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THRM > SEC Filings for THRM > Form 10-Q on 5-Aug-2014All Recent SEC Filings

Show all filings for GENTHERM INC

Form 10-Q for GENTHERM INC


5-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD LOOKING STATEMENTS

This Report contains forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of our plans and objectives for future operations, assumptions underlying such plans and objectives and other forward-looking statements included in "Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations," and in other places in this Report. Such statements may be identified by the use of forward-looking terminology such as "may," "will," "expect," "believe," "estimate," "anticipate," "intend," "continue," or similar terms, variations of such terms or the negative of such terms. The forward-looking statements included in this Report are made as of the date hereof and are based on management's current expectations and beliefs. Such statements are subject to a number of factors and uncertainties, which are set forth below and elsewhere in this Report and are also detailed from time to time in reports filed with the SEC and in particular, those set forth under "Risk Factors" in our most recent Annual Report on Form 10-K for the year ended December 31, 2013, that could cause actual results to differ materially from those described in the forward-looking statements. Except as required by law, we expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

The following discussion and analysis should be read in conjunction with, and is qualified in its entirety by, our financial statements and related notes thereto included elsewhere in this Report and in our Annual Report on Form 10-K for the year ended December 31, 2013.

General

Gentherm is a global technology and industry leader in the design, development, and manufacturing of innovative thermal management technologies and cable systems. We operate in locations aligned with our major customers' product strategies in order to provide locally enhanced design, integration and production capabilities and identify future climatic comfort product opportunities in both automotive and other markets. We concentrate our research on the development of new technologies that will improve overall product effectiveness and customer satisfaction. New design applications of our existing technologies help us to create new product and market opportunities for thermal comfort solutions.

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 design, coordination and testing of proposed new components and 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 original equipment manufacturers ("OEMs").

On April 1, 2014, we acquired all of the stock of privately-held Global Thermoelectric Inc. Global Thermoelectric is a global market leader and developer of thermoelectric generators. The principal application for Global Thermoelectric's products include natural gas well and pipeline protection systems and remote power generation for instrumentation, automation and telecommunication systems.

As part of the initiative to integrate the operations of historical Gentherm and W.E.T., changes were made to Gentherm's structure of internal organization. The financial information used by our chief operating decision maker to assess performance and allocate resources reflects the changes brought about through this initiative. See Note 5 to the consolidated condensed financial statements included herein for a further description of our reportable segments, including segment information about the reported product revenues and operating income of the Company for the three-month and six-month periods ended June 30, 2014 and 2013.

We internally manufacture a large portion of our products at our production facilities. Other products we sell are manufactured by third parties. Our primary manufacturing locations are in Mexico, China and the Ukraine, all countries that have historically experienced a heightened degree of political, civil and labor uncertainty. Recent demonstrations and related violence in the Ukraine in particular highlight this risk to our manufacturing process. Although our manufacturing facility in the Ukraine is located in the far eastern part of the country and approximately 700 miles by road from Kiev, and approximately the same distance from the activities along the border of Ukraine and Russia, we cannot be certain that similar demonstrations, unrest and international tensions will not affect our facility. Furthermore, most of our products manufactured in the Ukraine are shipped across the border from the Ukraine to Hungary for further delivery to our customers. If that border crossing were to be closed for any reason, we would essentially experience a loss of the use of our Ukraine facility, which would have a material adverse effect on our business. Approximately 24% of our revenues are derived from products manufactured at our Ukraine facility.


Second Quarter 2014 Compared with Second Quarter 2013

Product Revenues. Product revenues for the three months ended June 30, 2014 ("Second Quarter 2014") were $206,182,000 compared with product revenues of $160,520,000 for the three months ended June 30, 2013 ("Second Quarter 2013"), an increase of $45,662,000, or 28%. Higher revenue was primarily driven by continued strong shipments of climate controlled seat systems ("CCS") and due to the revenue from Global Thermoelectric Inc., which was acquired on April 1, 2014, totaling $8,174,000. CCS revenue increased by $23,200,000, or 37%, to approximately $85,200,000, during the Second Quarter 2014. This increase was partially the result of new program launches since Second Quarter 2013 and by strong production volumes and sales of the vehicles equipped with CCS systems, particularly vehicles in the luxury segment of the automotive market. Additionally, certain vehicles that have been redesigned since the Second Quarter 2013 are experiencing very strong production and sales levels, including the General Motors full size SUV platform ("K2XX") and the Jeep Grand Cherokee. Our seat heater revenue also increased by approximately $11,100,000, or 16%, to approximately $81,700,000. This reflected market penetration on certain vehicle programs and also the strong production volumes on General Motors' K2XX platform. We also have significant growth in our heated steering wheel heater product which showed an increase of $2,600,000, or 40%, to approximately $8,900,000. Our European based sales were significantly higher than the prior year as local economies and car sales in that region continue to improve. Foreign currency translation of our Euro denominated product revenue for Second Quarter 2014, which was 39,248,000 versus 35,454,000 during Second Quarter 2013, increased our product revenues by approximately $2,600,000 or 1.3%. The average US Dollar/Euro exchange rate for Second Quarter 2014 was 1.3715 versus 1.3056 for Second Quarter 2013.

