UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
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, Northville, MI
48167
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (248) 504-0500
Securities registered pursuant to Section 12-(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock, no par value
THRM
NASDAQ
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
At October 25, 2019, there were 32,659,545 issued and outstanding shares of Common Stock of the registrant.
TABLE OF CONTENTS
Part I. Financial Information
3
Item 1.
Financial Statements (Unaudited)
Consolidated Condensed Balance Sheets
Consolidated Condensed Statements of Income (Loss)
4
Consolidated Condensed Statements of Comprehensive Income (Loss)
5
Consolidated Condensed Statements of Cash Flows
6
Consolidated Condensed Statements of Changes in Shareholders’ Equity
7
Notes to Unaudited Consolidated Condensed Financial Statements
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
27
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
35
Item 4.
Controls and Procedures
36
Part II. Other Information
37
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
38
Signatures
39
2
PART I. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
September 30,
2019
December 31,
2018
ASSETS
Current Assets:
Cash and cash equivalents
$
45,200
39,620
Restricted cash
2,504
—
Accounts receivable, less allowance of $1,040 and $851, respectively
170,823
166,858
Inventory:
Raw materials
65,337
61,679
Work in process
6,863
5,939
Finished goods
46,591
44,917
Inventory, net
118,791
112,535
Derivative financial instruments
897
92
Prepaid expenses and other assets
39,884
54,271
Assets held for sale
6,742
69,699
Total current assets
384,841
443,075
Property and equipment, net
162,783
171,380
Goodwill
63,501
55,311
Other intangible assets, net
51,338
56,385
Operating lease right-of-use assets
12,136
Deferred financing costs
1,692
647
Deferred income tax assets
54,380
64,024
Other non-current assets
7,000
12,225
Total assets
737,671
803,047
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable
89,293
93,113
Accrued liabilities
67,482
65,808
Current lease liabilities
4,483
Current maturities of long-term debt
2,500
3,413
Liabilities held for sale
13,062
Total current liabilities
170,500
175,396
Pension benefit obligation
6,596
7,211
Non-current lease liabilities
7,391
Long-term debt, less current maturities
97,123
136,477
Deferred income tax liabilities
1,142
1,177
Other non-current liabilities
3,326
3,087
Total liabilities
286,078
323,348
Shareholders’ equity:
Common Stock:
No par value; 55,000,000 shares authorized, 32,741,826 and 33,856,629 issued and
outstanding at September 30, 2019 and December 31, 2018, respectively
103,781
140,300
Paid-in capital
11,348
14,934
Accumulated other comprehensive loss
(54,814
)
(39,500
Accumulated earnings
391,278
363,965
Total shareholders’ equity
451,593
479,699
Total liabilities and shareholders’ equity
See accompanying notes to the consolidated condensed financial statements.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (LOSS)
(In thousands, except per share data)
Three Months Ended
Nine Months Ended
Product revenues
240,056
261,504
741,303
792,490
Cost of sales
165,364
185,800
518,590
558,452
Gross margin
74,692
75,704
222,713
234,038
Operating expenses:
Net research and development expenses
18,838
19,056
56,990
63,382
Selling, general and administrative expenses
26,861
35,117
91,683
105,803
Restructuring expenses
8,664
5,818
11,809
12,898
Total operating expenses
54,363
59,991
160,482
182,083
Operating income
20,329
15,713
62,231
51,955
Interest expense
(1,148
(1,241
(3,756
(3,661
Foreign currency gain
4,083
125
3,482
721
Gain on sale of business
4,970
Impairment loss
(837
(11,476
(21,206
Other income
231
212
545
1,538
Earnings before income tax
22,658
3,333
46,266
39,077
Income tax expense
6,771
3,688
19,214
9,807
Net income (loss)
15,887
(355
27,052
29,270
Basic earnings (loss) per share
0.48
(0.01
0.81
0.80
Diluted earnings (loss) per share
Weighted average number of shares – basic
32,839
36,104
33,283
36,364
Weighted average number of shares – diluted
32,933
36,448
33,419
36,470
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
Other comprehensive income (loss), gross of tax:
Foreign currency translation adjustments loss
(14,857
(3,266
(15,454
(14,519
Unrealized (loss) gain on foreign currency derivative securities
(257
1,753
806
2,304
Unrealized loss on commodity derivative securities
(218
Other comprehensive loss, gross of tax
(15,114
(1,513
(14,648
(12,433
Other comprehensive income (loss), related tax effect:
Cumulative effect of accounting change due to ASU 2018-02
(40
(315
15
(489
(217
55
(536
(177
(684
(59
Other comprehensive loss, related tax effect
