UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number: 0-21810
GENTHERM INCORPORATED
(Exact name of registrant as specified in its charter)
Michigan
95-4318554
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
21680 Haggerty Road, Ste. 101, Northville, MI
48167
(Address of principal executive offices)
(Zip Code)
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 the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
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 7, 2014, the registrant had 35,701,556 shares of Common Stock, no par value, issued and outstanding.
TABLE OF CONTENTS
Cover
Table of Contents
Part I. Financial Information
3
Item 1.
Financial Statements (Unaudited)
Consolidated Condensed Balance Sheets
Consolidated Condensed Statements of Income
4
Consolidated Condensed Statements of Comprehensive Income
5
Consolidated Condensed Statements of Cash Flows
6
Consolidated Condensed Statement of Changes in Shareholders’ Equity
7
Notes to Unaudited Consolidated Condensed Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
19
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
23
Item 4.
Controls and Procedures
26
Part II. Other Information
27
Legal Proceedings
Item 1A.
Risk Factors
Item 6.
Exhibits
Signatures
28
2
PART I. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands, except share data)
September 30,2014
December 31,2013
(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents
$
65,169
54,885
Accounts receivable, less allowance of $2,369 and $1,807, respectively
147,061
118,283
Inventory:
Raw materials
46,168
33,783
Work in process
4,322
2,864
Finished goods
24,293
27,570
Inventory, net
74,783
64,217
Derivative financial instruments
145
67
Deferred income tax assets
10,149
10,616
Prepaid expenses and other assets
31,372
21,864
Total current assets
328,679
269,932
Property and equipment, net
88,760
79,234
Goodwill
30,264
25,809
Other intangible assets
77,277
83,431
Deferred financing costs
1,054
1,072
19,341
7,103
1,158
1,969
Other non-current assets
11,140
13,373
Total assets
557,673
481,923
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable
73,638
61,662
Accrued liabilities
69,288
66,783
Current maturities of long-term debt
4,816
21,439
2,944
2,552
Deferred income tax liabilities
669
710
Total current liabilities
151,355
153,146
Pension benefit obligation
6,926
6,868
Other liabilities
3,419
1,601
Long-term debt, less current maturities
89,976
60,881
6,531
9,358
19,348
17,975
Total liabilities
277,555
249,829
Shareholders’ equity:
Common Stock:
No par value; 55,000,000 shares authorized, 35,641,556 and 34,929,334 issued and outstanding at September 30, 2014 and December 31, 2013, respectively
242,549
232,067
Paid-in capital
(6,329
)
(9,582
Accumulated other comprehensive loss
(21,204
(5,203
Accumulated earnings
65,102
14,812
Total shareholders’ equity
280,118
232,094
Total liabilities and shareholders’ equity
See accompanying notes to the consolidated condensed financial statements.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
Three Months EndedSeptember 30,
Nine Months EndedSeptember 30,
2014
2013
Product revenues
206,012
171,182
606,132
479,792
Cost of sales
144,427
125,265
426,765
354,672
Gross margin
61,585
45,917
179,367
125,120
Operating expenses:
Net research and development expenses
15,278
12,718
42,873
36,962
Acquisition transaction expenses
—
326
1,075
1,911
Selling, general and administrative
22,307
18,319
62,368
53,483
Total operating expenses
37,585
31,363
106,316
92,356
Operating income
24,000
14,554
73,051
32,764
Interest expense
(857
(1,062
(2,758
(2,916
Debt retirement expense
(730
Revaluation of derivatives
294
217
(293
1,201
Foreign currency gain(loss)
938
(1,612
(905
(1,514
Gain realized from step acquisition of subsidiary
785
Income from equity investment
77
319
Other income
495
191
796
691
Earnings before income tax
24,140
12,365
69,946
30,545
Income tax expense
6,852
3,600
19,656
6,343
Net income
17,288
8,765
50,290
24,202
Income attributable to non-controlling interest
(63
(1,340
Net income attributable to Gentherm Incorporated
8,702
22,862
Convertible preferred stock dividends
(159
(1,622
Net income attributable to common shareholders
8,543
21,240
Basic earnings per share
0.49
0.25
1.42
0.64
Diluted earnings per share
0.48
0.24
1.40
0.63
Weighted average number of shares – basic
35,522
34,447
35,317
33,261
Weighted average number of shares – diluted
36,271
34,886
35,943
33,584
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Three Months Ended
September 30,
Nine Months Ended
Other comprehensive income (loss), gross of tax:
Foreign currency translation adjustments
(13,178
8,642
(16,533
1,848
Unrealized gain on derivative securities
(529
30
(330
105
Other comprehensive income (loss), gross of tax
(13,707
8,672
(16,863
1,953
Other comprehensive income (loss), related tax effect:
(88
862
(197
Other comprehensive income (loss), related tax effect
Other comprehensive income (loss), net of tax
(13,699
8,584
(16,001
1,756
Comprehensive income
3,589
17,349
34,289
25,958
Less: comprehensive income (loss) attributable to the non-controlling interest
(104
1,173
Comprehensive income attributable to Gentherm Incorporated
17,453
24,785
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
Operating Activities:
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization
24,565
23,467
Deferred tax provision
(6,294
(2,455
Stock compensation
3,449
1,861
Defined benefit plan income
(33
Provision of doubtful accounts
500
369
Gain on revaluation of financial derivatives
(1,264
(2,859
Gain on equity investment
(318
Loss on sale of property and equipment
202
48
Unrealized foreign currency gain
(467
(785
Changes in operating assets and liabilities:
Accounts receivable
(25,190
(19,606
Inventory
(4,000
(8,824
(8,240
(2,458
8,039
11,250
4,679
4,099
Net cash provided by operating activities
45,451
28,617
Investing Activities:
Purchase of non-controlling interest
(46,835
Acquisition and investment in subsidiary, net of cash acquired
(31,739
Proceeds from the sale of property and equipment
96
Purchase of property and equipment
(26,990
(30,016
Cash invested in corporate owned life insurance
(266
Net cash used in investing activities
(58,633
(77,110
Financing Activities:
Borrowing of debt
91,592
48,923
Repayments of debt
(76,904
(18,966
Distribution paid to non-controlling interests
(3
Excess tax benefit from equity awards
4,004
1,317
Cash paid to Series C Preferred Stock Holders
(9,142
Proceeds from the exercise of common stock options
6,282
2,901
Net cash provided by financing activities
24,974
25,030
Foreign currency effect
(1,508
1,314
Net increase (decrease) in cash and cash equivalents
10,284
(22,149
Cash and cash equivalents at beginning of period
58,152
Cash and cash equivalents at end of period
36,003
Supplemental disclosure of cash flow information:
Cash paid for taxes
13,181
7,174
Cash paid for interest
1,990
2,249
Supplemental disclosure of non-cash transactions:
Common stock issued to Board of Directors and employees
2,026
1,028
Issuance of common stock to non-controlling interest
42,517
Issuance of common stock for Series C Preferred Stock conversion
15,108
CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
Common Stock
Paid-inCapital
AccumulatedEarnings
AccumulatedOtherComprehensiveLoss
Total
Shares
Amount
Balance at December 31, 2013
34,929
Exercise of Common Stock options for cash
650
8,456
(2,174
Tax benefit from exercises of Common Stock options
Stock option compensation
1,423
Common Stock issued to Board of Directors and employees
62
Interest rate hedge, net
81
Foreign currency hedge, net
(411
Currency translation, net
(15,671
Balance at September 30, 2014
35,641
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
Note 1 – The Company and Subsequent Events
Gentherm Incorporated is a global technology and industry leader in the design, development, and manufacturing of innovative thermal management technologies. Unless the context otherwise requires, the terms “Gentherm”, “Company”, “we”, “us” and “our” used herein refer to Gentherm Incorporated and its consolidated subsidiaries. We operate in locations aligned with our major customers’ product strategies in order to provide locally enhanced design, integration and production capabilities and to identify future climatic comfort product opportunities in both automotive and other markets. We concentrate our research on the development of new technologies that will enable new products, improve overall effectiveness of existing products and maximize customer satisfaction. We also focus on developing new design applications from our existing technologies to create new products and market opportunities for thermal comfort solutions.
