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THRM > SEC Filings for THRM > Form 10-K on 15-Mar-2013All Recent SEC Filings

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Form 10-K for GENTHERM INC


15-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with, and is qualified in its entirety by, our financial statements (and notes related thereto) and other more detailed financial information appearing elsewhere in this report. Consequently, you should read the following discussion and analysis of our financial condition and results of operations the "Risk Factors" section of this report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. See also "Forward-Looking Statements" in Item 1A of this report.

Overview

We design, develop, manufacture and market proprietary thermal seat comfort systems and cable systems for sale to automobile and truck original equipment manufacturers ("OEMs"). In 2012, we completed our thirteenth full year of producing and selling our Climate Control Seat™ ("CCS™") products, which provide year-round comfort by providing both heating and cooling to seat occupants.

We also sell a heated and cooled cup holder and a heated and cooled mattress that utilize our proprietary TED technology.

On May 16, 2011, we acquired a majority interest in W.E.T., a German publicly traded company based in Odelzhausen, Germany. W.E.T.'s primary product categories include automotive seat comfort systems and specialized automotive cable systems. The automotive seat comfort systems category includes automotive seat heaters, climate comfort systems (similar to Gentherm's climate controlled seat technology) for automotive seats, automotive steering wheel heater systems and integrated electronic components. The specialized automotive cable systems category includes ready-made wire harnesses and related wiring products.

W.E.T.'s primary customers are also Tier 1 suppliers and automotive OEMs. W.E.T. also offers product solutions to other customer groups, namely customer groups related to seat heating equipment for the automotive aftermarket, ski lifts and sports stadiums and the production of ventilation systems for the automotive and various other industries.

We primarily sell directly to seat manufacturers. Our five largest customers are Johnson Controls, Lear Corporation, Magna, Sanyo and Dymos.

We operate as a Tier II supplier to the auto industry. Inherent in this market are costs and commitments well in advance of the receipt of orders (and resulting revenues) from customers. This is due in part to automotive manufacturers requiring the coordination and testing of proposed new components and sub-systems. Revenues from these expenditures may not be realized for two to three years as the manufacturers tend to group new components and enhancements into annual or every two to three year vehicle model introductions. These customers in turn sell our product, as a component of an entire seat or seating system, to automotive OEMs.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosures at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions. These estimates and assumptions include, but are not limited to:

• Warranty reserves,

• Litigation reserves,


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• Allowances for doubtful accounts,

• Income taxes,

• Inventory reserves,

• Stock compensation and

• Patents.

Accrued Warranty Costs

Historical Gentherm does not offer our customers explicit warranty terms; however, we do honor warranty claims for defective products. W.E.T. offers customers explicit warranty terms. We have secured errors and omissions insurance which provides certain coverage for defects in our product designs; however, historical Gentherm does not maintain a product recall insurance policy. W.E.T. maintains a product recall insurance policy. Provision for estimated future cost of warranty for product delivered is recorded when revenue is recognized. While we believe our warranty reserve is adequate and that the judgment applied is appropriate, such estimates could differ materially from what will actually transpire in the future. The warranty policy is reviewed by management annually. Based on historical information available to the Company and claims filed to date, the warranty accrual is periodically adjusted to reflect management's best estimate of future claims.

Litigation Reserves

We record estimated future costs related to new or ongoing litigation. These estimates include costs associated with attorney fees and potential claims and assessments less any amounts recoverable under insurance policies.

Allowance for doubtful accounts

We record an allowance for doubtful accounts once exposure to collection risk of an accounts receivable is specifically identified. We analyze the length of time an accounts receivable is outstanding, as well as a customer's payment history to determine the need for and amount of an allowance for doubtful accounts.