(260
(521
(666
(1,000
Other comprehensive loss, net of tax
(15,374
(2,034
(15,314
(13,433
Comprehensive income (loss)
513
(2,389
11,738
15,837
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
Operating Activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
33,281
38,721
Deferred income taxes
5,072
(19
Stock compensation
5,268
6,360
Defined benefit plan income
(754
(219
Provision of doubtful accounts
209
247
Loss on sale of property and equipment
319
2,273
Operating lease expense
4,477
21,206
11,476
(4,970
Other
189
Changes in assets and liabilities:
Accounts receivable
(6,170
(13,855
Inventory
(5,512
(3,510
9,594
(7,867
(3,097
8,376
(2,172
(712
Net cash provided by operating activities
83,992
70,541
Investing Activities:
Proceeds from the sale of property and equipment
137
703
Proceeds from sale of a business
47,500
Acquisition of subsidiary, net of cash acquired
(14,823
(15
Purchases of property and equipment
(18,340
(31,815
Net cash provided by (used in) investing activities
14,474
(31,127
Financing Activities:
Borrowing of debt
29,470
18,000
Repayments of debt
(69,049
(61,210
Cash paid for financing costs
(1,278
Cash paid for the cancellation of restricted stock
(1,213
(882
Proceeds from the exercise of Common Stock options
13,879
14,062
Repurchase of Common Stock
(58,040
(64,151
Net cash used in financing activities
(86,231
(94,181
Foreign currency effect
(4,151
(1,253
Net increase (decrease) in cash, cash equivalents and restricted cash
8,084
(56,020
Cash, cash equivalents and restricted cash at beginning of period
103,172
Cash, cash equivalents and restricted cash at end of period
47,704
47,152
Supplemental disclosure of cash flow information:
Cash paid for taxes
6,676
19,255
Cash paid for interest
3,437
3,617
Supplemental disclosure of non-cash transactions:
Common Stock issued to Board of Directors and employees
4,576
3,893
CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Accumulated
Common Stock
Paid-in
Comprehensive
Shares
Amount
Capital
Income (Loss)
Earnings
Total
Balance at December 31, 2018
33,857
Cumulative effect of accounting change due to
adoption of ASU 2016-02
261
Stock repurchase
(200
(8,040
Exercise of Common Stock options for cash
13
1,021
(807
214
Cancellation of restricted stock
(17
(376
Stock option compensation
386
Common Stock issued to Board of Directors and
employees
1,581
Currency translation, net
(4,251
Foreign currency hedge, net
599
8,414
Balance at March 31, 2019
33,653
134,486
14,513
(43,152
372,640
478,487
(630
(25,000
116
4,936
(379
4,557
(21
(550
(114
30
1,438
3,480
232
2,751
Balance at June 30, 2019
33,148
115,310
14,020
(39,440
375,391
465,281
(635
228
12,201
(3,093
9,108
(12
(287
421
1,557
(15,172
(202
Balance at September 30, 2019
32,742
CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (continued)
Balance at December 31, 2017
36,761
265,048
15,625
(20,444
293,645
553,874
adoption of ASU 2014-09
(3,264
adoption of ASU 2016-16
31,645
adoption of ASU 2018-02
40
57
1,061
(310
751
(24
(659
840
Common stock issued to Board of Directors and
1,362
11,665
1,545
Commodity hedge, net
(277
12,966
Balance at March 31, 2018
36,794
266,812
16,155
(7,551
335,032
610,448
(629
(20,241
241
5,335
(1,120
4,215
(25
(223
803
20
1,057
(23,150
(1,142
16,659
Balance at June 30, 2018
36,401
252,740
15,838
(31,843
351,691
588,426
(938
(47,111
284
11,466
(2,368
9,098
823
1,474
(3,251
1,217
Balance at September 30, 2018
35,749
218,569
14,293
(33,877
351,336
550,321
8
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(In thousands, except share and per share data)
Note 1 – Overview
Gentherm Incorporated is a global developer and marketer of innovative thermal management technologies for a broad range of heating and cooling and temperature control applications. Unless the context otherwise requires, the terms “Gentherm”, “Company”, “we”, “us” and “our” used herein refer to Gentherm Incorporated and its consolidated subsidiaries. Our products provide solutions for automotive passenger climate comfort and convenience, battery thermal management and cell connecting systems, as well as patient temperature management within the health care industry. Our automotive products can be found on the vehicles of nearly all major automotive manufacturers operating in North America, Europe and Asia. We operate in locations aligned with our major customers’ product strategies to provide locally enhanced design, integration and production capabilities and to identify future thermal technology product opportunities in both automotive and other markets. The Company is also developing a number of new technologies and products that will help enable improvements to existing products and to create new product applications for existing and new markets.
