Gentherm Incorporated (THRM) Q2 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Gentherm Second 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, Investor Relations for Gentherm. Thank you, Ms. Bentley. You may begin.

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 website. 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&A period. I would now like to turn the call over to Dan. Dan?

Yes. Good morning, Kathleen. And good morning, everyone. Thank you for joining us on our second quarter and first half review. As you probably saw this morning from our release we had a very good quarter and a pretty solid first half all the way around. The quarter we managed a 5% growth and Barry is going to give you a whole lot of details about how this goes, so I will continue to stay high level on this. But even with only 5% growth we did very well on our operating results and so we're quite pleased with that. We're also interested, the auto business grew very well, despite our largest marketplace, the North America market being in a bit of a downturn. Several of our large customers were making adjustments to inventory. But our non-automotive sectors grew very well. And so we're very pleased with that event and hoping to looking in the market in general. On a personal basis, we also announced during the quarter that I'm going to be retiring at the end of the year. I'd like to thank our Board of Directors for taking up the long planned strategy to find a replacement, a cabinet [ph] replacement for me, might be the opportunity for us to finally get a good CEO in here to run things. I have announced that I will be leaving at the end of the year, as many of you know my 65th birthday is next month and the Board is working on very diligently on developing a smooth transition plan for us to bring in some people to look at from the outside. We’re interviewing internal candidates and we’re trying to find the best person to come in and help us strategize and implement strategies for Gentherm for the next period. So we're very excited about that. I personally I am very excited about it, but I'm also very excited about the business and we've got a year to complete. So we're very excited about what we want to get done. And the second quarter was a good solid base for that, the first half which is in good position to be able to achieve our goals for 2017. We're going to hear some details on how the first half and second quarter have gone from Mr. Barry Steele, our alerted CFO. Barry?

Thank you, Dan. Thanks everyone for joining us today. Our before tax earnings for the quarter was $10.9 million. This included a significant unrealized currency loss totalling $12 million. The unrealized currency loss similar in nature to the $7 million gain during the 2016 fourth quarter was mainly the result of the stronger European euro in the quarter. We hope that significant amount of our cash in US dollars at our foreign subsidiary. We also have significant inter-company current account, which you know, US subsidiaries and our foreign subsidiary. These balances which continue to grow over time, our market adjust to each period resulting in an unrealized loss in the current quarterly period and both gains and losses in other period. These gains and losses are reported in our income statement rather than through our currency translation adjustment account and of guarantee [ph] as is the case for other foreign balance sheet account. Further strengthening as we have seen here in July will likely lead to further unrealized currency losses, whereas European Euro weakening will reverse the effect and we would enter [ph] for unrealized gain. Our quarterly revenue grew to $243.4, which is an increase of $10.7 million or about 5% compared with the prior year. This increase was not – was completely organic, as the prior year comparison now has a full amount of revenue for CSZ, our 2015 acquisition. This time revenue growth came primarily from our non-automotive businesses, which on a combined basis contributed $6.7 million of the higher revenue and grew by 32% over the prior year. Global Power Technology or GPT continue to benefit from better market conditions and shipments of programs deferred in the prior year [indiscernible] Sub-Zero or CSZ benefited from strong shipments and custom climate chambers, as well as improved revenue in its medical product business over the prior year. Our automotive products grew off - also grew by 2% percent during the quarter. This slower pace was impacted by lower industry deal production volume. For example, according to IHS data, vehicle production in North America are most important market as Dan mentioned was down by nearly 4%. Revenue for our climate control seat products, which were disproportionately impacted by this headwind was lower than the prior year partly due to a change in some programs and the higher price heated and cooled version to lower price heated and validated [ph] version. Revenue on all other automotive products was positive, beating the industry production trend. We continue to forecast 2017 revenue growth of 5% to 10%. However, the lower end of that range is more likely given a lower growth during the second quarter and continue softness in projected automotive industry production volume. This outlook also consider the small benefit from currency translation, a higher euro in particular, continued organic growth for CSZ, continued penetration of our automotive products, continued recovery for GPT and the first very small amount of shipment of the new advanced battery thermal management product. And for that only in our press release today you'll see that we've now broken out our lower based battery thermal management products with [indiscernible] in our product line for some time a smaller amount, but in - we'll be showing that along with the advanced battery thermal management product on portfolio [ph] basis. Our gross margin was 32.2% during the second quarter. This is higher than the prior year second quarter of 38.7%. However, the prior amount grew that onetime acquisition related purchase accounting adjustment for CSZ totalling $4 million. Adjusting for this one time charge, the prior gross margin was about the same as the current second quarter or 32.4%. This amount was lower than the 2017 first quarter amount of 34%, mainly due to a mix shift at CSZ favouring the industrial end [ph] product, which included some large custom program which experienced some cost overhead. Our gross margin percentage tends to fluctuate from period-to-period due to mix shift, currency translation adjustment and other factors. The lower second quarter margin represents the lower end of that range, whereas the higher first quarter margin would represent the higher end. Our operating expenses were again higher than the prior year and totalled $53.2 or a $4 million or 8% increase. This increase includes $2.6 million in higher equity incentive compensation resulting from a higher trading price adjustment common stock during the quarter. As in the last three quarters the rest of the increase comes in the form of investment or higher development cost for many new price initiatives some of which we have announced like the battery thermal management product and electronics products and some we have not yet announced for strategic improvement or for strategic improvements in our business systems. Our earnings per share of $8.5 million was $0.22 per diluted share. On a non-GAAP basis adjusting for the unrealized currency loss and acquisition related amortization, the earnings were about $0.53 per share. This compare to a similarly adjusted non-GAAP amount of $0.57 per share during the second quarter of 2016. During the first quarter we had favourable operating cash flow totalling $27.5 million. Our cash of $164 million increased similarly by $30.2 million during the second quarter. Outstanding debt was $153 million at the end of the quarter, which reverses our net debt position of $29 million at the beginning of the quarter to a small net-net cash positive position of $1 million. Available borrowing capacity and our revolving credit facility is still $203 million, which brings our total available liquidity along with the cash to $358 million. Dan, that’s all I have. I would turn it back over to you.

