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Gentherm Incorporated (NASDAQ:THRM)

Q4 2013 Earnings Conference Call

March 5, 2014 11:30 a.m. ET

Executives

Jill Bertotti - Director Investor Outreach, Allen & Caron, Inc.

Daniel Coker - President & CEO

Barry Steele - CFO

Analysts

Philip Shen - ROTH Capital

Steve Dyer - Craig-Hallum

Josh Goldberg - G2 Investment Partners

Kevin Sonnett - RK Capital

Operator

Good morning ladies and gentlemen and thank you for standing by. Welcome to the Gentherm 2013 Fourth Quarter and Year-End Results Conference Call. (Operator Instructions)

I would now like to turn the presentation over to our host Ms. Jill Bertotti of Allen & Caron. Please go ahead, ma’am.

Jill Bertotti

Good morning and thank you for joining us today for the Gentherm Incorporated 2013 fourth quarter and year end results conference call. Before we start today’s call, there are few items I’d like to cover with you.

First, in addition to disseminating through PR Newswire this morning’s news release announcing Gentherm’s results, an e-mail copy of the release was also sent to a number of conference call participants. If any of you need a copy of the news release, you may download a copy from either the Gentherm website at www.gentherm.com or the Allen & Caron website at www.allencaron.com. Additionally, a replay of this conference call will be available via a link provided on the Events page of the Investors section at Gentherm’s website.

Finally, I’ve also been asked to make the following statement. During this conference call, representatives of the company may make forward looking information within the meaning of federal securities laws. These statements reflect current views with respect to future events and financial performance and actual results may materially differ. Please see the Gentherm Incorporated SEC filings and the related 10-K and subsequent reports for a discussion of various risks and uncertainties underlying any forward looking statement.

On the call today from Gentherm, we have President and Chief Executive Officer Dan Coker, Chief Financial Officer, Barry Steele, and Chairman, Bud Marx. Management will provide a review of the results, after which there’ll be a question-and-answer period.

I’d now like to turn the call over to Dan. Good morning, Dan.

Daniel Coker

Good morning, Jill, and thank you very much. And thanks to everyone for joining us on our call. We had an extraordinary 2013 and our fourth quarter was pretty good as well.

To start the call, I would like to thank all of our associates that worked so hard to deliver the performance that you see from our company in 2013. A lot of people worked very hard to generate these results. I’d also like to thank all of our vendors who worked very hard to keep up with our growth and also our customers who have helped us with acceptance of our products. It’s been an extraordinary year.

This year, we topped $660 million in revenue, up from $555 million [ph] in ’12. So this has been an extraordinary year in almost every front of our business and we are very pleased with the result and we would like to take a few minutes and share some of our thoughts and then open the floor to questions.

At this point in time, I will turn the conversation over to our CFO, the learned Barry Steele who will guide us through the details of the out – Barry?

Barry Steele

Thank you, Dan. Our earnings for the 2013 fourth quarter were $0.31 per share on a fully diluted basis. This stemmed from a number of things, including our product revenues which for the fourth quarter were $182.3 million. This represented an increase of $34 million or 23% over the fourth quarter 2012 product revenue. It also represented a sequential increase of $11.1 million or 6.5% over the product revenue of the 2013 third quarter. The increase is due to strong performance in all of our regions, including Europe and especially in North America and Asia. Our European-based revenues benefited from strong shipping volumes and new programs in our specialty cable business.

Our gross margin for the fourth quarter was 27.2%, which was 1.4% higher than the prior year and 40 basis points higher than the 2013 third quarter. Our gross margin varies from quarter-to-quarter for a number of reasons, including shipping mix in underlying product, timing of our customer pricing, concessions as compared with cost savings initiatives and special items both positive and negative which occurs from time to time.

As we mentioned in the past, our future target for gross margin is 28% currently. The performance this quarter demonstrates progress towards that goal. Our continuing ramp-up process for our electronics manufacturing facility and electronic design initiative decreased our gross margin but not as much it did in the 2013 second and third quarter. We expect that the benefits of this new facility will increase in future quarters as [indiscernible] continues to increase and as such this unfavourable impact on gross margin will reverse and become a favourable impact.