Basis of Presentation
The unaudited consolidated condensed financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to those rules and regulations. The information furnished in the consolidated condensed financial statements include all adjustments (consisting of only normal, recurring adjustments), considered necessary to present fairly the results of operations, financial position and cash flows of the Company. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. The operating results for interim periods are not necessarily indicative of results that may be expected for any other interim period or for the full year.
Certain amounts in the prior period’s financial statements have been reclassified to conform with the current period presentation. Notably, $2,565 and $7,883 in customer relationship amortization was reclassified from product revenues to selling, general and administrative expenses for the three and nine months ended September 30, 2018, respectively.
In preparing these financial statements, management was required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are based on our historical experience, the terms of existing contracts, our evaluation of trends in the industry, information provided by our customers and suppliers and information available from other outside sources, as appropriate. However, these estimates and assumptions are subject to an inherent degree of uncertainty. As a result, actual results in these areas may differ significantly from our estimates.
Note 2 – New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
Leases
In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standard Update (“ASU”) 2016-02, “Leases (Topic 842)” (as amended, “ASU 2016-02”). ASU 2016-02 requires lessees to recognize a lease liability and a right-of-use asset on the balance sheet for all leases, except for short-term leases with terms of twelve months or less. The lease liability represents the lessee’s obligation to make lease payments arising from a lease, and is measured as the present value of the lease payments. The right-of-use asset represents the lessee’s right to use a specified asset for the lease term, and is measured at the lease liability amount, adjusted for lease prepayment, lease incentives received and the lessee’s initial direct costs. Leases are to be classified as finance or operating leases, with classification affecting the pattern and classification of expense recognition in the statement of income (loss).
The Company adopted ASU 2016-02 on January 1, 2019, by applying the modified retrospective method and recognized a cumulative-effect adjustment to the opening balance in retained earnings. Financial information has not been updated and disclosure under the new standard have not been provided to dates and periods before January 1, 2019, and the Company’s reporting for the comparative periods in the consolidated financial statements will continue to be in accordance with Accounting Standards Codification Topic 840, Leases (“ASC 840”).
ASU 2016-02 did not have an impact on our consolidated condensed statements of income for the three and nine months ended September 30, 2019, but had a significant impact on our consolidated condensed balance sheet as of September 30, 2019. The cumulative effects of the changes made to the Company’s consolidated condensed balance sheet as of January 1, 2019 for the adoption of ASU 2016-02 were as follows:
Balance as of
Adjustments
due to adoption
of ASU 2016-02
January 1,
(74
54,197
4,127
73,826
13,019
4,136
17,198
Deferred tax liabilities
114
1,291
12,561
364,226
The Company elected the package of practical expedients provided in ASU 2016-02, which permits a lessee to not reassess under the new standard its prior conclusions about lease identification, lease classification and initial direct costs. Gentherm elected the use-of-hindsight to determine whether lease terms included periods covered by the lessee’s option to extend or terminate a lease, whether to purchase the underlying asset at the end of the lease agreement, and in assessing impairment of operating lease right-of-use assets. Finally, Gentherm elected to not assess whether existing or expired land easements that were not previously accounted for as leases are or contain a lease. Land easements previously accounted for as leases were not eligible for this practical expedient.
Recently Issued Accounting Pronouncements Not Yet Adopted
Expected Credit Losses
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019. Early adoption of the amendments in this update is permitted. We are currently in the process of determining the impact the implementation of ASU 2016-13 will have on the Company’s financial statements and note disclosures.
Cloud Computing Arrangements That Are Service Contracts
In August 2018, the FASB issued ASU 2018-15, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” ASU 2018-15 requires implementation costs incurred by customers in cloud computing arrangements to be deferred and recognized over the term of the arrangement if those costs would be capitalized by the customer in a software licensing arrangement under the internal-use software guidance. ASU 2018-15 is effective for annual and interim periods beginning after December 15, 2019. Early adoption of the amendments in this update is permitted. We are currently in the process of determining the impact the implementation of ASU 2018-15 will have on the Company’s financial statements and note disclosures.
