Kathleen Bentley - IR Dan Coker - President and CEO Barry Steele - CFO.

Steve Dyer - Craig-Hallum Christopher Van Horn - FBR Matt Koranda - ROTH Capital Partners Gary Prestopino - Barrington Research.

Greetings, and welcome to the Gentherm Incorporated Third Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kathleen Bentley, Investor Relations for Gentherm. Thank you, Ms. Bentley, you may begin..

Thank you, operator, and good morning everyone and thank you for joining us today. Gentherm’s earnings results were released earlier this morning and a copy of the release is available at gentherm.com. Additionally a webcast replay of today’s call will be available later today on the Investor Relations section of Gentherm’s website.

During this call, representatives of the company may make forward-looking statements within the meaning of federal security laws. Statements reflect current views with respect to future events and financial performance and actual results may materially differ.

Please see the company’s SEC filings, including the latest 10-K and subsequent reports for discussions of various risk factors and uncertainties underlying such forward-looking statements. During the call, the company may discuss non-GAAP financial measures as defined by SEC Regulation G.

Reconciliations of these non-GAAP financial measures to the comparable GAAP financial measures are included in the company’s earnings release. On the call, we have Dan Coker, President and Chief Executive Officer; and Barry Steele, Chief Financial Officer. Management will provide a review of the results, after which there will be a Q&A period.

I would now like to turn the call over to Dan.

Dan?.

Good morning and thank you, Kathleen. We would like to welcome everybody to our third quarter review.

The third quarter was a turbulent quarter for us and was kind of dominated a bit by the softer revenue that we saw, which was primarily a result of the softness of the North American marketplace, which is our largest market, about half of our overall revenue was generated here in the North American business and the total market here was off about 10%, while our business itself actually grew about 2%.

That softness in this home market was too much for us to overcome, and we missed our own internal goals for growth during the quarter. Our Asian and European businesses did show some growth, but those markets were not strong enough to offset the softness in the North American business.

I said we were turbulent in the quarter, and there were lots of moving pieces. I think Barry has done a very good job of identifying and categorizing those things for you in our press release, and he will give us a much more detailed view of what exactly happened in his comments. So we’ll start with that, Barry, over to you, sir..

Thank you, Dan, appreciate it. The 2017 third quarter has been one of the most complex periods that I can remember here at Gentherm, marked with many unusual issues and transactions. We’ve tried to describe most of these for you in today’s press release.

The unusual items are both positive and negative, some are operational issues that require attention, some mark important transitions.

None of them, however, changed the long-term mission of Gentherm, which is to focus on creating new and innovative technologies and leverage those technologies across a wide range of new and existing products in markets.

We continue to be excited about our future, even as the automotive industry, our most important market by far, loses a little steam. Let me take a few minutes and comment on some of the important events of the quarter that impacted our financial results. We recorded a customer rebate totaling 2 million.

This one-time lump-sum discount is a little unusual for us, although, common in the automotive supply industry. Since most of our customer price incentives come in the form of annual price decreases on running programs.

This one was different in form, but had the same overall economic impact, as the more regular pricing programs we have with most of our customers.

I can’t promise you that we wouldn’t use rebates as a way to incentivize our customers in the future, but I can tell you that if and when that happens, we will have secured significant value in the form of new business awards where opportunities for significant cost efficiencies or both as is the case today.

During the quarter, we also took a charge for the write-down on certain of our slow-moving inventories. Most importantly, about $2 million in stock we are holding for our heated and cooled mattress business.

We had invested in this inventory in order to be ready to meet customer demands, given long lead time in our supply chain, but have struggled to find the correct market channel for this product.

We continue to work to make this product a success and have made new relationships with new customers, but could not justify the valuation of the inventory due to the uncertain outlook and potential for different product design.

Our CSZ business, with its two product lines including the patient temperature management product and the product testing equipment business has put up some very nice growth since we acquired it just last year. Before that acquisition, the business was growing very slowly and was booking just over 60 million in annual revenues.

During the last four quarters, however, revenue has totaled nearly 76 million, although this quarter was a little slower having a total of just over 16 million. This slower pace was partly due to the tapering off of the blood heater cooler or Hemotherm sales, which had benefited recently from issues in the market on a competitive product.