Income Taxes

We record income tax expense using the liability method which specifies that deferred tax assets and liabilities be measured each year based on the difference between the financial statement and tax bases of assets and liabilities at the applicable enacted Federal and state tax rates. A valuation allowance is provided for a portion of our net deferred tax assets when we consider it more likely than not that the asset will not be realized. At December 31, 2012 and 2011, a valuation allowance has been provided for an estimated portion of our NOLs generated prior to a 1999 change in control, as defined by the internal revenue code, which limits our ability to utilize those NOLs. If future annual taxable income were to be significantly less than current and projected levels, there is a risk that some of our NOLs not already provided for by the valuation allowance would expire prior to utilization. We do not expect significant differences between our taxable income and our book earnings before income taxes.

We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.

Stock Based Compensation

We account for all share-based payments to employees, including grants of employee stock options, as compensation expense based upon the fair value on the date of grant. We determine fair value of such awards


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using the Black-Scholes option pricing model. The Black-Scholes option pricing model incorporates certain assumptions, such as risk-free interest rate, expected volatility, expected dividend yield and expected life of options, in order to arrive at a fair value estimate. Expected volatilities are based on the average of the historical volatility of the Company's common stock and that of an index of companies in our industry group. Since the Company has little historical data to help evaluate the expected lives of options, we considered several other factors in developing this assumption including the average holding period of outstanding options, their remaining terms and the cycle of our long range business plan. The risk free interest rate is based upon quoted market yields for United States Treasury debt securities. The expected dividend yield is based upon the Company's history of having never issued a dividend and management's current expectation of future action surrounding dividends. We believe that the assumptions selected by management are reasonable; however, significant changes could materially impact the results of the calculation of fair value.

Patent Costs

Our business strategy largely centers on designing products based upon internally developed and licensed technology. When possible, we protect these technologies with patents. During the fourth quarter 2012, we changed our method of accounting for costs, all of which were external, associated with the application for patents. Prior to the change we capitalized the external legal and filing fees associated with new patent applications in addition to the cost of purchased patents. These costs were then amortized on a straight-line basis over their estimated economic useful lives which ranged from 4 to seventeen years. Under the new method, external legal costs are expensed as incurred and classified as research and development expenses in our consolidated statement of operations. We believe that this change is preferable because it will result in consistent treatment for all costs, that is, under our new method both internal and external costs associated with the application for patents are expensed as incurred. In addition, the change will provide a better comparison with our industry peers. Costs associated with the purchase of patents and patent rights, including those acquired in conjunction with a business combination, continue to be capitalized as before. We periodically review the recoverability and remaining life of our capitalized patents based upon market conditions, competitive technologies and our projected business plans. Change in these conditions could materially impact the carrying value for our capitalized patents.

Results of Operations Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

The following table presents select operations data for the period as reported, amounts for W.E.T. operations and amounts for Gentherm less the W.E.T. amounts representing the historical portion of Gentherm. These Historical Gentherm financial results, which are non-GAAP measures, are provided to help shareholders understand Gentherm's results of operations in light of the acquisition of W.E.T. These non-GAAP financial measures should be viewed in addition to, and not as an alternative for, Gentherm's reported results prepared in accordance with GAAP.

                                                   Twelve month period ended December 31, 2012
                                                                 (In Thousands)
                                                                                           Historical
                                            As Reported            Less: W.E.T.             Gentherm
Product revenues                           $      554,979         $       422,714         $    132,265
Cost of sales                                     413,052                 316,471               96,581

Gross margin                                      141,927                 106,243               35,684
Gross margin percent                                 25.6 %                  25.1 %               27.0 %
Operating expenses:
Net research and development expenses              40,950                  30,600               10,350
Selling, general and administrative
expenses(1)                                        64,919                  45,089               19,830
Operating income                                   36,058                  30,554                5,504

Earnings before income tax                         32,672                  29,621                3,051


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(1) During the period ending December 31, 2012, historical Gentherm incurred approximately $1,950 in expenses related to the efforts to register a Domination and Profit and Loss Transfer Agreement ("DPLTA"), and Sarbanes-Oxley compliance for W.E.T. within selling, general and administrative expenses. See the Liquidity and Capital Resources section of this report for additional information about the DPLTA.

