Gentherm Incorporated (THRM) Earnings Call Transcript & Summary

I'm Ryan Brinkman, the automotive equity research analyst at JPMorgan. Thanks for joining us for the 2020 JPMorgan Automotive Conference being held virtually this year. Before we get going with the next presentation, which is going to be with Gentherm, I just wanted to remind the investors that you're able to ask a question, you can submit it via the conference website, and I'd be happy to ask it to management on your behalf without identifying your name or firm. So with that, I want to get going with Phil Eyler, President and Chief Executive Officer of Gentherm. Phil, thanks for being with us. Appreciate it.

Good afternoon, Ryan, excited to be here with you. Thanks for the invite.

Absolutely. We decided to ask all of the suppliers at the conference this year just a few questions around coronavirus, top of mind issues, including the first one is, how you think it impacts profitability long-term, in the global financial crisis, margins compressed a lot, but then they rebounded eventually to higher than they were before. And if you just kind of fast forward to the current situation, you think about the costs that are coming on relative to PPE, relative to supply chain compression, maybe that stays with us. But also kind of learning to be leaner. Everybody is cutting deep into SG&A. Some of that will come back, I know, but when it all shakes out, you think the margins of Gentherm will be lower, same, higher long-term, what do you think?

It's -- the biggest challenge, I think, for all companies, it certainly applies to us is, obviously, as vehicle production is declining, contracting and who knows how the recovery is going to look, estimates are we're still a few years away from even recovering to 2019. So the most difficult part is just losing your revenue-based leverage when it comes to margins. So certainly, when I talk about Gentherm, the good news is for us, we had been working since 2018, beginning of 2018 on our Fit-For-Growth program. So bringing down costs, both variable costs and fixed costs, and we're very far along in that reduction. So we felt like we had good momentum there. Anyway, obviously, we have to take more actions on cost, given the reduction in revenue base this year, and certainly, our estimate is that year is not going to recover to the full level of '19. That said, our target is still to hit the EBITDA goals that we put out there for ourselves of getting into the high teens, that we think we can do that in a relatively reasonable time period. So I think we're well-structured, kind of adapt to it. I think the industry, in general, is definitely, as compared to the economic crisis back in '08 to 2010, is much better prepared for that kind of thing and especially in our space. But it's just making it more difficult, certainly.

Sure. And then I wanted to ask too, if the coronavirus crisis causes you to think any differently about capital allocation. For example, how are you thinking about how much capital cushion is appropriate to carry going forward with the right sort of debt-to-equity level is with the right amount and timing of return of capital to shareholders is?

Well, first and foremost, we move very quickly at the onset of the crisis to increase our cash positions, through down, healthy percentage of our revolver. And just as a precautionary measure. Things are picking back up now. So it's a little less urgent. But certainly, we're in a much more conservative mindset when it comes to our cushion, if you will. But we're also have [ spring ] to look forward a little bit and say, well, what are some of the opportunities that might present themselves in a little more dynamic environment in our space? Are there, for example, an area where for certainly, that's on our mind is M&A opportunity for us. Or are there better opportunities strategically [indiscernible]. Technologies we might find that fit well to our growth strategy. We're certainly open to those ideas as things stabilize in the market. When it comes to share repurchases, we definitely put that on hold for a while. Again, as things stabilize, you have still some authorization open throughout the year and we'll make some decisions if we want to increase that authorization going forward. And opportunistically, certainly that's something down the road, we'll consider [indiscernible].

Okay. And then just also lastly relative to coronavirus, talk to ask on how you think that it may impact the type or pace or degree of technological change within the industry. Does the virus speed up, slow down or have no effect, do you think, on pre-existing trends such as electrification, autonomous driving, et cetera.

I'll start with electrification. That's certainly an area that if you look at --

You can end with electrification, too. I know you're not awfully levered to autonomous driving.