Cost of Sales. Cost of sales increased to $145,425,000 in Second Quarter 2014 from $120,368,000 in Second Quarter 2013. This increase of $25,057,000, or 21%, is due to increased sales volume, including that of Global Thermoelectric Inc., partially offset by higher gross margin percentages. A favorable change in product mix, greater coverage of fixed costs at the higher volume levels, favorable contribution from our new electronics manufacturing facility in China and foreign currency impact on production expenses in the Mexican Peso ("MXN") and Ukraine Hryvna ("UAH") increased historical gross profit percentage during Second Quarter 2014 to 29.5% compared with 25.0% during Second Quarter 2013. The favorable product mix is primarily attributable to the greater sales growth in CCS products on which we have historically had better margin performance. The new electronics manufacturing facility launched during the second quarter of 2013. This new facility has since been in the process of increasing production volumes by producing existing component products that had formerly been produced by outside suppliers. The Second Quarter 2014 is the second reporting period where the savings from insourcing were larger than the additional overhead costs of the facility. We expect to capture further margin improvements as this manufacturing facility continues to increase production volumes. Our manufacturing plants are located in Ukraine, Mexico and China. As a result, our production labor costs are incurred in the local currency of each of those countries. During the Second Quarter 2014, MXN and UAH decreased in value to the USD by 4.2% and 45%, respectively.

Net Research and Development Expenses. Net research and development expenses were $14,550,000 during Second Quarter 2014 compared to $12,403,000 in Second Quarter 2013, an increase of $2,147,000, or 17%. This increase is primarily driven by additional resources, including personnel, focused on application engineering for new production programs of existing products, development of new products and a program to develop the next generation of seat comfort products. New product development includes automotive heated and cool storage devices, automotive interior thermal management devices, medical thermal management devices, battery thermal management devices and other potential products. Net research and development expenses also increased by $270,000 due to the acquisition of Global Thermoelectric Inc.

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.

Acquisition Transaction Expenses. During the Second Quarter 2013, we incurred $422,000 in fees, legal and other expenses associated with the acquisition of W.E.T. shares. During the Second Quarter 2014, we did not incur any such expenses.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $21,972,000 in Second Quarter 2014 from $18,908,000 in Second Quarter 2013, an increase of $3,064,000, or 16.2%. This increase in expenses is due to increased management incentive compensation costs, higher general legal, audit and travel costs, as well as wages and benefits costs resulting from new employee hiring and merit increases. The amount also includes the selling, general and administrative expenses of Global Thermoelectric Inc. totaling $2,149,000 since it was acquired on April 1, 2014. The additional employees are primarily related to establishing a new electronics production facility in Shenzhen, China, and increasing sales and marketing efforts aimed at supporting our current product development strategy.


Income Tax Expense. During Second Quarter 2014, we recorded an income tax expense of $6,502,000 representing an effective tax rate of 28% on earnings before income tax of $22,925,000. This amount included unfavorable adjustments relating to previously unrecognized tax expenses offset partially by a shift in the mix of income by legal jurisdiction favoring lower statutory tax rate locations. Our estimated tax rate without these adjustments is 25.8% based upon a forecast of our full year results. During the Second Quarter 2013, we recorded an income tax expense of $1,948,000 representing an effective tax rate of 26% on earnings before income tax of $7,476,000. The effective tax rates for Second Quarter 2014 and Second Quarter 2013 were lower than the US Federal rate of 34% primarily due to the impact of lower statutory rates for our subsidiaries operating in foreign jurisdictions.

