UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended September 30, 2012
OR
For the transition period from to .
Commission File Number: 0 - 21810
GENTHERM INCORPORATED
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Registrant’s telephone number, including area code: (248) 504-0500
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
At November 5, 2012, the registrant had 29,701,225 shares of Common Stock, no par value, issued and outstanding.
TABLE OF CONTENTS
Cover
Table of Contents
Part I. Financial Information
Item 1.
Consolidated Condensed Balance Sheets
Consolidated Condensed Statements of Operations
Consolidated Condensed Statements of Comprehensive Income
Consolidated Condensed Statements of Cash Flows
Consolidated Condensed Statement of Changes in Shareholders’ Equity
Notes to Unaudited Consolidated Condensed Financial Statements
Item 2.
Item 3.
Item 4.
Part II. Other Information
Item 1A.
Item 6.
Signatures
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PART I. FINANCIAL INFORMATION
GENTHERM INCORPATED
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands, except share data)
ASSETS
Current Assets:
Cash & cash equivalents
Accounts receivable, less allowance of $2,221 and $1,937, respectively
Inventory:
Raw Materials
Work in process
Finished goods
Inventory
Derivative financial instruments
Deferred income tax assets
Prepaid expenses and other assets
Total current assets
Property and equipment, net
Goodwill
Other intangible assets
Deferred financing costs
Other non-current assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable
Accrued liabilities
Current maturities of long-term debt
Deferred tax liabilities
Total current liabilities
Pension benefit obligation
Other liabilities
Long-term debt, less current maturities
Total liabilities
Series C Convertible Preferred Stock
Shareholders’ equity:
Common Stock:
No par value; 55,000,000 shares authorized, 29,701,225 and 23,515,571 issued and outstanding at September 30, 2012 and December 31, 2011, respectively
Paid-in capital
Accumulated other comprehensive loss
Accumulated deficit
Total Gentherm Incorporated shareholders’ equity
Non-controlling interest
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying notes to the consolidated condensed financial statements.
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CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Product revenues
Cost of sales
Gross margin
Operating expenses:
Research and development
Research and development reimbursements
Net research and development expenses
Acquisition transaction expenses
Selling, general and administrative
Total operating expenses
Operating income
Interest expense
Debt retirement expense
Revaluation of derivatives
Foreign currency gain (loss)
Other income
Earnings before income tax
Income tax expense
Net income
Loss (gain) attributable to non-controlling interest
Net income attributable to Gentherm Incorporated
Convertible preferred stock dividends
Net income (loss) attributable to common shareholders
Basic earnings (loss) per share
Diluted earnings (loss) per share
Weighted average number of shares – basic
Weighted average number of shares – diluted
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CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Other comprehensive income, net of tax:
Foreign currency translation adjustments
Unrealized loss on interest rate derivative securities
Other comprehensive income (loss), net of tax
Comprehensive income (loss)
Less: comprehensive income (loss) attributable to the non-controlling interest
Comprehensive income (loss) attributable to Gentherm Incorporated
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CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
Operating Activities:
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization
Deferred tax provision
Stock compensation
Defined benefit plan expense
Provision of doubtful accounts
Loss (gain) on revaluation of financial derivatives
Loss on equity investment
Loss on sale of property, plant and equipment
Excess tax benefit from equity awards
Changes in operating assets and liabilities:
Accounts receivable
Net cash provided by operating activities
Investing Activities:
Purchases of derivative financial instruments
Maturities of short-term investments
Purchase of W.E.T. Automotive AG, net of cash acquired
Cash invested in corporate owned life insurance
Proceeds from the sale of property, plant and equipment
Purchase of property and equipment
Loan to equity investment
Patent costs
Net cash used in investing activities
Financing Activities:
Distribution paid to non-controlling interest
Borrowing of debt
Repayments of debt
Cash paid for financing costs
Proceeds from the sale of Series C Convertible Preferred Stock
Proceeds from the sale of embedded derivatives
Proceeds from public offering of common stock
Cash paid to Series C Preferred Stock Holders
Proceeds from sale of W.E.T. equity to non-controlling interest
Proceeds from the exercise of Common Stock options
Net cash provided by financing activities
Foreign currency effect
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosure of cash flow information:
Cash paid for taxes
Cash paid for interest
Supplemental disclosure of non-cash transactions:
Issuance of Common Stock for Series C Preferred Stock redemption
Issuance of Common Stock for Series C Preferred Stock dividend
Common stock issued to Board of Directors and employees
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CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
Balance at December 31, 2011
Exercise of Common Stock options for cash
Tax benefit from exercises of Common Stock options
Public stock offering
Stock option compensation
Common Stock issued to Board of Directors and employees
Preferred stock principal paid in common stock
Preferred stock dividend paid in common stock
Proceeds from subsidiary issuance of equity shares
Currency hedge
Currency translation
Balance at September 30, 2012
See accompanying notes to the condensed consolidated financial statements.
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NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(In thousands, except share, per share data and unit of product data)
Note 1 – The Company
Gentherm Incorporated (formally known as Amerigon Incorporated until September 5, 2012) designs, develops, manufactures and markets proprietary technology electronic components and systems for sale to car and truck original equipment manufacturers (“OEMs”). Unless the context otherwise requires, the terms “Gentherm”, “Company”, “we”, “us” and “our” used herein refer to Gentherm Incorporated. The term “historical Gentherm” used herein excludes W.E.T. Automotive Systems AG (“W.E.T.”), a majority-owned subsidiary of Gentherm. One of the Company’s primary automotive seat comfort products is the Climate Control Seat™ (“CCS™”), which provides year-round comfort by providing both heating and cooling to seat occupants.