The longer term outlook for the medical line of products is very favorable, however, as we have made a significant new investment in a direct sales force, and as we work to develop new products and improve and update the existing products. The sales force mostly in place now is costing about 1 million per quarter.

Although so far we’ve only seen a small impact from this investment, we continue to be confident in the strategy. The test equipment business has also grown, but in the last two quarters has struggled to achieve our standard gross margin on a number of large custom projects.

We have taken steps to correct this very recent issue partly in the form of more flexible pricing strategies that better reflect design and other (inaudible) inherent in this highly value-added business. Gentherm Power Technologies has had a much lower revenue quarter than we have seen recently.

However, the sequential decline is completely due to one large custom project that was actually shipped before the end of the quarter, but didn’t count in our revenue due to the incoterms that require the product to reach the customer location in Southeast Asia, before we could count its 4 million in sales.

Obviously, that will benefit the fourth quarter, and we expect the full year revenue of GPT to top 30 million. This delay costs us a bit and the gross margin, but we expect to get that back too during the fourth quarter.

We reported a 6 million unrealized currency loss to [Mother Nature] to the 7 million gains during the 2016 fourth quarter and the $12 million loss in the 2017 second quarter.

Once again, this was mainly the result of the stronger European euro in the quarter and due to the significant amount of US dollar cash and some intercompany balances at our foreign subsidiaries. The last item and for me, personally the saddest, is a 2.5 million expense related to the upcoming leadership transition.

We’ll see a similar expense in the fourth quarter at which point we can then call it a non-recurring item. Our cash of 148 million decreased during the quarter mainly due to repayments under various debt facilities and due to the repurchase of common stock of just over 5 million.

On September 30, our outstanding debt was 146 million, which is a decrease of 17 million for the quarter. Available borrowing capacity under the revolving credit facility is now 221 million, which brings our total available liquidity along with the cash to 368 million.

That’s all I have, Dan?.

As I indicated earlier, Barry has worked very hard to try to simplify this very turbulent quarter. Again, there were lots of moving pieces. I think that he’s made that very clear. But we’d certainly be interested in hearing any questions from the audience. Operator, Brock, we are about ready to open it up for questions..

[Operator Instructions] Our first question today is from Steve Dyer of Craig-Hallum. Please go ahead. .

The CCS sort of mix headwind continues to persist. Just wondering maybe what inning we were in of that or what you see happening there? There was a point not too long ago where heated and cooled was actually a much bigger business than heat vent.

Just pretty much everybody up for heat vent now or maybe some more color around that would be very (inaudible)..

As we’ve indicated in the past couple of years, this transition has been anticipated, it’s been planned for, and we are designing products to help our customers find the exact right product platform for their platform applications. The heat vent systems were designed specifically for the midrange vehicles, where the cost and power were a concern.

The heat cool businesses are going to be impacted over the future, although we do continue to see them growing and we see new opportunities, particularly in our European business, where the customers are beginning to be more open to the concepts of delivering thermal energy through the seat services as well as open to finding new methods of securing the comfort of the passenger inside the cabin with HVAC systems.

So it’s going to continue frankly for quite a while. We’re not in this since the baseball game was last night, and our ace pitcher Mr. [Verlander] helped the Houston team eke out a victory down there. We’ll put it in terms of baseball game. We are nowhere near the (inaudible) inning stretch right now.

We are still working with customers, the auto industry is a very slow moving business, and it takes a lot of time to think through, plan and execute change. We’re in the midst of doing that now.

The CCS business will continue to be a very strong business for us, but in the long term, the heat vent business will continue to grow I think at a much faster rate and will wind up being a significantly bigger business than heat cool over time. For us, this is a very positive impact.

It opens up a much broader market for us, for our products and technologies. The returns and margins on both products are very good and very strong. We’re very happy about seeing the concept of delivering thermal energy through the contact points inside the cabin as opposed to a pure convective system that have been used since the 1950s.

So we think this is a good opportunity for us, but in the short term, there is some transition and it’s going to continue for a while..

And then I’m just wondering a little bit BTM, sounds like it’s finally here kind of in Q4 (inaudible).

How do we think about sort of the revenue trajectory of that based on the deals you kind of have in hand or the next year or two?.

