Gentherm Incorporated (THRM) Q3 2020 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Gentherm Third Quarter Earnings Conference Call. As a reminder, all participants are in a listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Yijing Brentano, Investor Relations. Please go ahead.

Thank you, 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, we may make forward-looking statements within the meaning of federal security laws. Statements reflect our current views with respect to future events and financial performance. We undertake no obligation to update them, and actual results may differ materially. Please see Gentherm's SEC filings, including the latest 10-K and subsequent reports for discussions of our risk factors and other risks and uncertainties, underlying such forward-looking statements. During the call, we 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 our earnings release or investor presentation. On the call with me today are Phil Eyler, President and Chief Executive Officer; and Matteo Anversa, Chief Financial Officer. During their comments, Phil and Matteo will be referring to a presentation deck that we have made available on our website at gentherm.com/events. After their prepared remarks, we will be pleased to take your questions. Now I'd like to turn the call over to Phil.

Thank you, Yijing. Good morning, everyone, and thank you for joining us today. In the third quarter, the global pandemic continued to create challenges and uncertainties worldwide. However, the automotive industry has seen a recovery from the extremely low second quarter production level. I'm very proud of the global Gentherm team for the continued strong execution of our focused growth strategy while maintaining the health and safety of our team members. Let me start by sharing some of the key highlights of the quarter on Slide 4. In the third quarter, we generated our highest quarterly revenue in two years despite divesting all of the non-core businesses as part of the focused growth strategy. In Automotive, we delivered the highest quarterly revenue in the history of the company, and we outperformed light vehicle production in our key markets by approximately 800 basis points. More importantly, new launches, higher take rate and added content per vehicle, including electronics, battery thermal management, as well as climate and comfort solutions for second and third rows, positioned us to continue to outperform light vehicle production. In Medical, we again delivered double-digit revenue growth. The momentum on the top line, along with our relentless focus on productivity, enabled us to achieve the highest quarterly gross margin and gross margin rate in three years as well as record quarterly operating income and adjusted EBITDA in the company's history. On the award front, we secured approximately $80 million in automotive new business awards in the third quarter. This award level is lower than we anticipated, and it reflects the limited opportunities in the quarter, as OEMs continue to conservatively manage sourcing decisions, and thus, pushed out the timing of several awards. That said our RFQ pipeline remains strong into the upcoming quarters. On the operations front, our global manufacturing and supply chain teams performed exceptionally by quickly pivoting to meet the increased demand from our customers, while still assuring safety of all of our employees. Even with the increased working capital needs in the quarter, we were able to generate $20 million in cash flow from operations. Importantly, our balance sheet remains strong with total liquidity of nearly $450 million at quarter-end. Matteo will provide more details on our financial results in just a few moments. Now turning to Automotive highlights on Slide 5. In the third quarter, we launched our automotive solutions on 29 different vehicles across 14 OEMs, including Daimler, FCA, Great Wall, Hyundai Kia and Volkswagen. We continue to see momentum for our CCS products and launched on the Buick Envision, Jeep Compass, Kia Sorrento and the Mercedes S-Class, our first CCS launch with Mercedes. In addition, our innovative combined steering wheel heat and hands-on-detection sensor solution launched for Volkswagen, is now available on an increasing number of name plates, including the Golf8, Tiguan L Coupe, Skoda Octavia, Karoq and Kodiaq, as well as multiple vehicles manufactured by SEAT. The ramp-up of this solution has exceeded our expectations. On the technology front, our strong progress on ClimateSense development projects continues. Recall that in 2019, General Motors and Gentherm jointly presented our development project results at the Society of Automotive Engineers Thermal Management System Symposium. And these results were subsequently highlighted in a number of industry publications. I'm very pleased to announce that General Motors has decided to extend our partnership, and we've kicked off a third phase of the advanced development project. Our growing portfolio of development