Gentherm Incorporated
Q1 2020 Earnings Call Transcript

Published: 10 May 2020

[Operator:]

Greetings, and welcome to the Gentherm Inc. First Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. . As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Yijing Brentano with Investor Relations and Corporate Communications. Please go ahead.

[Yijing Brentano:]

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.

[Phillip Eyler:]

Thank you, Yijing. Good morning, everyone, and thank you for joining us today. As we're all well aware, the outbreak of the global pandemic has created a significant hardship and challenge worldwide. Our hearts go out to the communities and individuals deeply affected by the COVID-19 pandemic. We would like to express our gratitude for all of those on the front line, including healthcare workers, first responders, and other essential service providers. From the outset of the pandemic, our top priority has remained clear ... the health, safety, and support of our global team members and the communities we serve. Now, let me move to Slide 4. COVID-19 will have severe economic ramifications, the full extent of which are still to be determined. Since launching our focused growth strategy two years ago, we've built a strong foundation from a capital, liquidity, and balance sheet perspective. As no one can perfectly predict the severity or longevity of the virus's has impact on the global economy, we've moved quickly to take additional actions to further improve our financial flexibility and conserve cash. Shown on Slide 4, these include, we drew down an additional $169 million under our revolving credit facility in March. We have re-prioritized capital expenditures and are reducing our planned capital spending. We're actively reducing operating expenses. We're deferring a portion of employee compensation beginning May 1, including a 30% to 40% deferral at the executive level and a 20% deferral for all other salaried employees. We are managing working capital with strong discipline to improve cash flow.

[Matteo Anversa:]

Thank you, Phil. And thank you to everyone joining the call today. So let me start on Slide 11 and focus on the items that most significantly impacted our first quarter results. So for the quarter, product revenues declined by 11% compared to the same period of last year. And if we adjust for the impact of FX, our overall product revenue decreased by approximately 10%. The primary driver of the year-over-year decline was the impact of the COVID-19 outbreak, which accounted for approximately $27 million in revenue shortfall in the quarter. If we exclude the impact of COVID-19, our revenues in the quarter would have been pretty much flat year-over-year. Our Automotive segment was significantly impacted by the COVID-19 outbreak, and revenue declined 11% year over year, or down 9% if we exclude FX. In comparison, according to IHS latest data, light vehicle production declined 24% for our key markets of North America, Europe, China, Japan and Korea. While our automotive business was impacted by COVID-19 in all the product lines, we saw strength in Steering Wheel Heaters where revenue was up 13% year-over-year, due to higher volume at FCA, Ford and VW. And additionally, revenue in BTM was also up 4%, primarily due to the newly launched e-Mini program.

[Operator:]

. Your first question comes from the line of Chris Van Horn with B. Riley FBR. Please proceed with your question.

[Chris Van Horn:]

Good morning everyone. Thanks for taking my call and hope everyone is doing well.

[Phillip Eyler:]

Hi, Chris.

[Matteo Anversa:]

Hi, Chris. Good morning.

[Chris Van Horn:]

So I guess in your conversations as we're progressing here in April go on, have you got -- we're hearing some product launches slated for 2020 are proceeding as planned or is best to their knowledge and some are being deferred. Have you looked at kind of your product launch schedule and talked to the OEMs and maybe give us an update around that?

[Phillip Eyler:]

Yeah, sure, Chris. We're -- obviously we're very closely watching how that plays out. Based on what we've seen, we're kind of watching the 2020 and 2021 launches extremely closely. Those are the ones that have the most meaningful impact. We've seen 14 vehicle delays over those the course of those couple of years so far. And that's on a base -- at least the projects we have right now about 150 vehicles, so that kind of puts it in perspective, wouldn't be surprised to see some more flow in. But that's where we're at right now.

[Chris Van Horn:]

Got it, okay. And you've been really, really good at executing despite the challenges here. I'm just curious on the cost side of what you've been able to kind of extract from there. What's permanent versus more temporary? Have you broken that out or could you break that out?

