Ladies and Gentlemen, good morning and welcome to the Gentherm Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Yijing Brentano, Senior Vice President of Strategy, Corporate Development and IR. Please go ahead..

Thank you and good morning everyone, and thanks 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, we may make forward-looking statements within the meaning of federal securities law. Statements reflect our current views with respect to future events and financial performance, and actual results may differ materially. We undertake no obligation to update them, except as required by law.

Please see Gentherm's earnings release and its SEC filings, including the latest 10-K and subsequent reports, for discussions of our risk factors and other risks and uncertainties underlying such forward-looking statements.

During the call, we may discuss non-GAAP financial measures as defined by SEC Regulation G, including certain pro forma measures related to the Alfmeier acquisition. Reconciliations of these non-GAAP financial measures to the comparable GAAP financial measures are included in our earnings release and investor presentation.

On the call with me today are Phil Eyler, President and CEO; and Matteo Anversa, CFO. During their comments, Phil and Matteo will be referring to a presentation deck that we have made available on our website at gentherm.com/events. After their prepared remarks, we will be pleased to take your questions. Now I'd like to turn the call over to Phil..

Thank you, Yijing. Good morning, everyone, and thank you for joining us today. I'm pleased with the continued strong momentum in the third quarter and year-to-date. Demand for our thermal comfort, massage, and lumbar solutions continues to accelerate.

The $520 million in new business awards achieved in Q3 set a third quarter record, bringing us to $1.7 billion in new business awards year-to-date. I am thrilled to announce that as of today we have now exceeded all prior year records for new business wins, which now stands at $2 billion with more than two months left in the fiscal year.

Also, during the third quarter, we achieved record revenue in the key product lines of Climate Control Seat and Steering Wheel Heaters, as well as improved profitability. During the quarter, we continued to strengthen our operational execution and further improve productivity.

We delivered the highest quarterly adjusted EBITDA in the past 10 quarters, up 15% compared to the third quarter of 2022 and an increase of 12.5% from the second quarter of 2023. We also continue to make progress on our Fit for Growth 2.0 initiatives and on the preparations for our footprint expansion in Morocco and Monterrey, Mexico.

These actions will help us to continue to expand margin and return to a high teens adjusted EBITDA margin rate in the midterm. Now turning to the automotive highlights on Slide 4. In the third quarter, we launched our automotive solutions on 16 different vehicles across eight OEMs, including BMW, BYD, Ford, General Motors, Great Wall, and Volkswagen.

We continue to see expanded application of our CCS solutions. In the third quarter, our CCS solutions were launched on the BMW 5 Series, Chevrolet Equinox EV, Great Wall Mecha Dragon, Hongqi eH5, and Xpeng G9. Now let me give you a quick update on ClimateSense.

First of all, I'm pleased to announce that Gentherm's ClimateSense won the 2023 Automotive D.R.I.V.E Honours for reducing emissions. D.R.I.V.E is the Reuters event's annual recognition for automotive excellence.

ClimateSense is the industry's first scalable, intelligent, automotive microclimate comfort solution that offers an interior cabin experience that uniquely delivers energy efficient, personalized comfort for each occupant that extends electric vehicle range.

Our proprietary ClimateSense leverages thermal physiology principles to determine which areas of the body to target at specific intensity and duration to provide optimal comfort with minimized energy consumption. I would like to congratulate the Gentherm team for winning this coveted recognition.

In addition to ClimateSense, our advanced engineering team continues to integrate our thermal products with lumbar and massage products to create innovative full system solutions.

The combination of heating and cooling the body with massage, including our industry's first proprietary pulsating massage, Pulse A, is opening vast opportunities for solutions that promote health and wellness experiences, alertness enhancements, and physical recovery in the car.

Now on to Slide 5, where, as I mentioned, we secured $520 million of awards in automotive in the third quarter. We won several CCS awards in the quarter. Of note, we won the Dodge Ram 2500 and 3500, Mazda CX-5, and Volkswagen Tyrone. And in China, we won Audi A4, a future electric Buick SUV, Ford Explorer, and Hyundai Tucson Fuel Cell EV.

We continue to gain momentum with some of the fastest growing Chinese EV makers. Of note, in the third quarter, we won three full CCS awards with Li Auto on their L8, L9, and the future electric SUV. Additionally, I am pleased to share that we just won our first combined CCS and pneumatic massage award from Li Auto in October.