                                                  Twelve month period ended December 31, 2011
                                                                (In Thousands)
                                                                                            Historical
                                         As Reported             Less: W.E.T.(1)             Gentherm
Product revenues                        $      369,588         $           237,248         $    132,340
Cost of sales                                  274,621                     179,374               95,247

Gross margin                                    94,967                      57,874               37,093
Gross margin percent                              25.7 %                      24.4 %               28.0 %
Operating expenses:
Net research and development
expenses                                        29,733                      18,793               10,940
Acquisition transaction expenses                 5,316                         468                4,848
Selling, general and
administrative expenses                         42,110                      27,747               14,363
Operating income                                17,808                      10,866                6,942

Earnings before income tax                      15,869                       9,050                6,819

(1) On May 16, 2011, Gentherm acquired a majority interest in W.E.T. Balances shown for W.E.T. represent only the portion of the year that occurred on or after the acquisition date.

Product Revenues. Product revenues for 2012 were $554,979,000 compared with product revenues of $369,588,000 for 2011, an increase of $185,391,000, or 50%, reflecting a full twelve months of W.E.T. revenues earned in 2012 compared with seven and a half months of W.E.T. revenues earned in 2011. In addition, the results for 2012 reflect new program launches for CCS, including the Ford Flex, Nissan Pathfinder, Infiniti JX, Hyundai i40 and Kia K9 Cadenza. Certain existing vehicle programs had higher revenue during the period as a result of our customers expanding the availability of our product to additional geographic regions. These vehicles include the Kia Optima which is now also offered in the China and North American markets. Partially offsetting higher product revenues during YTD 2012 is a decline related to the weakening of the Euro against the U.S. dollar which negatively impacted our Euro denominated revenues. Our Euro denominated product revenue for 2012 was €126,602,000 and the average US Dollar/Euro exchange rate for 2012 was 1.2861. If the average exchange rate for YTD 2012 been equal to the average US Dollar/Euro rate for all of 2011 of 1.3921, we would have reported incrementally higher revenue of approximately $13,400,000.

Cost of Sales. Cost of sales increased to $413,052,000 during 2012 from $274,621,000 during 2011. This increase of $138,431,000 or 50%, is due to a full twelve months of W.E.T. cost of sales incurred in 2012 compared with seven and a half months of W.E.T. cost of sales incurred during 2011, offset by higher gross margin percentages. Historical Gentherm's 2012 costs of sales include $1,611,000 to accelerate royalty obligations from a worldwide license agreement. Adding back the effect for this one time charge, historical Gentherm's 2012 gross margin percentage improved slightly compared with 2011.

Net Research and Development Expenses. Net research and development expenses increased to $40,950,000 during 2012 from $29,733,000 during 2011, reflecting a full twelve months of W.E.T. research and development expenses incurred in 2012 compared with seven and a half months of W.E.T. expenses incurred during 2011. The decrease in historical Gentherm net research and development costs is due to an increase in funding reimbursements from U.S. Department of Energy sponsored research and product development.


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Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $64,919,000 during 2012 from $42,110,000 during 2011. This $22,809,000, or 54%, increase is primarily due to a full twelve months of W.E.T. expenses incurred in 2012 compared with seven and a half months of W.E.T. expenses in 2011, and higher selling, general and administrative expenses at historical Gentherm. Historical Gentherm's 2012 expenses increased $5,467,000, or 38%, and included approximately $950,000 in legal expenses related to a Domination and Profit and Loss Transfer Agreement ("DPLTA") for W.E.T., approximately $1,000,000 in expenses related to the Sarbanes-Oxley implementation for W.E.T. and approximately $686,000 in one time fees associated with an investigation of a potential merger. The remaining increase in historical Gentherm's selling, general and administrative expenses is due to higher general legal, audit and travel costs, as well as wages and benefits costs resulting from new employee hiring and merit increases. See the Liquidity and Capital Resources section of this report for additional information about the DPLTA.

