Gentherm Incorporated (THRM) Earnings Call Transcript & Summary

Good afternoon. I'm Ryan Brinkman, the U.S. automotive equity research analyst here at JPMorgan. Thanks for joining us for the 2022 JPMorgan Tech Auto Forum, bringing together a group of semiconductor and automotive technology companies. Very excited to get going with our next session, which is with Gentherm. And we have here with us, you can see on the screen, Phil Eyler, President and Chief Executive Officer. Phil, thanks for coming. We really appreciate your time.

Ryan, it's an honor to be here again, and Happy New Year to you and all those listening on the webcast.

You as well. I'm just going to turn it over to you for any sort of opening remarks and then we'll launch into Q&A.

Sounds great, Ryan. Like so many companies, we're certainly fighting through all of the challenges with the supply chain and so forth. But I thought it was really important to get a chance to give you a brief overview of Gentherm and why we think we're so well positioned not just to get through this challenging time, but to really thrive, and why we think Gentherm is a very compelling investment thesis for the long term. First of all, let me talk about our mission, which I think is absolutely core to what differentiates us as a company. And that is that we're focused centrally on the human being and providing breakthrough solutions for the well-being of humans, both in the car and in the hospitals. And we do that by creating manufacturing and delivering solutions that make a meaningful difference in everyday life. And we really focus on 4 areas, which I think is quite a bit different than almost any supplier, and that is health, wellness, comfort and energy efficiency, and really bringing all of those key areas together. That's our North Star. That's where we invest. We're very laser-focused on where we put our resources. Most people know Gentherm as the global leader in thermal management. And we believe we have significant differentiation opportunities in really 4 areas. And I'll tell you, electrification and EV momentum plays a big part in the growth that we see in our company. Let me talk about the 4 areas real quick. One is our core business of climate comfort solutions for automotive. This is where most people know our company where really our product originated. And it's basically all the thermal components in a cabin without -- including the HVAC system. So seat heat, climate control seat, which would be cooled and heated seats combined, heated steering wheel, heated and cooled surfaces in the vehicle. And underpinning all of that, we provide all of the electronics and software for those solutions as well. We have a fairly commanding market share in that space. If you look at seat heat alone, we have 40% market share. Next highest market share is right around 20% in the seat heat space. And when you look at our climate controlled seats, sometimes called [ vintage ] or active cooled seats, we have 60% market share. And the next highest market share in that space is less than 10%. So very strong position built over years, and we continue to innovate, refine our products. We're very much a product-oriented company focused around the performance at the end for these products. Great thing about this business, there are a lot of tailwinds in the market that we believe are going to really help us to grow take rates, adoption rates and content per vehicle. A few quick stats. Only about 30% of vehicles worldwide have heated seats, and 10% or so have the heated and cooled seats. So pretty significant opportunity there. And we see really nice tailwinds for some time. Second area to talk about is really around electrification and EVs and what we're doing, we think, to really transform thermal solutions in a vehicle. One thing that a lot of people don't know is that energy consumption is a major challenge when it comes to heating and cooling passengers. The HVAC system is actually the second largest consumer of energy in the vehicle, only behind the powertrain in an EV. So there's a huge need to transform how to heat and cool passengers in an EV. And Gentherm has really invented a platform that we call ClimateSense. It's a proprietary system that creates a micro climate around the passengers in the vehicle, both the driver, each passenger. Only activates when the passenger is in the vehicle and needs it. It uses a lot of microclimate thermal products around the human body, not just in the seat, but also in the body trim and the armrest and the steering wheel and the footwell, even above the body on the headliner, and really to create a cone, let's call it, of thermal solution around the passenger. That is all underpinned by Gentherm's proprietary software algorithm, which is created using the science of human thermal management. It's called thermophysiology, and we'll talk a little bit more about that when we talk about the rest of our business. But this is very exciting. We've done development projects with customers and proven that in the cold weather cycle, we can deliver a 50% to 70% power consumption reduction in the heating and cooling system. This equates to about a 33% improvement in range in that cycle. Really significant and powerful, and it's garnered a lot of interest. In the hot weather cycle, we see about a 30% improvement in power consumption. So on top of getting a better experience for the passenger, you also gained significantly in the energy consumption. So we're very proud last year to announce our first production award, which will go into production in 2024. And there's a lot of discussions happening with that customer and others to expand that. So we're really excited about this. And we think it will transform the company in the next decade. On top of that, with electrification, and I know we'll probably touch on this in a little bit, we have several solutions around battery performance. And we've actually started that side creating thermal solutions to help manage the temperature of the battery cells, of the lithium-ion cells, and that's expanded into more solutions, including cell connecting. So that's a business that's pure incremental growth for us, and we're seeing a lot of interesting opportunities in that space. The final business that -- and I think this really makes us unique is our medical business. We have a medical division focused on patient temperature management. And it's big differentiator in automotive, believe it or not. But that business, what we really are focused on is managing the body's temperature in an operating room or in an ICU. Something a lot of people don't know is when a patient is under anesthesia, the part of the brain that controls the body's temperature stops working. So there are more and more studies that solutions like ours that can actually raise the body temperature or manage the body temperature at the appropriate level can lead to dramatically improved outcomes in the hospitals. So why do I say that, that has a lot of synergy with comfort in the vehicle. There's a science behind managing the body's temperature in medical. It's called thermophysiology, and we've really built a strong expertise there. And we've taken that science and created an algorithm, a very proprietary unique algorithm that can optimize where to heat and cool the body, at what time and for how long. And what this can do is dramatically improve the energy efficiency of the solution and create better results. Obviously, in the hospital, it's critical. But in the vehicle, it also is significantly important in terms of comfort. So we're really excited about the medical business, helping us to differentiate and create advanced solutions. Final point before we go into the Q&A, just about the company. Over the last 4 years, we've really sharpened our financial execution. As you know, we focus very heavily on those 4 areas I just mentioned, sold off businesses, shut down investments and really allowed us also to focus on cost improvement. And this has helped us to unleash a lot of resources that we can flow back into R&D on these 4 focus areas. So we're really proud of the work we've done there and the muscles we've built on financial management, has created a very strong balance sheet that helps us to weather storms and certainly help through the COVID times. But now puts us in a great position to look at opportunistic investments and potentially M&A to help us really fuel the focused growth areas. So the bottom line, we feel like we're really well positioned to deliver significant shareholder value over time.