Retirement Benefits
In August 2018, the FASB issued ASU 2018-14, “Compensation – Retirement Benefits – Defined Benefit Plans – General (Subtopic 715-20): Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans.” ASU 2018-14 removes certain disclosure requirements, including (i) the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next fiscal year, and (ii) the amount and timing of plan assets expected to be returned to the employer. ASU 2018-14 also adds new disclosure requirements, including (i) the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates and (ii) an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. ASU 2018-14 is effective for annual periods
10
ending after December 15, 2020. Early adoption of the amendments in this update is permitted. We are currently in the process of determining the impact the implementation of ASU 2018-14 will have on the Company’s financial statement note disclosures.
Fair Value Measurement
In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 removes certain disclosure requirements, including (i) the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, (ii) the policy for timing of transfer between levels, and (iii) the valuation processes for Level 3 fair value measurements. ASU 2018-13 also adds new disclosure requirements, including (i) the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and (ii) the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for annual and interim periods beginning after December 15, 2019. Early adoption of disclosures that are removed is permitted, but adoption is delayed for the new additional disclosures until their effective date. We are currently in the process of determining the impact the implementation of ASU 2018-13 will have on the Company’s financial statement note disclosures.
Note 3 – Acquisitions and Divestitures
Divestiture of Cincinnati Sub-Zero Industrial Chamber Business (CSZ-IC)
On February 1, 2019, as part of the Company’s Fit-for-Growth initiative to eliminate investments in non-core businesses, we completed the sale of the Cincinnati Sub-Zero industrial chamber business (“CSZ-IC”) and former Cincinnati Sub-Zero headquarters facility to Weiss Technik North America, Inc. for total cash proceeds of $47,500, including $2,500 of cash proceeds placed into an escrow account for a period of up to one year as partial security for the Company’s obligations under the sale agreement. In connection with the sale, Gentherm entered into an operating lease agreement for a portion of the office and manufacturing building space purchased by Weiss Technik North America, Inc. The Company recognized a $4,970 pre-tax gain on the sale of CSZ-IC during the nine months ended September 30, 2019.
Acquisition of Stihler Electronic GmbH
On April 1, 2019, Gentherm acquired Stihler Electronic GmbH (“Stihler”), a leading developer and manufacturer of patient and blood temperature management systems, for a purchase price of $15,476, net of cash acquired and including $653 of contingent consideration to be paid upon achievement of a milestone that must be completed by September 2020. In addition, the purchase agreement includes a contingent payment of $653 to be paid if the selling shareholder remains employed by Stihler through December 2020. This amount will be recorded as a component of selling, general and administrative expenses ratably over the service period. The results of operations of Stihler are reported within the Company’s Industrial segment from the date of acquisition. During the three and nine months ended September 30, 2019, the Company incurred acquisition-related costs of approximately $19 and $399, respectively. These amounts were recorded as incurred, within the Company's consolidated statements of income.
11
The acquisition was accounted for as a business combination, with the total purchase price allocated on a preliminary basis using information available in the second quarter of 2019. The preliminary purchase price and related allocation to the acquired net assets of Stihler, based on their estimated fair values as of the acquisition date, are shown below:
Purchase price, cash consideration, net of cash acquired
14,823
Purchase price, fair value of contingent consideration
653
Total purchase price, net of cash acquired
15,476
883
1,698
263
Property and equipment
260
Other intangible assets
4,380
9,816
Assumed liabilities
(2,065
Net assets acquired
Other intangible assets primarily include amounts recognized for the fair value of customer-related intangible assets, which will be amortized over their estimated useful lives of approximately 9 years. The estimated fair value of these assets was based on third-party valuations and management’s estimates, generally utilizing an income approach. Goodwill recognized in this transaction is primarily attributable to intangible assets that do not qualify for separate recognition. It is estimated that $2,524 of the goodwill recognized will be deductible for income tax purposes.
The purchase price and related allocation are preliminary and could be revised for up to one year from the acquisition date as a result of adjustments made to the purchase price, additional information obtained regarding liabilities assumed, including, but not limited to, contingent liabilities, revisions of provisional estimates of fair values, including, but not limited to, the completion of independent appraisals and valuations related to property, plant and equipment and intangible assets, and certain tax attributes.
The pro forma effect of the Stihler acquisition does not materially impact the Company’s reported results for any period presented, and as a result no pro forma financial statements are presented.
12
Note 4 – Assets and Liabilities Held for Sale
During 2018, the Company determined that its Gentherm Global Power Technologies (“GPT”) business met the held for sale criteria and recognized $2,190 in impairment loss.
