Gentherm Inc (THRM) 2017 Q2 法說會逐字稿

Greetings, and welcome to the Gentherm Incorporated First Quarter 2017 Earnings Conference Call. (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 the Gentherm website. During this call, representatives of the company may make forward-looking statements within the meaning of federal security 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 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, 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 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 how things are looking in market in general.

On a personal basis, we also announced during the quarter that I am going to be retiring at the end of the year. I'd like to thank our Board of Directors for taking up the long plan strategy to find a replacement, a competent replacement for me, might be an opportunity for us to finally get a good CEO here to run things. I've 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 bit period. So we are very excited about that. I personally am very excited about it, but I am 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 puts us in good position to be able achieve our goals for 2017.

We're going to hear some details on how in the first half and in the second quarter have gone from Mr. Barry Steele, our learned 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 totaling $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 hold a significant amount of our cash in U.S. dollars at our foreign subsidiaries. We also have significant intercompany current account between our U.S. subsidiaries and our foreign subsidiaries. These balances, which continue to grow over time are market adjusted each period resulting in the unrealized loss in the current quarterly period and both gains and losses in other periods. These gains and losses are reported in our income statement rather than through the -- through our current translation adjustment account and the balance sheet as is the case for other foreign balance sheet accounts. Further strengthening, as we have seen here in July will likely lead to further unrealized currency losses whereas euro weakening will reverse the effect and we would then report unrealized gains.

Our quarterly revenue grew to $243.4 million, 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 2016 acquisition. This 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 Technologies, or GPT, continue to benefit from better market conditions and shipments of programs deferred in the prior year while Cincinnati Sub-zero, or CSZ, benefited from strong shipments in constant climate chambers as well as improved revenue in its medical product business over the prior year.

Our automotive products grew -- also grow by 2% during the quarter. This lower pace was impacted by lower industry vehicle production volumes. For example, according to IHS data, vehicle production in North America, our most important market as Dan mentioned, was down by nearly 4%. Revenue for our climate-controlled seat products, which were disproportionally impacted by this headwind was lower than the prior year partly due to change in some programs from the higher price heated and cooled version to lower price heated and ventilated version. Revenue on all other automotive products was positive, beating the industry protection trend. We continue to forecast 2017 revenue growth of 5% to 10%, however, the lower end of that range is more likely given the lower growth during the second quarter and continued softness in projected automotive industry production volume. This outlook also considers a small benefit from currency translation, the higher euro in particular, continued organic growth for CSZ, continued penetration of our automotive products, continued recovery for GPT and the first (inaudible) shipment of the new advanced Battery Thermal Management product. Incidentally, in our press release today, you'll see that we have now broken out our lower based Battery Thermal Management products, which we have in our product line for some time for a smaller amount, but in -- we'll be showing that along with the Advanced Battery Thermal project on a go forward bases.

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 year amount included a one-time acquisition related purchase accounting adjustments for CSZ totaling $4 million. Adjusting for this one-time, charge the prior year 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 favoring the industrial line of product, which included some large custom programs, which experienced some cost overruns.

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 will represent the higher end. Our operating expenses were again higher than the prior year and totaled $53.2 million for a $4 million or 8% increase. This increase includes $2.6 million in higher equity incentive compensation resulting from the higher trading price of Gentherm common stock during the quarter. As in the last 3 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 product and electronics products and some we have not yet announced, for strategic improvements -- or for strategic improvement in our business systems. Our earnings, our earnings per share -- our earnings 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 compares to a similarly adjusted non-GAAP amount of $0.57 per share during the second quarter of 2016. During the first quarter, we had favorable operating cash flow totaling $27.5 million, our cash of $164 million increased similarly by $30.2 million during the second quarter. Outstanding debt was $163 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 -- cash positive position of $1 million. Available borrowing capacity under 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'll turn it back over to you.

All right, Gary. Thanks for your usual very concise and detailed report. Don't your love how excited he gets when he talks about foreign currency remeasurements. For us right now, we would like to open the floor to questions. As we said we think we had a pretty solid first half and we would love to hear what you guys have to say. Operator, we're raring for our first question.

(Operator Instructions) Our first question comes from the line of Matt Koranda with Roth Capital Partners.

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've heard that we have seen some weakness in the North American market, there is also significant weakness of the European market right now as well. So when we look at the market going forward, the general -- the overall market is shrinking in these 2 areas , there's a bit of a slowdown. We are doing better than slowing down, but there is definitely going to be weakness in the automotive segments.