That's great. Thanks for that overview, Phil. It may be a good first place to start with questions could be on the semiconductor chip shortage. We do have a lot of the semiconductor companies at the conference this year so I just wanted to be sure to hit on that. Where do you think we are with regards to it? Is it getting better? IHS is currently projecting that 4Q production rose 18% sequentially versus 3Q. I remember on your call, you may have been a bit more cautious suggesting that at least at that time, that 4Q was, so far, looking more similar to 3Q. Did conditions improve in the back half of the quarter, post the call? I know it's been a tough and frustrating and, in some ways, disappointing year with regards to chip availability and the impact on customer production. But just curious if you think that we might be rounding the corner here. Where are we headed next? And do you have any estimate or updated estimate when the situation may normalize?

Well, look, I think it's still -- we're still -- I think the industry and ourselves still in the battle. I think it's still quite a challenge. And it's sporadic. It really is very dependent on the semiconductor manufacturer and their unique situation. But certainly, we are hearing positive, optimistic outlook from our suppliers and also from the OEMs, that's kind of a gradual improvement through '22 and maybe even a return to close to stable supply in the second half. But -- so we're doing okay. We're hanging in there. But I can tell you, we're having to move mountains to make it happen. Expedited freight, spot buys, crazy things to keep production going. So it's been a brutal year when it comes to semiconductors for the industry, and certainly, we're no exception.

Yes, absolutely. And maybe just a follow-up on that. I saw that General Motors is temporarily removing seat heaters and steering wheel heaters from certain 2022 model year pickups and crossovers due to the chip shortage. I think their message to the dealers was, hey, by cutting these corners, we can get some vehicles out the door to you. And I'm sure they're happy to get any vehicles they can. At the same time, that was a pretty forceful pushback from dealers, right? They said, hey, we need those seat heaters. Consumers very highly desire them. And then shortly after the announcement of the seat heaters not being available, it was mentioned, well, maybe we can retrofit them later to add the seat-heating because it is so important, if not for the steering wheel heaters. What do you think the impact is to Gentherm from all of this? And what would you say is the outlook going forward?