The Company is engaged in a program to improve the efficiency of our advanced thermoelectric device (“TED”) technologies and to develop, market and distribute new products based on this technology. Included in this initiative are the development and testing of new materials that show increased thermoelectric efficiency.
W.E.T.’s primary product categories include automotive seat comfort systems and specialized automotive cable systems. The automotive seat comfort systems category includes automotive seat heaters, climate comfort systems (similar to Gentherm’s climate controlled seat technology) for automotive seats, automotive steering wheel heater systems and integrated electronic components. The specialized automotive cable systems category includes ready-made wire harnesses and related wiring products.
The Company has evaluated subsequent events through the date that the consolidated condensed financial statements were issued. No events have taken place that meet the definition of a subsequent event that requires adjustment to or disclosure in this filing.
Note 2 – Basis of Presentation and New Accounting Pronouncements
The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring items, considered necessary for a fair presentation have been included. The balance sheet as of December 31, 2011 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. Operating results for the three and nine months periods ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. It is suggested that theses condensed financial statements be read in conjunction with the financial statements and the notes thereto for the year ended December 31, 2011 included in our Annual Report on Form 10-K.
Disclosures about Offsetting Assets and Liabilities.
In December 2011, the Financial Accounting Standards Board issued ASU No. 2011-11 which amends Topic 210 (Balance Sheet). ASU No. 2011-11 is intended to enhance the disclosure requirements for offsetting (netting) assets and liabilities and the effect or potential effect on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial and derivative instruments. The amendments in ASU No. 2011-11 include quantitative disclosure requirements to be presented in tabular format. The tabular disclosure components are as follows:
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Note 2 –Basis of Presentation and New Accounting Pronouncements – Continued
ASU No. 2011-11 is to be applied retrospectively upon adoption and is effective for annual periods beginning on or after January 1, 2013, and interim periods within those annual periods. While the adoption of ASU No. 2011-11 is not expected to have a material impact on our consolidated condensed financial statements, it could expand our disclosures around certain financial and derivative instruments.
Note 3 –Earnings per Share
Basic earnings per common share are computed by dividing net income by the weighted average number of shares of stock outstanding.
The Company’s diluted earnings per common share give effect to all potential shares of Common Stock outstanding during a period that are not anti-dilutive. In computing the diluted earnings per share, the treasury stock and if converted methods are used in determining the number of shares assumed to be purchased from the conversion of Common Stock equivalents. The following summarizes the amounts included in the dilutive shares as disclosed on the face of the consolidated condensed statements of operations:
Weighted average number of shares for calculation of basic EPS – Common Stock
Impact of stock options outstanding under the 1997, 2006 and 2011 Stock Option Plans
Weighted average number of shares for calculation of diluted EPS
The accompanying table represents Common Stock issuable upon the exercise of certain stock options, the Series C Convertible Preferred Stock and potential dividends paid in common stock that have been excluded from the diluted shares calculation because the effect of their inclusion would be anti-dilutive.
Stock options outstanding under the 1993, 1997, 2006 and 2011 Stock Option Plans
Note 4 – Segment Reporting
Segment information is used by management for making operating decisions and assessing the performance of the Company. Management evaluates the performance of its segments based primarily on operating income.
The Company’s reportable segments are as follows:
Climate Control Seats (CCS) – variable temperature seat climate control system designed to improve the temperature comfort of automobile passengers. This segment also includes the heated and cooled cup holder and heated and cooled mattress divisions.
Advanced Technology – a division engaged in research and development efforts to improve the efficiency of thermoelectric devices and to develop, market and distribute products based on this new technology. It includes U.S. Department of Energy sponsored research projects, such as the development of a commercially viable thermoelectric generator.
W.E.T. Automotive AG (W.E.T.) –W.E.T. is being evaluated currently as an individual segment until such time as Gentherm is able to fully evaluate and implement its future integration plans and strategy.
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Note 4 – Segment Reporting – Continued
The tables below present segment information about the reported product revenues and operating income of the Company for the three months and nine month periods ended September 30, 2012 and 2011. With the exception of goodwill, asset information by segment is not reported since the Company does not manage assets at a segment level at this time. Goodwill as of September 30, 2012 and 2011 pertained entirely to our W.E.T. segment.
Three Months Ended September 30,
2012:
Operating income (loss)
2011:
The Advanced Technology operating loss for the three months ended September 30, 2012 and 2011 is net of $656 and $235, respectively, of reimbursed research and development costs. Reconciling items include historical Gentherm’s corporate selling, general and administrative costs and, for 2011 only, acquisition transaction costs. W.E.T. product revenues include the effect of the first historical Gentherm vehicle program to be produced in a W.E.T. facility totaling $6,534 and $4,426 for the three months ending September 30, 2012 and 2011, respectively.
Nine Months Ended September 30,
The Advanced Technology operating loss for the nine months ended September 30, 2012 and 2011 is net of $1,763 and $581, respectively, of reimbursed research and development costs. Reconciling items include historical Gentherm’s corporate selling, general and administrative costs and, for 2011 only, acquisition transaction costs. W.E.T. product revenues include the effect of the first historical Gentherm vehicle program to be produced in a W.E.T. facility totaling $20,650 and $4,426 for the nine months ending September 30, 2012 and 2011, respectively.
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Total revenues information by geographic area:
United States
China
Germany
Japan
South Korea
Canada
Hungary
Czech Republic
Mexico
Other
Total product revenues
Note 5 – Public Offering of Common Stock
On March 23, 2012, the Company completed a public offering of 5,290,000 shares of common stock, including the sale of 690,000 shares pursuant to the full exercise of the underwriters’ over-allotment option. The shares were sold at a price to the public of $15.25 per share. Net proceeds to the Company from the sale of the shares including the over-allotment option were $75,487 after the deduction of underwriting discounts and other offering expenses. The Company has and intends to continue to use the net proceeds from this offering to make future redemption installment payments on, and pay dividends on, outstanding Series C 8% convertible preferred stock and, to the extent not used for such purposes, for general corporate purposes (see Note 6).