During 2019, the Company continued to assess the fair value of the GPT disposal group, less costs to sell, at each reporting period. As a result of these fair value measurements, the Company recorded additional impairment losses of $837 and $16,720 for the three and nine months ended September 30, 2019, respectively. Additionally, during the first quarter of 2019, the Company determined that an equity investment met the held for sale criteria and recognized impairment losses of $0 and $4,486 for the three and nine months ended September 30, 2019, respectively.
Subsequent to the end of the Company's third quarter, effective October 1, 2019, the Company completed the divesture of GPT. The Company expects to record approximately $6,000 pre-tax loss on sale, in the fourth quarter of 2019, which includes approximately $4,000 related to the release of previously deferred foreign currency translation losses recorded in accumulated other comprehensive loss.
The assets and liabilities of the GPT disposal group classified as held for sale as of September 30, 2019 are as follows:
Cash
1,422
Accounts receivable, net
2,238
215
3,926
Investment
7,356
1,033
4,371
(18,910
Total assets held for sale
6,587
420
Operating lease liabilities
3,929
Total liabilities held for sale
The equity investment described above, does not have a readily determinable fair value and is measured at cost, less impairments, adjusted for observable price changes in orderly transactions for identical or similar investments of the same issuer.
Note 5 – Restructuring
Manufacturing Footprint Rationalization
On September 23, 2019, the Company committed to a restructuring plan to improve the Company’s manufacturing productivity and rationalize its footprint. Under this plan, the Company will relocate and consolidate certain existing automotive manufacturing and, as a result, certain other activities, overall reducing the number of plants by two. During the third quarter of 2019, the Company recognized expense of $5,200 for employee separation costs that will be paid pursuant to the terms of statutory requirements of the affected locations. Additionally, the Company recognized $1,612 of accelerated depreciation and fixed asset impairment.
The Company expects to incur total costs of between $20,000 and $24,000, of which between $17,000 and $21,000 are expected to be cash expenditures. The total expected costs include employee separation costs of between $9,000 and $11,000, capital expenditures of between $4,500 and $5,500 and non-cash expenses for accelerated depreciation and impairment of fixed assets of approximately $3,000. The Company also expects to incur other transition costs including recruiting, relocation, and machinery and equipment move and set up costs of between $3,500 and $4,500. The actions under this plan are expected to be substantially completed by the end of 2021. The actual timing, costs and savings of the Plan may differ materially from the Company’s current expectations and estimates.
Other Restructuring Activities
As part of the Company’s continued efforts to optimize its cost structure, the Company has undertaken several discrete restructuring actions. During the three and nine months ended September 30, 2019, the Company recognized $1,467 and $2,726 of employee separation costs, respectively, and $385 and $734 of other related costs, respectively. These restructuring expenses were primarily associated with restructuring actions focused on the rotation of our manufacturing footprint to lower cost locations and the reduction of global overhead costs. These discrete restructuring actions are expected to approximate the total cumulative costs for those actions. The Company will continue to explore opportunities to improve its future profitability and competitiveness. These actions may result in the recognition of additional restructuring charges that could be material.
During the three and nine months ended September 30, 2018, the Company recognized $3,303 and $5,040 of employee separation costs, respectively, and $1,332 and $2,831 of other related costs, respectively.
Advanced Research and Development Rationalization and Site Consolidation
In June 2018, Gentherm completed the sale of its battery management systems division located in Irvine, California. A loss on the sale of $1,107 was recognized in restructuring expenses during nine months ended September 30, 2018. An additional asset impairment loss of $0 and $425 was recognized during the three and nine months ended September 30, 2019.
During the three and nine months ended September 30, 2018, Gentherm recognized employees separation costs of $157 and $1,038, respectively, and $589 and $1,024 of other related costs associated with the closure of two leased facilities located in Azusa, California. The Company also recognized $50 and $1,250 for the three and nine months ended September 30, 2018, for the disposal of long-lived assets controlled and used in Azusa, California.
The Company has recorded approximately $4,669 of restructuring expenses since inception of this program and it is considered complete.
GPT and CSZ-IC
During 2018, Gentherm launched a program to actively market GPT and CSZ-IC. Costs associated with the divestiture process were classified as restructuring.
During the three and nine months ended September 30, 2019, the Company recognized $0 and $251 of employee separation costs, respectively, and $0 and $861 of other related costs, respectively.
During the three and nine months ended September 30, 2018, the Company recognized $262 and $472 of employee separation costs, and $125 and $125 of other related costs, respectively.