All right, Barry. Thanks for your usual very concise and detailed report. Don't you love how excited he gets when he talks about foreign currencies and the measurements. But for us right now, we’d like to open the floor to questions, as we said, we think we had a pretty solid first half and we'd love to hear what you guys had to think. Operator, we're ready for our first question.

Thank you. [Operator Instructions] Our first question comes from the line of Matt Koranda with ROTH Capital Partners. Please proceed with your question.

Hey, guys. Good morning. Just wanted to start off with, trying to model the implied revenue guidance for the second half. So I need to remove about $30 million from my estimates. Can you just help a bit more with some color on sort of where we should be looking at cutting in terms of product groups? I know that CSZ and GPT are still running pretty strong. Should we be mostly looking at cutting CCS and seat heaters?

I think that from our comments you have heard that we have seen some weakness in the North America market. There is also significant weaknesses in European market right now as well. So when we look at the market going forward, the general - the overall market is shrinking in these two areas, there is a bit of a slowdown. We are doing better than slowing down, but there is definitely going to be weakness in the automotive sectors.

Got it. And then could you help maybe with the Q3, Q4 cadence as well, I mean it seems like a lot of those shutdowns are happening in Q3. So we should be dialling that back a bit more, but any additional color there in terms of the breakdown?

Well, honestly Q4 has always been a weak quarter for the auto industry worldwide. So any business that's got predominance of its revenue coming from the automotive industry was used to seeing a pretty soft December. This year we'll see a little bit more, I would say slowdown in North America and Europe in the third quarter. So I think you're going to see most of the balancing I think will probably come out of the third quarter, as the North American clients seem to be trying to balance their stocks back down a more rational basis. Ford in particular is taking some steps, but they still have pretty good inventories. GM has taken some steps, their inventories are responding. But there's still a lot of work to go to get their inventory levels back down to what they are now calling their traditional run rate. So we're going to see some slowdown, this is pretty significant I think in the third quarter, especially in the early parts of the third quarter or so.

what I would add to that Matt, is given the strength in the – of the non-automotive businesses and how they offset the auto space, we see them - some of these shift in auto also being clearly offset in the future period as well. So I think that sort of the peaks and valleys that you might normally see in terms in auto will be a little bit muted by these other businesses, as different things occur. You know, as you know that GPT business has a tendency to fluctuate a bit. So I think that you won't see a lot of peaks and valleys in the next couple of quarters and will be a little bit closer to even with each other.

Got it. Okay. And then you guys discussed the production weakness in Europe, in North America relatively clearly here. But could you guys just talk about the dynamics that play in Asia right now. I know the China markets maybe up a touch this year, but it looks like mostly kind of locally and gaining share there. So one, maybe you could just discuss the dynamics there for the rest of the year and how that feeds into the revenue outlook? And then two, you know, is it worthwhile to pursue business with some of the local brands in China, can you earn your margin there? Do they see value in the heat and cool or heat and ventilated products or even better thermal management?