I'd like to congratulate our global team for this breakthrough win, our first high-end massage system with a domestic Chinese OEM. And in addition, we received pneumatic lumbar and massage awards with Stellantis and Mercedes in the third quarter. We continue to win pneumatic lumbar and massage awards at a much faster pace than expected.

Allow me to remind you that in just 14 months since the Alfmeier acquisition, we have won conquest pneumatic lumbar and massage awards with BMW, General Motors, Jaguar Land Rover, Stellantis, Volkswagen, and one of the largest global EV manufacturers.

These wins confirm our Alfmeier acquisition thesis of leveraging Gentherm's strong customer relationships to introduce Alfmeier's industry-leading technologies. Also of note, in the third quarter, we received 10 Steering Wheel Heater awards across eight OEMs. These included Audi, BAIC, BMW, MINI, Fiat, GMC, Honda, Hongqi, and Volvo.

And importantly, six of these awards are hands-on detection enabled. Turning to ClimateSense, our demonstrations of range extension and superior thermal comfort enabled by ClimateSense have driven higher thermal content, higher take rates, and adoption of our solutions on electric vehicles, which contributed to our record awards in 2023.

Of special note, we have won a follow-on Heated Interior solutions award, including our electronic control units from Honda for additional EV platforms. Our ongoing ClimateSense development project with Honda has demonstrated significant savings in HVAC energy consumption by combining seat heat, steering wheel heat, and interior heat.

We are excited about our ongoing partnership with Honda in Japan. Moving on to electronics and software, I'm pleased to share that we won our first Multi-Function Electronic Control Unit Award from General Motors as part of their software-defined vehicle platform. This is truly a breakthrough win for Gentherm.

Our electronics hardware will be on every General Motors software-defined vehicle requiring control of thermal devices along with other features, resulting in a higher take rate of electronics and higher content per vehicle for Gentherm. This award opens the door for us to be a major player in the software-defined vehicles of the future.

Our multi-function electronic control units, which operate the thermal functions as well as control motors and other actuators, are increasingly in demand as OEMs look to combine ECUs and remove sensors to decrease weight and complexity. And this is just the beginning.

As the industry's SDV ecosystem continues to grow, we expect to add incremental electronics and software features that will enable greater energy efficiency, more personalization, and novel comfort and wellness experiences. Software and electronics are fundamental to our strategy.

We have significantly increased our resources and competency from embedded devices to algorithm-driven connected solutions. Now let's turn to Slide 6 for a discussion of our medical business. Medical revenue in the third quarter increased 10% year-over-year, primarily driven by revenue growth of our Dacheng air warming blankets.

In the third quarter, we added 20 new hospital customers in China. In the U.S., we were awarded contract extensions with two of the largest group purchasing organizations, Premier and Vizient, for our flagship Blanketrol product.

These contract extensions will give us continued access to more than 70% of the domestic acute care hospitals associated with these GPOs.

Given the change in purchasing behaviors in the medical device market, post-COVID, we have adapted our go-to-market model in the medical business to leverage large partnerships, distribution channels, and white label opportunities.

As we announced on the last earnings call, we're partnering with SourceMark Medical, a certified minority supplier, to provide world-class patient warming solutions to the U.S. healthcare market. Consequently, we have reduced the size of our in-house sales team to improve our cost structure in medical.

We remain cautiously optimistic about the opportunity in medical and are laser-focused on improving returns in this business in the near term. And with that, I'll turn the call over to Matteo for a little more color on the financial results..

Thank you, Phil. Let me turn to Slide 7 and focus on the most significant items in our third quarter results. For the quarter, product revenues increased by 10% compared to the same period of last year, including the contribution from the acquisitions. If we adjust for the impact of acquisitions and FX, our overall product revenue increased by 3%.

Starting with the automotive segment, automotive revenues were $355 million, reflecting a 10% increase compared to the prior year period.

Adjusting for the contribution from Alfmeier in both periods and foreign currency translation, automotive revenue increased by 3.1%, which is 150 basis points lower than the 4.6% increase in the actual light vehicle production in our key markets of North America, Europe, China, Japan and Korea.

Excluding the non-automotive electronics business, which we are in the process of phasing out, and last year's one-time benefit from spot buy recoveries, we were in line with the production volume for the third quarter and year-to-date we outperformed the market by 370 basis points.

It is worth noting that our core thermal product lines, which include CCS, seat heaters, and steering wheel heaters outperformed the production in our relevant market by over 500 basis points in the third quarter and 650 basis points year-to-date.