projects with OEMs in North America, Europe and Asia demonstrates that our ClimateSense offering is a compelling solution for passenger comfort and energy efficiency in future vehicles. Lastly, I'm pleased to announce that Gentherm was named a top North American supplier by Honda, one of only 41 suppliers out of a total of 735. I'm proud of our team for winning the top North American Supplier for our excellence and value. This recognition reflects our commitment to developing innovative solutions and our team's dedication and commitment to quality, innovation and operational excellence. Now on to Slide 6, where you can see that in the third quarter, we secured approximately $80 million in new program awards across six different customers. Even though automotive production rebounded in the third quarter, OEMs remained cautious, and have shifted out the timing for awarding a number of projects unless we're in the middle of several RFQs that we expect will lead to significant awards in the upcoming quarters. In the third quarter, we won multiple CCS awards including platform wins with BMW X5 in China and PSA. Of note, this is our first CCS award with the French OEM PSA in China. In addition, we received multiple steering wheel heater awards from FCA, as well as an additional award from one of the largest electric vehicle manufacturers. On the Battery Thermal Management front, we continued to make progress in expanding our business, winning air cooling awards with both Hyundai and Kia. Moreover, we partnered with OEMs such as General Motors, Great Wall, Hyundai and Kia to drive significant take rate increases in products like CCS, seat heaters and steering wheel heaters. For example, our revenue from Great Wall doubled in the third quarter as compared to the prior year period. The majority of the growth resulted from our China team's efforts to drive incremental CCS take rate on the popular Haval Hover H6 and H7 SUVs. New and follow-on climate and comfort awards, new technology launches, increased content per vehicle, as well as strong take rate increases demonstrate the continued momentum we have in Automotive. Now let's turn to Slide 7 for a discussion of our Medical business. In the third quarter, we continued to see double-digit revenue growth, growing 17% year-over-year. I am pleased to share that approximately 1/3 of this growth is driven by incremental sales of Stihler blood warming products, proving the growth synergy we expected from this acquisition. In addition, Blanketrol and Hemotherm equipment demand continued to grow in international markets, including Spain, Brazil and Hong Kong. Although we saw some recovery in elective procedures, we believe it could be some time to return to normalized levels. Finally, I'm excited to report that we achieved an important milestone in our Medical business recently. We received 510(k) clearance from the FDA, and have added the ASTOPAD patient warming system to our product portfolio in the United States. This system can be utilized in all surgical procedures and helps prevent and treat hypothermia in patients throughout the perioperative journey. Introduction of the ASTOPAD patient warming system demonstrates our deep understanding of human thermophysiology and how we're able to leverage technology from our Automotive business to provide advancements in patient temperature management in our Medical business. Our unique carbon fiber resistant heating technology was originally designed for comfort, warmth, reliability and safety in automotive passenger thermal management. This technology is ideal for the operating room and anywhere in a hospital when medical professionals need quiet, comfortable and reliable warming to help prevent and treat hypothermia in a surgical patient. Now before I close, let me remind you of our four pillars of the focused growth strategy on Slide 8. One, accelerate core automotive Climate and Comfort growth; two, introduce our innovative microclimate solution ClimateSense; three, drive Battery Thermal Management; and four, expand patient thermal solutions. All of this is enabled by our electronics and software systems. We're very pleased to see significant progress on each of these pillars, and more importantly, the growth generated by our focused growth strategy. Now let me summarize on Slide 9. Our results in the third quarter demonstrate continued successful execution of our strategic plan to focus growth, realign our cost structure and bring innovative solutions to market. This record performance is attributable to our global team and their dedication and agility to successfully deliver on our commitments to our customers during these unprecedented times. While there's still certainly near-term uncertainty in the macroeconomic environment, our improving operating performance, expanding technology leadership and strong balance sheet give us confidence in delivering long-term shareholder returns. With that, I'll turn the call over to Matteo for a little more color on the financial results.