Autonomous driving, certainly, some of the trends around autonomous driving, we are very interested in. And related to comfort, we believe that in that environment, comfort, wellness, features that maybe would have been -- potentially may have been more focused on the driving, now would be more on how do I utilize the time in the cabin. So we're definitely watching. That's an important part of our go-forward focus. It does seem, at least from what I'm seeing that, that is tempering down just a little bit, maybe with a more heavy focus on ADAS extension. So we'll see how that plays out. Electrification, though, is really the big trend that we're focused on, that we look across our different focus growth areas certainly will have a big impact, first of all, in our climate and comfort business, both our core internal heating and cooling product, plus our ClimateSense product, are really designed to help improve energy efficiency in an EV. And we've been watching that really closely. And of course, we have the Battery Thermal Management business directly tied to hybrid and electric vehicles. So that's an area, we wondered how that would play out. On a positive note though, almost all the OEMs who we've been working with to do development projects and working on specific vehicles, EVs, that they're launching in the upcoming year, have kept those as a high priority. So it appears to me that the investment on EV has been strong. I think there's a lot of question in terms of how the consumer acceptance of the products will be over time. But I'm pretty optimistic that it's coming. The question is how fast. Indications still to me are pretty strong. Regulatory focus is still there, if maybe pushed out a little bit. And I think consumer demand and environmental improvement demands around that are still something very top of mind for people. So I think we're really well positioned for that. We're definitely investing very heavily in our product that support the OEMs EV movement.

I wanted to ask you around growth over market. Your sales in 2Q shrink less than the global light vehicle production when adjusting for your different geographic exposures. I think you outperformed by about 700 basis points in the first quarter, you outperformed by 560 basis points. I know you've suspended official guidance apart from some parameters around 3Q including revenue, but just obviously given the uncertainty in vehicle production. But when you think about -- and are you able to comment about how you may perform relative to whatever that production ends up being? How do you think that your growth over market will track in the back half of this year? Or just more generally going forward, what are the biggest factors that have been allowing you to grow faster than the change in light vehicle production? How would you rate the sustainability of those factors, including in this new environment?

No, I think we've been steadily outperforming overall vehicle production in our relevant markets on a weighted basis. And as we look forward, I expect to expand that, over time, pretty significantly over time. And the real drivers, I'll talk about some of the key drivers. First of all, in our core business, which is the climate control seats, heated seats, steering wheel, all the different climate-controlled elements of the vehicle, demand is really picking up. So consumer demand for those solutions in the vehicle. And then, thus the -- we're seeing a pretty steady increase in take rates in the vehicles and even higher content. So we're seeing ac seats have our climate product, which is driving up content per vehicle, and that's going to help us outperform. So that's 1 area called penetration rates and take rates, and also more of high-volume vehicles are starting to adopt the technology in their vehicle where in the past they haven't. Great success story for us. Just to use 1 example is Mazda. Mazda, on virtually all vehicles is offering CCS in the vehicle. And that's -- obviously, that's a little bit more price-sensitive product, outstanding product, but we're seeing that on more and more customers. And then when you look towards where we see growth, Battery Thermal Management is a key new technology that we're rolling out, that's a pretty small part of our business, but as hybrid vehicles and, well EVs start to pick up, we're winning awards that will start layering in that. That's a very unique area of growth that will help us outperform. So I think that, and plus a little bit more electronics content. Most people don't know that we have a pretty sizable electronics business at Gentherm, partially to support our climate and comfort products, but also as a stand-alone electronics business. So we're seeing more momentum pick up on electronics as well. So I think we've got a lot of good vectors that are increasing content and penetration that'll help us expand that.

Great. I thought to ask too about the impact of COVID-19 on your medical business, right? I mean, medical sales were up 18% year-over-year in 2Q versus auto sales are down 44%. So clearly, a really big divergence there. You called out on the call, your Blanketrol control product line as having benefited from COVID-19, driving the growth there. Can you just remind us of what this product does exactly? Why it is helpful for COVID-19 treatment? Do you expect continued tailwind from Blanketrol just as long as the pandemic lasts? And then, are there other potential headwinds to think about in medical, like the deferring of elective surgeries, et cetera? Clearly, this netted out very positively in 2Q. But what would you say is the outlook going forward?

Well, Ryan, we're very happy with the medical business. We've been -- even pre-COVID, we've been steadily running at a double-digit growth rate. We're close to a double-digit growth rate. So really, very pleased with the momentum we have in that business. As COVID hit, one of our core products is, that you just called out is called Blanketrol. And that product is used -- it's a liquid-based product that's used in cases to help control fever or to control the temperature of the body. In this case, in a COVID situation, in circumstances where high fever is very difficult to manage. They'll use our product to help bring down, to kind of cool the body, bring down a patient's temperature. And that did -- we did see a significant pickup in that in the first 2 quarters of the year. That's coming down just a little bit because I think there's a little bit less critical patients out there. And of course, most of the hospitals are now starting to get those units in place. So I would expect it to be a little bit less going forward. But we're really proud that, that's been a go-to product for medical professionals to use in the hospital. Another one that we just received FDA emergency authorization for use is our Hemotherm product, which is a blood heating and cooling product. Normally, that product is used in cardiac surgery. When the blood is diverted from the body in cardiac surgery, it's really important to maintain a proper temperature. So you'll warm and cool the temperature, depending on the state of the cardiac surgery and our product performs that. That's now being used in longer-term care for patients we need to have infusions, that have COVID complications. So that was an emergency authorization approval. That's now being used for that kind of application. So we're excited that we were able to also provide some support there. overlift position Now going forward, I think hitting the 18% to 20% growth rate in the quarter is going to be pretty difficult to maintain, because we'll see a little bit of a slowdown on the COVID-based peak. But then on top of that, we are seeing some headwinds when it comes to elective surgeries. Many of our products are used in hospitals for orthopedic surgeries, things like that. Definitely, we're seeing a pullback there. But then as that starts opening back up, [indiscernible].