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Note 6 – Series C Convertible Preferred Stock
On March 31, 2011, we issued 7,000 shares of our Series C Convertible Preferred Stock (each a “Preferred Share” and, collectively, the “Preferred Shares”) having an initial stated value of $10,000 per Preferred Share, subject to adjustment.
The Series C Convertible Preferred Stock is to be redeemed in nine equal quarterly installments that began on September 1, 2011 and will end on September 1, 2013 (each, an “Amortization Date”) by paying cash, issuing shares of our Common Stock or any combination thereof for $10,000 per Preferred Share plus accumulated and unpaid dividends. Total Series C Convertible Preferred Stock installments made during the nine months period ended September 30, 2012 is as follows:
Dividend
Principal
Total
The following table summarizes the Series C Preferred Stock activity during the nine months ended September 30, 2012:
Preferred stock principal paid in cash
Preferred stock accretion of fees and embedded derivative
Note 7 – Debt
The Company has two outstanding credit agreements with a syndicate of banks led by Bank of America; the US Bank of America credit facility and the W.E.T. Bank of America credit facility. The US Bank of America credit facility consists of the US Term Note and Europe Term Note. These notes are subject to quarterly principal payments, with total principal amortization of 10% of the original principal amount in the first year and amortization of 12.5%, 15%, 17.5% and 20% of the original principal amount during years two, three, four and five, respectively with all remaining amounts owing under each term facility due and payable in full at the term loan maturity date. The W.E.T. Bank of America credit facility consists of the W.E.T. Term Note, which is subject to quarterly principal payments totaling 20% annually. Principal outstanding under both the US Bank of America credit facility and W.E.T. Bank of America credit facility will be due and payable in full on March 30, 2016. Interest is payable at least quarterly. The Company has the option to elect interest rates based on either a Eurocurrency (LIBOR or EUIBOR) rate (“Eurocurrency Rate Loans”) (0.20% – 0.60% at September 30, 2012) or a base rate (“Base Rate Loans”) plus a margin (“Applicable Rate”) which varies based on the Consolidated Leverage Ratio of the Company, as defined by the US and W.E.T. Bank of America credit agreements. The base rate is equal to the highest of the Federal Funds Rate (0.09% at September 30, 2012) plus 0.5%, Bank of America’s prime rate (3.25% at September 30, 2012), or a one month Eurocurrency rate plus 1.0%. The Applicable Rate for the current period is 2.5% for Eurocurrency Rate Loans and 2.0% for Base Rate Loans.
On March 30, 2012, the Company entered into the fourth amendment (the “Amendment”) to the US Bank of America credit facility. The amendment removed a requirement that previously obligated Gentherm to make prepayments on its outstanding indebtedness equal to the net proceeds received from the sale of Gentherm common stock in excess of the future obligations owed to the holders of Gentherm’s Series C 8% convertible preferred stock. The amendment permits Gentherm to retain any such excess amounts for general corporate purposes.
On May 16, 2012, W.E.T. sold all remaining shares of its treasury stock to current shareholders. In accordance with the terms of the W.E.T. Bank of America credit facility, net proceeds from the sale of treasury shares, including approximately $6,353 paid by historical Gentherm, were used to pay down the outstanding indebtedness on the W.E.T. term note. W.E.T. made a payment of $8,237 on the euro denominated tranche of the W.E.T. term note.
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Note 7 – Debt – Continued
On September 11, 2012, we borrowed ¥20,000, or $3,159, from Bank of China to fund a plant expansion project in China. The Bank of China loan is due in lump sum on September 10, 2013 with interest calculated at a fixed rate of 6.9%.
The following table summarizes the Company’s debt at September 30, 2012 and at December 31, 2011.
US Term Note
Europe Term Note
W.E.T. Term Note
Bank of China
Capital Leases
Total debt
Current portion
The Company must maintain certain financial ratios including a minimum Consolidated Fixed Charge Coverage Ratio and a maximum Leverage Ratio as defined by the Bank of America credit agreement.
As of September 30, 2012, we were in compliance with all terms as outlined in the credit agreement for each of the US Bank of America credit facility, the W.E.T. Bank of America credit facility and the Bank of China loan.
Note 8 – Derivative Financial Instruments
We are exposed to market risk from changes in foreign currency exchange rates, short term interest rates and price fluctuations of certain material commodities such as copper. Foreign currency exchange risks are attributable to sales to foreign customers not denominated in the seller’s functional currency, foreign plant operations, intercompany indebtedness and purchases from foreign suppliers and include exposures to the European Euro, Japanese Yen, Canadian Dollar, Hungarian Forint, Korean Won and Mexican Peso. The Company regularly enters into derivative contracts with the objective of managing its financial and operational exposure arising from this risk by offsetting gains and losses on the underlying exposures with gains and losses on the financial instruments used to hedge them. We do not enter into derivative financial instruments for speculative or trading purposes. Our hedging relationships are formally documented at the inception of the hedge, and hedges must be highly effective in offsetting changes to future cash flows on hedged transactions both at the inception of a hedge and on an ongoing basis to be designated for hedge accounting treatment. We record the ineffective portion of hedging instruments, if any, to other income (expense) in the consolidated condensed statements of operations.