Our operating expenses were $32.8 million during the fourth quarter, representing an increase of $3.5 million or 11.9%. This included approximately $1 million in expenses related to the new electronics facility, including design initiative and engineering. Much of the remaining increase reflects resources that are being directed to development of existing and new product and the related marketing activities for those new products which we expect will continue to support our product revenue growth target.

On a combined basis, we reported net loss or a loss of $909,000 for the revaluation of derivatives in foreign currency during the fourth quarter compared to a loss of $1.4 million during the prior year fourth quarter. Much of these effects come from our portfolio of standard financial instrument such as currency forward and option contract which we use to hedge our exposures to foreign currency. For example, we incurred expenses in the Hungarian forint, which are coupled with our European euro denominated European revenue.

These contracts are marked to market in each quarter. As such, we report gains and losses for instruments that are intended to hedge transactions for future period. In measuring our adjusted EBITDA, we add back unrealized portion of these items, which we believe better reflects the current operating performance of the business.

Looking at EBITDA – our fourth quarter adjusted EBITDA was $25.6 million, which was $7.5 million or 41% higher than that of the fourth quarter 2012.

Just a couple of brief comments on the balance sheet, our cash has increased now by $18.9 million and currently stand at, at end of the year at $54.9 million. Our total outstanding debt was $82.3 million which represented a decrease of $5.1 million during the quarter. And our revolver capacity is $56 million.

Of the increase in our cash balance is primarily due to working capital decreases which was driven by these associated decreases coming from holiday shutdowns in customers’ production at the end of the quarter. We expect that our working capital amount will once again build up now during the first quarter as we get back to normal shipping activity.

That’s all I have, Dan.

Daniel Coker

Thank you, Barry. Very comprehensive report as usual. One thing I would like to point out, I think it’s important we mentioned it in the press release is that we had an extremely strong year in all segments of our business and all regions of the business. And we believe that the results showed a very strong revenue increase of 19.2% for the year. That was helped by a very extraordinary fourth quarter which sometimes if you followed us, you know that the fourth quarter is a little bit volatile and swings one way or the other. This year swing very favourably for us.

But included in our results are also about $280 million of our $660 million comes from our heated and cool, and heated and ventilated seat product lines, and these, we believe are extremely important to us in the long-range and the long term and that revenue was up a little bit higher than the average revenue, I think it was up about 21% to 22%.

With those general comments, I think we will close our comments. I think we will open the floor to questions. Operator, we're ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Philip Shen with ROTH Capital.

Philip Shen - ROTH Capital

So I'd like to start off with your guidance. You've guided to plus 10% to 15% in ‘14. Do you have a sense for which regions you're most excited about and perhaps the ones that might grow faster than your guidance? And then which ones might lag or be slower than what you're guiding towards?

Daniel Coker

I think that in general, I think that the North American market continues to be our strongest market worldwide. We saw some softness in Europe throughout 2013. I think we're going to see that recover, in general it’s still a little bit flat but we think that’s going to recover. And I think the Asian markets are going to pick up again in 2014 and ’15. So I think in general you’re going to continue to see a very strong North American business and you’re going to see improvement in Europe and I think a much improved Asian market.

Philip Shen - ROTH Capital

In terms of the Chinese facility in Shenzhen, can you give us a general update on the facility? What kind of utilization are you at now? What does the ramp look like? And can you update us on perhaps the latest economic benefits of this facility?

Daniel Coker

Well, in general the facility – it came on a little bit slower than we’d hoped. We had some kind of general start-up issues in getting things rolling. But in the second half of the year things picked up very nicely. And the fourth quarter actually was getting very close to our economic target. We see in 2014 this ramp up will continue and we believe will be fully functional by midyear, this will be a strong contributor to our business. In fact, we believe so much that it’s a strong contributor to our business, that we have recently acquired all of the interest of a former joint venture partner in our North American business and we now are investing in a similar facility in our Aquino [ph] Mexico business that will allow us to extend our electronics capability to our North American customers as well.

Philip Shen - ROTH Capital

Interesting, great. Do you have a sense for what that acquisition costs might be? And then perhaps Barry can comment on what your CapEx expectations are for 2014.