Buyout of Joint Venture Partner
On February 12, 2014 we acquired all of the previously unowned shares in our North American electronics manufacturing joint venture which had previously been accounted for under the equity method. The purchase was accounted for using the acquisition method and resulted in a gain of $785.
Gentherm Global Power Technologies
On April 1, 2014, we acquired all of the stock of privately-held Global Thermoelectric Inc., now known as Gentherm Global Power Technologies (“GPT”), in an all-cash transaction. GPT is the global market leader and developer of thermoelectric generators. GPT’s world headquarters and manufacturing operations are located in Alberta, Canada. See Note 3, “Gentherm Global Power Technologies” for additional information regarding GPT.
Subsequent Events
We have evaluated subsequent events through the date that our consolidated financial statements are issued. No events have taken place that meet the definition of a subsequent event requiring adjustments to or disclosures 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 pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in the audited annual consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations. In the opinion of management, all adjustments, consisting of normal recurring items, considered necessary for a fair presentation of our results of operations, financial position and cash flows have been included. The balance sheet as of December 31, 2013 was derived from audited annual consolidated 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 month periods ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. These consolidated condensed financial statements should be read in conjunction with the financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013.
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, “Revenue from Contracts with Customers.” ASU 2014-09 was developed to enable financial statement users to better understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The update’s core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Companies are to use a five-step contract review model to ensure revenue gets recognized, measured and disclosed in accordance with this principle.
ASU 2014-09 is effective for fiscal years and interim periods beginning after December 15, 2016. The amendments in this update should be applied retrospectively either to each prior reporting period presented or to disclose the cumulative effect recognized at the date of initial application. Gentherm is developing a plan to complete the five-step contract review process for all existing contracts with customers. We are still in the process of determining the impact the implementation of ASU 2014-09 will have on the Company’s financial statements.
Note 2 – Basis of Presentation and New Accounting Pronouncements – Continued
Share-Based Payments
In June 2014, the FASB issued ASU 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” This update provides guidance on the treatment of awards containing performance targets that affect vesting and that could be achieved after an employee’s requisite service period. The update states that these types of performance targets should be treated as performance conditions and, therefore, not reflected in estimating the fair value of awards at the grant date. Compensation cost shall be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service period has been rendered. Should the probability of achievement occur before the end of the requisite service period, the remaining unrecognized compensation cost shall be recognized prospectively over the remaining requisite service period. The total compensation cost reflects the number of awards expected to vest and shall be adjusted to reflect when those awards ultimately vest.
ASU 2014-12 is effective for fiscal years and interim periods beginning after December 15, 2015. Gentherm has not assigned specific performance targets to share-based awards that are currently outstanding and therefore it is unlikely this update will materially impact the Company’s financial statements.
Note 3 – Gentherm Global Power Technologies
GPT develops, manufactures and sells thermoelectric and non-thermoelectric power generation systems and related products. The principal application for these technologies include natural gas well and pipeline protection systems and remote power generation for instrumentation, automation and telecommunication systems.
Results of operations for GPT are included in the Company’s consolidated condensed financial statements beginning April 1, 2014. GPT contributed $8,532 and $16,706 in product revenues and $639 and $597 in operating income for the three and nine month periods ended September 30, 2014, respectively.
Purchase Price Allocation
The purchase price of approximately $31,102, net of cash acquired of $3,061, has been allocated to the values of assets acquired and liabilities assumed as of April 1, 2014. The allocation of the purchase price is preliminary. The Company is in the process of obtaining additional information required to finalize the valuation. An appraisal will be completed to assist management in determining the fair value of acquired assets and assumed liabilities, including identifiable intangible assets. The final purchase price allocation may be materially different than the preliminary allocation recorded. The purchase price allocation is expected to be finalized by December 31, 2014. The preliminary allocation as of April 1, 2014 was as follows:
10,200
6,487
Deferred income tax assets, net
3,499
Order backlog
815
258
Property and equipment
716
Customer relationships
5,524
Technology
2,807
Trade name
725
6,601
Assumed liabilities
(6,530
Net assets acquired
31,102
Cash acquired
3,061
Purchase price
34,163
9
Note 3 – Gentherm Global Power Technologies – Continued
Supplemental Pro Forma Information
The unaudited pro forma combined historical results for the amounts of GPT’s revenue and earnings that would have been included in the Company’s consolidated condensed statements of income had the acquisition date been July 1, 2013 for the three months ended September 30, 2013 period, January 1, 2014 for the nine months ended September 30, 2014 period or January 1, 2013 for the nine months ended September 30, 2013 period are as follows:
176,272
619,143
501,307
6,735
52,168
19,742
The pro forma information includes adjustments for the effect of the amortization of intangible assets recognized in the acquisition. This pro forma information is not necessarily indicative of future operating results.