Okay. Great. And then you've identified advancing microclimate solutions or ClimateSense as being 1 of the 4 primary areas or pillars that you are focused on. Just a few questions around that, including what is the path to commercialization there? Are you aware of others working on similar solutions? And do you think that you will be first to market? And then could you update us, too, on the announcement with Lear last week, with regard to pairing of their INTU seating system with your ClimateSense technology?

Yes. Let me quickly describe ClimateSense for those who aren't familiar with it. ClimateSense is, it's really a futuristic platform that we're working on that is beyond just seat-based climate. We're really looking at augmenting complete heating and cooling system in a car such that we have -- we give a personalized climate zone around an individual. Truly a microclimate that can be operated individually in each seat of the vehicle. And it's a combination of thermal effectors, whether it's resistive or air movement devices or even radiative heating devices for the body. And we've come up with a really novel way to do that from a thermoelectric -- thermodynamic standpoint, but then more importantly, we've developed a control module that has -- that utilizes an algorithm based on thermophysiology or the science of how a body gets to a comfort state. And we've -- obviously, that thermophysiology is kind of the backbone of Gentherm. It's the science that we use in our medical, the vision, the science that we use, in that case, it's for improving outcomes in hospitals, helping to save lives. And in the automotive side, it's to help with comfort and wellness. So that we've actually learned so much over the years that we've been able to develop an algorithm that takes inputs from the vehicle, can modify real-time how it's bringing heating and cooling for the passenger to get quickly to comfort and to maintain comfort over a long period of time. So we're really excited about this. Pretty significant content increase per vehicle. It's really anywhere from 3 to 4x multiplier, compared to the current content we have in a vehicle. And then longer term, we expect that to not necessarily be an option to the vehicle, but to be an integral part of the standard climate system in a car. So that's kind of it in a nutshell, and I've announced over the last year or so, several development contracts that we have with OEMs, 1 in particular that we announced publicly was General motors, which has been going very, very well. In fact, we presented with the Chief of General Motors at a major conference and had very significant results in terms of comfort. But then very importantly, energy-efficiency and reduction in power consumption in the vehicle, anywhere from 50% to 70% power consumption reduction in the HVAC, overall HVAC system in the cold-weather climate. I mean, that's one that really stands out and it's kind of a game changer for the climate system in an EV. So we've got a lot of interest with OEMs. We have 8 different projects that we've worked on or are working on kind of with different OEMs. I just had the pleasure this quarter to announce that we won a second phase development contract with BMW. So we've got -- I mean you look at BMW and GM, pretty good partners to be working with when it comes to ClimateSense, and much of the focus is around electric vehicles. That's really where this solution can really pay big dividends for the OEM. So really excited about that. We're moving down the path pretty aggressively in terms of development. And obviously, as the OEMs we're working with progress this, our hope is to get into commercialization with this in the not-so-distant future. I think that probably the earliest would be '23, '24. But clearly, that's on our mind.

Okay. I think it's important to improve the efficiency of all vehicles, but with electric vehicles, in particular, there's a range benefit, right? It matters for the consumer. What work have you done around how much the claimed range of electric vehicles could increase based upon the use of that type of product?

It's all based on the application and how it's integrated into the system, but the case study we did with General Motors, this is the data they presented. By the way, this wasn't data that -- through their independent testing at the car level was, in the cold weather climate, about a 30% overall increase in range. Just by adopting this technology and optimizing the use of the microclimate with a minimal use of an HVAC system. So 30% on the cold weather -- it's like, it's a very dramatic range extension.

And apart from the range of prevented -- I mean, are you sacrificing something by going with a microclimate solution? Or does it actually improve comfort?