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Note 8 – Derivative Financial Instruments – Continued
The Company uses a market approach to value derivative instruments, analyzing observable benchmark rates at commonly quoted intervals for the instrument’s full term. Information related to the recurring fair value measurement of derivative instruments, including W.E.T.’s currency related interest rate swap (“CRS”), in our consolidated balance sheet as of September 30, 2012 is as follows:
CRS
Total CRS
Foreign currency derivatives
Total foreign currency derivatives
Interest rate swap derivatives
Information relating to the effect of derivative instruments on our consolidated income statements is as follows:
Location
Commodity derivatives
Interest Rate Swap
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Series C Convertible Preferred Stock embedded derivatives
We did not incur any hedge ineffectiveness during the nine months ended September 30, 2012 and 2011. We recorded an expense of $127 from interest payments on interest rate swap agreements designated as hedging instruments within interest expense during the nine months ended September 30, 2012.
Note 9 – Fair Value Measurement
The Company bases fair value on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We have adopted a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:
Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and also considers counterparty credit risk in its assessment of fair value.
The Company’s derivative instruments and hedging activities and pension assets qualify as financial assets and liabilities whose fair value is measured on a recurring basis each reporting period. Fair value measurement disclosures for our derivative instruments and hedging activities are located within Note 8. The carrying amounts of financial instruments comprising cash and cash equivalents, short-term investments and accounts receivable approximate their fair values due to their short-term nature. The carrying value of the Company’s long-term debt approximates its fair value because interest charged on the loan balance is variable. There were no significant changes to interest rates during the period.
Certain Company assets are required to be recorded at fair value on a non-recurring basis when events and circumstances indicate that the carrying value may not be recoverable. As of September 30, 2012 and 2011, the Company did not realize any changes to the fair value of these assets due to events that negatively impacted their recoverability.
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FORWARD LOOKING STATEMENTS
Certain matters discussed or referenced in this report, including expectations of increased revenues and continuing losses, our financing requirements, our capital expenditures, our potential acquisitions and our prospects for the development of platforms with major automotive manufacturers, are forward-looking statements. Other forward-looking statements may be identified by the use of forward-looking terminology such as “may”, “will”, “expect”, “believe”, “estimate”, “anticipate”, “intend”, “continue”, or similar terms, variations of such terms or the negative of such terms. All forward-looking statements speak only as of the date of this report, and we expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained in this report to reflect any change in our expectations with regard to such statements or any change in events, conditions or circumstances on which any such statement is based. Although such statements are based upon our current expectations, and we believe such expectations are reasonable, such expectations, and the forward-looking statements based on them, are subject to a number of factors, risks and uncertainties that could cause our actual results to differ materially from those described in the forward-looking statements, including those described below and in our other filings with the Securities and Exchange Commission (“SEC”).
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General
Gentherm Incorporated (formally known as Amerigon Incorporated until September 5, 2012) designs, develops, manufactures and markets proprietary technology electronic components and systems for sale to car and truck original equipment manufacturers (“OEMs”). One of the Gentherm’s primary automotive seat comfort products is the Climate Control Seat™ (“CCS™”), which provides year-round comfort by providing both heating and cooling to seat occupants. During the second quarter of 2011, Gentherm acquired a majority interest in W.E.T. Automotive Systems AG (“W.E.T.”), a developer, manufacturer and distributor of heating and cooling systems, interior equipment, electronics and accessories used in automobile seats and other automotive and electronic applications in the automotive industry. The activities of W.E.T. represent a significant portion of the Company’s consolidated assets, liabilities, revenues and expenses. The term “historical Gentherm” used herein excludes W.E.T.
Third Quarter 2012 Compared with Third Quarter 2011
The following table presents select operations data for the period as reported, amounts for W.E.T. operations and amounts for Gentherm less the W.E.T. amounts representing the historical portion of Gentherm. These historical Gentherm financial results, which are non-GAAP measures, are provided to help shareholders understand Gentherm’s results of operations in light of the 2011 acquisition of W.E.T. These non-GAAP financial measures should be viewed in addition to, and not as an alternative for, Gentherm’s reported results prepared in accordance with GAAP.
Gross margin percent
Selling, general and administrative expenses (1)
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Selling, general and administrative expenses
Product Revenues. Product revenues for the three months ended September 30, 2012 (“Third Quarter 2012”) were $141,058,000 compared with product revenues of $125,639,000 for the three months ended September 30 2011 (“Third Quarter 2011”), an increase of $15,419,000, or 12%. Product revenues at W.E.T. for Third Quarter 2012 were $11,970,000 higher compared to Third Quarter 2011 driven by strong customer demand on existing vehicle programs, as well as new vehicle programs launched since September 30, 2011. W.E.T. revenues include the effect of the first historical Gentherm vehicle program to be produced in a W.E.T. facility totaling $6,534,000 for the Third Quarter 2012. Adding back the transferred program’s revenues in both periods, historical Gentherm’s product revenues would have increased $5,557,000, or 16%, reflecting new vehicle program launches since the end of the Third Quarter 2011 and expansion of certain programs into new geographic regions by our customers on existing vehicles. New program launches for CCS include the Ford Flex, Nissan Pathfinder, Infiniti JX, Hyundai i40 and Kia K9 Cadenza. Certain existing vehicle programs had higher revenue during the period as a result of our customers expanding the availability of our product to additional geographic regions, including the Kia Optima which is now also offered in the China and North American markets. Partially offsetting higher product revenues during the Third Quarter 2012 is a decline related to the weakening of the Euro against the U.S. dollar which negatively impacted our Euro denominated revenues. Our Euro denominated product revenue for the Third Quarter 2012 was €31,855,000 and the average US Dollar/Euro exchange rate for the quarter was 1.2514. If the average exchange rate for the quarter had been equal to the average US Dollar/Euro rate for all of 2011 of 1.407, we would have reported incrementally higher revenue of approximately $5,000,000.