We recorded goodwill of approximately $6,601 arising from the acquisition. It is estimated that none of the goodwill recognized will be deductible for income tax purposes.
Intangible Assets
In conjunction with the acquisition, intangible assets of $9,871 were recorded. The Company’s estimate of the fair value of these assets at the time of the acquisition is preliminary and will be determined with the assistance of an independent third-party valuation firm. As part of the estimated valuation, an estimated useful life for the assets was determined.
Intangible assets, net consisted of the following (balances are lower as of September 30, 2014 than as of April 1, 2014, the acquisition date, due to fluctuations in foreign currency exchange rates totaling $120):
September 30, 2014
Gross Value
AccumulatedAmortization
Net Value
Useful Life
5,457
(230
5,227
12 yrs
805
(805
0.5 yrs
2,773
(140
2,633
10 yrs
(103
613
3.5 yrs
9,751
(1,278
8,473
Amortization expense of $667 and $1,316 for the three and nine months ended September 30, 2014 respectively, was recorded as follows:
Three Months EndedSeptember 30, 2014
Nine Months EndedSeptember 30, 2014
(119
(235
Selling, general and administrative expense
548
1,081
10
Amortization expense for the prospective five years is estimated to be as follows:
October 1, 2014 through December 31, 2014
234
2015
937
2016
2017
885
2018
732
Property & Equipment
Property and equipment consist of the following:
Asset Category
Land
Indefinite
15
Buildings
20 yrs
Leasehold improvements
5-7 yrs
Machinery and equipment
2-5 yrs
423
Computer hardware and software
3-5 yrs
169
Note 4 – Earnings per Share
Basic earnings per common share are computed by dividing net income by the weighted average number of shares of stock outstanding during the period. The Company’s diluted earnings per share give effect to all potential common shares outstanding during a period that do not have an anti-dilutive impact to the calculation. In computing the diluted earnings per share, the treasury stock method is used in determining the number of shares assumed to be purchased from the conversion of Common Stock equivalents.
The following summarizes the common shares included in the basic and diluted shares, as disclosed on the face of the consolidated condensed statements of income:
Three MonthsEnded September 30,
Nine MonthsEnded September 30,
Weighted average number of shares for calculation of basic EPS – Common Stock
35,522,407
34,447,098
35,317,359
33,261,115
Stock option under the 2006, 2011 and 2013 Equity Incentive Plans
748,873
439,364
625,452
323,111
Weighted average number of shares for calculation of diluted EPS
36,271,280
34,886,462
35,942,811
33,584,226
The accompanying table represents Common Stock issuable upon the exercise of certain stock options that have been excluded from the diluted earnings calculation because the effect of their inclusion would be anti-dilutive.
Stock options outstanding under the 2006, 2011 and 2013 Equity Incentive Plans
500,000
508,000
11
Note 5 – Segment Reporting
As part of the initiative to integrate the operations of historical Gentherm and W.E.T. Automotive Systems AG, now known as Gentherm GmbH (“Gentherm GmbH”), changes were made during the first quarter of 2014 to Gentherm’s structure of internal organization. Gentherm no longer treats the operations of historical Gentherm and Gentherm GmbH as separate segments. The integration initiative also changed the scope of research and development activities which changed our reporting of segment information.
As discussed in Note 3 – Gentherm Global Power Technologies, Gentherm acquired GPT on April 1, 2014. The acquisition enhances key elements of the Company’s business strategy by expanding the breadth of products derived from core thermal technologies as well as the markets in which they are applied. The chief operating decision maker analyzes the operational results of GPT separate from the automotive segment. The Company evaluated the significance of the GPT acquisition and determined it did not meet the thresholds to be presented in a separate and distinct segment. The operating results of GPT and the advanced research and product development division, formally known as the Advanced Technology segment, are presented together as a reporting segment for the Company due to the high concentration of thermoelectric technologies and power generating programs being researched by Gentherm and due to technical synergies that exist between GPT and the advanced research and product development division. The changes to the internal organization structure are reflected in the financial information used by our chief operating decision maker to allocate Company resources and assess operating performance.
Corporate reconciling items include certain selling, general and administrative costs previously reflected in the Gentherm GmbH segment.
Management evaluates the performance of the Company’s segments based primarily on operating income or loss.
The Company’s reportable segments are as follows:
Automotive – the aggregated operating results from Gentherm’s three geographic operating segments: North America, Europe and Asia.
Industrial – the combined operating results of GPT and Gentherm’s advanced research and development division. Advanced research and development includes efforts focused on improving the efficiency of thermoelectric devices and advanced heating wire technology as well as other applications. The segment includes government sponsored research projects, including those sponsored by the U.S. Department of Energy, the German Ministry of Economics and Technology and the European Union.
Reconciling Items – include corporate selling, general and administrative costs and acquisition transaction costs. For the three and nine month periods ended September 30, 2014 and 2013, Gentherm allocated certain computer technology costs across all three reporting segments that had previously been reported in Reconciling Items. The total amount of computer technology costs allocated to the Automotive and Industrial segments and previously reported in Reconciling items was $2,800 and $2,600 for the six month periods ended June 30, 2014 and 2013, respectively.
12
Note 5 – Segment Reporting – Continued
The following table presents segment information about the reported product revenues, depreciation and amortization and operating income (loss) of the Company for the three and nine month periods ended September 30, 2014 and 2013. Information presented for 2013 has been restated to conform with our new segment reporting structure, including the allocation of computer technology costs across all segments. 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. As of September 30, 2014, goodwill assigned to our Automotive and Industrial segments were $23,663 and $6,601, respectively. Goodwill as of December 31, 2013 pertained entirely to our Automotive segment.
Three Months Ended September 30,
Automotive
Industrial
ReconcilingItems
ConsolidatedTotal
2014:
197,480
8,532
7,062
700
872
8,634
Operating income (loss)
29,534
(1,832
(3,702
2013:
6,477
118
1,142
7,737
20,428
(150
(5,724
589,426
16,706
20,790
1,650
2,125
105,550
(5,689
(26,810
21,231
343
1,893
64,114
(4,781
(26,569
Total product revenues information by geographic area is as follows:
United States
96,680
47
%
76,543
45
Germany
22,529
20,847
South Korea
21,339
13,546
China
17,557
18,285
Japan
11,970
10,281
Czech Republic
6,457
4,114
United Kingdom
5,363
5,180
Mexico
4,991
4,230
Canada
4,811
3,432
Other
14,315
14,724
Total Non U.S.