Well, first and foremost, for us, when we implement this, is we want to see a stepwise increase in the comfort of the passenger or the driver. And we're seeing that very steadily. Every test we've done, because it's so localized and so personalized, one of the nuances behind the software system that we've developed is it can take the preferences of each individual and adapt the level of heating and cooling to the preferences of the individual. So whether that's applying different heating and cooling to a different part of the body, that's associated with the preference or in some cases, associated with even the different types of demographics of the passenger. And that could be gender, it could be nationality. They are different -- we're learning a lot about those kinds of factors. So definitely comfort is enhanced with this. In fact, on that note, Ryan, we're -- it's not just EVs where we're getting interest on this. Some luxury OEMs that we're working on -- working with this, working on with this, are also interested just in comfort enhancement. And we're seeing a lot of the benefits being developed there.

Yes. It was sort of a loaded question. I knew what the answer was because I sat on 1 of your prototype vehicles, right, and had the hot air blown on my neck on a cold day. It feels good, right? It's not just about efficiency. Maybe switching gears to Battery Thermal Management, another one of your focus areas, another pillar, right? So what's the latest there in terms of new awards or launches that you can report? I know last year, you had that interesting win with BMW's MINI brand, which saw you branch out from sort of more hybrid or 48-volt type applications to now serving battery electric vehicles. Can you talk about that product, I think on the cell connecting side, does that now increase the addressable market of your BTM business? Maybe talk about what kind of content per vehicle you could get from cell connecting and monitoring for beds. Should investors expect more awards in this area, just given all the numbers of electric vehicles that are supposed to be hitting the markets here in the coming years?

Sure. Yes. Help me if I miss any of those questions as -- certainly, let me just talk about BTM, that we really have -- we have 4 key product lines that we've developed within BTM. Of course, we're working on -- we have aspirations for bringing in more, but we have a thermal electric heating and cooling device that's primarily for the 48-volt mild hybrid products, and that's been very successful within the 48-volt. Area of note, Mercedes has it on all of their 48-volt vehicles that they're launching, and that's won a PACE Award at -- in partnership with Mercedes, that specific product. So that's something that -- now that said, 48-volt is certainly not growing at the pace that experts expected, just as recently as 2018. Now the great news is, we've created a product line that really addresses plug-in hybrid and -- for EVs, and really started with the battery heating device, up to the battery cell heating device that we created. And that was a proprietary based thin foil heater, that was based on an internal, a really impressive internal manufacturing process. And that -- we won our first big award through LG for Chrysler, the deep family of hybrid vehicles. And a spin-off of that thin foil, the proprietary thin foil technology, we also found that we could address cell connecting, which obviously has a huge market, potential because you have to have cell connecting in every EV. Battery temperature management kind of varies depending on the application. So fortunately, with that thin foil product, we were able to win a nice award last year and we're seeing a ton of interest on that product. That product, by the way is, it's thinner, lighter, much more environmentally friendly. You have to use a mechanical process to etch the proper circuit in this device, as opposed to most thin foil products, they use chemical etching, which can have a little more trouble when it comes to environmental friendliness. So that's been a great product for us. We announced an award with a large European OEM. You mentioned the BMW MINI award. That's a wire-based cell connecting device. So that's another product that we have within the cell connecting and also within the family of BTM, we have air-based cooling devices, which has been a big part of our growth in BTM. So any place that there's a trouble spot in terms of where the battery is located, and this can be 48-volt or full EV, we can employ some of our intelligent air moving devices to cool those devices. So in terms of market, we think, especially given the cell connecting, it's a multibillion dollar market, fairly conservatively between $1.5 billion and $2 billion within just a few short years. So it's an area right now, we're less than $100 million, well less than $100 million. We think we have pretty significant upside opportunity.

Okay. Great. Then even as you're growing the business by inventing these new products on the BTM side or with ClimateSense, can you just talk about the tailwind that exists for growing penetration rates for the core existing products, even traditional seat heating or heat vents, active cooling, steering wheel heaters, cup holders, all that stuff, how do you think that is going to evolve over time? And are you seeing it more in certain segments or geographies or anything like that?