The Company has recorded approximately $2,173 of restructuring expenses since inception of this program and it is considered substantially complete.
Restructuring Expenses By Reporting Segment
The following table summarizes restructuring activity for the three and nine months ended September 30, 2019 and 2018 by reporting segment:
Automotive
7,820
2,919
9,016
4,038
Industrial
88
1,486
1,689
5,320
Reconciling Items
756
1,413
1,104
3,540
14
Restructuring Liability
Restructuring liabilities are classified as accrued liabilities on the consolidated condensed balance sheets. The following table summarizes restructuring activity for the nine months ended September 30, 2019:
Employee
Separation
Costs
Accelerated
Depreciation and
Asset Impairment
Charges
Other related
costs
2,079
468
2,547
Additions, charged to restructuring expenses
8,177
2,037
1,595
Cash payments
(4,069
(1,458
(5,527
Non-cash utilization
(2,037
Reclassification to lease liability
(193
6,187
412
6,599
Note 6 – Earnings Per Share
Basic earnings per 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 Stock 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 issued from the exercise of Common Stock equivalents.
The following summarizes the Common Stock included in the basic and diluted shares, as disclosed on the face of the consolidated condensed statements of income:
Weighted average number of shares for calculation of basic
EPS
32,838,636
36,103,520
33,282,584
36,364,380
Stock options, restricted stock awards and restricted stock
units under equity incentive plans
94,043
344,642
135,971
105,379
Weighted average number of shares for calculation of
diluted EPS
32,932,679
36,448,162
33,418,555
36,469,759
The following 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 for equity incentive plans
441,435
12,000
1,359,250
Note 7 – Segment Reporting
Segment information is used by management for making strategic operating decisions for the Company. 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 – this segment represents the design, development, manufacturing and sales of automotive climate control seat (CCS) products, seat heaters, steering wheel heaters, automotive cables, battery thermal management (BTM), electronics and other automotive products.
Industrial – the combined operating results of GPT, Gentherm Medical and Gentherm’s advanced research and development division. We perform advanced research and development on thermal management systems, including those that utilize new proprietary comfort software algorithms, to enhance the efficiency and functionality of our automotive heating and cooling products. Unlike research and development that relates to a specific product application for a customer, advanced research and development activities affect products and technologies that are not currently generating product revenues. The segment includes government sponsored research projects.
Reconciling Items – include corporate selling, general and administrative costs and acquisition transaction costs.
The tables below present segment information about the reported product revenues, depreciation and amortization and operating income (loss) of the Company for three and nine months ended September 30, 2019 and 2018. With the exception of goodwill, asset information by segment is not reported since the Company does not manage assets at a segment level.
Three Months Ended September 30,
Industrial(1)
Reconciling
Items
Consolidated
2019:
228,243
11,813
10,170
480
414
11,064
Operating income (loss)
36,629
(3,496
(12,804
2018:
Product revenues(1)
238,849
22,655
11,060
1,170
668
37,908
(4,335
(17,860
700,300
41,003
30,660
1,319
1,302
114,456
(12,131
(40,094
724,420
68,070
3,822
2,060
116,312
(18,896
(45,461
(1)
Industrial segment includes $3,418 and $30,460 in product revenues, $0 and $1,894 in depreciation and amortization, and $206 and $659 in operating income from CSZ-IC for the nine months ended September 30, 2019 and 2018, respectively.
16
Automotive and Industrial segment product revenues by product category for the three and nine months ended September 30, 2019 and 2018 are as follows:
Climate Control Seats (CCS)
88,133
97,578
270,924
276,191
Seat Heaters
71,030
70,768
218,578
235,164
Steering Wheel Heaters
16,621
18,095
49,620
53,192
Automotive Cables
20,361
24,961
66,316
77,471
Battery Thermal Management (BTM)(a)
11,890
7,461
31,531
18,863
Electronics
11,729
12,590
36,035
44,409
Other Automotive
8,479
7,396
27,296
19,130
Subtotal Automotive
Remote Power Generation (GPT)
3,477
4,378
11,181
14,310
Industrial Chambers
9,829
3,418
30,460
Gentherm Medical
8,336
8,448
26,404
23,300
Subtotal Industrial
Total Company
a)
Battery Thermal Management or BTM product revenues include Gentherm’s automotive grade, low cost, heat resistant fans and blowers used by customer for battery cooling through ventilation and production level shipments of the advanced TED based active cool system.