Cost of Sales. Cost of sales increased to $104,258,000 in the Third Quarter 2012 from $94,795,000 in the Third Quarter 2011. This increase of $9,463,000, or 10%, is due to increased sales volume offset by higher gross margin percentages. A favorable change in product mix and greater coverage of fixed costs at the higher volume levels increased historical gross profit percentage during the Third Quarter 2012 to approximately 26% compared with 25% during the Third Quarter 2011.
Net Research and Development Expenses. Net research and development expenses were $10,046,000 in the Third Quarter 2012 compared to $11,285,000 in the Third Quarter 2011, a decrease of $1,239,000, or 11%, driven by a weakening of the Euro against the Dollar. The average Euro-to-Dollar exchange rate for Third Quarter 2012 decreased approximately 11% to 1.2541 compared with the Third Quarter 2011 rate of 1.407. The decrease in historical Gentherm’s research and development expense is due to an increase in funding reimbursements from U.S. Department of Energy sponsored research and product development.
We classify development and prototype costs and related reimbursements as research and development. This is consistent with accounting standards applied in the automotive industry. Depreciation costs for tooling are included in cost of sales.
Acquisition Transaction Expenses. We incurred $200,000 in fees and expenses associated with the acquisition of W.E.T. during the Third Quarter 2011. The acquisition closed in the second quarter of 2011. We did not incur any acquisition transaction expenses during the Third Quarter 2012.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $16,560,000 in the Third Quarter 2012 from $13,545,000 in the Third Quarter 2011, an increase of $3,015,000, or 22%. Historical Gentherm’s Third Quarter 2012 selling, general and administrative included approximately $150,000 in legal expenses related to a Domination and Profit and Loss Transfer Agreement (“DPLTA”) for W.E.T. and approximately $450,000 in incremental audit and accounting expenses driven by Sarbanes-Oxley compliance implementation for W.E.T. Approximately $500,000 in one-time fees associated with
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an investigation of a potential acquisition were incurred, in total, by W.E.T. and historical Gentherm. Historical Gentherm paid non-cash commissions of approximately $350,000 to our newly created Yongsan Korea JV on Hyundai and Kia vehicle sales in August and September, which was eliminated in consolidation. The remaining increase in historical Gentherm’s selling, general and administrative expenses is due to higher general legal, audit and travel costs, as well as wages and benefits costs resulting from new employee hiring and merit increases. We anticipate incurring additional expenses in the fourth quarter related to the Sarbanes-Oxley project for W.E.T. as well as a significant drop in these expenses in the first quarter of 2013 and going forward. See the Liquidity and Capital Resources section of this report for additional information about the DPLTA.
Income Tax Expense. We recorded an income tax expense of $2,425,000 during the Third Quarter 2012 representing an effective tax rate of 30% on earnings before income tax of $8,195,000. This effective tax rate was lower than the US Federal rate of 34% primarily due to the impact of lower statutory rates for our subsidiaries operating in foreign jurisdictions. During the Third Quarter 2011, we recorded an income tax expense of $973,000 representing an effective tax rate of 39% on earnings before income tax of $2,492,000. We had lower statutory tax rates in jurisdictions in which we experienced losses before income tax and higher statutory rates in jurisdictions in which we had earnings before income tax. The effect of these resulted in an effective tax rate higher than the US Federal rate. Our effective tax rate was estimated based upon a forecast of our full year results not including the non-deductible acquisition transaction costs which were reflected separately as a discrete tax item during 2011.
Nine Months Ending September 30, 2012 Compared with Nine Months Ending September 30, 2011
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Product Revenues. Product revenues for the nine months ended September 30, 2012 (“YTD 2012”) were $406,737,000 compared with product revenues of $238,572,000 for the nine months ended September 30, 2011 (“YTD 2011”), an increase of $168,165,000, or 70%, reflecting a full nine months of W.E.T. revenues earned in YTD 2012 compared with four and a half months of W.E.T. revenues earned in YTD 2011. W.E.T. revenues include the effect of the first historical Gentherm vehicle program to be produced in a W.E.T. facility totaling $20,650,000 for YTD 2012. Adding back the transferred program’s revenues for both periods, historical Gentherm’s product revenues would have increased $14,069,000, or 14%, reflecting new vehicle program launches since the end of the Third Quarter 2011 and expansion of certain programs into new geographic regions by our customers on existing vehicles. New program launches for CCS include the Ford Flex, Nissan Pathfinder, Infiniti JX, Hyundai i40 and Kia K9 Cadenza. Certain existing vehicle programs had higher revenue during the period as a result of our customers expanding the availability of our product to additional geographic regions. These vehicles include the Kia Optima which is now also offered in the China and North American markets. Partially offsetting higher product revenues during YTD 2012 is a decline related to the weakening of the Euro against the U.S. dollar which negatively impacted our Euro denominated revenues. Our Euro denominated product revenue for the YTD 2012 was €95,483,000 and the average US Dollar/Euro exchange rate for YTD 2012 was 1.2824. If the average exchange rate for YTD 2012 been equal to the average US Dollar/Euro rate for all of 2011 of 1.3921, we would have reported incrementally higher revenue of approximately $10,500,000.
Cost of Sales. Cost of sales increased to $303,275,000 in YTD 2012 from $177,671,000 in YTD 2011. This increase of $125,604,000, or 71%, is due to a full nine months of W.E.T. cost of sales incurred in YTD 2012 compared with four and a half months of W.E.T. cost of sales incurred in YTD 2011, and by higher cost of sales for historical Gentherm, offset by slightly higher gross margin percentages. The $1,356,000, or 2%, decrease on cost of sales attributable to historical Gentherm is due to lower sales volumes on some of our foreign vehicle programs.