We see very dramatic growth in expansion of a completely new product category for us. The battery thermal management systems we have, as you know we’ve got a couple of very good partners that we’re working with.

Again, the auto industry moves very slow, particularly it’s something that has to do with the power system, the drive train or the electrical system of a car. Takes lots of testing, lots of evaluation and we’re very excited about being a part of this. This business will provide dramatic growth for us for the next five years.

Our first two customers alone will generate somewhere around $50 million worth of additional revenue with full run rate. We have additional customers coming online and additional people are testing our concepts and we’re adding new product options in the portfolio as we move forward.

So that’s going to be a really, really exciting thing, we’re going to invest in this business. We see it as a big part of our future..

And then last for me, I think this is typically about the time of year where you give kind of your initial revenue look into the following year.

I noticed there was nothing in the press release, but kind of given the flattened out production etcetera, how should we think about growth going forward? It’s kind of historically - I know you’ve shot for that 10, 10 plus, 10% to 15% range, what does next year sort of look like at this early stage?.

It’s like retirement for me, but I think that you got timing a little bit wrong. We don’t usually give our next year forecast at our third quarter earnings call. We usually wait until we’ve seen the results of the existing year before we guide. But I’d say that you’re going to see a continued trend in the auto industry.

I think you’re going to see a flattening of the overall growth primarily driven by the North American marketplace. I think the steam has come out of the business just a bit here, and you’re going to see a good solid steady run rate. You’re not going to see any, kind of, dramatic reductions.

But we’re going to see the growth rates flatten out, and I think you’re going to continue to see good strength in Europe and in Asia. So add to that the new product mixes that we’re bringing into the business, I think they’re going to be quite exciting, you’re going to see some good growth.

But we’re not prepared to give a number today on what we think next year will be..

The next question is from Christopher Van Horn of FBR. Please go ahead. .

I want to ask about production in 4Q and some of the visibility you might have there? Some OEMs are talking this week around possible production increases on some of their certain better selling vehicles.

I just want to see what kind of visibility you have on the production side into 4Q?.

We actually have pretty good visibility into 4Q. It’s already started and we have pretty much solid releases for the entire quarter. So I think you’ll notice in the press release that we did give a forecast, an indication of what we thought 2017 full year results would be.

That would indicate we have a pretty good sense of what the fourth quarter is going to be, and we see it being a very good quarter for us. We also see the first early stages of some very small but significant results from our battery thermal management units actually shipping..

So that production visibility is part of that guidance that you issued. And then on the steering wheels and battery thermal management, volume was very good in the quarter.

Is it volume-based, are there new wins, is it a combination of both, are you seeing more adoption for the steering wheel product and the BTM product, or is it you’re getting new wins, what’s kind of driving that?.

Well, it’s actually yes to all of that. It’s new wins, it’s new adoption, its spreading through our platform. So for us, this is a very good and positive sign. The steering wheel heater is an example of something that we got a very good product. It’s priced competitively, performs well, was easier to install.

So that’s continuing to grow very nicely as it has for the past few years. The battery thermal management products that we indicate are adaptations of products that we have across a broader market and are giving us new opportunity, so new penetration there..

And then sorry I forgot to include this, is that a similar story for what’s going on with the cable business or was there a big win in the quarter?.

The cable business is a little bit more dependent upon successes of our customers, and our customers had a very good quarter. So we had a good quarter..

And then I just want to touch base because it’s first time we’re kind of talking to you since you announced the Mercedes Award. Could you just walk us through how that award came to fruition, and it seems like Mercedes is starting you off on a platform and maybe there’s an opportunity to expand that. I just want to get your temperature on that award..

Well, the comment on that is it’s taken a lot of hard work by a lot of good people working to try to understand the needs of a very important customer, and to explain our capabilities and to show our product portfolio to the one of the most important customers in the world. It’s been a long time coming.

We’ve had a lot of hard work to introduce our products there, get them tested and validated. And the announcement was frankly a validation of a lot of people’s hard work, and it’s also an indication of the new level of trust that the Mercedes team has placed in us and our capabilities. So I think that’s a very good sign.

And yes, we now have an early stage product offering for them. We’ve always supplied seat heaters and other products to the Mercedes team and we’re quite proud of our relationship.