Daniel Coker

Yes, we have a general understanding of what the investment is. The investment is a couple million bucks. So it is nothing really that’s going to blow the doors off but we are putting in some new equipment and some new facilities and we will be training a few new associates to be able to help us grow the business. So it’s a very good opportunity for us and we are – frankly, we’re already winning contract for these facilities. Barry?

Barry Steele

Just generally our CapEx will probably [indiscernible] 2014 as compared to 2013, so it’s going to be in that $30 million to $35 million range, it’s in the plan – that we have in our plan.

Operator

Our next question is from Steve Dyer with Craig-Hallum.

Steve Dyer - Craig-Hallum

Congrats on a really, really good results guys. Couple of things. Just tying up the loose ends as it relates to Shenzhen, so would you still anticipate that, that's going to be a bit of a margin tailwind, is it there yet? Or is that sort of what you were referring to kind of midyear?

Daniel Coker

No, honestly I was trying to hint to you that in the fourth quarter I think we achieved our financial goals for 2013 where we were essentially breakeven to the cost of the operation. I think in 2014 we’re going to see positive impact of the gross margin.

Steve Dyer - Craig-Hallum

Any way to quantify that, or are you willing to?

Daniel Coker

Not willing to. There was ways to quantify, not willing to quantify.

Steve Dyer - Craig-Hallum

Is the plan in Shenzhen still to sort of internally, produce for internal needs in '14 and then potentially look outside after that for revenue generating opportunities?

Daniel Coker

That's exactly the strategic plan is to first take care of our own growing needs for electronics systems internally. But frankly we’re already looking on the outside. We’re already beginning to put together teams of people working with the client customers to be able to identify and qualify opportunities outside of our own and those are being well served.

Steve Dyer - Craig-Hallum

Any chance at any external revenue from that in ‘14, or is it just too early?

Daniel Coker

It’s early for us to comment.

Steve Dyer - Craig-Hallum

So the [Aquino] Mexico facility, is that going to create a similar drag as it did getting Shenzhen up and running or not?

Daniel Coker

Not really – sorry, certainly not to the extent that we thought. But I don't expect any drag at all. What we did was we established a joint venture with a partner a couple of years ago, and we essentially now have bought out that partner, now that we believe that we're ready in the marketplace to move in, into the business ourselves. So the business is already there and it's been running for a while. And what we're doing now is taking over that business completely and we’re expanding on that business for our own needs.

Barry Steele

This is Barry, just a little extra comment there. In our current financial statement, there is a line item called loss from equity investment, that is that facility in our joint venture, that loss will go away or that line item will go away as we fully consolidate that operation.

Steve Dyer - Craig-Hallum

Is that the ZT Plus line item or a different one?

Barry Steele

No, it’s called loss from equity investment.

Steve Dyer - Craig-Hallum

Just jumping back to the seat business, obviously a fantastic growth year, well in advance of the global production increase. If you look at kind of the different categories between heated, heated ventilated and heated and cooled, any way to kind of quantify where the growth really came from, if not number, at least anecdotally?

Daniel Coker

Actually, we provided those numbers in the press release that says that we had about $280 million worth of sales for the heated cooled and heated ventilated business, which was up about 21% over the prior year's numbers. The overall business grew at about 19.2% from 550 to 662, and that $280 million is included there. So you see that the heated and cooled and heated and vent business is growing at a little bit faster rate than the rest of the business and also to further comment there, we also have had a very strong growth out of our independent cable business, which is – cables and wiring harnesses have been doing very good for us particularly in Europe.

Steve Dyer - Craig-Hallum

And then you had a lot in the press release about new products in the R&D section. And maybe a comment on beds first of all and how those are progressing. And then, secondly, any of that kind of list of products or technologies that you plan to kind of commercialize from a revenue-generating standpoint this year? I think if my checks are right, the cold storage box will be one of them. But anything else there we should pay attention to?

Daniel Coker

Yes, we're seeing very strong interest in the heat and cool cup holders, and you are correct, we do anticipate to begin revenues in the second half of 2014 for the kind of the cousin of the heated and cooled cup holder, which is the heated and cooled storage box. And those revenues will be modest again -- we believe they will continue to grow. So that is a very solid area for us. We continue to see strong market interest in our heated steering wheel product and we are -- we're seeing very strong interest in our bed product and we are working very hard to try to position ourselves in the market and to establish clean lines of distribution to make sure that the opportunities for beds present themselves in 2014.