109,332
53
94,639
55
100
13
270,597
211,462
44
70,491
61,332
67,293
39,069
50,850
47,972
34,291
28,591
19,398
11,893
18,162
13,319
14,752
11,696
12,542
10,533
47,756
43,925
335,535
268,330
56
Note 6 – Debt
Credit Agreement
On August 7, 2014, the Company, together with certain direct and indirect subsidiaries, entered into a new Credit Agreement (the “Credit Agreement”) with a syndicate of banks led by Bank of America.
The Credit Agreement provides for a $50,000 secured term loan facility for Gentherm (the “US Term Loan”), a €20,000 secured term loan facility for Gentherm GmbH (the “Europe Term Loan”), and a $100,000 secured revolving credit facility (with specific borrowing limits for foreign subsidiaries party to such agreement). The Credit Agreement allows the Company to increase the revolving credit facility or incur additional secured term loans in an aggregate amount of $50,000.
All obligations under the Credit Agreement (including all the obligations of any US or non-US loan party) are unconditionally guaranteed by Gentherm and specified US subsidiaries. Additionally, such parties entered into a pledge and security agreement, granting security interest in substantially all of their personal property to secure their respective obligations under the Credit Agreement, including the stock and membership interests of specified subsidiaries (limited to 66% of the stock in the case of certain non-US subsidiaries). Further, specified foreign subsidiaries guarantee all obligations of the non-US loan parties under the Credit Agreement.
The following amounts were borrowed under the credit agreement:
Borrowing proceeds on August 7, 2014
CurrencyBorrowed
USDollars
US Term Loan
50,000
US Revolving Note
C$
15,000
13,695
Europe Term Loan
€
20,000
26,730
On August 7, 2014, all amounts owed under the existing US Term Note, US Revolving Note, Europe Term Note and W.E.T. Term Note (collectively, the “Old Credit Agreements”) were repaid without penalty. The Old Credit Agreements and related security and pledge agreements were terminated as of such date. Unamortized capitalized financing costs totaling $730 related to the Old Credit Agreements were expensed to debt retirement expense in the three months ended September 30, 2014.
The Company incurred expenses associated with the Credit Agreement which have been recorded as deferred financing costs and will be amortized over the life of the Credit Agreement using the effective interest method. The US Term Loan, Europe Term Loan and US Revolving Note mature on August 7, 2019.
14
Note 6 – Debt – Continued
Under the Credit Agreement, U.S. Dollar denominated loans bear interest at either a base rate (“Base Rate Loans”) or Eurocurrency rate (“Eurocurrency Rate Loans”), plus a margin (“Applicable Rate”). Base Rate Loans are equal to the highest of the Federal Funds Rate (0.07% at September 30, 2014) plus 0.50%, Bank of America’s prime rate (3.25% as of September 30, 2014), or a one month Eurocurrency rate plus 1.00%. Eurocurrency Rate Loans denominated in US Dollars or European Euros (“Euros”) are equal to the London Interbank Offered Rate and the Canadian Dealer Offered Rate for Canadian Dollar denominations. All loans denominated in a currency other than the US Dollar, including the Europe Term Loan, must be Eurocurrency Rate Loans. Interest is payable at least quarterly.
The Applicable Rate from the initial period of August 7, 2014 through the fiscal quarter ending December 31, 2014 is 1.75% per annum for Eurocurrency Rate Loans and 0.75% for Base Rate Loans. After the initial period, the Applicable Rate will vary based on the Consolidated Leverage Ratio of the Company, as defined by the Credit Agreement. As long as the Company is not in default of the terms and conditions of the Credit Agreement, the lowest and highest possible Applicable Rate is 1.50% and 2.00%, respectively, for Eurocurrency Rate Loans and 0.50% and 1.00%, respectively, for Base Rate Loans.
The Company must maintain certain financial ratios consisting of a minimum Consolidated Fixed Charge Coverage Ratio and a maximum Consolidated Leverage Ratio as defined by the Credit Agreement.
DEG Loan
The Company has a fixed interest rate loan with the German Investment Corporation, a subsidiary of KfW banking group, a German government-owned development bank (“DEG Loan”). The DEG Loan is subject to semi-annual principal payments beginning March, 2015 and ending September, 2019. Under the terms of the DEG Loan, the Company must maintain a minimum Debt-to-Equity Ratio, Current Ratio and Debt Service Coverage Ratio based on the financial statements of Gentherm’s wholly owned subsidiary, Gentherm Automotive Systems (China) Limited, as defined by the DEG Loan agreement.
Capital Lease
The Company has a capital lease agreement for an enterprise resource planning system. Under the terms of the lease, the Company must maintain certain financial covenants. Ownership of the system will be transferred to the Company at the end of the agreement.
The following table summarizes the Company’s debt at September 30, 2014 and at December 31, 2013.
InterestRate
PrincipalBalance
Credit Agreement:
1.98
1.81
25,267
3.00
13,419
Prior Credit Agreements:
US Term Note
24,500
Europe Term Note
38,899
W.E.T. Term Note
10,920
4.25
5,053
5,561
Capital leases
4.20
1,053
2,440
Total debt
94,792
82,320
Current portion
(4,816
(21,439
The scheduled principal maturities of our debt as of September 30, 2014 is as follows:
Year
USTermLoan
EuropeTerm Loan
U.S.RevolvingNote
CapitalLeases
625
316
395
1,336
2,500
1,263
1,011
658
5,432
2,812
1,421
5,244
3,750
1,895
6,656
4,063
2,053
7,127
2019
36,250
1,009
68,997
Principal outstanding under the US Term Loan, the Europe Term Loan and the US Revolving Note will be due and payable in full on August 7, 2019. As of September 30, 2014, we were in compliance with all terms as outlined in the Credit Agreement, the DEG Loan and the capital lease agreement.
Note 7 – Derivative Financial Instruments
We are exposed to market risk from changes in foreign currency exchange rates and short term interest rates. 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 and purchases from foreign suppliers not denominated in the location’s functional currency, foreign plant operations and intercompany indebtedness, and include exposures to the Euro, Mexican Peso, Canadian Dollar, Hungarian Forint, Ukraine Hryvnia, Japanese Yen, Chinese Renminbi and Korean Won.
The Company regularly enters into derivative contracts with the objective of managing its financial and operational exposure arising from these risks 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 foreign currency gain (loss) in the consolidated condensed statements of income. Though we continuously monitor the hedging program, derivative positions and hedging strategies, foreign currency forward exchange agreements have not always been designated as hedging instruments for accounting purposes.