Got it. And then could you help maybe with the Q3, Q4 cadences as well. It seems like a lot of the shutdowns are happening in Q3, so we should be dialing that back a bit more. But any additional color there in terms of the breakdown?

So 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 is 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 third quarter. As the North America clients seem to be trying to balance their stocks back down to more rational basis. Ford in particular, is taking some steps, but they still have pretty good inventories. GM is taking some steps and their inventories are responding. But there's still a lot of work to go to get good inventories back down to what they're now calling their traditional run rate. So we're going to see some slowdown, pretty significant I think in the third quarter, especially early parts of the third quarter.

What I would add to that Matt is given the strength of the non-automotive businesses and how they, sort of, offset the auto space. We see them -- some of these shifts in auto also being clearly offset in the future periods as well. So I think that sort of the peaks and valleys that you might normally see coming from the auto, will be a little bit muted by these other business as different things occur. As you know, 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 it will be a little bit closer to each other.

Got it. Okay. And then you guys discussed the production weakness in Europe and North America relatively clearly here. But could you guys just talk about the dynamics at play in Asia right now. I know the China markets may be up a touch this year, but it looks like mostly kind of local OEMs gaining share there. So 1, maybe if you could just discuss the dynamics there for the rest of the year and how that feeds into the revenue outlook? And then 2, 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 heated and cooled or heated and ventilated products or even better at 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 are 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 that I would call in global sense, entry-level and midrange automobiles. Our products are well thought of in China. We are considered to be a very strong supplier in 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 are developing very tight relationship 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 a little bit flat to what we would hope, the Japanese market is doing very well. So overall, I would say, that our outlook for the Asian market is pretty good and 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 midrange and eventually, ultimately, up to luxury car brands. It's going to be very, very good. Our products and our company and our people are very well accepted at the Chinese market as local. So I think that's a good spot.

Great. Okay. Maybe just a last one from me guys. Gross margins for the remainder of the year I know you mentioned kind of the low end is 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 in contribution from CSZ and GPT. So as those kind of increase as part of the mix in the back half of the year, I guess my assumption is 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?

Yes --

Barry, are you going to answer that?

Sorry.

Yes. Let me answer that. I would say that as we indicated, this is sort of the lower end of our range. It's very specific to this quarter. I think that as you kind of look at the future quarters, those other nonautomotive businesses certainly help 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 very high end of the bit, but certainly not the low end of it either.

I would reiterate that, that would be what I would cite. I would say that this 32% you saw this quarter is going to be the low water mark and you'll see closer to the 33% and the 34% mostly likely in subsequent quarters.

Got it. Okay. I know we've got a couple of more quarters with you Dan on the call, but just wanted to extend my congrats for the retirement and say we'll definitely miss your good humor 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.

Our next question comes from the line of Christopher Van Horn with FBR Capital Markets.

And let me echo the congrats Dan, on the retirement. I think it makes sense of where the headwinds came from just a production standpoint. Have you ever disclosed your, kind of, passenger car versus SUV/truck mix. Because, obviously, I think passenger cars are little bit weaker here as we head to the back half and into the next year. But I was curious, if you 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 segregate it that way in our own minds or in our management of the business. Right now we're seeing a lot -- you are correct, we're seeing a lot of strength in SUVs and pickup trucks still. We had seen strength there all along, but we're continuing to see that. And you are right, the weaknesses are falloffs in sedans, what I would call sedans. We don't segregate it and break it out. But your assumption is correct.

Okay. I'd like to kind of highlight that the accelerating growth in some of these other business 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, are those new programs, and I am specifically talking about cables, the legacy BTM here and then some other automotive that you cited here?

It's a combination of all of those, actually. The CSV, our medical business is doing very well, as Barry 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 industry chamber business, we expect to see good results there. We've had some pretty good results and we have 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 Thermal electric unit, GPT group, is beginning a slow and steady rebound out of the that trough that was the oil crisis and we are seeing good solid work by that team, scrapping and fighting for every order around the world and they are beginning to see some orders. 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 point out they are small, they are very profitable and they are very good opportunities for growth for us. So that's kind of my, I guess, my summary. The non-Auto -- sorry, the auto segments that are growing, the Battery Thermal Management piece that Barry pointed out, we've been tasked by a couple of our customers as we've been working into this Battery Thermal Management areas. Some of our customers have different challenges. We've had to design some very specialized equipment to help, in this case, ventilate some of the battery chambers in more traditional cars and that business has been -- has not been considered part of the Battery Thermal Management Group, until recently we looked at it and saw that yes, that should be part of that effort. So we kind of reclassified that from pure automotive into the Battery 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 that traditionally what we have called the battery heating and cooling systems will be beginning revenues in the fourth quarter. So we're excited about that, everything there is going well according to plan.