We saw growth in the majority of our product lines with quarterly records in both steering wheel heaters and CCS. More specifically, steering wheel-heater revenue increased by 27% compared to the prior year period due to higher demand of our hands-on detection-enabled steering wheel-heaters on multiple VW models.

CCS revenues increased by 12% due to higher production volume of GM trucks and SUVs, as well as higher take rate with Hyundai-Kia and the start of production at one of our the largest global EV manufacturers.

This was partially offset by reduced volume of several model year changeovers and slower ramp-up than expected of some customer electric vehicles. Cable revenues increased 7% due to higher sales with Bosch.

Seat heater revenues increased by 2% due to higher production volume at Ford, Honda, as well as ramp-up on an electric vehicle for a global EV manufacturer.

Lumber and massage and valve systems revenue was relatively flat year-over-year on a pro forma basis due to lower production volume of certain vehicle models at one of the largest global electric vehicle manufacturers.

CCS revenue declined 15% due to lower volumes with Jeep and Mercedes driven by earlier than expected decrease of the mild hybrid vehicle production. This was the primary driver of our at-market versus above-market performance during the quarter.

Electronics revenue decreased 16% due to lower production volume with Ford and the phase-out of non-automotive electronics. Other automotive revenue decreased 60% primarily due to last year's one-time benefit from spot buy recoveries.

Turning to medical, medical revenues increased 10% primarily as a result of growth of our Dacheng air warming blankets as well as strong sales of our liquid cooling disposable blankets in the United States.

Moving to adjusted EBITDA, adjusted EBITDA rate in – adjusted EBITDA in the quarter was $47.7 million, up from $41.6 million in the prior year period and $42.2 million in the prior year performance. The adjusted EBITDA rate for the third quarter was 13%, the highest profitability rate in seven quarters.

This compares to 12% in the year-ago period on a comparable pro forma basis. That 100 basis point year-over-year improvement was driven by lower freight costs, productivity at the factories, and fixed cost leverage on higher sales volume.

These were partially offset by material and wage inflation and lower price recoveries relative to the prior year period, which had included catch-up recoveries of previous quarter.

It is worth noting that sequentially adjusted EBITDA margin rate rose 160 basis points despite lower sales volume driven by improved profitability from Alfmeier, higher factory productivity and supplier cost reduction. Operating expenses were $62.5 million in the quarter compared to $57.5 million in the prior year period.

If we adjust for acquisition, integration and restructuring costs, as well as non-cash stock compensation expenses in both periods, operating expenses were $56.4 million, up from $51.6 million in the third quarter of last year.

The year-over-year increase of approximately $5 million was primarily driven by additional expenses from the acquired businesses, as well as higher compensation and R&D expenses partially offset by higher reimbursement of R&D costs. Our effective tax rate in the quarter was approximately 30%.

And finally, adjusted diluted earnings per share in the quarter were $0.64 per share compared to $0.70 per share in the third quarter of last year. If we move to the balance sheet on Slide 8, our cash position at the end of the quarter was approximately $154 million, and our net debt stood at $54 million.

Net debt increased by $5 million in the quarter, due to capital expenditures and share repurchases, partially offset by $21 million of cash generated from operating activity. Our net leverage ratio was 0.3 at the end of the third quarter in line with the prior quarter, and well below our target of 1.5 times.

Based on the trading 12-month consolidated adjusted EBITDA end of September 30, we had approximately $293 million of remaining availability on our line of credit, and the total available liquidity as of September 30 was $447 million. Now let me turn to Slide 9 for our 2023 guidance.

For comparison purposes, we included the actual results as reported for 2022, as well as the pro forma 2022 values if we had incorporated the results of Alfmeier since the beginning of the year.

Based on our performance year-to-date and the best information that we currently have from our customers and suppliers, we are updating the full year 2023 guidance that was provided at the beginning of the year. The UAW situation remains volatile.

However, for the purpose of the guidance, we assume that the OEM plans impacted by the UAW strike as of October 25 will remain idled through the end of November. For 2023, we now expect the revenue to be in the range of $1.45 billion to $1.47 billion, assuming FX remains at the current level.

The midpoint of our guidance implies a growth rate of 9% on a pro forma basis, excluding the impact of foreign exchange. We now expect adjusted EBITDA margin rate to be in the range of 11.5 to 12.5% for 2023.