Income Tax Expense. We recorded an income tax expense of $8,351,000 during 2012 representing an effective tax rate of 25.6%. Our tax rate differs from the federal statutory rate for a number of factors. Factors increasing our tax expense include state and local taxes, expenses that are not deductible for tax purposes, certain acquisition expenses incurred in conjunction with the W.E.T. acquisition that are not tax deductible, withholding taxes imposed when our subsidiaries pay upstream dividends, and non deductible stock compensation. Factors that decrease our tax expense include research and development tax credits, tax exempt income, which includes a portion of our foreign currency gains, nontaxable gains on derivatives and lower tax rates in certain foreign jurisdictions. Finally, the American Taxpayer Relief Act of 2012 ("the Act") was signed into law but not until January 2, 2013. The Act retroactively restored the research and development credit and certain exemptions under the foreign income tax rules, however, because a change in tax law is accounted for in the period of enactment, the retroactive effect of the Act on the Company's U.S. federal taxes for 2012, a benefit of approximately $1,300,000 will not be recognized until the first quarter of 2013. See Note 5 to our Consolidated Financial Statements for further discussion regarding these differences. During 2011, we recorded an income tax expense of $4,666,000, representing an effective tax of 29.4%. This rate differs from the federal statutory rate due to the above listed factors as well as factors relating to the acquisition of W.E.T.

Results of Operations Year Ended December 31, 2011 Compared to Year Ended December 31, 2010

The following table presents select operations data for the period as reported, amounts for W.E.T. operations and amounts for Gentherm less the W.E.T. amounts representing the historical portion of Gentherm. These Historical Gentherm financial results, which are non-GAAP measures, are provided to help shareholders understand Gentherm's results of operations in light of the acquisition of W.E.T. These non-GAAP financial measures should be viewed in addition to, and not as an alternative for, Gentherm's reported results prepared in accordance with GAAP.

                                                                                                 Twelve month
                                        Twelve month period ended December 31,                ended  December 31,
                                                         2011                                        2010
                                       As
                                    Reported           Less: W.E.T.                  Historical Gentherm
                                                                   (In Thousands)
Product revenues                  $    369,588         $     237,248        $ 132,340        $             112,403
Cost of sales                          274,621               179,374           95,247                       79,648

Gross margin                      $     94,967         $      57,874        $  37,093        $              32,755
Gross margin percent                      25.7 %                24.4 %           28.0 %                       29.1 %
Operating expenses:
Net research and development
expenses                                29,733                18,793           10,940                       10,436
Acquisition transaction
expenses                                 5,316                   468            4,848                           -
Selling, general and
administrative expenses                 42,110                27,747           14,363                       10,955
Operating income                        17,808                10,866            6,942                       11,364
Earnings before income tax              15,869                 9,050            6,819                       11,501


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Product Revenues. Product revenues for 2011 were $369,588,000 compared with product revenues of $112,403,000 for 2010, an increase of $257,185,000, or 229%, primarily reflecting additional revenue for W.E.T. of $237,248,000. The increase of $19,937,000 attributable to historical Gentherm was primarily the result of a much improved automotive marketplace. Unit shipments of CCS were 1,922,000 during 2011 compared with unit shipments of 1,597,000 during 2010, an increase of 325,000 units. The higher product revenues and unit volumes are due to increased shipments on vehicles that were launched during 2010 and, for 2011, include a full year's worth of production activity. These include the Ford F-250, Ford Explorer, Hyundai Veracruz, Kia Sportage, Kia Optima and Kia Sonata. Strong product revenue performance was partially offset by lower sales volumes for the Jaguar XJ and Land Rover Range Rover. Strong demand for our heated and cooled mattress in the first full year of sales, as well as for our heated and cooled cup holder also contributed to the growth in product revenues.

