I don't think there's anything that would materially put us out of that. As we grow, we should be able to improve that, and as we look at how we're operating with W.E.T. in cooperation, we may find some opportunities to take some costs out as well. So I would think that the ability for us to improve that is better than the risk, I think, that we see.

We've also pointed out, I think, that the tellurium costs that run through the Gentherm books has abated quite a bit in the first half of the year and we're starting to see some positive impact on that although it's not wildly significant. We do see a little bit of pressure being relieved there and a little bit of improvement expected in the second half on margins for Gentherm.

Where would some of the costs be coming out of the W.E.T.? Is this just the result of maybe ramping up on some of these cooperation agreements, or anything particular we should be thinking about?

This is Barry again. I don't think there's anything specific that we'll give you a laundry list for, but just generally we're looking at this as an area of focus and cooperating.

Okay. And then, I guess, just lastly here, as it relates to the minority shareholders that W.E.T. and you have a lot of liquidity to get a transaction done, but can you just give us an update as to what's your level of communication with the shareholders and what they might be communicating to you? Just any update there?

Well, our typical means of communication are through lawyers, so we don't really have regular fireside chats with these guys. They're investors. They make their thoughts known through the courts. So we simply respond through our legal representation. We don't have any direct contact with these guys.

Our next question comes from the line of Mark Tobin, Roth Capital Partners.

Following up on the operating expense questions, Barry, can you give us, I guess, may be help us quantify the level of magnitude of the Sarbanes and legal type of impacts that can potentially peel off as time goes by?

The legal is not as easy to predict, but the Sarbanes-Oxley, I think we're between $300,000 and $400,000 in this quarter. We’re probably going to tick down slightly next quarter, if not be about the same, and then it should fall off pretty significantly after that. But legal, I can't really give you a guidance on.

What was the legal for Q2?

It was anywhere between, depending on how you slice and dice it and what things you include and don't include anywhere between $600,000 and just over $1 million. Those will be sort of the incremental things that are a little unusual for our normal business operation.

Okay, understood. And we talked about the courts. On the cooperation agreements, which it sounds like you guys are making progress there, can you give us an idea of timing and what we could expect to see as those start to be implemented?

Certainly the agreements that we have in place are the guidelines or the framework of how our 2 teams can work together toward the future, is really what we're talking about. And these agreements have been laid out. There are kind of ground rules as to how we work together and behave, and our teams are responding very favorably to this. And we do expect to see some positive results, but these results are the beginning of the cooperation now and we'll start seeing results in the coming periods, so there's not going to be any red flag drops and you are going to see all sorts of fantastic cost reductions or anything else coming. These are basically working groups that are trying to get together and achieve a set of common goals.

And within those agreements, are there under German law, are there still constraints as far as what you're able to do and is there a level of approval that's required as you implement them?

There's certainly clear guidelines as to how these agreements are structured and how we are to respond within them. Essentially, Mark, if you just think of it, is we are 2 separate independent companies who are working together on a series of projects to try to achieve common goals.

[Operator Instructions] And our next question is from the line of Adam Brooks with Sidoti & Company.

Just a few quick questions here. Is it fair to assume that maybe the underlying demand was stronger than expected in Q2? Revenue up pretty nicely, sequentially even though the euro deteriorated during the quarter.

I think the demand has been fairly steady. I think we had an unusual occurrence in the first quarter with the Gentherm orders out of Asia, but I think that our demand is fairly normal and predictable. I'd say that the -- your question about the euro, I think there is some issues with the euro in terms of an evaluation and currency exchange for us in terms of measuring back into dollars. Again the big concerns we have are; will things happen in Europe that will cause the whole market in Europe to drag down. Right now, the German market still holding pretty steady and our order book looks pretty steady for the second half. But I think that everything is pretty much on projection for us.

Okay. And then if we talk about material costs, you said from 1Q to 2Q, a little bit higher. Can you maybe quantify sequentially, and then, maybe, also year-over-year, the hit from higher material costs?

We would not give any real specifics about the exact amount. You are probably looking at 2% to 3% may be year-over-year.

Okay. And maybe any updated conversations you’ve had with some of the European OEMs. Has there been any progress there or is it still kind of wait and see as you wait to fully integrate W.E.T.?

We've always had good discussions with our European potential customers and those discussions have continued. The new opportunity of having the W.E.T. partnership can only be good news for us and we believe that that process will yield good results in the future. But again, there’s no short-term announcements coming.

Okay. And then, lastly, can you maybe talk about pulling more platforms, historical Gentherm platforms into W.E.T. facilities? Are we going to see more of that in the next few quarters or is that on hold? And is the situation with the minority shareholders putting that off or are there any other reasons?

Well. I think, you won’t see anything occurring right away. I think the institution of our cooperation agreements allow us a very, let's say, organized way to start thinking about that. We will begin that process with these new agreements in place now and we'll start our plan, but you won’t see anything happening immediately.

[Operator Instructions] Gentlemen, I'm showing no further questions at this time. I'd like to turn the conference back over to you for any closing remarks.

Absolutely, thank you. This is Dan Coker again from Europe. We think we had a very solid second quarter and we think we've had a very strong first half. The second half looks good to us right now, although we would caution that there is uncertainty in Europe. We're not exactly certain which way the market is going to go here. There is tremendous underlying pressure on the European currency. The euro is kind of giving the whole world a little bit of a headache. The automotive market has been down in Europe, the German market size has been affected by this downturn, but not as dramatically as some of the other areas. We still feel at the mid-point of the year that things look pretty good, based upon our assessment of where things go and our original projections on how we felt this year would go. So I think we're on a good track. We certainly welcome everybody and we appreciate everybody using our new Gentherm name and trademark. So with that, we will see you next quarter. Thank you very much. Bye-bye.

Thank you, sir. Ladies and gentlemen, this does conclude the Gentherm Inc., 2012 second quarter and 6 months results conference call. Thank you very much for your participation. You may now disconnect.