Well, I think you pointed out what is maybe the silver lining of a very challenging few months of getting those parts recovered. But the silver lining is that the demand for the product is really big. I have a lot of friends that are in the dealership network, and they were definitely pushing hard. We've got to have that. That's -- our consumers are demanding it. So that's a good thing. We're obviously working feverishly at -- 24/7 with GM to make sure that we can get that recovery and support the retrofit activity, which I think is really going to help.

And how will that work, just from a technical perspective? Is there going to be some sort of deferred revenue aspect to it? Or over a 6- or 9-month period, there's no impact, but there is initially upfront? Or just is there a timing difference that investors should think about as they model? Or what do you think?

Well, I think that basically, you're going to see as many vehicles as possible with the hardware, all the thermal hardware and then follow up with adding the electronics at the dealership whenever they're available, and that will be kind of spread out. So like I said, I think we're, together with GM, working on a plan that I think is pretty good.

Okay. That sounds encouraging. And recently, Gentherm has been outgrowing light vehicle production by -- amongst the fastest rate of any of the 14 suppliers that we cover, including by 15 points in the third quarter. If you had to break that down, how much of the outperformance do you think relates to various different factors like higher take rates, backlog from earlier business wins or maybe other factors, mix factors, et cetera? And what would you say is Gentherm's normalized outgrowth of light vehicle production? Is there a target that you have in mind for the company?

Well, we don't really target a specific number because it's something that's not linear. A lot of it depends on mix and regional production and things like that. But we're very proud of our outperformance record. You can just look at it. It's significant. And it's driven by a couple of things. The take rate part, which we talk about a lot, is definitely happening, and that's -- it's more vehicles that are taking the heated and cooled seats and steering wheels and so forth and including electronics. You're seeing higher take rates in vehicles that may have only had 5% or 10% of vehicles. Now they're up to 30% or 40% of vehicles that have the solution. Seeing more content in the vehicles, rear seats, we're really picking up a lot of business in and multiple seat structures in the vehicles. And then more -- from our side, we're winning at a very high rate, and you're starting to see more of those launches happen. So we're really excited. EVs are having a very positive impact on the numbers of vehicles with our heated and cooled products. In fact, we're going to talk in the earnings a little bit more about we had a breakthrough win in the quarter. We're going to finish up the year with really strong awards and -- in the fourth quarter and had a breakthrough win with one of the largest EV manufacturers, with CCS and heat. So we're really excited about that. On top of that, you've got the new technology launches with Battery Performance Solutions starting to grow more electronics from our side is really helping us to increase content and even different types of products, such as memory seat modules and motor controls in the vehicle. And a lot of those are combined with our thermal solutions. So that's an area that we really see an opportunity is also in electronics.

We look forward to learning more about that breakthrough win with an leading EV manufacturer. One of the areas that's been contributing to the outgrowth, right, has been the Battery Performance Solutions division. A couple of years ago, you changed the name from Battery Thermal Management to Battery Performance Solutions given your expansion into aspects of battery solutions beyond thermal management, such as cell connecting and cell health monitoring, et cetera. On your last earnings call, it was mentioned that this newer focus of your cell connecting is now the fastest-growing product in the portfolio. Can you maybe review the success you've had here to date, including, I think, starting with Jeep. And then next this year, we'll kick into a higher gear right with launches with BMW. Is that right? And how should we think about the materiality of the BMW launch relative to the revenue you've already got in this product category?

Yes. I mean the area -- we used to call it Battery Thermal Management, and that's where we started. A lot of our customers came to us because of -- and really want to tap into our thermal expertise to help manage the temperature fluctuation in the battery, which can have a dramatic effect on performance and longevity of the batteries. At the time we started, it was really focused around 48-volt, and we've got some tremendous product for 48-volt solutions. And that actually continues to grow, but not nearly at the pace that we expected because 48-volt battery, mild hybrid doesn't seem to be taking off as much. So we shifted our focus to high voltage, plug-in hybrid and full EV solutions. And one of the solutions we developed was a thin foil battery heater using our proprietary manufacturing process called a mechanical structuring process, which is a proprietary process that basically allows a thin foil circuit to be etched using a mechanical removal process. And that's the only one in the market. Typically, you're seeing chemical etching in the space, which is -- that's the prevalent solution out there. It poses some problems, environmental problems because it uses some pretty harsh chemicals. And so this solution, we really were focused on heating the battery, and we won a nice award with LG Chem for several Jeep vehicles and a lot of interest still happening there. But in parallel with that, with BMW, we created a wire-based cell connecting system a couple of years back, and we launched that. And BMW was aware of this time, they said, well, hey, might that technology work on cell connecting? And so we, on our own, developed a really exciting thin foil cell connector and that's going to watch with BMW next year -- no, this year, actually. And so we're really excited about that solution, and we've got a ton of interest from battery makers all over the world and OEMs. We'll announce next quarter another win that we're excited about in that business. And the battery heating is important, but when you think about cell connecting, every cell has to have a cell connector. Every EV has to have it. And we think we have a really compelling solution that provides a competitive product versus what's on the market. So we'll have to see how that pans out. The other thing that we're heavily working on is adding more functionality to our cell connecting, including onboard semiconductors and cell sensing devices, trying to move that more closely to the lithium-ion cells themselves.