Cost of Sales. Cost of sales increased to $274,621,000 during 2011 from $79,648,000 during 2010. This increase of $194,973,000 or 245%, is primarily attributable to the costs of sales of W.E.T. of $179,374,000. The remaining increase of $15,599,000 attributable to historical Gentherm is due to higher sales volumes and slightly lower gross profit percentages. The gross profit percentage during 2011 was approximately 26% compared with 29% during 2010. This decrease in gross profit was the result of an unfavorable change in product mix and higher raw material costs. Partially offsetting this decrease is a greater coverage of fixed costs at the higher volume levels.

Net Research and Development Expenses. Net research and development expenses increased to $29,773,000 during 2011 from $10,436,000 during 2010, primarily reflecting additional research and development expenses for W.E.T. of $18,793,000. We classify development and prototype costs and related reimbursements as research and development. This is consistent with accounting standards applied in the automotive industry. Depreciation costs for tooling are included in cost of sales.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $42,110,000 during 2011 from $10,955,000 during 2010. This $31,155,000, or 284%, increase is primarily due to the selling, general and administrative expenses for W.E.T. of $27,747,000, or 89%, of the total increase. The remaining $3,408,000, increase attributable to historical Gentherm is due to full a year's worth of expenses at our China office, an increase in the number of sales and marketing employees at our Korea office, certain costs related to integration activities of W.E.T. and higher bad debt expense related to certain receivable balances. Higher compensation expense from employee merit and headcount increases also contributed to higher 2011 historical Gentherm selling, general and administrative expenses compared with 2010.

Income Tax Expense. We recorded an income tax expense of $4,666,000 during 2011 representing an effective tax rate of 29.4%. Our tax rate differs from the federal statutory rate for a number of factors. Factors increasing our tax expense include state and local taxes, expenses that are not deductible for tax purposes, certain acquisition expenses incurred in conjunction with the W.E.T. Acquisition that are not tax deductible, withholding taxes imposed when our subsidiaries pay upstream dividends, and non deductible stock compensation. Factors that decrease our tax expense include research and development tax credits, tax exempt income, which includes a portion of our foreign currency gains, nontaxable gains on derivatives and lower tax rates in certain foreign jurisdictions. See Note 5 to our Consolidated Financial Statements for further discussion regarding these differences. During 2010, we recorded an income tax expense of $2,609,000. This amount included and adjustment to our deferred tax asset valuation allowance which lowered income tax expense by $1,375,000. This adjustment reflected a change in the amount of Federal Net Operating Losses that are limited due to a 1999 change in control. Our effective tax rate during 2010, prior to this adjustment was 35% on pre-tax income of $11,408,000.


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Liquidity and Capital Resources

The following table represents our cash and cash equivalents and short-term investments:

                                         December 31,       December 31,
                                             2012               2011
                                                 (in Thousands)
            Cash and cash equivalents   $       58,152     $       23,839

                                        $       58,152     $       23,839

We manage our cash, cash equivalents and short-term investments in order to fund operating requirements and preserve liquidity to take advantage of further business opportunities. Cash and cash equivalents increased by $34,313,000 in 2012.

Cash provided by operating activities during 2012 was $36,865,000 and was attributable to net income of $24,321,000, plus non-cash adjustments. Non-cash adjustments included depreciation and amortization of $30,627,000, loss on the sale of property, plant and equipment of $555,000, stock compensation of $1,252,000, deferred income tax expense of $789,000, and other items. Partially offsetting these was a net increase in net operating assets and liabilities of $21,340,000.

As of December 31, 2012, working capital was $124,935,000 as compared to $65,955,000 at December 31, 2011, an increase of $58,980,000, or 89%. Increases in cash and cash equivalents, account receivable, inventory and prepaid expenses of $34,313,000, $19,866,000 $7,412,000 and $3,124,000, respectively, were partially offset by increases in accrued liabilities and current maturities of long-term debt of $7,864,000 and $2,648,000, respectively. The increase in cash and cash equivalents is primarily related to a public offering of 5,290,000 . . .

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