Okay, thank you Phil, and thank you to everyone joining the call today. So let me start on Slide 10 and focus on the items that most significantly impacted our third quarter results. For the quarter, our product revenues increased by 8% compared to the same period of last year. And if we adjust for the impact of FX and divested assets, our overall product revenue also increased by approximately 8%. Starting with Automotive, Automotive segment revenue was a quarterly record of almost $250 million, a 9.4% increase compared to the prior-year period. Adjusting for foreign currency translation, Automotive revenue increased by approximately 8%. In comparison, according to IHS' latest data, light vehicle production for our key markets of North America, Europe, China, Japan and Korea was essentially flat compared to the prior-year quarter. As a result, we outperformed light vehicle production by approximately 800 basis points. We saw strength in virtually all of the Automotive product lines and more specifically, Steering Wheel Heaters revenue increased by 35% compared to the third quarter of last year, as a result of the newly-launched hands-on detection-enabled heaters with Volkswagen that Phil just mentioned. BTM revenues increased 34% as a result of the new cell connecting board solution that we launched in the new e-Mini, as well as strength of our BTM products with FCA, primarily the battery heating solution for LGChem. Electronics revenue increased 23% due to the Memory Seat Module program with Ford and the recovery of the RV market. CCS revenue has increased 10% primarily due to higher volumes with Hyundai Kia, General Motors and Daimler. These increases were partially offset by decreases in Automotive Cables and Other Automotive. If we move to the Industrial segment, revenue decreased 17% due to the disposition of the GPT business, which occurred on October 1, 2019. Conversely, we saw continued strength in our Medical business, where revenues increased more than 17% year-over-year, primarily due to the higher demand of the Stihler resistant blood warming products, as well as growth in Hemotherm and Blanketrol sales. If we move to gross margin, gross margin rate for the third quarter was 31.8%, the highest rate in the past three years. And this compares to 31.1% in the year ago period. The 70 basis point increase was driven by labor productivity, including the fixed cost leverage due to the volume increase, as well as supplier cost reductions and positive mix. And these were partially offset by annual customer price reductions and wage inflation. Moving to operating expenses, which were $44.1 million in the quarter compared to $54.4 million in the prior year period. The current year amount included $0.3 million of restructuring charges. And this compares to last year's third quarter when we incurred approximately $8.7 million of restructuring charges, primarily related to our footprint realignment project that we announced in September 2019. If we adjust for the restructuring charges in both periods, operating expenses were $43.8 million, down from $45.7 million in the third quarter of 2019. The year-over-year improvement of 4% was primarily driven by the impact of the divestiture of GPT, lower SG&A due to decreased headcount, reduced travel cost, as well as lower consulting and R&D costs. This positive effect was partially offset by incentive compensation adjustments. Now please keep in mind that the reduced operating expenses are also a result of reduced travel, trade shows and other activities which will resume once the COVID restrictions are lifted. Adjusted EBITDA of $50.1 million, the highest in the company's history, increased to more than $9 million or 23% from the prior year period, in addition, the adjusted EBITDA rate of 19.3% improved 230 basis points. Finally, adjusted EPS in the quarter was $0.91 per share compared to $0.68 per share in the third quarter of last year. And our tax rate in the quarter was approximately 28.5% in line with our expected range of 27% to 29%. Now moving to the balance sheet on Slide 11, our cash position at the end of the quarter was approximately $230 million including $2.5 million of restricted cash coming from the disposition of the CSZ Industrial Chambers business. Our cash position in the quarter increased by $17 million from the end of the second quarter, primarily as a result of the $23 million of cash generated from operating activities. Net debt decreased by $22 million by negative $9 million last quarter to negative $31 million at the end of the third quarter and total debt stood at approximately $195 million. Similar to last quarter, as of September 30, we were in a net cash position, as cash on hand exceeded the gross debt. And as a result, our net leverage ratio was negative 0.24. Based on the trailing 12-month consolidated adjusted EBITDA end of September 30, we had approximately $221 million of remaining availability on our line of credit, up from $159 million at the end of the second quarter. And total available liquidity at the end of the third quarter was $448 million, up from $369 million at the end of last quarter. As you're aware, we withdrew our guidance for 2020 in late March due to the uncertainty of the macroeconomic environment. However, while we have not provided specific guidance, based on current customer demand and assuming no significant market changes due to the resurgence of COVID, we're expecting fourth quarter product revenues to be in the range of $240 million to $260 million, reflecting our typical fourth quarter seasonality and launch timing. As a result, we expect the gross margin rate to decrease in the fourth quarter as compared to the third. And in addition, we expect higher operating expenses in the fourth quarter, primarily due to the timing effects of R&D project spend. In conclusion, our global team delivered strong financial results in the third quarter, including a number of company records, all under unprecedented and extremely difficult circumstances. While the macroeconomic environment remains uncertain, the results that we achieved in the third quarter are strong proof points of the positive impact of the focused growth strategy on our financial results. And with that, I'll turn the call back to the operator to begin the Q&A session.