We still expect our adjusted full year effective tax rate, excluding the impact of the previously recorded goodwill impairment, to be in the range of 28% to 32%. And we now expect capital expenditures to decrease to the range of $40 million to $50 million. With that, I will turn the call back to Phil..

Thanks, Matteo. Now let me summarize. As the new business wins, record revenues in key product lines and improve profitability in Q3 demonstrate, the Gentherm team is executing strongly. As we've discussed, we're driving content per vehicle and simultaneously increasing our penetration into key EV product lines and into OEMs globally.

We are effectively leveraging the Alfmeier acquisition, winning global conquest, pneumatic, lumbar, and massage awards with a growing number of OEMs globally. And we are laser-focused on building an even stronger foundation for the future, as we expand our global manufacturing capabilities with investments in Morocco and Mexico.

While the automotive production environment remains challenging, including the UAW strike, our relentless focus on strong operational execution, innovation, and cash flow generation, along with our record performance on new business awards, positions us well to continue to drive shareholder value over the long term.

With that, I'll turn the call back to the operator to begin the Q&A Session..

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Matt Koranda with Roth Capital Partners. Please go ahead..

Hey guys, it's Mike Zabran, on for Matt..

Good morning..

Good morning..

Good morning. I guess starting on the topline may be just speak to why organic and ex-FX automotive revenue growth lacked industry production in the third quarter.

I know we called out some spot buy recoveries in the prior year period, but are we also seeing lack of launch activity, are take rates lite? I guess just some more color on 3Q would be helpful.

And then how do we expect revenue to trend relative to industry production in 4Q?.

Sure thanks. I'll take that, Matt. First of all, you're right, we were basically flat to market, excluding the spot buys and the phase out revenue from our non-automotive electronics business. Outside of that, I'll just kind of break it down by product category to explain how we performed.

First off, we grew basically in line with expectations that we had previously on our core climate business, so CCS, seat heat, steering wheel heat. There were some puts and takes in there, though.

I mean, we had some higher take rates and vehicle launches than we expected, but those were somewhat offset by lower volume on some vehicle changeovers and some delayed EV ramp ups, which I think, has been well publicized with some OEMs.

So all in all, kind of right on track with the climate business, where we saw the most significant impact below our expectations was with our Battery Performance Solutions.

So we talked about in the past, the majority of our revenue currently in that category is with 48-volt mild hybrid vehicles, and that's where we have our thermal electric-based battery thermal management product. We've known over time that that's going to gradually phase down.

Unfortunately, it was a little faster of a phase down or ramp down in the quarter than we expected. Now, those customers are Jeep and Mercedes. So revenue will still be there on those products. It's just gradually phasing down.

Over the longer period for BPS, I think, if you look at the next several quarters, probably going to be relatively flat on our BPS business due to that ramp down. On the good side, we're launching some new products, mostly through our MSP-based flex circuits.

So the BMW self-connecting board, the Renault battery heater, Mercedes battery heater, products like that. We're also ramping up our growing air-cooled battery products. So some good guys that are coming, but that will be basically offset by the declining 48-volt mild-hybrid business. So, that's BPS.

On the other products, as you look into the full year, as you know, we kind of softened the top line a little bit. The BPS plays a significant impact there. The rest of the year, we still see the climate product about online with our expectations.

If you look at the pneumatics products, we are going to see a little bit of a delay in the outperformance on our pneumatic lumbar massage. We expected quite a ramp up of EVs in the back half of the year, and some of those customer ramp ups are happening a little slower or delayed than expected.

So that's kind of the high-level assessment of the revenue..

Got it. Super helpful. Moving down to gross margins, feels like we're not totally getting the margin pull-through maybe that we were expecting.

Could you help bridge the 60 bps of year-over-year decline in a little bit more detail?.

Yes, sure. So I think for the gross margin, we – in the quarter, we recorded about $3 million, $3.5 million charge on inventory related to the non-automotive electronics that we are phasing out, as we announced last year. So that's what is impacting the gross margin in the quarter.

I think if we want to look at the profitability of the quarter, probably the better metric is the EBITDA. And that's where we see, on a pro forma basis, the 100 basis points year-over-year improvement, and 160 basis points sequential improvement.

On the year-over-year side, on the positive, we continue to see a normalization of the environment, particularly around freight. So the biggest extension margin was the reduction of expedited and regular freight in the quarter. Productivity at the factory also was a nice lift.

We achieved better productivity in the factory in this quarter compared to the last several ones.