Sure. Well, for us when we say our Asian business, we don't just mean China, we mean Korea, Japan China and all of Southeast Asia. So for us the Chinese market of course is a very significant business. And you're right, it is showing some signs of strength and you're also right most of that strength is the locals and most of the locals are producing, I would say, what I would call a global since entry level of mid-range automobiles. Our products are well thought of in China. We are considered to be a very strong supplier of the Chinese market. We've been present there for decades. We are the main supplier for our products to all the Chinese OEMs, as well as the international transplants. Our biggest customer base there right now is the international transplants. But we have great working relationships and we're developing very tight relationships with all of the domestics who are kind of pulling away from the pack. And I think that's going to be a significant area of growth for our company in the long-term future. But right now it's still not just a Chinese market, it also includes the Korean and Japanese market. The Korean market for us has been a little bit flat this year, not doing too bad, but they are little bit flat to what we would hope, the Japanese markets doing very well. So overall, I would say that our outlook for the Asian market is pretty good and the long-term outlook for our Asian markets with the advent of the Chinese market developing and maturing, particularly the local domestics as they migrate up to upper mid range and eventually ultimately up to the luxury car brands is going to be very, very good. Our products and our company and our people are very well accepted in the Chinese market as local. So I think that’s a good spot.

Great. Okay. Maybe just last one for me guys. Gross margins for the remainder of the year, I know you mentioned kind of the low end bracketed around the 32% range, the high end 34%. And things can kind of swing quite a bit. I guess we've seen in the last couple of quarters based on contribution from CSZ and GPT. So as those kind of increase is part of the mix in the back half of the year, I guess my assumption is that that those would drive the gross margin toward at least the middle to the higher end of the range. But can you help us understand the puts and takes there for the remainder of the year?

Barry, you would answer that.

Sorry.

Yeah. Let me answer that. I would say that this as we indicated, this is sort of lower end of our range. It's very specific to this quarter, I think that as you kind of look at future growth of the other non-automotive - non-automotive business has certainly helped us, they just didn't help us quite as much in this period. So I would be expecting more in the middle of that range, we won't be at the very high end of it, but certainly not at the low end of it either.

I would reiterate that, that would be what I would say, I would say that this 32 that you saw this quarter is kind of going to be the low watermark and you'll see closer to the 33% and 34% in subsequent quarters.

Got it. Okay. I then we’ve got a couple more quarters Dan I think on the call, but just wanted to extend my congrats for the retirement and say that we’ll definitely miss your good humour on these calls. So I'll leave it there.

Don't worry, I'll be around. I'll still be on the board of directors, so.

Thanks.

Thanks, for your comments Matt. And thanks for your questions.

Thank you. Our next question comes from the line of Christopher Van Horn with FBR Capital Markets. Please proceed with your question.

Good morning. Thanks for taking the call and let me echo the congrats Dan on the retirement.

Thank you.

So you know, I think it makes sense where the headwinds came from you know, just a production standpoint. Have you ever disclosed your kind of passenger car versus SUV/truck mix, because obviously I think passenger cars are a little bit weaker here as we head to the back half and into next year? But I was just curious if you've ever disclosed the mix there?

I don't believe we ever have. I think we might have early, early on, when we had a dozen platforms, but now that we have thousands of platforms it's kind of an onerous task and we don't really separate or segregated that way in our own minds or in our management of the business. Right now we're seeing a lot of - you're correct, right now we're seeing a lot of shrink in SUV and pickup trucks still. We have seen shrink there all along, but we're continuing to see that. And you're right, the weaknesses are fall-offs in Sedans, what I would call Sedan. So we don't segregate it, break it out, but your assumption is correct.

Okay. And then you know, I'd like to kind of highlight [ph] to the accelerating growth in some of these other business and in auto, and I know they're a little bit small relative to CCS and heaters. But can you kind of identify is that taking share of those new programs and I'm specifically talking about cables. You know, the legacy BTM here and then some other automotive that you have cited here?