Steve Dyer - Craig-Hallum

Perfect, last question from me, and then I will turn over the floor. Operating expenses, I know you kind of talked generally about them leveling off here as the integration works further into it. How should we think of maybe the absolute level either on a quarterly basis or year-over-year basis versus kind of how we went out in ‘14?

Daniel Coker

What we're looking at in terms of operating expenses, we’re making a conscious effort to try to hold down our base level of engineering and R&D in particular and -- but we are investing in areas that we see big opportunities and we just talked about the electronics area. We will be building up an internal capability to support full-service electronics systems for our customers and that will include some additional resources for software development and some additional resources for hardware development. We will need some additional testing personnel and equipment. We will also need some very competent engineers to help us communicate with the customers’ electronic engineering team. So we will continue to invest in the areas but I think that in general what you will see is a flatter growth rate for our engineering and R&D and SG&A costs as we move forward. And you're going to continue to see our topline revenue numbers outpace our growth in operating expense.

Operator

(Operator Instructions) And our next question is from [Fazal Hadim with Geo Capital].

Unidentified Analyst

Just a quick question on the automotive waste heat recovery project or initiative. What's the update there and kind of how should we think about, is that still sort of a 3 to 5 year project or is it making faster progress in there?

Daniel Coker

No, actually we’re continuing to make very steady progress in the waste heat recovery systems. As we've kind of focused in the past calls, we are focusing very hard on trying to design systems particularly for what we would call the industrial market applications as a preliminary area for us to study and learn in kind of a smaller arena. We then plan to turn our attention to some, what I would call mobile systems and that would be things like heavy truck and bus and then after we get a good set of working experience and facilities and capacity to be able to those projects, we plan to look at the final, market opportunity for the passenger car. So we're making good progress. We’re not making fast enough progress, we’re making good progress on the technology and we’ve come up with [indiscernible].

Unidentified Analyst

Got it.

Daniel Coker

Operator, there’s quite a bit of distortion on the line.

Operator

Yes, give me one minute.

Daniel Coker

Sorry guys –

Operator

Our next question is from Josh Goldberg with G2 Investment Partners.

Josh Goldberg - G2 Investment Partners

Hey guys, good morning. Just a couple of quick things. Obviously your gross margins improved all through the year and in the year above 27%. Based on what you are communicating in terms of some of these facilities and ability to scale some of these operating efficiencies, are you comfortable – I realize you’re trying to get to this 28 longer-term outlook, do you feel comfortable with your topline growth outlook that your margins – gross margins to stay flat to up in 2014?

Daniel Coker

Yes, we do feel comfortable that [indiscernible] margin improvement is ongoing for us. It’s a constant effort, a continuous improvement and that we are working very hard to try to achieve our target. A 28% gross profit for us is essential to achieving our financial goals for our bottom-line results. So I do feel confident that we’re strong and on the path to that goal. I don't know that we’re going to make 28% in 2014 but that’s objective.

Josh Goldberg - G2 Investment Partners

In terms of the fourth quarter, there wasn't any one-time items that helped you on the gross margin side?

Barry Steele

No, there wasn't. There was a lot of good coverage of fixed costs. One thing I would point out in the future, and that is that as we grow very rapidly, there's always the potential for extra cost associated with that growth that could sneak up on us. [multiple speakers]

Josh Goldberg - G2 Investment Partners

And then second question is, obviously exiting the year 19% topline growth, especially in the fourth quarter at 23%, seems like we’re seeing a lot of really good at 30 [ph]. And yet the guidance of 10% to 15%, I know it’s above what the analysts are expecting, but obviously half of the growth of what you’re doing this year, is there something you’re seeing out there, the market that's making you more concerned this year, a little bit more worried about the macro or kind of 3 months into the year, you feel pretty confident that 10% to 15% is where you’re going to start out and see where the cards drop by the end of the year?