The Company uses a market approach to value derivative instruments, analyzing observable benchmark rates at commonly quoted intervals for the instrument’s full term. For information about notional values and expected maturities of derivative instruments, see Part I, Item 3 “Quantitative and Qualitative Disclosures About Market Risk” included in this Report.
16
Note 7 – Derivative Financial Instruments – Continued
Information related to the recurring fair value measurement of derivative instruments in our consolidated condensed balance sheet as of September 30, 2014 is as follows:
Asset Derivatives
Liability Derivatives
Net Asset/ (Liabilities)
Hedge Designation
Fair ValueHierarchy
Balance SheetLocation
FairValue
CRS
Not a hedge
Level 2
Current liabilities
2,532
Non-current liabilities
Total CRS
9,063
(9,063
Foreign currency derivatives
Cash flow hedge
412
(412
Current assets
Non-current assets
Total foreign currency derivatives
1,303
891
Information relating to the effect of derivative instruments on our consolidated condensed statements of income is as follows:
Location
Three MonthsEndedSeptember 30,2014
Nine MonthsEndedSeptember 30,2014
Three MonthsEndedSeptember 30,2013
Nine MonthsEndedSeptember 30,2013
557
398
581
(694
(129
64
94
(73
(141
Other comprehensive income
(571
Foreign currency gain (loss)
(606
(1,054
(426
(844
(758
(1,243
155
(1,538
(263
(690
(372
1,887
Interest rate derivatives
(1
42
We did not incur any hedge ineffectiveness during the nine months ended September 30, 2014 and 2013.
17
Note 8 – 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 that 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.
Except for derivative instruments, pension liabilities and pension plan assets, the Company has no financial assets and liabilities that are carried at fair value at September 30, 2014 and 2013. The carrying amounts of financial instruments comprising cash and cash equivalents 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. See “Note 7 – Derivative Financial Instruments” for information regarding the fair value of derivative instruments and hedging activities.
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, 2014 and 2013, 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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ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This Report contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of our plans and objectives for future operations, assumptions underlying such plans and objectives and other forward-looking statements included in this “Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in other places in this Report. Such 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. The forward-looking statements included in this Report are made as of the date hereof and are based on management’s current expectations and beliefs. Such statements are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements, including risks and uncertainties set forth in this Report and under “Risk Factors” in our most recent Annual Report on Form 10-K for the year ended December 31, 2013 and subsequent reports filed with or furnished to the Securities and Exchange Commission. Except as required by law, we expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
The following discussion and analysis should be read in conjunction with, and is qualified in its entirety by, our financial statements and related notes thereto included elsewhere in this Report and in our Annual Report on Form 10-K for the year ended December 31, 2013.
General
Gentherm is a global technology and industry leader in the design, development, and manufacturing of innovative thermal management technologies and cable systems. We operate in locations aligned with our major customers’ product strategies in order to provide locally enhanced design, integration and production capabilities and identify future climatic comfort product opportunities in both automotive and other markets. We concentrate our research on the development of new technologies that will enable new products, improve overall effectiveness of existing products and maximize customer satisfaction. New design applications of our existing technologies help us to create new product and market opportunities for thermal comfort solutions.
We operate as a Tier II supplier to the auto industry. Inherent in this market are costs and commitments well in advance of the receipt of orders (and resulting revenues) from customers. This is due in part to automotive manufacturers requiring the design, coordination and testing of proposed new components and systems. Revenues from these expenditures may not be realized for two to three years as the manufacturers tend to group new components and enhancements into annual or every two to three year vehicle model introductions. These customers in turn sell our product, as a component of an entire seat or seating system, to automotive original equipment manufacturers (“OEMs”).
On April 1, 2014, we acquired all of the stock of privately-held Global Thermoelectric Inc., now known as Gentherm Global Power Technologies (“GPT”). GPT is a global market leader and developer of thermoelectric generators. The principal applications for GPT’s products include natural gas well and pipeline protection systems and remote power generation for instrumentation, automation and telecommunication systems.
As part of the initiative to integrate the operations of historical Gentherm and W.E.T. Automotive Systems AG, now known as Gentherm GmbH (“Gentherm GmbH”), changes were made to Gentherm’s structure of internal organization. The financial information used by our chief operating decision maker to assess performance and allocate resources reflects the changes brought about through this initiative. See Note 5 to the consolidated condensed financial statements included herein for a further description of our reportable segments, including segment information about the reported product revenues and operating income of the Company for the three-month and nine-month periods ended September 30, 2014 and 2013.
We internally manufacture a large portion of our products at our production facilities. Other products we sell are manufactured by third parties. Our primary manufacturing locations are in Mexico, China and the Ukraine, all countries that have historically experienced a heightened degree of political, civil and labor uncertainty. Recent demonstrations and related violence in the Ukraine in particular highlight this risk to our manufacturing process. Although our manufacturing facility in the Ukraine is located in the far western part of the country and approximately 700 miles by road from Kiev, and approximately the same distance from the political unrest along the border of Ukraine and Russia, we cannot be certain that similar demonstrations, unrest and international tensions will not affect our facility. Furthermore, most of our products manufactured in the Ukraine are shipped across the border from the Ukraine to Hungary for further delivery to our customers. If that border crossing were to be closed for any reason, we would essentially experience a loss of the use of our Ukraine facility, which would have a material adverse effect on our business. Approximately 26% of our revenues are derived from products manufactured at our Ukraine facility.
Third Quarter 2014 Compared with Third Quarter 2013
Product Revenues. Product revenues for the three months ended September 30, 2014 (“Third Quarter 2014”) were $206,012,000 compared with product revenues of $171,182,000 for the three months ended September 30, 2013 (“Third Quarter 2013”), an increase of $34,830,000, or 20%. Higher revenue was primarily driven by continued strong shipments of climate controlled seat systems (“CCS”) and the revenue of $8,532,000 from GPT, which was acquired on April 1, 2014. CCS revenue increased by $19,024,000, or 28%, to $87,674,000, during Third Quarter 2014. This increase was partially the result of new program launches since Third Quarter 2013 and strong production volumes and sales of the vehicles equipped with CCS systems, particularly vehicles in the luxury segment of the automotive market. Additionally, certain vehicles that have been redesigned since the Third Quarter 2013 are experiencing very strong production and sales levels, including the General Motors full size SUV platform (“K2XX”) and the Jeep Grand Cherokee. Our seat heater revenue also increased by $7,169,000 or 10%, to $78,602,000. This reflected market penetration on certain vehicle programs and also the strong production volumes on General Motors’ K2XX platform. We also have significant growth in our heated steering wheel product which showed an increase of $1,087,000, or 14%, to $9,017,000. Our European based sales were higher than the prior year, even as local economies in that region begin to show signs of softening. Foreign currency translation of our Euro denominated product revenue did not have an impact on our product revenue results since the average US Dollar/Euro exchange rate for the Third Quarter 2014 was nearly the same as that for the Third Quarter 2013 at 1.3254. Our product revenues denominated in the Euro were €37,965,000 during the Third Quarter 2014 versus €35,683,000 during Third Quarter 2013. If further weakening in the Euro since Third Quarter 2014 continues, it will have a moderate unfavorable impact on our revenues during future periods.