Yeah, look it's a combination of all of those. Actually the CSZ, our medical business is doing very well, as Barry has explained quite eloquently. We've made a decision a while back that we would be better off, better served by having our own direct sales force. We have a good portion of those people completed their training and in the field now and doing good work for us. We're starting to see some very good results from that. We expect better results from that, as we go forward and we complete our sales team and the support teams necessary to take care of the medical customers there. Our industrial business, we expect – sorry our industrial chamber business, we expect to see good results there. We've had some pretty good results and we've got - our new team is being focused on trying to find better and bigger projects for that group. So we expect to see that growing and healthy and profitable as well. The Global Power from electric unit GPT Group is beginning a slow and steady rebound out of the trough was the oil crisis and we're seeing good solid work by that team scrapping and fighting for every order around the world and they are beginning to see some order, so that's again very good. We're very excited about the fact that these non-auto units are doing so well, because while you pointed out they're small, they are very profitable and they are very good opportunities to grow for us. So that's kind of my - I guess my - sorry the non-auto, sorry the auto segments that are growing, the battery thermal management piece that Barry pointed out, we've been passed by a couple of our customers as we've been working into this battery thermal management areas. Some of our customers have different challenges and we had to design some very specialized equipment to help in this case ventilate [ph] some of the battery chambers and more traditional cars and that business has been - has not been considered a part of the battery thermal manager group. Until recently we looked at it and saw that yes that should be a part of that effort. So we've kind of reclassified that from you know, pure automotive and to be batter thermal management group. And there's continued growth and lots of good success there for us as well. These require very specialized products that have to survive in some very harsh environments and perform some very tight specifications. The non-auto group, also for us the battery thermal management group, the traditional we call the battery heating and cooling system. We'll be getting revenues in the fourth quarter. So we're excited about that, everything there is going well according to plan.

Great. Thanks for all the color and I appreciate the time.

Thank you.

Thank you. Our next question comes from the line of Steve Dyer with Craig-Hallum. Please proceed with your question.

Thanks. Good morning Dan. Congratulations on a good long run as CEO. As we look at it I guess CCS business over the last I guess, six or so quarters, it's reverted to you know, kind of a growth rate more in line with overall global production. I know you have kind of the mix headwind to keep vent. But I'm just wondering kind of what you're seeing in new program wins, it seems like maybe that's been a little slower than in years past and maybe within the context of how penetrated or saturated you feel like these seats are kind of within the target market? Any color there would be great.

Well, I think there's tremendous growth with CCS product line. The heat and cool than heated ventilated combined. Heat and vent is going to be and always was planned to be a much more significant segment in terms of growth and revenue than CCS was. CCS, the heat and cooled seats were always targeted to the high end luxury market, that's only about 10% to 15% percent of the cars built in the world. The heat and vent is targeted to the midrange and can go all the way down to the entry level models because of lower power requirements and because of the cost concerns. And we know that's going to be a big segment and it's proving to be true. Where we do see customers contemplating, shifting from heat cooled over to heat vent the take rates – and the early take rate indications are that heat vent is going to be on more vehicles than the heat cooled was simply because of power constrain and because of cost. So in the long-term they're still very solid growth available for both of those two sub-segments. I remind you that we have virtually zero customers for heat cooled products in Europe and we have a kind of an early stage market in China that's beginning to appreciate the luxury segments and the local domestic markets you're trying to get into that set. So we're going to see growth in heat cool and in heat vent and I think you're going to see the growth in heat vent outpace the growth in heat cool, but you'll see growth in both segments.

Great. That's helpful. So over the last couple of quarters would you say that kind of the slowing growth is more a function of the mix headwind as it relates to revenue or have you shipped maybe a little air pocket as it relates to just whether it's new you know, new models being released et cetera? What’s - I guess, what sort of has that growing low to mid single digits lately?

Yeah, I think that's a good part of, what you saw - like what we saw last year, where several of the platforms that were scheduled to be released with heat cooled were pushed out because of the auto industries fear of this existing downturn that we're in right now. And now that we're in this downturn, there is a reluctance to push new features or new models into the marketplace. So that will slow things down and has slowed things down for the past year, year and a half. And it's a phenomenon that we think is temporary, it's not something that we certainly haven't reached anywhere near a saturation point for either of the two products. In fact, we just barely hit into the heat vent business. A lot of our customers are appreciating the fact that heat cooled in particular contributes greatly to the overall HVAC [ph] cabbage strategy. Many of our customers are looking at what their long-term future product looks like in terms of how they heat and cool and how they keep the occupants warm. There's a big shift coming in powertrains and how cars are going to be pushed down the road. You probably saw this week that England announced that they are going to have no new diesel or gasoline vehicles registered after 2040. They're going to go all non combustion engine system. So that brings a whole new set of challenges for the automakers and a whole [ph] electric system that makes heating and cooling and delivers that energy through a seat or through a seatback or through a ceiling or through a door panel or even with dash [ph] will be I think a very attractive product.