Net Research and Development Expenses. Net research and development expenses increased to $29,717,000 in YTD 2012 from $18,340,000 in YTD 2011, an increase of $11,377,000, or 62%, reflecting a full nine months of W.E.T. research and development expenses incurred in YTD2012 compared with four and a half months of W.E.T. expenses incurred in YTD 2011. The decrease in historical Gentherm is due to an increase in funding reimbursements from U.S. Department of Energy sponsored research and product development for YTD 2012 compared with YTD 2011.
Acquisition Transaction Expenses. We incurred $5,380,000 in fees and expenses associated with the acquisition of W.E.T. during YTD 2011. The acquisition closed in the second quarter of 2011. We did not incur any acquisition transaction expenses during YTD 2012.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $45,972,000 in YTD 2012 from $26,092,000 in YTD 2011. This $19,880,000, or 76%, increase is primarily due to a full nine months of W.E.T. expenses incurred in YTD 2012 compared with four and a half months of W.E.T. expenses in YTD 2011, and higher selling, general and administrative expenses at historical Gentherm. Historical Gentherm’s YTD 2012 selling, general and administrative expenses increased $4,782,000, or 47%, and included approximately $860,000 in expenses to pursue a DPLTA for W.E.T., and approximately $830,000 in expenses related to the Sarbanes-Oxley implementation for W.E.T., approximately $250,000 in one-time fees associated
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with an investigation of a potential merger, and approximately $350,000 in non-cash commissions paid to our newly created Yongsan Korea JV on Hyundai and Kia vehicle sales in August and September. The remaining increase in historical Gentherm’s selling, general and administrative expenses is due to higher general legal, audit and travel costs, as well as wages and benefits costs resulting from new employee hiring and merit increases. See the Liquidity and Capital Resources section of this report for additional information about the DPLTA.
Income Tax Expense. We recorded an income tax expense of $7,580,000 during YTD 2012 representing an effective tax rate of 28% on earnings before income tax of $26,623,000. This effective tax rate was lower than the US Federal rate of 34% primarily due to the impact of lower statutory rates for our subsidiaries operating in foreign jurisdictions. During YTD 2011, we recorded an income tax expense of $4,117,000 representing an effective tax rate of 71% on earnings before income tax of $5,788,000. We incurred acquisition transaction expenses of $5,380,000 which were not deductible and therefore our income tax expense for that same period did not reflect any related tax benefit. Our estimated effective tax rate for YTD 2011 was 37% before the effect of the non-deductible acquisition transaction expenses. Our effective tax rate was estimated based upon a forecast of our full year results not including the non-deductible acquisition transaction costs which were reflected separately as a discrete tax item during 2011.
Liquidity and Capital Resources
The following table represents our cash and cash equivalents and short-term investments which are available for our business operations:
Cash and cash equivalents
We manage our cash, cash equivalents in order to fund operating requirements and preserve liquidity to take advantage of future business opportunities. Cash and cash equivalents increased by $48,440,000 in YTD 2012. As of September 30, 2012, the Company had approximately $24,397,000 in cash and cash equivalent at foreign locations. If that cash and cash equivalents were needed for our operations in the U.S. in the future we would be required to accrue and pay U.S. taxes in order to repatriate these funds. Based on our current plans, we believe we have sufficient cash in the U.S. to fund our U.S. operations and our intent is to permanently reinvest these foreign amounts outside of the U.S.
Cash provided by operating activities during YTD 2012 was $29,373,000 and was attributable to net income of $19,043,000, net of non-cash adjustments. Non-cash adjustments included depreciation and amortization of $22,902,000, deferred tax provisions of $2,390,000, stock compensation of $911,000, gains on revaluation of financial derivatives of $1,064,000, excess tax benefit from equity awards and other items. Partially offsetting these was a net increase in net operating assets and liabilities of $12,905,000.
As of September 30, 2012, working capital was $119,019,000 as compared to $65,955,000 at December 31, 2011, an increase of $53,064,000, or 80%. This increase is primarily related to a public offering of 5,290,000 shares of common stock totaling $75,487,000, an increase in accounts receivable totaling $16,728,000, an increase in inventory totaling $4,250,000, an increase in prepaid and other assets of $7,264,000, partially offset by an increase in accounts payable of $4,622,000, an increase in accrued liabilities of $10,715,000 and by payments on our outstanding term notes and Series C Convertible Preferred Stock Total payments on outstanding term notes were $19,149,000, including mandatory repayments using proceeds from the sale of W.E.T. treasury shares, and total Series C Convertible Preferred Stock payments were $17,340,000. Working capital was also impacted by changes in currency exchange rates.
Cash used in investing activities was $26,559,000 during YTD 2012, reflecting purchases of property and equipment totaling $15,344,000, cash paid to acquire new derivative financial instruments of $7,787,000, cash paid to acquire new patents and patent application filings of $2,593,000 and cash loaned to an equity investment of $590,000. Purchases of property and equipment for the period are primarily related to expansion of production capacity, as well as replacement of existing equipment.
Cash provided by financing activities was $46,225,000 during YTD 2012, reflecting the public offering of common stock totaling $75,487,000, excess tax benefit from equity awards of $1,577,000, proceeds from exercises of Common Stock options of $733,000, borrowing of debt of $3,286,000 and $1,921,000 in proceeds from non-controlling interests related to the sale of W.E.T.’s outstanding treasury shares. These amounts were partially offset by aforementioned repayments on our outstanding term notes and Series C Convertible Preferred Stock totaling $19,149,000 and $17,340,000, respectively.