Cost of Sales. Cost of sales increased to $144,427,000 in Third Quarter 2014 from $125,265,000 in Third Quarter 2013. This increase of $19,162,000, or 15%, was due to increased sales volume, including that of GPT, partially offset by higher gross margin percentages. A favorable change in product mix, greater coverage of fixed costs at the higher volume levels, favorable contribution from our new electronics manufacturing facility in China and foreign currency impact on production expenses in the Mexican Peso (“MXN”) and Ukrainian Hryvnia (“UAH”) increased historical gross profit percentage during Third Quarter 2014 to 29.9% compared to 26.8% during Third Quarter 2013. The favorable product mix is primarily attributable to the greater sales growth in CCS products on which we have historically had better margin performance. The new electronics manufacturing facility was launched during the second quarter of 2013. This new facility has since been in the process of increasing production volumes by producing existing component products that had formerly been produced by outside suppliers. Third Quarter 2014 is the third continuous reporting period where the savings from insourcing were larger than the additional overhead costs of the facility. We expect to capture further margin improvements as this manufacturing facility continues to increase production volumes. Our manufacturing plants are located in Ukraine, Mexico and China. As a result, our production labor costs are incurred in the local currency of each of those countries. During the Third Quarter 2014, MXN and UAH decreased in value to the USD by 2% and 54%, respectively.
Net Research and Development Expenses. Net research and development expenses were $15,278,000 during Third Quarter 2014 compared to $12,718,000 in Third Quarter 2013, an increase of $2,560,000, or 20%. This increase was primarily driven by additional resources, including personnel, focused on application engineering for new production programs of existing products, development of new products and a program to develop the next generation of seat comfort products. New product development includes automotive heated and cooled storage devices, automotive interior thermal management devices, medical thermal management devices, battery thermal management devices and other potential products. Net research and development expenses also increased by $330,000 due to the acquisition of GPT.
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. During the Third Quarter 2013, we incurred $326,000 in fees, legal and other expenses associated with the acquisition of Gentherm GmbH shares. During the Third Quarter 2014, we did not incur any such expenses.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $22,307,000 in Third Quarter 2014 from $18,319,000 in Third Quarter 2013, an increase of $3,988,000, or 22%. Over half of the increase in selling, general and administrative expenses was due to expenses from GPT, totaling $2,072,000 during Third Quarter 2014. The remaining increase in expenses is due to increased management incentive compensation costs, higher general legal, audit and travel costs, as well as wages and benefits costs resulting from new employee hiring and merit increases. The additional employees are primarily related to establishing a new electronics production facility in Shenzhen, China, and increasing sales and marketing efforts aimed at supporting our current product development strategy.
20
Income Tax Expense. During Third Quarter 2014, we recorded an income tax expense of $6,852,000, representing an effective tax rate of 28% on earnings before income tax of $24,140,000. During the Third Quarter 2013, we recorded an income tax expense of $3,600,000 representing an effective tax rate of 29% on earnings before income tax of $12,365,000. The effective tax rates for Third Quarter 2014 and Third Quarter 2013 were lower than the US Federal rate of 34% primarily due to the impact of lower statutory rates for our subsidiaries operating in foreign jurisdictions.
YTD 2014 Compared with YTD 2013
Product Revenues. Product revenues for the nine months ended September 30, 2014 (“YTD 2014”) were $606,132,000 compared with product revenues of $479,792,000 for the nine months ended September 30, 2013 (“YTD 2013”), an increase of $126,340,000, or 26%. Higher revenue was primarily driven by continued strong shipments of CCS and revenue of $16,706,000 from GPT, which was acquired on April 1, 2014. CCS revenue increased by $68,163,000, or 37%, to $254,850,000, during the YTD 2014. This increase was partially the result of new program launches since YTD 2013 and strong production volumes and sales of the vehicles equipped with CCS systems, particularly vehicles in the luxury segment of the automotive market. Additionally, certain vehicles that have been redesigned since the YTD 2013 are experiencing very strong production and sales levels, including the General Motors K2XX platform and the Jeep Grand Cherokee. The increase was also attributable to improvement in sales to our Japan based customers who recovered from weaker sales during YTD 2013. Our seat heater revenue also increased by $33,736,000, or 16%, to approximately $240,704,000. This reflected market penetration on certain vehicle programs and also the strong production volumes on General Motors’ K2XX platform. We also have significant growth in our heated steering wheel product which showed an increase of $6,836,000, or 34%, to $26,699,000. Our European based sales were significantly higher than the prior year as local economies and car sales in that region have improved. Foreign currency translation of our Euro denominated product revenue for YTD 2014, which was €116,279,000 versus €106,103,000 during YTD 2013, increased our product revenues by $4,558,000 or 0.8%. The average US Dollar/Euro exchange rate for YTD 2014 was 1.3564 versus 1.3172 for YTD 2013.
Cost of Sales. Cost of sales increased to $426,765,000 in YTD 2014 from $354,672,000 in YTD 2013. This increase of $72,093,000, or 20%, was due to increased sales volume, including that of GPT, partially offset by higher gross margin percentages. A favorable change in product mix, greater coverage of fixed costs at the higher volume levels, favorable contribution from our new electronics manufacturing facility in China and foreign currency impact on production expenses in the Mexican Peso (“MXN”) and Ukraine Hryvnia (“UAH”) increased historical gross profit percentage during YTD 2014 to 29.6% compared with 26.1% during YTD 2013. The favorable product mix is primarily attributable to the greater sales growth in CCS products on which we have historically had better margin performance. We launched our new electronics manufacturing facility during the second quarter of 2013. This new facility has since been in the process of increasing production volumes by producing existing component products that had formerly been produced by outside suppliers. Third Quarter 2014 was the third continuous reporting period where the savings from insourcing were larger than the additional overhead costs of the facility. We expect to capture further margin improvements as this manufacturing facility continues to increase production volumes. Our manufacturing plants are located in Ukraine, Mexico and China. As a result, our production labor costs are incurred in the local currency of each of those countries. During YTD 2014, MXN and UAH decreased in value to the USD by 3.5% and 37.5%, respectively.