Great. That's very helpful. As it relates just to the heat vent business. That's been one that's been sort of more susceptible to chatter of competition over the last, I don’t know, years and years and years. Have you seen anything really different there in the last 12 months or is it sort of as it's always been?

Yeah, we're still seeing the same players, that people like some of the German OEMs are still making their own. They've been - they've been reconsidering that strategy. I think they're working. They're evaluating all of our products with us and we're making very good headway there. The same other players, the typical seat heater suppliers, who are slapping fans [ph] on their traditional seat heaters and offering them into the market places cheap alternatives are still out there. So there's nothing really big or significant changing there, although we are putting a big push on trying to you know, make sure that people understand the advantages of our technologies. Our vent system is not like everybody else's heat vent systems. They were better. They are easier to package and they are, I’d say cost competitive with anything in the marketplace.

That’s helpful. Thanks, Dan. And then Barry one last housekeeping I guess, question for me. Operating expenses were a bit higher this quarter and I'm having trouble just with the stock comp piece of it, trying to figure out maybe what was one time, should we kind of grow from that $53 million number going forward? Or was there something that won't repeat there?

While the year-on-year variance for the stock comp was $2.6 million, I think that gets a little easier as we move to the next quarter, because we didn't have the favourable benefits in the second half of last year, as we did in the first half, so you could probably sort of even that out a bit. Other than that nothing really unusual, I think we will – you’ll see R&D continue to climb slightly. We still haven't even met our internal plans for getting the resources required to get some of the things - the things were working on completed, but it won't be – I don’t think it’s dramatic what you’ve seen in this particular quarter.

Great. Thank you.

Thank you. Our next question comes from the line of Gary Prestopino with Barrington Research. Please proceed with your question.

Hi, good morning. Just want to drill down a little bit on you know, automotive and your forecast at the beginning of the year versus where we are now. I mean, with the production volume declines in North America, does that kind of take you by surprise in terms of more of a decline than you had initially thought at the beginning of the year?

Yes, in a word it did. We knew there would be some softening in the market from the overall economic pictures of what we were seeing in terms of numbers. But I think it didn't only surprise us, I think it surprised the hell out of Ford and GM who were running along at their normal - fairly normal production rates have suddenly found themselves with over 100 days of inventory across the board. So I think it's been a big surprise to everybody.

Okay. And that's – I know GM, ramped up production and now they're scaling back, that’s why I wanted to ask that question. And then in terms of the gross margin where you say we're kind at a low watermark and it should be 33% to 34%. Does that entail what happened in Cincinnati Sub-Zero was somewhat of an outlier this quarter in that the environmental test chambers grew at a higher pace than the blood product? And you know, is that pace of the blood product growth is that's slowing now just because there is some catch up from the competitive product that had some issues in the market?

Yeah. Our Hemotherm product and we believe that we have kind of satisfied all the short term kind of emergency demand that we saw, that we're still seeing. We still believe we see good growth of the Hemotherm product and we have another product that's coming out, that will be so primarily in Europe, but it's a another similar type of blood heating and cooling unit that's coming into the market right now. So yes, there is a little bit of a shift in - I'd say a good normalization of demand there. And back on the industrial chamber business, we had a couple of very large programs that were kind of legacy pieces that were - some of these programs are you know, they are big enough to put a house, that they look like houses, that when we see them on the floor and when we ship these things it's a huge piece of revenue. And then we don't always make a huge same kind of money that we do in other the project. So what we're trying to do is to make sure that we do a better job of getting our margin requirements out of a growth business there as well.

Okay. Thank you.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to management for closing remarks.

Thank you very much, operator. And thank everyone for joining us on our second quarter review and first half summary. I think we had a very good first half of the year. The market is slowing down a little bit in North America in the automotive sector and also in Europe. We still have tremendous opportunities in each of those markets despite that overall market softness we still have good opportunities for new products and new penetration. We've got a lot of good people working very hard. And as I said earlier, I'm very pleased to announce that my retirement from this team after 22 years of being with the company. It's been a great honour and a privilege to serve with each and every one of these folks that you see carrying Gentherm business cards. It's been an honour to serve with each of our board members past and present. And I look forward to the next six months of identifying the new CEO who's going to come in and help us set the new tone [ph] for the future of the company. And I will continue to work with that person and this team as a member of the Board of Directors. So we will ask everyone to come back in about 90 days and see how the third quarter actually turned out. Operator, thank you very much. Good bye.