Daniel Coker

Well, by nature we are conservative people. What we see, we look out in the market is a series of opportunities and some risk. For us right now looking at where we are, we just finished the year where we did a 19% growth rate for a full year and that was a lot of hard work by a lot of people. When we look out at this year we see the opportunity to grow on top of that 19%, another 10% to 15%. We don't know exactly whether it’s going to be 10% or 15% right now. Obviously we’re pushing our team to grow as rapidly as physically possible and still achieve all of our quality and customer service requirements. So I wouldn’t say that we’re under estimating the marketplace nor over-estimating. We try to be real. We had a really good fourth quarter last year.

Our comps as we go forward, our first and second quarter comps will be easier to achieve. The numbers that we’ve given, the third and fourth quarters are going to be very difficult for us. So you’re going to see some strong growth I think in the first half and I think you’re going to see some good growth in the second half. I just don't know how it's going to add up, that's why we gave a range and frankly I think a range of 10% to 15% is potentially higher than most of our new technology compatriots.

Josh Goldberg - G2 Investment Partners

Just correct me if I'm wrong, but going into 2013, you projected a 10% top line growth, correct?

Daniel Coker

We did. We indicated that we felt there was a 10% growth opportunity and at that time we strongly believed that. We had some good luck and some hard work and we were able to beat that number.

Josh Goldberg - G2 Investment Partners

Okay. Last one from me is in terms of the tax rate, looks like you came up a little bit, is there any kind of guidance you can give us for tax rate in ‘14 in terms of – is it going to be 24%, 26% or something even higher than that?

Barry Steele

We would continue to guide at the high-end of 20 – 25, 26 in that range. It’s important to point out that as you look at the profitability that we have in each region, we have very different tax rate, so significant portion of business is in the U.S. which is the highest tax rate in our whole business, whereas we have earnings in China, they are much, much lower rate. So there is a lot of volatility in the rate that we see as we grow. But we felt, we’re probably in the upper 20% range.

Josh Goldberg - G2 Investment Partners

Okay, and then the cups opportunity, heated cups, on a unit basis, are those gross margins higher than what you're seeing in your corporate average right now?

Daniel Coker

There is what I would call an early development start. They are not higher than our corporate average, but we have plans to push them to that level.

Operator

Our next question is from Kevin Sonnett with RK Capital.

Kevin Sonnett - RK Capital

Really I just wanted to let the conference operator know that at least on my line, I was getting quite a bit of interference as well a few minutes ago. It seems to have gotten better. But that's all great. Great job, guys.

Operator

Ladies and gentlemen, this concludes the Gentherm – I am sorry, we have a question from Josh Goldberg. Please go ahead.

Josh Goldberg - G2 Investment Partners

Sorry guys. Just in case I get all my questions answered. When you talked about the first half of the year having a much easier compare, can you just give us a little bit of a review of what was it that was difficult in the first half of last year and why you don't think those circumstances should play out again? I mean I guess differently said, you were flat in the March quarter versus December quarter last year and I'm just wondering, what would give you the level of confidence that you have an easy compare at the beginning of this year?

Daniel Coker

Well, it's actually just a mathematical formulation. It's very simple. Our first quarter of this year is going to be compared to a first quarter of 2013 of around $150 million. The second quarter for 2013 was $160 million, for the third quarter was $170 million and the fourth quarter was $180 million. So those numbers obviously escalate as all of our new programs fade in that we are very much a seasonally biased business. So comparing a quarter four of -- against $180 million base as opposed to quarter one of $150 million, it's just simply a mathematical equation.

Our business is seasonal. We do see a pickup in the second half of new programs, new projects that we win, and as we win those, obviously we have to stack those up against the wins from the previous year. So I'm not, I'm not foreshowing any doom or anything. I'm just saying that it gets tougher as the year goes on for us to meet our number. The number we gave of 10% to 15% is a full-year January through December. So there's some growth that we have to keep in mind that already occurred in ‘13 that we have to overcome to achieve our target.

Josh Goldberg - G2 Investment Partners

So at the beginning of the year, you might be even closer to higher end of that 10% to 15% -- as you get tougher comps in the back half?

Daniel Coker

That’s very possible. We’re working to try to avoid that but that's possible.

Operator

Ladies and gentlemen, that does conclude Gentherm 2013 fourth quarter and year end results conference call. Thank you for your participation and you may now disconnect.

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