Total product revenues information by geographic area is as follows (based on shipment destination):
United States
111,570
125,936
340,656
369,798
Germany
20,379
22,681
63,889
68,670
Japan
20,508
16,672
59,102
43,520
China
17,591
22,756
49,598
71,887
South Korea
14,543
12,814
45,098
42,419
Czech Republic
8,805
10,742
30,956
33,563
Canada
8,833
7,778
29,226
33,482
United Kingdom
8,315
9,037
23,980
28,349
29,512
33,088
98,798
100,802
Total Non-U.S.
128,486
135,568
400,647
422,692
17
Note 8 – Revenue Recognition
The aggregate amount of transaction price allocated to material rights that remain unsatisfied as of September 30, 2019 is $747. We expect to recognize into revenue, 42% of this balance in the next 3 months, and the remaining 33%, 9%, 9% and 7% in 2020, 2021, 2022 and 2023, respectively.
Unearned revenue related to the Automotive segment was $747 and $1,597 as of September 30, 2019 and December 31, 2018, respectively.
Changes in unearned revenue were as follows:
Nine Months Ended September 30, 2019
Balance, beginning of period
1,597
Additions to unearned revenue
549
Reclassified to revenue
(1,211
Reclassified to held for sale
(168
Currency impacts
(20
Balance, end of period
747
Revenue allocated to remaining performance obligations represents contracted revenue that has not yet been recognized, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods.
Total costs to obtain a contract that were recognized on the consolidated condensed balance sheets as of September 30, 2019 and December 31, 2018 were immaterial.
Note 9 – Income Taxes
At the end of each interim period, the Company makes its best estimate of the annual expected effective income tax rate and applies that rate to its ordinary year-to-date earnings or loss. The income tax provision or benefit related to unusual or infrequent items, if applicable, that will be separately reported or reported net of their related tax effects are individually computed and recognized in the interim period in which those items occur. In addition, the effect of changes in enacted tax laws or rates, tax status, judgment on the realizability of a beginning-of-the-year deferred tax asset in future years or income tax contingencies is recognized in the interim period in which the change occurs.
The computation of the annual expected effective income tax rate at each interim period requires certain estimates and assumptions including, but not limited to, the expected pre-tax income (or loss) for the year, projections of the proportion of income (and/or loss) earned and taxed in respective jurisdictions, permanent and temporary differences, and the likelihood of the realizability of deferred tax assets generated in the current year. Jurisdictions with a projected loss for the year or a year-to-date loss for which no tax benefit or expense can be recognized due to a valuation allowance are excluded from the estimated annual effective tax rate. The impact of such an exclusion could result in a higher or lower effective tax rate during a particular quarter, based upon the composition and timing of actual earnings compared to annual projections. The estimates used to compute the provision or benefit for income taxes may change as new events occur, additional information is obtained or as our tax environment changes. To the extent that the expected annual effective income tax rate changes, the effect of the change on prior interim periods is included in the income tax provision in the period in which the change in estimate occurs.
18
A summary of the provision for income taxes and the corresponding effective tax rate for the three and nine months ended September 30, 2019 and September 30, 2018, is shown below (in thousands, except effective tax rates):
Effective tax rate
29.9
%
110.7
41.5
25.1
Income tax expense excluding impairment loss
Earnings before income tax excluding impairment loss
23,495
14,809
67,472
50,553
Effective tax rate excluding impairment loss
28.8
24.9
28.5
19.4
For the nine months ended September 30, 2019, the Company recognized a loss of $21,206 related to an impairment loss for which no tax benefit was provided. Similarly, for the nine months ended September 30, 2018, the Company recognized a loss of $11,476 related to a non-deductible impairment loss. Income tax expense, earnings before income tax and effective tax rate excluding the impairment loss are noted above.
The Company’s effective tax rate for the three months ended September 30, 2018 included a discrete benefit related to stock-based compensation. For the nine months ended September 30, 2018, the Company’s effective tax rate included a discrete benefit related to certain intercompany transactions which disproportionately benefited lower tax rate jurisdictions.
The annual effective tax rates differ from the U.S. statutory rate primarily due to foreign rates which differ from those in the U.S., U.S. taxes on foreign earnings, the realization of certain business tax credits, including research and development and foreign tax credits, and the applicable withholding taxes on the projected future repatriations of the earnings from the Company’s non-U.S. operations that are not considered permanently reinvested.