[Phillip Eyler:]

Yeah, Matteo will tell you.

[Matteo Anversa:]

So I think, Chris, if you're referring to the actions that we have been taking since the pandemic -- the impact of the pandemic became clear, I would say a couple of things. Fore and foremost, our first priority was to make sure that we had -- we protected the liquidity of the company. So the mid of March, we concurrently drew down 50% of the revolver roughly and then halted the share buybacks. And then we looked at all our operations starting with CapEx, which is a little bit the easier one. And we identified opportunities to reduce CapEx, as I said in my prepared remarks, by about 20% to 30% compared to the original guidance that we gave in February. And I give you a couple of examples of what we will be doing. So first of all, we delayed any CapEx expenditure related to capacity expansion until the volume picture becomes clearer. We also delayed all kinds of non-critical programs, such as for example building improvements that we have planned throughout the year and some of the non-essential IT programs that will be planned in the year. So I would expect these delays to be effective in 2020. And then we will reassess if we will postpone this and expenditure will come through in 2021 at a later date, once we have a better clear view of the older volume. On the operational -- on the OpEx side, a similar approach. So we did a bottoms-up, we kind of reduced all the discretionary operating expenses ... obviously travel, but this includes also training costs, outside services costs. We put very strict controls on hirings. So all these costs, the reduction that I would expect would yield approximately about $10 million of annualized benefits starting from the run rate that we had in the second quarter -- in the first quarter. I think these cost will -- you will see they will hit in the next 8 to 12 months, mostly back-end loaded towards the end of the year. And I would assume this cost to be -- cost reduction to be there to stay, at least until we get a clearer picture on the volume.

[Chris Van Horn:]

Okay, great.

[Phillip Eyler:]

Just on top of that obviously will -- we'll be looking at really closely where production volumes and orders from our customers kind of level out. And obviously we'll be preparing and are preparing adjustments to our overall cost structure to meet that, both on the cost of sales side and OpEx side.

[Chris Van Horn:]

Okay, great, thanks for all that color. Maybe on the award side, a positive here, -- the air cooling award with Mercedes. It seems like a new application or a potentially new application. Can you maybe describe a little more detail what that is and what you were able to -- how you able to kind of win that?

[Phillip Eyler:]

Yeah. We have a great relationship, as you know, with Mercedes and they were having some overheating issues on their design and came to us and asked for some help analyzing thermally the situation. And then that kind of one thing led to another and our product became an obvious choice for them. So it was kind of the engineering help, an assessment along with a really good product that we could that we could craft for them. So, as I pointed out many times, our number one goal is to consistently be sitting across the table from advanced engineering at our customers. And I think in this case, it proved to be pretty valuable.

[Chris Van Horn:]

Okay, great. Thank you so much for the time this morning, and stay safe and healthy.

[Matteo Anversa:]

Thanks.

[Phillip Eyler:]

Thank you, Chris. You too.

[Operator:]

. Your next question comes from the line of Ryan Brinkman with JPMorgan. Please proceed with your question.

[Rajat Gupta:]

All right, thanks for taking my question. This is Rajat Gupta for Ryan.

[Phillip Eyler:]

Good morning, Rajat.

[Rajat Gupta:]

Hey. Hi, how are you? Just had a follow-up on the previous response. I mean clearly pretty good execution here in the first quarter on decremental margins. Based on the OpEx cost that you talked about in other cost reductions, what kind of decremental margin should we be expecting here like in the second quarter? And then also, how would that progress again in the third and fourth quarter, you know, when the rate of decline starts to improve? And as a follow-up on the cash flow side, like how should we think about the working capital? You're in the second quarter-- like what the cash burn rate might be through -- through April and through mid-May? And then how do you -- how should we expect that to rewind or unwind later in the quarter and in the second half? Thanks.