Thank you, sir. [Operator Instructions] Our first question is from Gary Prestopino with Barrington Research. Please go ahead.

Good morning, everyone.

Hi, Gary.

Hi. Phil, you often have said in prior calls, what percentage of, I guess, these RFQs that you're winning. Are you still winning things in the high-80%, 90% range that you're trying to get in the fold?

Yes, Gary, this was a good quarter. We were above 80% in the quarter.

Okay. 80%. Okay, good. And then in terms of some of this pushback on – you see the model rollouts or new awards, do you feel that in Q4, you're going to see a plethora of decisions made on things that were pushed out in Q3, or could this even dribble into 2021?

Well, yes, I think we feel pretty good about Q4. Again, there's still some uncertainty there, but based on what we see right now, we see a pretty good path to likely achieving a little bit higher in the second half than in the first half. That should give you a little bit of a feeling for what we expect in Q4. But I will say this; the pipeline going forward is still really strong.

So the pipeline is pretty ebullient?

Yes.

Okay. That's good to hear. And then just in terms of what's going on with the battery thermal management products and all that, could you give us some idea of how many actual models, at least on the EV side, that you guys participate in for this – where are these Battery Thermal Management products?

I don't have the number of specific models, but just to give you a sense, certainly if you look at our thermoelectric BTM, we're on all of Daimler's 48-volt mild hybrid systems; and also have new platforms with Jeep on that program. And then in terms of the resistive heat using our innovative thin foil technology that just launched on the Jeep Renegade and Compass. And we've got some upcoming programs using a similar technology for Cell Connecting. Unfortunately, we haven't been able to announce those platforms. And then if you look at air cooling, there are, I would say, over a dozen programs just to estimate, but that one is rolling out pretty prevalently in terms of air cooling. Good momentum there. Then thinking about EVs, just to expand on that beyond just the BTM, of course, our Climate and Comfort products where the CCS seat heat or steering wheel are really rolling out significantly on EVs.

Okay. And then just lastly, and I'll let somebody else get in. On the OpEx side, in a normalized environment, Matteo, where you're doing traveling and trade shows, would that OpEx as a percentage of sales maybe tick up 100 basis points to 200 basis points versus where it was this quarter? I mean, it was about 17% of sales now. Do those – some of these categories that – of expenses, how much would they raise that number? I'm just trying to get an idea, with all that you've done, what would be a good run rate as a percentage of sales for OpEx?

Yes. So I think, Gary, the way I would look at a couple of things, I would say, more – let me start with the longer-term first and then I maybe bring you back a little bit on the fourth quarter and what we've seen more short-term. So longer-term, our target remains to have OpEx as a percent of sales between 15% and 17%, as we outlined that in the Investors Day back in June 2018. So that's the number that we are shooting for.

Right.