But now, with a lot of hard work, we are beginning to expand our product portfolio within their system and they’re seeing a lot of the advantages that we offer with some of our components and we believe that, that will continue to grow and to lead to a much stronger and much more deep relationship as we prove ourselves and the customers.

The consumers actually see the benefit of the new and improved products that we offer..

The next question is from Matt Koranda of ROTH Capital Partners. Please go ahead.

Just wanted to touch on the gross margin since I don’t think we have it yet. It looks like if we sort of adjust out some of the one-time items you guys called out. You guys would have been kind of in the low 31% range for gross margins, which seems still a little lighter than I would have expected.

Could you just help us understand kind of the moving pieces in the quarter there? Is it mainly GPT, lighter on the gross margins? And then how do we kind of factor that in to the snapback that’s expected in Q4? Do we get back to the 33% range that you guys have kind of typically been in?.

Well generally, as you’ll recall Matt, we’ve been advertising and working very hard to try to achieve something in the low-30s as our gross margin target. Barry, I think, has done a very good job of identifying the factors that contributed to this quarter’s results.

And actually I won’t speak for him, I’ll let him speak for himself, but I think he has a good explanation..

So Matt, in terms of the table that we presented in our press release, you’ll see that you actually get closer to the 33%. Now these aren’t necessarily one-time items, I think there are still some things we need to work through. The real drivers though were GPT and CSZ, for some of the reason that I mentioned.

The auto business is, with the exception of few things in the plant that we’ve seen for a ramp up of the battery thermal management, some costs there and some price increases or assuming some inflation in Ukraine, it’s more normal margin in the auto business..

And then the operational issues, I guess at CSZ the cost overruns in unfavorable product mix.

Is that sort of a discreet to Q3 or should we kind of layer in a little bit of inefficiency from that in the next quarter or two?.

Seen at least in the industrial product two quarters now with fairly low margins, unusually low margins, I think it will take us a couple of quarters to get out of that.

But we have good long-term outlook, as well as when we see new growth in the medical products that would help our margins substantially, because the mix is very important between those two different product lines..

And then just on CCS, if you could come back to that for a second. What’s sort of the right level of revenue growth for the CCS category? I know Dan gave some good puts and takes around heated and ventilated kind of growing as a percentage of the mix.

But just wanted to understand sort of when do we get back to positive territory in CCS? Is there kind of a near-term catalyst that you guys see either in the releases or program launches for next year that gets us there? A little bit of help or color on that would be helpful..

Sure. The transition as we’ve indicated has customers who had been buying CCS for mid-market applications migrating over to heat vent applications, and we think that’s an appropriate shift in product mix for them and of course, if it’s appropriate for them, it’s appropriate for us. So you’re going to continue to see pressure on CCS growth.

We continue to see good wins, but we also continue to see people making a transition. So you are not going to see a 25% or 30% growth in CCS for a while.

We are working with customers, we’re introducing some very exciting new concepts that involve active heating and cooling delivered through the seat services, customers are testing and evaluating these new concepts today, and we expect to have good wins for these products and these platforms in the future.

Although, in the immediate future, you can continue to see people shifting from CCS to heat vent and that’s going to continue for a while and that will continue to put pressure on growth for CCS..

Maybe just one last one, if I could sneak one in. So I wanted to get a little bit more granular on the battery thermal management ramp-up if we could, for the next several of quarters.

It’s my understanding you guys had that first program that will be roughly 25 million at a full annual run rate, and that ramp’s starting in Q4 and then throughout the balance to 2018.

Is that a pretty linear ramp for that, that you would expect or should we be kind of factoring in any kind of front half or back-half weighted revenue for that in 2018?.

That first customer, it takes about 18 months for it to ramp up. It comes in different pieces, several different vehicles that will happen over that time.

So I wouldn’t say it’s perfectly linear, but a little bit more linear than the second customer, which starts later in next year, (inaudible) if one or two programs that will ramp a little bit quicker.

So yes, I think you’ll see the first and second quarter to be a little bit of additional revenue and then it starts to pick up much faster in the second part of next year..

I think this is a little bit different than our traditional products. What you see in the battery thermal management is we are a standard feature on a power train. So when those power trains are chosen in the marketplace, we are chosen.