[Matteo Anversa:]

So let me start with the first one and talk about the margin. So let me start first with the -- the first quarter impact. So we had, as I mentioned in my prepared remarks, about $27 million of net impact in terms in revenue due to the COVID-19; obviously the majority was in Automotive, and then we have a little bump to the positive side on the Medical side. And that the decremental margin on this $27 million was about 35% to 40%, roughly in terms of rate. As far as the second quarter is concerned, let me give you -- maybe a little bit of color. I would say, so first of all, the visibility that we have right now on the second quarter is still very, very limited in terms of releases. But what I can say is starting from where we are seeing that happening on the topline, as we are in the process of closing the month of April, we are seeing the revenue in the month of April to be down year over year between 50% and 60%, which not surprisingly, the majority of the decline comes obviously in Europe and in North America, which is a little bit of a different regional mix of the decline compared to what we experienced in the first quarter. So, back to your question on the margin, I think, what I would expect, the decremental margin to be in the second quarter is to be obviously higher than what we experienced in the first quarter, just for a couple of reasons. First, the magnitude of the revenue decline is significantly higher. We are talking about a quarter with revenue, almost half of what we had over the last year. But also the regional mix, as I mentioned, is different, because it will be more weighted towards North America and Europe. So that impacts, in a negative way, the decremental margin. I would add also a couple of other points, I think, we need to consider as we look at the second quarter. First, we will have to maintain some of our labor force in preparation for the ramp up post COVID-19, which is still pretty unclear as we speak. In some of the locations where we work, we are required by the local government to continue to pay a certain percentage of the salary of the people regardless of the volume. And then depending on how the ramp-up will play out and how steep the ramp-up will be, I would expect that we will incur some additional cost on premium freight and expediting fees in order to serve our customers. That's also some of the items that we experienced as we ramped up back up Asia, in the -- in the first quarter. So that's to give you a little bit of color on how we are thinking about the decremental margins in the second quarter. As far as your second question on cash. So I think we're pretty pleased on where we started the year. I think the -- if you look at the year-over-year CFOA improvement that we experienced in the second quarter, $29 million versus $7 million last year. That really came from working capital improvement. So it's a good start to the year. In terms of what -- how the working capital will play out in the remaining three quarters, it's all a function honestly on how steep the ramp-up will be. But the way in the amount of that -- in different scenarios multiple scenarios that we have been running in the past few weeks, I would say that -- I would expect working capital in the next three quarters to be a drain to the cash flow for the company, but this all depends on how the ramp-up will be. And the drain will come, most likely between the second and third quarter, depending on the timing of the ramp up.

[Rajat Gupta:]

Got it, that's a super helpful color. Just to sum it up on the decremental margin. So you said that the detrimental margin on the COVID-related impact was 35% to 40%. So the second quarter could be a little bit on the higher end of that, of the 35% to 40% or was that comment more in relation to the overall 1Q decremental margin?

[Matteo Anversa:]

No, no. So I would expect the -- so you've got it correctly. The decremental margin in the first quarter was between 35% and 40%, and I would expect the second quarter decremental margin to be a little higher than that due to the reasons that I outlined.

[Rajat Gupta:]

Great, thanks so much and good luck.

[Matteo Anversa:]

Thank you very much. Stay safe.

[Operator:]

Your next question comes from the line of Scott Stember with C.L. King. Please proceed with your question.

[Scott Stember:]

Good morning and thanks for taking my questions.

[Matteo Anversa:]

Good morning.

[Scott Stember:]

Could you remind us that before COVID and all the maneuvers that you're taking place right now, the variability of your cost structure and your ability to flex up and down with the end markets?

[Phillip Eyler:]

Yeah, I think that's an area we've taken pretty great pride. If you can follow over the last several quarters, our gross margin performance, it's been consistently improving. And even in Q1 under a lot of pressure, we held it really close to kind of the going rate at almost 29%. So, I think we've got a lot of flexibility to maneuver our factories to adjusted demand. We've got a good model there that helps us do that. Obviously with the trough that we're facing in Q2, as Matteo just pointed out, it's - that's a little bit more difficult to adjust to, but I feel like once we get clarity -- what's going to transpire later in this year, we should be able to adjust pretty quickly to get back to that that run rate.