First Half 2014 Compared with First Half 2013

Product Revenues. Product revenues for the six months ended June 30, 2014 ("First Half 2014") were $400,120,000 compared with product revenues of $308,610,000 for the six months ended June 30, 2013 ("First Half 2013"), an increase of $91,510,000, or 30%. Higher revenue was primarily driven by continued strong shipments of CCS and due to the revenue from Global Thermoelectric Inc., which was acquired on April 1, 2014, totaling $8,174,000. CCS revenue increased by $49,200,000, or 42%, to approximately $167,200,000, during the First Half 2014. This increase was partially the result of new program launches since First Half 2013 and by strong production volumes and sales of the vehicles equipped with CCS systems, particularly vehicles in the luxury segment of the automotive market. Additionally, certain vehicles that have been redesigned since the First Half 2013 are experiencing very strong production and sales levels, including the General Motors K2XX platform and the Jeep Grand Cherokee. The increase was also attributable to improvement in sales to our Japan based customers which had recovered from weaker sales during First Half 2013. Our seat heater revenue also increased by approximately $26,600,000, or 19%, to approximately $162,100,000. This reflected market penetration on certain vehicle programs and also the strong production volumes on General Motors' K2XX platform. We also have significant growth in our heated steering wheel heater product which showed an increase of $5,800,000, or 48%, to approximately $17,700,000. Our European based sales were significantly higher than the prior year as local economies and car sales in that region continue to improve. Foreign currency translation of our Euro denominated product revenue for First Half 2014, which was 78,314,000 versus 70,420,000 during First Half 2013, increased our product revenues by approximately $4,500,000 or 1.1%. The average US Dollar/Euro exchange rate for First Half 2014 was 1.3709 versus 1.3133 for First Half 2013.

Cost of Sales. Cost of sales increased to $282,338,000 in First Half 2014 from $229,407,000 in First Half 2013. This increase of $52,931,000, or 23%, is due to increased sales volume, including that of Global Thermoelectric Inc., partially offset by higher gross margin percentages. A favorable change in product mix, greater coverage of fixed costs at the higher volume levels, favorable contribution from our new electronics manufacturing facility in China and foreign currency impact on production expenses in the Mexican Peso ("MXN") and Ukraine Hryvna ("UAH") increased historical gross profit percentage during First Half 2014 to 29.4% compared with 25.7% during First Half 2013. The favorable product mix is primarily attributable to the greater sales growth in CCS products on which we have historically had better margin performance. We launched our new electronics manufacturing facility during the second quarter of 2013. This new facility has since been in the process of increasing production volumes by producing existing component products that had formerly been produced by outside suppliers. The Second Quarter 2014 is the second reporting period where the savings from insourcing were larger than the additional overhead costs of the facility. We expect to capture further margin improvements as this manufacturing facility continues to increase production volumes. Our manufacturing plants are located in Ukraine, Mexico and China. As a result, our production labor costs are incurred in the local currency of each of those countries. During the First Half 2014, MXN and UAH decreased in value to the USD by 4.4% and 29%, respectively.

Net Research and Development Expenses. Net research and development expenses were $27,595,000 during First Half 2014 compared to $24,244,000 in First Half 2013, an increase of $3,351,000, or 14%. This increase is primarily driven by additional resources, including personnel, focused on application engineering for new production programs of existing products, development of new products and a program to develop the next generation of seat comfort products. New product development includes automotive heated and cool storage devices, automotive interior thermal management devices, medical thermal management devices, battery thermal management devices and other potential products. Net research and development expenses also increased by $270,000 due to the acquisition of Global Thermoelectric Inc.

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.

Acquisition Transaction Expenses. During First Half 2014, we incurred $1,075,000 in fees and expenses associated with the acquisition of Global Thermoelectric Inc. which was completed on April 1, 2014. During the First Half 2013, we incurred $1,585,000 in fees, legal and other expenses associated with the acquisition of W.E.T. shares. These fees included payments totaling $750,000 to the holders of our Series C Convertible Preferred Stock who waived certain equity offering participation rights allowing for the partial funding of the acquisition of W.E.T. shares with Gentherm common stock.


Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $40,061,000 in First Half 2014 from $35,164,000 in First Half 2013, an increase of $4,897,000, or 14%. This increase in expenses is due to increased management incentive compensation costs, higher general legal, audit and travel costs, as well as wages and benefits costs resulting from new employee hiring and merit increases. The amount also includes the selling, general and administrative expenses of Global Thermoelectric Inc. totaling $2,149,000 since it was acquired on April 1, 2014. The additional employees are primarily related to establishing a new electronics production facility in Shenzhen, China, and increasing sales and marketing efforts aimed at supporting our current product development strategy.