More short-term comment regarding the fourth quarter, so we are – I would expect the OpEx in the fourth quarter to increase sequentially compared to the third by, say, a couple of million. And this is really primarily driven by timing of R&D expenses, as a result of the fact that we have resumed some of the suspended OpEx, but primarily on the R&D side as a result of the improved market conditions. That's what I would expect for the fourth quarter. Then one last comment I would make, I think overall around the profitability that the team was able to deliver in the third quarter, I'd say that I think what we achieved, the 31.8% gross margin, the EBITDA rate about 19%, is really a proof point of the profitability that we can accomplish as a company, as we started to see improved revenue and we continue to focus on sourcing excellence, driving productivity at the factories, and obviously, tight expense management.

Okay. Thank you. Great answers.

Sure.

Our next question is from Matt Koranda with Roth Capital. Please go ahead.

Hey guys, good morning. I just wanted to clarify one of Phil's answers to Gary's question. It sounded like you said second half bookings could be higher than the first half. And I guess that would suggest that you'd be well north of $300 million in bookings potentially in the fourth quarter? So just wanted to get some color on that, and whether there are, I guess, just some large programs that are out there for bid at the moment and why the confidence that we get those booked?

Yes. We have a pretty significant pipeline, as I mentioned, RFQs that are in motion. And it's really about how the timing, the decision timing pans out. So the number you just said is right, obviously, if you do the math and put it north of the first half that would make sense. Still some uncertainty in the decision-making timing, but we think there's a path to get that done. And certainly, I'd think about it broader as the next couple of quarters, two to three quarters look really strong.

Great. And the mix of items kind of in the near-term pipeline is that more weighted towards CCS still, or is that sort of battery thermal management and steering wheel heaters? What's the sort of the mix composition of what's out for bid versus – maybe compare and contrast versus where we're at in terms of current revenue run rate and mix?

It's a good mix, and we typically don't break out the specific mix, but definitely, lots of CCS activity, good electronics activity. Actually, there's some decent opportunities there, and certainly, BTM is there as well. So it really covers just about everything we're doing.

Great. Okay. And then a question on the guidance in 4Q; I think it's well understood that we see the typical sequential decrease, just given the holiday shutdown schedules and whatnot. And so it makes sense that you see a sequential decrease in gross margins. But maybe could we talk a little bit about incremental margin, gross margin year-over-year. Any reason that we can't achieve sort of the solid 40% incremental margins that you did in 3Q? Maybe talk a little bit about the mix that's coming in 4Q and help us kind of triangulate around that to get to the right level of gross margin for 4Q?

Sure. This is Matteo. So I would say that I think what we have seen, even if you look at what we experienced between the second and third quarter, in general, our incremental – our gross margin over the incremental revenue tends to be between 40% and 45%. It was a little higher, on the higher side of the range in the third quarter. So I think that's a good number to use. And obviously, as we indicated in the revenue projection that we gave in the prepared remarks, this implies revenue in the fourth quarter, it is going to be slightly below what we experienced in the third. So I would expect, as a result of that, to have some decremental margin on the decremental revenue around 40%. So that's one thing that we're seeing in the fourth quarter. But I would also add another item that we are forecasting. We're expecting to have a little higher price reduction to selected customers in the fourth quarter compared to the third in conjunction with some big awards that we're working through that Phil just alluded to. So that's also an impact that we're seeing in the fourth quarter compared to the third.

Great. Very helpful on that front. And then just one more from me. The balance sheet obviously in great shape here. And just wondering preliminary thoughts on sort of reinstating the buyback and how we're thinking about deploying capital on a go-forward basis, just given the health of the balance sheet?

Sure. So I think one thing that we continue to monitor extremely carefully is how the macroeconomic environment reacts to the latest sharp increase in COVID cases, both in Europe and the United States. That's the first thing we are looking at. But overall, I think I'd say in terms of capital allocation strategy, I think these are the top priorities that we are [indiscernible] for most. We want to maintain the company safe and secure, so liquidity comes first. Second, we want to continue to allocate the proper amount of capital to continue to grow the company both organically and also inorganically, so towards M&A. And then third, the share buybacks. So that's the way I would think about – at least, how we are thinking about it right now.