Net Research and Development Expenses. Net research and development expenses were $42,873,000 during YTD 2014 compared to $36,962,000 in YTD 2013, an increase of $5,911,000, or 16%. This increase was primarily driven by additional resources, including personnel, focused on application engineering for new production programs of existing products, development of new products and a program to develop the next generation of seat comfort products. New product development includes automotive heated and cool storage devices, automotive interior thermal management devices, medical thermal management devices, battery thermal management devices and other potential products. Net research and development expenses also increased by $573,000 due to the acquisition of GPT.
Acquisition Transaction Expenses. During YTD 2014, we incurred $1,075,000 in fees and expenses associated with the acquisition of GPT which was completed on April 1, 2014. During the YTD 2013, we incurred $1,911,000 in fees, legal and other expenses associated with the acquisition of Gentherm GmbH shares.
21
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $62,368,000 in YTD 2014 from $53,483,000 in YTD 2013, an increase of $8,885,000, or 17%. The increase in selling, general and administrative expenses in the first nine months includes the expenses of GPT totaling $4,034,000 since it was acquired on April 1, 2014. The remaining increase in expenses was due to increased management incentive compensation costs, higher general legal, audit and travel costs, as well as wages and benefits costs resulting from new employee hiring and merit increases. The additional employees are primarily related to establishing a new electronics production facility in Shenzhen, China, and increasing sales and marketing efforts aimed at supporting our current product development strategy.
Income Tax Expense. During YTD 2014, we recorded an income tax expense of $19,656,000 representing an effective tax rate of 28% on earnings before income tax of $69,946,000. This amount included unfavorable adjustments relating to previously unrecognized tax expenses offset partially by a shift in the mix of income by legal jurisdiction favoring lower statutory tax rate locations. Our estimated tax rate without these adjustments is 27% based upon a forecast of our full year results. During the Second Half 2013, we recorded an income tax expense of $6,343,000 representing an effective tax rate of 20% on earnings before income tax of $30,545,000. This amount included a one-time benefit resulting from the American Taxpayer Relief Act of 2012 (“the Act”) which was signed into law on January 2, 2013. The Act restored the research and development credit and certain exemption under the foreign income tax rules, retroactively to the beginning of 2012. As a result, we recognized approximately $1,300,000 in benefits associated with our 2012 tax year during YTD 2013. Had the Act been adopted during 2012, the benefit would have been recorded during that year and YTD 2013 effective tax rate would have been 25%. The effective tax rates for YTD 2014 and YTD 2013 were lower than the US Federal rate of 34% primarily due to the impact of lower statutory rates for our subsidiaries operating in foreign jurisdictions.
Liquidity and Capital Resources
The Company has funded its financial needs primarily through cash flows from operating activities and equity and debt financings. Based on its current operating plan, management believes cash and cash equivalents at September 30, 2014, together with cash flows from operating activities, are sufficient to meet operating and capital expenditure needs, and to service debt, for the foreseeable future. However, if cash flows from operations decline, we may need to obtain alternative sources of capital and reduce or delay capital expenditures, acquisitions and investments, all of which could impede the implementation of our business strategy and materially and adversely affect our results of operations and financial condition. In addition, it is likely that we will need to complete one or more equity or debt financings if we consummate any significant acquisitions. There can be no assurance that such capital will be available at all or on reasonable terms, which could materially and adversely affect our future operations and business strategy.
On August 7, 2014 we completed a refinancing of our senior credit facilities. See Note 6 to the consolidated condensed financial statements for additional information related to our new credit facilities.
The following table represents our cash and cash equivalents and short-term investments which are available for our business operations:
We manage our cash, cash equivalents and short-term investments in order to fund operating requirements and preserve liquidity to take advantage of future business opportunities. Cash and cash equivalents increased by $10,284,000 in YTD 2014. Cash provided by operating activities during YTD 2014 was $45,451,000 and was attributable to net income of $50,290,000, plus non-cash adjustments. Non-cash adjustments included depreciation and amortization of $24,565,000 stock compensation of $3,449,000 and other items. Offsetting these positive operating activities was the net increase in net operating assets and liabilities of $24,712,000, including working capital items and gains on the revaluation of derivatives of $1,264,000.
As of September 30, 2014, working capital was $177,324,000 as compared to $116,786,000 at December 31, 2013, an increase of $60,538,000, or 52%. This increase was primarily related to the working capital associated with the acquisition of GPT totaling $15,453,000, increases in accounts receivable, inventory, prepaid expenses and other assets and decreases in the current portion of long-term debt totaling $25,190,000, $4,000,000, $8,240,000 and 16,623,000, respectively. These increases to working capital were partially offset by increases in accounts payable and accrued liabilities of $8,039,000 and $4,679,000, respectively, and decreases in deferred income tax assets of $6,294,000. Accounts receivable increased primarily as a result of increases in product revenues and timing differences between when sales in 2014 were realized compared with sales realized during 2013. Gentherm had proportionally more sales in the September 2014 compared with December 2013. Working Capital was also affected by changes in currency exchange rates.
22
Cash used in investing activities was $58,633,000 during YTD 2014, reflecting the purchases of GPT and the remaining equity in a joint venture totaling $31,739,000 and purchases of property and equipment totaling $26,990,000. Purchases of property and equipment for the period were primarily related to expansion of production capacity, as well as replacement of existing equipment. During YTD 2014, we entered into an agreement to purchase an unoccupied industrial property in Vietnam for purposes of expanding our Asia manufacturing capacity with a new production facility. We expect to begin construction of the new facility during the fourth quarter of 2014 and begin production during 2015. The new facility is estimated to cost between $10,000,000 and $15,000,000.
Cash provided by financing activities was $24,974,000 during YTD 2014, reflecting borrowings against our new Credit Agreement (the “Credit Agreement”) entered into with a syndicate of banks led by Bank of America on August 7, 2014 of $91,592,000. In addition, we received proceeds from the exercise of common stock options of $6,282,000. These amounts were partially offset by repayment of the outstanding principle amounts on our US Term Note, US Revolving Note, Europe Term Note and W.E.T. Term Note (collectively, the “Old Credit Agreements”) totaling $76,904,000. The Old Credit Agreements were repaid and extinguished on August 7, 2014. See Note 6 “Debt” to the consolidated condensed financial statements included herein for information about borrowings against the Credit Agreement and payment and extinguishment of the Old Credit Agreement.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily to our debt obligations and foreign currency contracts. We have in the past, and may in the future, place our investments in bank certificates of deposits, debt instruments of the U.S. government, and in high-quality corporate issuers.