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The Series C Convertible Preferred Stock is to be redeemed in nine equal quarterly installments beginning on September 1, 2011 and ending on September 1, 2013 (each, an “Amortization Date”) by paying cash, issuing shares of our Common Stock or any combination thereof for $10,000 per Preferred Share plus accumulated and unpaid dividends. Total Series C Convertible Preferred Stock installments made during the nine month period ended September 30, 2012 are as follows (in thousands, except share data):
We intend to use a portion of the net proceeds from the public offering of common stock to pay our future obligations to holders of our Series C Preferred Stock. These future cash payment obligations, assuming such shares are not earlier converted into shares of common stock by the holders, are approximately as follows (in thousands):
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The following table summarizes the Company’s debt at September 30, 2012 and December 31, 2011.
On August 16, 2011, W.E.T. held its annual general assembly meeting during which the W.E.T. shareholders approved the adoption of a Domination and Profit and Loss Transfer Agreement (“DPLTA”). Under the terms of the DPLTA, when the DPLTA is registered, the minority shareholders of W.E.T. will be guaranteed a recurring, annual payment (the “Guaranteed Compensation”) of EUR 3.71 per share of W.E.T. held, subject to statutory taxes and deductions, resulting in a net payment of EUR 3.17 per share beginning in 2012; however, the minority shareholders of W.E.T. can elect to forego the Guaranteed Compensation and instead tender their shares to Gentherm Europe for a one-time cash payment of EUR 44.95 per share after the agreement is registered. If all minority shareholders of W.E.T. tendered their shares, the total payment obligation of Gentherm Europe would be approximately EUR 33,139,000.
A minority shareholder of W.E.T. filed an action in Germany to set aside the shareholder approval of the DPLTA based on alleged violations of German corporate law. As a result, the DPLTA has not yet been registered and will not go into effect until the minority shareholder action is resolved. See Part II, Item 1, Legal Proceedings, for further information concerning the aforementioned minority shareholder action.
In order to provide financing for the potential tender offer to the minority shareholders of W.E.T., the Company entered into an amendment to the US Bank of America credit facility, on October 28, 2011. The amendment provides for a $45,000,000 term loan facility for Gentherm Europe, which replaced Gentherm Europe’s then existing Europe Term Note. As of September 30, 2012 €3,390,000, or $4,358,000, was outstanding under this term loan facility and $40,642,000 was available for future borrowing. Gentherm Europe is permitted to access this additional term loan financing in one or more draws through no later than January 1, 2013, and the proceeds of such draws may only be used by Gentherm Europe to fund the potential tender of shares of W.E.T. in connection with the DPLTA.
The Company has funded its financial needs from inception primarily through net proceeds received through its initial public offering as well as other equity and debt financing activities. Based on its current operating plan, management believes cash and equivalents at September 30, 2012 along with proceeds from future revenues are sufficient to meet operating needs for the foreseeable future.
Recent Accounting Pronouncement
Disclosures about Offsetting Assets and Liabilities. In December 2011, the FASB issued ASU No. 2011-11 which amends Topic 210 (Balance Sheet). ASU No. 2011-11 is intended to enhance the disclosure requirements for offsetting (netting) assets and liabilities and the effect or potential effect on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial and derivative instruments. The amendments in ASU No. 2011-11 include quantitative disclosure requirements to be presented in tabular format. The tabular disclosure components are as follows:
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We are exposed to market risk from changes in foreign currency exchange rates, short term interest rates and price fluctuations of certain material commodities, such as copper. Market risks for changes in interest rates relate primarily to our debt obligations under our Bank of America credit facilities. Foreign currency exchange risks are attributable to sales to foreign customers not denominated in the seller’s functional currency, foreign plant operations, intercompany indebtedness and purchases from foreign suppliers and include exposures to the European Euro, Japanese Yen, Canadian Dollar, Hungarian Forint, Korean Won and Mexican Peso. Our subsidiary W.E.T. regularly enters into derivative contracts with the objective of managing its financial and operational exposure arising from this risk by offsetting gains and losses on the underlying exposures with gains and losses on the financial instruments used to hedge them. While W.E.T. continuously monitors the hedging program, derivative positions and hedging strategies and maintains documentation as to the hedging objectives, practices and procedures, W.E.T. has not typically designated its derivatives as hedging instruments for accounting purposes.
In March 2008, W.E.T. entered into a 10 year currency related interest rate swap (“CRS”) having a notional value of €10,000,000 or $12,854,000 as of September 30, 2012, in order to offset the interest rate risk associated with a debt financing which was repaid prior to our acquisition of W.E.T. Under this agreement W.E.T. receives interest equal to the then six month Euro Interbank Offered Rate (“EURIBOR”), 0.44% at September 30, 2012, plus 1.40% and pays interest equal to the six month EUIBOR when the exchange rate between the European Euro (“EUR”) and the Swiss Franc (“CHF”), which was 1.21 at September 30, 2012, equals or exceeds 1.46 EUR to the CHF or pays interest equal to the six month EURIBOR plus a premium when this exchange rate is less than 1.46. The premium is calculated as [(1.46 – current EUR/CHF rate)/current EUR/CHF rate] x 100. W.E.T. has entered into offsetting derivative contracts that cancel out the payment due under the CRS through 2012.