Yes. I mean, let me talk about CCS, which is our largest product line by revenue. It's a product that back in 2018, we were running about 8%. Now we haven't announced, but the market was running about 8% penetration of all vehicles produced worldwide at that time. Our estimate is that would move to 20% by 2025, but seeing a lot of indicators that, that movement is happening. Many of the vehicles that we're winning, we're committing to much higher volumes because they're planning on penetrating that more. And we just announced a pretty, a very significant award with BMW for the 5 series, which was our first time ever, CCS award for the 5 series, and they're going to have very high take rates. We also recently heard an announcement that Lincoln has made, on some of their vehicles, where they will make CCS almost a standard part of those vehicles. So these are some of the signals that are happening in terms of penetration of existing vehicles that offer CCS, but as I mentioned earlier, we're really seeing this trend on mass production vehicles, applying CCS at some level. So a lot of momentum happening there. I expect that really pick up. And even more so as we get into hybrid vehicles and EVs, they're obviously -- the full-scale growth for us is moving to ClimateSense, but even in vehicles that haven't made that move, absolutely the data shows that using CCS improves power consumption in EVs. And/or it's -- for that matter, the studies have proven that using CCS in an ICE improves fuel consumption. So all the OEMs are aware of this, and they are trying to figure out how to make this higher percentage of their vehicle production. So that's a movement that's really exciting. When it comes to the heat product, that's a little bit more mature in terms of the growth, and we're still seeing big opportunities there. In terms of seat heating, the market is less than 30%, and we expect that to approach 40% by, let's call it, the 2025, '26 range. And then steering wheel heat is really pretty low, comparatively, but picking up a lot of steam. So we're kind of -- I think we're right on, right in the right spot when it comes to the products that we're offering that we've offered for a long time. We've been innovating in terms of performance and cost both, to make it more applicable to lower-priced vehicles and mid-priced vehicles. And so we're excited about the momentum there.

I saw an announcement from you a couple of months ago about providing seat heaters for a motorcycle. And the more I thought about that, it was just a little the more interesting to kind of sound it, because you think that including the manufacturer of that motorcycle also makes snowmobiles and things like that. You'd think in the cold weather, people might appreciate that. I don't know, commercial truckers. What about other non-light vehicle applications? Handle bar heaters for motorcycles, snowmobiles. Have you thought about these kind of things? What could the addressable market there be? Or do you kind of need high-volume production runs? What do you think?

Look, we always consider those opportunities on a case-by-case basis, and we'll continue to look at them. Obviously, it's kind of all about the business case for us. How much investment do we need, how much resources do we need to apply to it based on that return. And so we're very careful in terms of how we're applying our resources, especially in the difficult environment that we're in right now. Our resources are really critical. We have to pick the right projects to put them on. But certainly, we're looking at those, and there has been some interest in those different areas that you mentioned. And if we think it's a good move for us and it brings the right kind of growth for our business, we'll certainly address it.

Okay, and last question, I think a minute we have left, 1 minute. You could go a minute over, too. Just on M&A, I think all of your portfolio moves are pretty much done from a disposition perspective, Chris, correct me if I'm wrong, but also from an acquisition perspective, is there anywhere you're looking to fill out, maybe in the medical space or somewhere else?

As I pointed out earlier, this is something that's definitely, we've kind of gone through our first phase over the last couple of years, which is, what I call, a little bit of a reboot in the company, getting our cost structure in line. We're really focusing ourselves on the technologies where we can win and be a market leader. And I think we've done a good job of positioning ourselves to do that and really poised to grow organically in those key areas. But we really believe that the company is in a great spot in terms of balance sheet and liquidity. And when the right opportunity presents itself, of course, we're actively evaluating different strategic possibilities out there. But we'll focus on technology, can we bring in more technology that helps us enhance our value proposition and keep differentiating Gentherm from a technology standpoint for our customers and providing the best to hospitals. We're constantly looking at those. We know we can't develop everything in-house. And so that's a really top priority. Medical, as you mentioned, our team is doing a fantastic job. So proud of our leadership team in medical and the sales leadership in our medical group. And we want to provide them more products that fill out the thermal offerings. And we think there's some interesting opportunities there. Those are going to be pretty small acquisitions down the road, I think, similar to the acquisition we made of Stihler last year, which has been very successful. We've been really able to turn that into growth. So that we'll certainly see. On the automotive side, content. Are there content adds that we think really are synergistic to where we're trying to go, whether those are electronic based, software based, comfort based, those kinds of things that help us, again, enhance our value proposition for an OEM and provide a great potential return on our investment. We're definitely considering some of those.

Okay. And I guess we're out of time now, but thanks so much, Phil. That was really helpful. I appreciate that. Amazing color.

And certainly wish all the best to everyone out there dealing with the ongoing COVID crisis. And our thanks to, especially the medical professionals who are really doing an amazing job in this difficult time.

Great. Thank you.

Thanks, Ryan.