Gentherm Incorporated
Q3 2020 Earnings Call Transcript

Published: 1 Nov 2020

[Operator:]

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. I would now like to turn the conference over to Yijing Brentano, Investor Relations. Please go ahead.

[Yijing Brentano:]

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.

[Phil Eyler:]

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.

[Matteo Anversa:]

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.

[Operator:]

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

[Gary Prestopino:]

Good morning, everyone.

[Phil Eyler:]

Hi, Gary.

[Gary Prestopino:]

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?

[Phil Eyler:]

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

[Gary Prestopino:]

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?

[Phil Eyler:]

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.

[Gary Prestopino:]

So the pipeline is pretty ebullient?

[Phil Eyler:]

Yes.

[Gary Prestopino:]

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?

[Phil Eyler:]

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.

[Gary Prestopino:]

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?

[Matteo Anversa:]

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.

[Gary Prestopino:]

Right.

[Matteo Anversa:]

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.

[Gary Prestopino:]

Okay. Thank you. Great answers.

[Phil Eyler:]

Sure.

[Operator:]

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

[Matt Koranda:]

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?

[Phil Eyler:]

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.

[Matt Koranda:]

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?

[Phil Eyler:]

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.

[Matt Koranda:]

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?

[Matteo Anversa:]

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.

[Matt Koranda:]

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?

[Matteo Anversa:]

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 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.

[Matt Koranda:]

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?

[Phil Eyler:]

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.

[Matt Koranda:]

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

[Phil Eyler:]

Thanks, Matt.

[Matteo Anversa:]

Thanks, Matt.

[Operator:]

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

[Ryan Sigdahl:]

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?

[Phil Eyler:]

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.

[Ryan Sigdahl:]

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?

[Phil Eyler:]

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.

[Ryan Sigdahl:]

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

[Phil Eyler:]

Thank you.

[Matteo Anversa:]

Thank you.

[Operator:]

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

[Phil Eyler:]

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.

[Operator:]

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