We are exposed to market risk from changes in foreign currency exchange rates and short term interest rates. 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 and purchases from suppliers not denominated in the functional currency of an individual location, foreign plant operations, intercompany indebtedness and include exposures to the European Euro, Canadian Dollar, Hungarian Forint, Ukrainian Hryvnia, Mexican Peso, and Korean Won. 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 income. Though we continuously monitor the hedging program, derivative positions and hedging strategies, foreign currency forward exchange agreements have not always been designated as hedging instruments for accounting purposes.
In March 2008, Gentherm GmbH entered into a 10 year currency related interest rate swap (“CRS”) having a notional value of €10,000,000 or $12,633,000 as of September 30, 2014, in order to offset the interest rate risk associated with a debt financing which was repaid prior to our acquisition of Gentherm GmbH. Under this agreement, Gentherm GmbH received interest equal to the then nine-month Euro Interbank Offered Rate (“EURIBOR”), 0.20% at September 30, 2014, plus 1.40% and pays interest equal to the nine-month EURIBOR when the exchange rate between the European Euro (“EUR”) and the Swiss Franc (“CHF”), which was 1.21 at September 30, 2014, equals or exceeds 1.46 EUR to the CHF or pays interest equal to the nine-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.
In 2011, Gentherm GmbH brought a lawsuit against UniCredit Bank AG (“UniCredit”), a past financial advisor, stemming from the recommendation to invest in the aforementioned CRS. On March 25, 2013, the Munich District Court in Munich, Germany ruled in favor of Gemtherm GmbH, asserting that UniCredit violated its duty to properly advise Gentherm GmbH with respect to the initial negative market value of the CRS and UniCredit’s inherent conflict of interest in recommending that Gentherm GmbH invest in such CRS. The Munich District Court ruled that UniCredit must (1) pay €144,000 to Gentherm GmbH and (2) bear the costs of all future obligations under the CRS, which were €7,174,000 or $9,064,000 as of September 30, 2014, plus additional accrued liabilities for past due payments under the CRS of approximately €7,075,000 or $8,939,000 as of September 30, 2014. UniCredit has appealed the decision and such appeal is pending. As a result of the pending appeal, the Company cannot be certain that any portion of the award by the Munich District Court will be realized by Gentherm GmbH. See Note 7 “Derivative Financial Instruments” to the consolidated condensed financial statements included herein for information about our future obligations under the CRS as of September 30, 2014 and 2013, respectively. The Company has entered into offsetting derivative contracts designed to limit the market risk of payments due under the CRS through the end of the CRS agreement, in 2018.
Information related to the fair values of all derivative instruments in our consolidated balance sheet as of September 30, 2014 is set forth in Note 8 to the consolidated condensed financial statements included herein.
Interest Rate Sensitivity
The table below presents principal cash flows and related average interest rates by expected maturity for each of the Company’s debt obligations. The information is presented in U.S. Dollar equivalents, which is the Company’s reporting currency. The instruments actual cash flows are denominated in U.S. Dollars ($USD), European Euros (€EUR) or Canadian Dollars ($CAD), as indicated in parentheses.
Liabilities
Long Term Debt:
Fixed Rate (€EUR)
Average Interest Rate
Variable Rate ($USD)
Variable Rate (€EUR)
Variable Rate ($CAD)
24
Exchange Rate Sensitivity
The table below provides information about the Company’s foreign currency forward exchange rate agreements that are sensitive to changes in foreign currency exchange rates. The table presents the notional amounts and weighted average exchange rates by expected (contractual) maturity dates for each type of foreign currency forward exchange agreement. These notional amounts generally are used to calculate the contractual payments to be exchanged under the contract.
Expected Maturity or Transaction Date
Anticipated Transactions And Related Derivatives
Thereafter
(In thousands except rate information)
Euro functional currency
Forward Exchange Agreements:
(Receive HUF/Pay EUR€)
Total Contract Amount (€)
1,578
(35
Average Contract Rate
304.17
(Receive CHF/Pay EUR€)
6,218
12,336
12,437
12,302
6,151
49,444
1,032
1.20
(Receive EUR€/Pay KRW)
5,364
(246
1,398.3
$US functional currency
(Receive MXN/Pay USD$)
Total Contract Amount ($)
7,409
(56
13.413
25
ITEM 4.
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this quarterly report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2014, our disclosure controls and procedures were effective to ensure the information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods prescribed by the Securities and Exchange Commission, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
(b) Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II OTHER INFORMATION
LEGAL PROCEEDINGS
We are subject to litigation from time to time in the ordinary course of our business, however there is no current material pending litigation to which we are a party and no material legal proceeding was terminated, settled or otherwise resolved during the third quarter of the fiscal year ended December 31, 2014. See Part I, Item 3 “Quantitative and Qualitative Disclosures About Market Risk” for information regarding the dispute with UniCredit Bank AG and our currency related interest rate swaps.
ITEM 1A.
RISK FACTORS
There were no material changes in our risk factors previously disclosed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013. You should carefully consider the risks and uncertainties described therein.
ITEM 6.
EXHIBITS
Exhibits to this Report are as follows:
Incorporated by Reference
ExhibitNumber
Exhibit Description
Filed Herewith
Form
Period Ending
Exhibit /Appendix Number
Filing Date
10.1
Credit Agreement, dated as of August 7, 2014, by and among Gentherm Incorporated, Gentherm GmbH, Gentherm (Texas), Inc., Gentherm Canada Ltd., Global Thermelectric Inc., the lender party thereto, and Bank of America, N.A., as administrative agent.
8-K
8/7/2014
10.2
Pledge and Security Agreement, dated as of August 7, 2014, by and among Gentherm Incorporated, Gentherm (Texas), Inc., Westridge Haggerty LLC and Bank of America, N.A.
10.3
Service Agreement between Gentherm GmbH and Frithjof Oldorff dated as of September 22, 2014
9/22/2014
31.1
Section 302 Certification – CEO
X
31.2
Section 302 Certification – CFO
32.1
Section 906 Certification – CEO
32.2
Section 906 Certification – CFO
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
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.
Gentherm Incorporated
/s/ DANIEL R. COKER
Daniel R. Coker
Chief Executive Officer
(Duly Authorized Officer)
Date: November 10, 2014
/s/ BARRY G. STEELE
Barry G. Steele
Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)