Interesting. So maybe just sticking with Battery Performance Solutions. And you disclosed around the time of the earnings call, a new partnership with Datang NXP Semiconductors, which you'll work together to combine your thin foil cell connecting technology, which we just discussed with Datang NXP Semiconductors. Single cell monitoring, integrated circuit and electrical impedance spectroscopy. I understand from -- it's a little bit of jargon for an auto analyst there. I understand from our previous conversations, I get the thin foil connecting technology. Maybe you can bring me up to speed on what NXP's technology here is? And then what is the benefit of combining your 2 technologies together? The press release made mention of potential significant advances in electric vehicle battery performance, safety, longevity, user feedback. Things automakers are willing to pay for, right? So can you provide a little bit of background there?

Yes, we're excited about it. We've launched a development project with Datang NXP, and it uses their innovative impedance spectroscopy semiconductor, which basically allows sensing using impedance sensing of the battery cell directly. And what you're looking there for is characteristic changes within the battery, so maybe changes in resistance or other key characteristics using this impedence. And that helps you to diagnose potential coming failure modes. So it kind of gets away from surprising thermal events that can occur and really to kind of map the oncoming potential of a failure. So that's what's exciting. We're hearing from the battery makers a lot of interest there. And we've already done -- we've already kicked off a development project with one of the large battery makers using that. So we're pretty optimistic that, that will be something that could provide some real help in the space.

Interesting. Thanks. And I thought to ask for an update on ClimateSense, including after you were recognized alongside development partner, Lear, for a coveted 2021 Automotive News PACEpilot Innovations to Watch Award as your technology, which powers -- because of the technology that powers the Lear's into thermal comfort seat, right? So congratulations on that. So maybe if you could discuss if that has any further increased the awareness of or interest in your technology. And I'd be interested, too, if you see any impact to the continued development of this product alongside Lear after they acquired Kongsberg Automotive's Interior Comfort Systems business. I don't think Kongsberg has the product sophistication currently to meet the needs of a ClimateSense-type solution, right? So for example, they don't have thermal electrics, right? But I'm not sure if maybe their intention is to possibly parlay what they do have into more sophisticated solutions or to continue to work alongside yourselves, et cetera? What do you think the impact there is?

That's a lot. First of all, I think we're very proud of the work we do with Lear on the N2 seat. And to be clear, it's a seat-based solution. It's not a ClimateSense solution. It has some of the elements of ClimateSense, our proprietary ClimateSense embedded to help manage the seat level temperature management. So it's a good project. Obviously, we're very proud of the award that we received together and proud of our relationship. And we think there's opportunities to partner, and we'll kind of have to see how that plays out over time. Now when it comes to ClimateSense though, I just want to reiterate. ClimateSense for us is a full-blown system-level solution around the body. It's -- seat plays a factor, of course. All other surfaces around the body that I mentioned earlier, the neck, the foot -- the feet -- the footwell, the side panel, the armrest, the steering wheel, even the headliner are areas that are important. And then really underpinning it all is our software, our algorithm that's completely embedded and developed and now going into production in the very near future for Gentherm. So that's really where we're focused is executing that flawlessly, getting it into production and seeing where that can go. Just to kind of reflect on Lear. Obviously, they're going to do some vertical integration of thermal products. They made that very clear. And our job is to create the best solutions. And regardless of how the competitive situation looks and how the supply chain looks, we believe if we're focused on our mission, focused on innovating the very best solutions that we're going to win. And our OEMs have been awarding us at a level that would tell you that our product is really well regarded in the space. And Lear is a great customer of ours, and I expect that they will continue to be so. They're about 15% of our revenue. It is important to note that of that 15%, 70% is direct sourced by the OEM customer. So just to kind of put it all into perspective. But as I said, we're -- certainly -- we know we have to deliver the best product and continue to innovate. And I think we have a lot of differentiating factors that put us in a great position.