In July 2011, the Company entered into a series of interest rate swap contracts and a interest rate cap agreement designated as cash flow hedges in order to hedge the exposure to variable market interest rates on the Company’s senior debt. Gains and losses reported in accumulated other comprehensive income will be reclassified to earnings once the Company’s senior debt is repaid. Information on the interest rate swap contracts is as follows:
Contract Type
Swap
Cap
The Company uses a market approach to value derivative instruments, analyzing observable benchmark rates at commonly quoted intervals for the instrument’s full term. Information related to the fair values of derivative instruments in our consolidated balance sheet as of September 30, 2012 is as follows:
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Information related to the effect of derivative instruments on our consolidated income statements is as follows (in thousands):
We did not incur any hedge ineffectiveness during the nine months ended September 30, 2012 and 2011. We recorded an expense of $127,000 from interest payments on interest rate swap agreements designated as hedging instruments within interest expense during the nine months ended September 30, 2012.
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Interest Rate Sensitivity
The table below provides information about the Company’s derivative financial instruments and other financial instruments that are sensitive to changes in interest rates, including interest rate swaps and debt obligations. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. For interest rate swaps, the table presents notional amounts and weighted average interest rates by expected (contractual) maturity dates. Notional amounts are used to calculate the contractual payments to be exchanged under the contract. Weighted average variable rates are based on implied forward rates in the yield curve at the reporting date. The information is presented in U.S. dollar equivalents, which is the Company’s reporting currency. The instruments actual cash flows are denominated in both U.S. dollars ($USD) and European Euros (€EUR), as indicated in parentheses.
September 30, 2012
Liabilities
Long Term Debt:
Fixed Rate (€EUR)
Average Interest Rate
Fixed Rate (¥CNY)
Variable Rate ($USD)
Variable Rate (€EUR)
Derivative Financial Instruments:
Interest Rate Swap ($USD)
Interest Rate Cap (€EUR)
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Exchange Rate Sensitivity
The table below provides information about the Company’s derivative financial instruments, other financial instruments by functional currency and presents such information in U.S. dollar equivalents. The table summarizes information on instruments and transactions and are sensitive to foreign currency exchange rates, including foreign currency forward exchange agreements, €EUR denominated debt obligations and Chinese Yuan (¥ CNY) denominated debt obligations. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. For foreign currency forward exchange agreements, the table presents the notional amounts and weighted average exchange rates by expected (contractual) maturity dates. These notional amounts generally are used to calculate the contractual payments to be exchanged under the contract.
Anticipated Transactions And Related Derivatives
Euro functional currency
Forward Exchange Agreements:
(Receive USD$/Pay EUR€)
Total Contract Amount(€)
Average Contract Rate
(Receive HUF/Pay EUR€)
Total Contract Amount (€)
(Receive CHF/Pay EUR)
(Receive KRW/Pay EUR€)
$US functional currency
(Receive USD$/Pay CAD$)
Total Contract Amount ($)
(Receive USD$/Pay JPY¥)
(Receive USD$/Pay MXN)
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(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2012. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by our Quarterly Report on Form 10-Q, in light of the material weakness in Internal Control over Financial Reporting described below, our disclosure controls and procedures were not effective to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
As disclosed in our Annual Report on Form 10-K, management previously concluded that our internal control over financial reporting was not effective based upon the framework in “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management identified a material weakness in accounting for significant, non-routine transactions. Although there were no such significant, non-routine transactions during the nine month period ended September 30, 2012, we are working to remediate our material weakness in accounting for significant, non-routine transactions by hiring additional highly skilled accountants. Our remediation efforts are likely to be more difficult and costly than they otherwise would be if we were able to register a Domination and Profit and Loss Transfer agreement with our 76% owned subsidiary, W.E.T. Automotive AG. See PART II, ITEM 1., Legal Proceedings, for more information on our efforts to register a Domination and Profit and Loss Transfer agreement.
Notwithstanding the material weakness described above, we have performed additional analyses and other procedures to enable management to conclude that our consolidated financial statements included in this report were prepared in accordance with accounting principles generally accepted in the United States of America.
(b) Changes in Internal Control over Financial Reporting
During the fiscal quarter ended September 30, 2012, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II OTHER INFORMATION
At the first annual meeting of shareholders of W.E.T. following our acquisition of a majority interest in that company, held on August 16, 2011, the shareholders of W.E.T. approved an arrangement by which Gentherm Europe would take management control of W.E.T. and would directly receive W.E.T.’s annual profits and absorb W.E.T.’s annual losses, subject to certain conditions and obligations of Gentherm Europe. Such an arrangement (a “Domination and Profit and Loss Transfer”) is somewhat unique to German law and is subject to the terms and conditions applicable thereto under German law. On September 15, 2011, Deutsche Balaton AG, a minority shareholder of W.E.T., filed an action in a Regional Court in Munich, Germany (the “German Lower Court”) to set aside the shareholder approval of the DPLTA based on an alleged violations of German corporate law.
On April 5, 2012, the German Lower Court declared the W.E.T. shareholder approval of the Domination and Profit and Loss Transfer null and void based on such court’s conclusion that certain provisions in a separate document, a Business Combination Agreement between Gentherm, Gentherm Europe and W.E.T., were not deemed to be in accordance with German law. W.E.T. has appealed such ruling. As a result of the German Lower Court ruling, the Domination and Profit and Loss Transfer cannot be registered, and cannot go into effect, unless and until the decision of the German Lower Court is overturned by a German appellate court. Until the Domination and Profit and Loss Transfer is registered and effective, W.E.T. will not be subject to direct management control by Gentherm and W.E.T.’s profits can only be distributed by the declaration of dividends. W.E.T. has appealed the decision of the German Lower Court.
There were no material changes in our risk factors previously disclosed in Part I, Item 1A. of our Form 10-K for the year ended December 31, 2011.
Exhibits to this Report are as follows:
Exhibit
Number
Description
29
30
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
/s/ DANIEL R. COKER
Daniel R. Coker
Chief Executive Officer
(Duly Authorized Officer)
Date: November 5, 2012
/s/ BARRY G. STEELE
Barry G. Steele
Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
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