So it’s not like an optional feature that someone adds battery thermal management to their car or not, it’s a part of a drive train. And when that drive train is applied to a car, we come along. So as Barry says, that’s a little bit more linear than what we’re used to seeing.

But the launch rate and the opening run rates will be a little bit soft as we begin to build a position with the customer. And then as Barry says, in the second half and for the life of the product, it will run along with sales of those vehicles in the marketplace.

The second customer comes in the second half of next year and there will be a jump in revenue at that time and again, that customer is a little bit smaller than the first but very significant numbers..

Maybe one (inaudible), if I may is, what you see in the table today, the battery thermal management line is only our lower end product, that we have been selling for a number of years, that we’re blowing air only and you don’t see any of the advanced product there yet. But this is an area that’s growing rapidly itself..

[Operator Instructions] Our next question comes from Gary Prestopino of Barrington Research. Please go ahead..

When do the comps start getting easier on the blood warming product? I know you had a big ramp earlier part of this year, but do the comps start getting easier as we get into the mid 2018?.

Gary we had a very good – we started in the fourth quarter last year and then we had a very good first quarter and then it started to taper off.

So as the comps start to get easy not until third quarter, but I would say that there are other opportunities and other things we’re working on that will help offset that as we come for the medical products in the next few quarters..

Okay.

And then when you’re talking about the cost of overruns that CSZ and what you’re doing, could you maybe talk about some of the things that you’re doing to try and get that right-sided?.

The main issue that we have is these large custom projects that are very complex with a lot of expertise into them. Sometimes it’s difficult to understand the total cost. It’s a competitive business, and so we had cost overruns as we’ve had to make changes and design changes through the process.

The key for us is to have a better understanding of those issues in that business and put some possibilities in for a better pricing strategy. So that’s what we’ll have to work on over the next couple of quarters..

And then lastly, with the heat cool mattress with what you’re doing there and you had a write down there.

Are you getting to the point where maybe you’re starting to see indications that, this is just not a very viable product for the mass market or for the market in general? Just trying to get your appetite for how long you’re going to stay with this product and the investment you’re making in it?.

What you’re actually seeing is our inability to find the right channel to get to the broader market. We’ve tested a couple of things; we’re not experts in the bed business. I think we’ve proven that over the last five years. We keep trying to partner with folks who can lead us to success there.

All indications are that this is a highly desirable product. We’ve got a new partner whose done their own independent research and has come back to us and said that they are very excited about it. But what we had was, we had built up an inventory position in anticipation of prior programs being successful.

These programs have been less than successful and we’ve had to make it an adult decision to write down that inventory to make sure that we keep a strong balance sheet and that we keep flexibility in the marketplace. Barry pointed out earlier that there are potentials for product design changes and new improvements as we go forward.

We don’t want to be hampered by having old stock on hand. So I don’t think you can say that we have given up on the product or we don’t see the market. There is definitely a market there. We just have not figured out the best way to attack that market and provide a very desirable product to the market..

But in terms of R&D investment and whatever, a lot of that is past and it’s just the matter of now trying to find a channel of distribution that’s going to possibly kick-start some sell-through?.

Yes, we’re not spending a lot of money at all on the bed business. Most of the effort now is in sales and marketing..

There are no further questions at this time. I would like to turn the floor back over to Dan Coker for closing comments..

All right, folks, as I said that when we started this conversation, it was a very turbulent quarter. We’ve gotten a lot of very good questions. I thank you all for paying attention and reading so closely the press release and all of Barry’s comments.

But for us now this is a point of reference for the past and we’re looking forward to moving into the fourth quarter. We think the fourth quarter is going to be an uptick. We see good strengths in the marketplaces and we see that some of the hard work we’ve been doing should help us get closer back to our original path.

On a personal note, this may be one of the last calls that I’ll be attending.

So I want to thank all of you for all the years of support and attention that you’ve given to us and I very much enjoyed all of our interactions as we’ve gone through all the conferences and met with all of you and talked to all of you about our very exciting company and our future. So I know that Gentherm has a tremendous future going forward.

I’m very excited to see how it all goes, and I wish you all well. And we will talk to you in about 90 days. Thanks for calling..

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