Yes. And that was a follow-up I had. Thanks for that color there towards the end about the direct sourcing because while I think you are sort of technically a Tier 2 supplier into other suppliers, at the same time, you almost engage with the automakers more like a Tier 1, right? So maybe you could just talk a little bit about the relationship with the customers, the end customer and the degree to which the automaker desires your technology or your product or brand relative to someone else's and how you expect that to play out going forward?

Yes. I mean at the current moment, the significant majority of all of the sourcing is done directly to us or to the -- in most cases, the Tier 2 manufacturer, in this situation, then direct sourced to the seat manufacturer. But hey, those things -- again, back to my focus and our focus is delivering the absolute best performing system. So it doesn't matter how that's organized. But yes, I can tell you this is a very important feature to the OEMs. They have significant -- most of the large OEMs have significant resources focused around thermal management in-house. And we tend to be a thought leader that they depend on to help them develop solutions that can differentiate their vehicles. Consumer demand is really skyrocketing for convenience, for health, for wellness and comfort. And that's an area that they have to be expert at. And when you need to be expert, you call in the experts to help you. So I don't see that changing anytime soon.

I'm sure there are some synergies for Lear, customer introductions that they can capitalize upon. On the other hand, it's been suggested before that maybe a seating company would not say by Gentherm because there could be some dissynergies there in terms of, well, now if one seating company owns the lumbar, the massage, the ventilation and maybe the other seating company wouldn't want to necessarily be buying from their competitor. I don't know if there might be some even potential opportunities from a market share perspective that could help to offset any other factors. Do you have any thoughts on that for you?

Well, I would just say that we're winning at a very high rate. And Ryan, if you look at our win rate the last several quarters, it's been anywhere from 70% to 90% win rate. I don't know if that level of winning awards is sustainable. But that tells you that I think we have a great value proposition. It's the technology and the knowledge that we bring through our thermophysiology expertise, through our innovative technologies. We really design and develop the whole system, electronics, all of the hardware, including blowers. We're actually one of the largest blower design and manufacturing companies in automotive. A lot of people don't know that. You have to move air. So we're really big there. So that's what we have to keep focusing on is how do we continue to build up our value proposition and win. And like I said, we're winning at a high rate. So at least we're getting some positive feedback and -- but that doesn't mean we have -- we certainly have to stay focused and keep delivering.

Right. I wanted to ask about the penetration rates for some of your different products for vehicles that are under development and how that might differ if those vehicles are ICE vehicles versus EVs. So for example, we know that Battery Performance Solutions has higher content on EVs than ICE, right? And ClimateSense promises to really boost penetration for the interior comfort products in EVs. But what about -- for battery electric vehicles and internal combustion-powered vehicles currently under development that are not expected to use ClimateSense, do you find that EVs, whether because they're positioned as higher-end vehicles or because EVs are expected to have the latest technology, generally, et cetera, do you find that the EVs have higher penetration for seat heating or maybe heat cool solutions? And how much of a benefit do you think this big uptick in EVs could be just for the core thermal comfort business?

Pretty significant. First of all, almost -- I would say, the vast majority of the EVs that are starting to launch and being developed have a higher take rate than the traditional ICE of thermal comfort products. And that's a couple of reasons. The first is that it is showing to have a positive impact on energy efficiency, just with those core products alone. It allows the driver to get to a more comfortable situation without using as much of the HVAC system, which is driving satisfaction for the consumer. So I think that's going to continue to drive take rates. We went in at a very high clip in terms of percentage of EVs. So I expect that to continue. And as we talked repeatedly on this discussion, I think ClimateSense is where things are going. That's -- to me, it's almost a no-brainer to get there because that's a dramatic improvement in energy efficiency and Ryan, I think you've had a chance to sit in a vehicle with ClimateSense. It's -- the experience is really incredible. And I think once that starts to get out in the market, I think that's going to really start to pick up.

Yes, absolutely. It looks like we are out of time here, but I want to thank you for all the great color and insight that you shared today, and thanks for your time.

Thank you, Ryan. I enjoyed it.

Thank you.