Great. And as a follow-up, maybe Phil, could you talk a little bit about the M&A pipeline and how we're thinking about how that may be shaping up as we go forward here, and what – are we in sort of a target-rich environment, or are multiples sort of relatively stretched at the moment, just kind of given where the overall capital markets are?

Target-rich might be a little strong, but there's definitely activity. And a scenario, as I pointed out in the last quarter, we really focused – the first section of our focused growth strategy was getting our house in order. And we're getting the discipline in place when it comes to productivity and cost management and divestitures, et cetera, and I think we've passed that hurdle. It's a never-ending journey, but I think we've made good progress there. So definitely, our eyes are out for potential acquisitions that fit our focused growth strategy. And I think that's an important point that we'll be looking for technologies, expanding content in a vehicle that ties to our strategy. And so regional plays and of course, Medical, those are what I'd say are the four areas that we're looking into; and certainly, if we've got more resources, pursuing that at the moment.

Great. Very helpful guys. I’ll jump pack in queue.

Thanks, Matt.

Thanks, Matt.

[Operator Instructions] Our next question is from Ryan Sigdahl with Craig-Hallum Capital Group. Please go ahead.

Good morning. Two questions for me. So Auto production forecasts are expected to kind of be flattish to up sequentially Q4 versus Q3. Your revenue guidance implies a sequential decline. Any color there, I guess, on the puts and takes?

Sure, sure. Yes, I think a couple of key areas. One is that we've got some launch changes that occur in the fourth quarter. Especially one example is the Ford F-150, that's going through a changeover, a fairly big revenue product for us. We're going to see a little decline there. We also saw a little bit of upside in the Q3 period related to launches. And we've been launching a lot of new programs, both on core business, BTM, steering wheel heater product that is – by the way, we're really excited about that product. I haven't had a chance to highlight that. But with Volkswagen, we've launched a platform that not only heats the steering wheel, but is also used as a key sensor for hands-on detection. And Volkswagen is rolling this out across their lineup. So real excited to expand our technology offering; and I think that positions us well long term for growth with steering wheel business. Then on top of that, you've got shutdowns, the typical factory shutdowns that would occur in the December timeline. And as a Tier-2 supplier, you typically see that a little bit earlier. So those are, I'd say, the three big effects.

Good. Then a second one for me, you mentioned kind of ClimateSense third phase of a development project with GM, good to see. Also, working on it with BMW, so that one is going. And then if you're any closer to any other development projects? And then secondly, any thoughts on timing of when these development projects, how many of those phases you need before you could potentially see a commercial award?

Sure. Yes, I think – well, first of all, we have several development contracts underway right now really in all regions. So obviously, with GM, BMW. We have another OEM in Europe that we're working with and then also in Asia, so we've got our hands full with development contracts. And in terms of the process to award, obviously, this is a pretty significant architectural change in the car, so it's always a little bit longer process. We think this GM extension or next phase is a great indicator of how this thing is going to progress. Essentially, as the development contracts roll forward, you get into deeper and deeper levels of validating that the solution is viable in the vehicle. So we're really excited that we've been able to continue to show the kind of results that lead to ongoing development. Now timeline-wise, we're definitely looking at, I'd say, 2023 and beyond would be the earliest SOP. And clearly, we're hoping, in the not-too-distant future, to have some opportunities to announce awards.

Great. Thanks guys. That's it for me.

Thank you.

Thank you.

This concludes the question-and-answer session. I would like to turn the conference back over to Phil Eyler for closing remarks.

Great. Thanks, everyone, for joining our call today. I really want to again express my gratitude to the global Gentherm team, who have so impressively managed through the challenges of this pandemic. I especially want to highlight our manufacturing team. They've truly performed incredibly. I'm extremely proud of our team's relentless focus on operational execution, innovation and cost improvement in order to deliver on the commitments to all of our stakeholders. Despite the uncertainties in the macroeconomic environment, our strong liquidity, our relentless focus on productivity, enable us to continue to deliver significant long-term shareholder value. We certainly appreciate your interest and your support and look forward to keeping you apprised of our progress. Thank you.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.