Income Tax Expense. During First Half 2014, we recorded an income tax expense of $12,804,000 representing an effective tax rate of 28% on earnings before income tax of $45,806,000. This amount included unfavorable adjustments relating to previously unrecognized tax expenses offset partially by a shift in the mix of income by legal jurisdiction favoring lower statutory tax rate locations. Our estimated tax rate without these adjustments is 25.8% based upon a forecast of our full year results. During the Second Half 2013, we recorded an income tax expense of $2,743,000 representing an effective tax rate of 15% on earnings before income tax of $18,180,000. This amount included a one-time benefit resulting from the American Taxpayer Relief Act of 2012 ("the Act") which was signed into law on January 2, 2013. The Act restored the research and development credit and certain exemption under the foreign income tax rules, retroactively to the beginning of 2012. As a result, we recognized approximately $1,300,000 in benefits associated with our 2012 tax year during First Half 2013. Had the Act been adopted during 2012, the benefit would have been recorded during that year and Second Quarter 2013 effective tax rate would have been 22%. The effective tax rates for First Half 2014 and First Half 2013 were lower than the US Federal rate of 34% primarily due to the impact of lower statutory rates for our subsidiaries operating in foreign jurisdictions.

Liquidity and Capital Resources

The Company has funded its financial needs primarily through cash flows from operating activities and equity and debt financings. Based on its current operating plan, management believes cash and cash equivalents at June 30, 2014, together with cash flows from operating activities, are sufficient to meet operating and capital expenditure needs, and to service debt, for the foreseeable future. However, if cash flows from operations decline, we may need to obtain alternative sources of capital and reduce or delay capital expenditures, acquisitions and investments, all of which could impede the implementation of our business strategy and materially and adversely affect our results of operations and financial condition. In addition, it is likely that we will need to complete one or more equity or debt financings if we consummate any significant acquisitions. There can be no assurance that such capital will be available at all or on reasonable terms, which could materially and adversely affect our future operations and business strategy.

On June 3, 2014 we received a commitment for a proposed refinancing of the Bank of America credit facilities which would increase our revolving line of credit availability and extend the maturity to 2019. We expect to complete this refinancing during the third quarter of 2014.

The following table represents our cash and cash equivalents and short-term investments which are available for our business operations:

                                         June 30,       December 31,
                                           2014             2013
                                                (In thousands)
               Cash and cash equivalents $  43,154     $       54,885

We manage our cash, cash equivalents and short-term investments in order to fund operating requirements and preserve liquidity to take advantage of future business opportunities. Cash and cash equivalents decreased by $11,731,000 in First Half 2014. Cash provided by operating activities during First Half 2014 was $24,366,000 and was attributable to net income of $33,002,000, plus non-cash adjustments. Non-cash adjustments included depreciation and amortization of $15,391,000, stock compensation of $2,225,000 and other items. Offsetting these positive operating activities was the net increase in net operating assets and liabilities of $19,207,000, including working capital items and gains on the revaluation of derivatives of $217,000.

As of June 30, 2014, working capital was $140,900,000 as compared to $116,786,000 at December 31, 2013, an increase of $24,114,000, or 20.6%. This increase was primarily related to the acquisition of Global Thermoelectric Inc. of $14,679,000, increases in accounts receivable and prepaid expenses and other assets and a decrease in accounts payable of $17,456,000, 6,959,000 and $1,312,000, respectively. These increases to working capital were partially offset by decreases in inventory, deferred income tax assets and the current portion of long-term debt of $5,024,000, $6,309,000 and $1,920,000, respectively, and an increase accrued liabilities of $1,496,000. Accounts receivable increased primarily as a result of increases in product revenues and timing differences between when sales in 2014 were realized compared with sales realized during 2013. Gentherm had proportionally more sales in the June 2014 compared with December 2013. Working Capital was also affected by changes in currency exchange rates.


Cash used in investing activities was $47,184,000 during First Half 2014, reflecting the purchases of Global Thermoelectric and the remaining equity in a joint venture totaling $31,739,000 and purchases of property, plant and equipment totaling $15,489,000. Purchases of property and equipment for the period are primarily related to expansion of production capacity, as well as replacement of existing equipment. During the Second Quarter of 2014, we entered into an agreement to purchase an unoccupied industrial property in Vietnam for purposes of expanding our Asia manufacturing capacity with a new production facility. We expect to begin construction of the new facility during the fourth quarter of 2014 and begin production during 2015. The new facility is estimated to cost between $10,000,000 and $15,000,000.

Cash provided by financing activities was $8,546,000 during First Half 2014, reflecting borrowings against our US Revolving Note of $13,455,000 and proceeds from the exercise of common stock options of $3,406,000. These amounts were partially offset by repayments on our outstanding term notes totaling $12,470,000.

Gentherm, Inc. and our subsidiaries have outstanding credit agreements with a syndicate of banks led by Bank of America. See Note 6 "Debt" to the consolidated condensed financial statements included herein for a further description of our credit agreements.

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