And then on the negative side, we have seen a negative price, primarily due to the fact that we had a tough comp when you compare that to a quarter of 2023 versus last year, since we had a high elevated number of price recoveries in the third quarter of last year, just due to timing. So that's the walk year-over-year.

Sequentially, really, the improvement came from Alfmeier. As we said throughout the year, Alfmeier started the year in the single-digit EBITDA rates, and in the third quarter we were in the high single digits. So really a good improvement thanks to productivity, price recoveries, lower scrap.

And then we started to see also benefits coming from supplier on a sequential basis. So that's at a high level, the walk both sequentially and the year-over-year..

Got it. Super helpful. Last one from me. Good to hear, Alfmeier, margins improving. That was kind of my next question.

I guess just what needs to happen to get the segment to maybe low double-digit margins in 2024 if we still think this is a reasonable assumption for next year?.

I would say a little early to talk about 2024, but overall, I think the real lift on the EBITDA margin of Alfmeier will come from a couple of things. If you go back to what we said back in February, footprint optimization is one of the projects that we kicked off actually with the announcement that we had earlier in September.

And then obviously incremental volume, thanks to the huge number of awards that we have been winning since we owned the company. And then continue to work on productivity and scrap production across the factories. I think these are the three catalysts that will take the EBITDA margin of Alfmeier up..

I think it's important to add, first of all, that as Matteo said, we're winning at a much faster rate than we expected on our pneumatic, lumbar, and massage products. And besides the growth, that product is going to be coming in overtime at company margins. So that'll help to replace business and backfill lower margin business over time..

Very clear. That's all from you guys, thank you..

Thank you..

Thank you. [Operator Instructions] Our next question comes from the line of Ryan Sigdahl with Craig-Hallum Capital Group..

Good morning Phil, Matteo..

Good morning, Ryan..

Good morning, Ryan..

Curious, so within the guidance, you're assuming that the UAW strike goes through the end of November, kind of as is last night forward and UAW came to a tentative agreement.

Any comments, I guess, how that was factored, if at all, into the guidance for Q4 and the rest of the year?.

So obviously, Ryan, we are monitoring the situation between the UAW and the OEM very closely. There was no impact in the third quarter, but the impact will be in the fourth. And as I said in my remarks, we are assuming that the plans that were impacted up to yesterday will continue to be idled through the end of November.

So in terms of numbers, this equates to about $15 million to $20 million revenue impact for the fourth quarter. And Ford is about 25%, 30% of it. So that gives you kind of a gauge in case things change in the coming weeks.

Maybe last comment, I would make, this incremental margin on this $15 million to $20 million revenue is about 40%, which is a little higher than what we normally have, just because there are, embedded in the estimate, additional inefficiencies that we are expecting to incur due to the strike.

Then obviously, Ryan, if things were to continue, obviously, and if the strike gets prolonged, then we have a contingency plan in place, which we will enact, which includes obviously cost control at the OPEC side, tighter control and capital expenditures. But for sure, we are planning to – foremost, to protect our people and our customers.

We have delivered good, strong free cash flow in the year, so we can afford to build a little bit of inventory to make sure that we are ready for the ramp up once this issue is resolved..

And then as just my second question, it seems like you guys have had an accelerated traction with local Chinese OEMs.

Is this primarily customers demanding more thermal comfort solutions and more of your products, or is this primarily you guys winning conquest business away from competitors?.

It's both. The first one, for sure, we're seeing a rising demand for thermal and pneumatic features in China, period [ph]. So the consumer is growing more accustomed to those solutions and expecting it from the OEM. So that's great. Great tailwinds just on the features in general. On the other side, we have very tactically focused on specific OEMs.

In the past, most of our business, well, still is, and certainly traditionally has been with global OEMs who have formed joint ventures in China, and we've kind of transitioned our business with them into the market. In the last couple years, we've prioritized several domestic Chinese OEMs and are starting to make very good progress there.

We have a full support team in China, very large with three manufacturing plants, ready and able to aggressively go after those customers. And we're excited to announce that, especially with rising EV players, companies like Li Auto, BYD, Xpeng, and certainly Great Wall, that we've picked up a lot of business of late.

So it's a priority for us, and we're excited about what the team is doing there..

Great, thanks guys, good luck..

Thanks, Ryan..

Thanks, Ryan..

Thank you. [Operator Instructions] As there are no further questions, the conference of Gentherm has now concluded. Thank you for your participation. You may now disconnect your lines..