[Scott Stember:]

Got it. And as far as I guess where your facilities are operating at right now, the ones that are open. Is it fair to assume that at least in May that obviously it will improve somewhat as year-end markets start to pick production back up, but is it fair to assume that there is a direct correlation between that and from the comments that you made about, where you expect sales to be, particularly the Automotive segment for the quarter?

[Phillip Eyler:]

Yeah, I mean, obviously we are going by the information that everyone else has which is, Europe is gradually ramping up right now, still very low volume. North America is projected, not confirmed yet 100% but projected to start production May 18. And we're looking at that in May to be a very slow ramp-up. In fact -- keeping in mind too -- we're a Tier 2 supplier. So a lot of our product is in inventory at the Tier 1 suppliers' locations. So we expect -- there is going to be a little bit of delay in the ramp-ups. That's our expectation on our side, so which is why we project out a little less and a little more drop in the quarter than maybe IHS would show. But that said, we're -- all of our plants are ready. We've restructured each of the plants around the COVID or COVID-19 playbook, including safety measures, social distancing within the plant. We've actually had to go through and reconfigure many of our workstations and assembly lines to allow further distancing, which was no easy task, but I'm very proud of the team for preparing it. So as soon as that switch gets turned on, we'll be able to keep up with demand really well, albeit at a maybe slightly less productive manner. So all that said, I think it's kind of a wait and see. Let's see how the demand plays out.

[Scott Stember:]

Got it. And just last question, obviously appreciate the situation you guys are in and obviously it's pretty tough right now particularly with production being down, but can you talk about your ability for the year, do you think to remain free cash positive just given your crystal ball and some of the maneuvers that you can do on the working capital side?

[Matteo Anversa:]

Sure. I think, look -- I think I would say, the work that we have done in the last -- since we launched the focused growth strategy a couple of years ago, around building a strong foundation, strong processes around generating free cash flow and managing working capital are really paying off. I think we entered the year in a much better financial condition than where we were just on year-on-year and a half ago and this is really a credit to all the work that the team has done. I think today if I look at our days to pay to days to collect, they're in sync, so around mid-60s. And I think we still have some opportunities to work on that and make sure that we collect some of the longstanding past dues that we have. But again as I said before, it's all going to be I think a function on how steep the ramp-up will be. And that will -- how much drain that we'll put into the working capital. I would also say, I think in terms of inventory right now, we are sitting in a relatively good position. So that also should help. But we are obviously striving to maintain strong momentum in our free cash flow for 2020, but for sure, it will be obviously lower than what we delivered in 2019.

[Scott Stember:]

Got it. All right, thank you so much.

[Phillip Eyler:]

Thank you.

[Operator:]

Ladies and gentlemen, we have reached the end of the question and answer session. And I would like to turn the call back to Mr. Phil Eyler for closing remarks.

[Phillip Eyler:]

All right, thank you very much. Well, thank you all for joining our call today. I did want to highlight one area where maybe a question wasn't asked and that's on the advanced development and innovation front. One of the positive signs I see is that we consistently see our customers maintain focus on advanced technology that we are working on. So ClimateSense as an example ... our key partners have continued that effort and prioritize that. As everyone knows OEMs and suppliers are looking at ways to cut costs. We're encouraged that even in the midst of heavy shutdowns and resource reviews that we're seeing our project still boil up to the critical level. So that's pretty exciting for us and very proud of our teams being flexible and creative to keep those projects moving forward on all of our different businesses. So with that said, as I've consistently shared in the past, we remain very focused on operational execution, innovation and cost improvement, which has become even more important in today's COVID-19 environment. I'm extremely proud of our team's agility, flexibility and dedication to deliver on our commitments to all of our stakeholders. Despite these current uncertainties around an economic recovery and what that means for both Gentherm and our customers, our strong liquidity and our continued focus on productivity position us well to emerge from the current crisis with the ability to deliver significant long-term shareholder value. We appreciate your interest and your support and look forward to keeping you apprised of our progress. Thank you.

[Operator:]

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