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

As we look at CCS business over the last, I guess, 6 or so quarters, it's reverted to kind of a growth rate more in line with overall global production. I know you have the mix headwind to keep vent, but I'm just wondering kind of what you are 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 is tremendous growth for CCS product line. The heated and cooled and heated and ventilated combined. Heated 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 was, the heat/cooled seats, were always targeted to the high end luxury market. That's only about 10% to 15% of the cars built in the world. The heat/vent is targeted to the midrange and can go all the way down to the entry-level models, because of the 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 -- 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 constraint and because of cost. So in the long term, there's still very solid growth available for both of those 2 subsegments. I remind you that we have virtually 0 customers for heat/cooled products in Europe and we have kind of an early stage market in China that's beginning to appreciate the luxury segments and the local domestic markets are trying to get into that segment. So we're going to see growth in heat/cool and in heat/vent and I think you're going to see the growth of heat/vent outpace the growth of heat/cool, but you'll see growth of 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 hit maybe a little air pocket as it relates to just -- whether its new models being released, et cetera, what sort of has that growing low to mid-single digits lately?

I think that's a good part of -- what we saw last year was several of the platforms that were scheduled to be released with heat/cooled were pushed out because of the auto industry's fear of this existing downturn that we're in right now. And now that we are 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 1 year, 1.5 year and it's a phenomenon that's we think is temporary. It's not something that's -- we certainly haven't reached anywhere near a saturation point for either of the 2 products, in fact, we've just barely tipped 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 cabin 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're going to have no new diesel or gasoline vehicles registered after 2040. They're going to go all non-combustion engine systems. So that brings a whole new set off challenges for the automakers and an all-electric system that makes heating and cooling and delivers that energy through a seat or through a seat back or through a ceiling or through a door panel or even through a dash 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 more susceptible to chatter of competition over the last 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?

No. We're still seeing the same players. The people like some of the German OEMs are still making their own. They've been reconsidering that strategy, I think, they're working -- they're evaluating all of our products with us. And we are making very good headway there. But the same other players, the typical seat heater suppliers, who are slapping fans on their traditional seat heaters and offering them into the marketplaces as 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 make sure that people want understand the advantages of our technology, our heat/vent system is not like everybody else's heat/vent systems. They work better, they're easier to package and they are, I would say, cost competitive with anything in the marketplace.

That's helpful. Thanks, Dan. And then Barry, one last housekeeping 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?

Well, the year-over-year variance -- was $2.6 million. I think that gets a little easier as we move to the next quarters because we didn't have the payroll benefits in the second half of last year as we did in the first half, so you can 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 we're working on completed. But it won't be -- I don't think it's as dramatic as what you've seen in this particular quarter.

Our next question comes from the line of Gary Prestopino with Barrington Research.

Just wanted to drill down a little bit on 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, did 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 surprises us, I think it surprised the hell out of Ford and GM, who were running along at their normal -- fairly normal production rates and suddenly found themselves with over 100 days of inventory across the Board. So and I think it's been a big surprise to everybody.

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

Yes. Our hemotherm product, we believe that we have kind of satisfied all the short term, kind of, the emergency demand that we saw. But we're still seeing -- we still believe we see good growth with the hemotherm product and we have another product that's coming out that will be sold primarily in Europe, but it's 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 -- or I would 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 big enough to put a house, they look like houses, when we see them on the floor. And when we ship these things, it's a huge piece of revenue and we don't always make a huge -- same kind of money that we do on other projects. So what we are trying to do, is to make sure that we do a better job of getting our margin requirements out of a growing business there as well.

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

Thank you very much, operator, and thanks everyone, for joining us on our second quarter review and first half summary. I think we have 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, and we still have good opportunities for new products and new penetrations. We have 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 honor and a privilege to serve with each and every one of these folks that you see carrying Gentherm business cards. It's been an honor to serve with each of our Board members, past and present. And I look forward to the next 6 months of identifying the new CEO, who is going to come in and help us set the new tone 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. Goodbye.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.