Note 10 – Goodwill
A summary of changes in the carrying amount of goodwill, by operating segment, for the nine months ended September 30, 2019 is as follows:
37,533
17,778
Stihler acquisition
Currency impact
(1,388
(238
(1,626
36,145
27,356
Note 11 – Debt
Amended Credit Agreement
As of December 31, 2018, the Company, together with certain direct and indirect subsidiaries, had a credit agreement (the “Credit Agreement”) which included a revolving credit note (“U.S. Revolving Note”) with a maximum borrowing capacity of $350,000.
On June 27, 2019, the Company entered into an Amended and Restated Credit Agreement (the “Amended Credit Agreement”) with a consortium of lenders and Bank of America, N.A. as administrative agent. The Amended Credit Agreement amends and restates in its entirety the Credit Agreement. The outstanding principal and interest of the U.S. Revolving Note under the Credit Agreement continued and constitute obligations under the Amended Credit Agreement.
19
The Amended Credit Agreement increased the U.S. Revolving Note from $350,000 to $475,000 and extended the maturity from March 17, 2021 to June 27, 2024. Subject to specified conditions, the Company can increase the U.S. Revolving Note or incur secured term loans in an aggregate amount of $175,000.
The U.S. borrowers and guarantors participating in the Amended Credit Agreement have entered into a related amended and restated pledge and security agreement. The amended and restated security agreement grants a security interest to the lenders in substantially all of the personal property of the Company and its U.S. subsidiaries designated as borrowers to secure their respective obligations under the Amended Credit Agreement, including the stock and membership interests of specified subsidiaries (limited to 66% of the stock in the case of certain non-U.S. subsidiaries). In addition to the security obligations, all obligations under the Amended Credit Agreement are unconditionally guaranteed by certain of the Company’s subsidiaries. The Amended Credit Agreement restricts the amount of dividend payments the Company can make to shareholders.
The Amended Credit Agreement requires the Company and its subsidiaries to comply with customary affirmative and negative covenants, and contain customary events of default. The Amended Credit Agreement also requires the Company to maintain a minimum Consolidated Interest Coverage Ratio and Consolidated Leverage Ratio, as defined in the agreement.
Under the Amended 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”). The rate for Base Rate Loans is equal to the highest of the Federal Funds Rate (1.90% at September 30, 2019) plus 0.50%, Bank of America’s prime rate (5.00% at September 30, 2019), or the Eurocurrency rate (0.00% at September 30, 2019) plus 1.00%. The rate for Eurocurrency Rate Loans denominated in U.S. Dollars is equal to the London Interbank Offered Rate (2.02% at September 30, 2019). All loans denominated in a currency other than the U.S. Dollar must be Eurocurrency Rate Loans. Interest is payable at least quarterly.
The Applicable Rate varies based on the Consolidated Leverage Ratio reported by the Company. As long as the Company is not in default of the terms and conditions of the Amended Credit Agreement, the lowest and highest possible Applicable Rate is 1.25% and 2.25%, respectively, for Eurocurrency Rate Loans and 0.25% and 1.25%, respectively, for Base Rate Loans.
In connection with the Amended Credit Agreement, the Company incurred debt issuance costs of $1,278 which have been capitalized and will be amortized into interest expense over the term of the credit facility.
The Company also has two fixed interest rate loans with the German Investment Corporation (“DEG”), a subsidiary of KfW Banking Group, a Germany government-owned development bank.
DEG China Loan
The first DEG loan, a loan we used to fund capital investments in China (the “DEG China Loan”), was subject to semi-annual principal payments that began March 2015 and ended in September 2019. During the third quarter of 2019, the DEG China Loan was paid in full.
DEG Vietnam Loan
The Company’s second fixed interest rate loan agreement with DEG was used to finance the construction and set up of the Vietnam production facility (“DEG Vietnam Loan”). The DEG Vietnam Loan is subject to semi-annual principal payments that began November 2017 and will end May 2023. Under the terms of the DEG Vietnam Loan, the Company must maintain a minimum Equity Ratio and Enhanced Equity Ratio, as defined by the DEG Vietnam Loan agreement, based on the financial statements of Gentherm’s wholly owned subsidiary, Gentherm Vietnam Co. Ltd.
Undrawn borrowing capacity under the U.S. Revolving Note was $385,129 as of September 30, 2019. The following table summarizes the Company’s debt as of September 30, 2019 and December 31, 2018:
Interest
Rate
Principal
Balance
Amended Credit Agreement:
U.S. Revolving Note (U.S. Dollar Denominations)
3.29%
70,000
122,000
U.S. Revolving Note (Euro Denominations)
1.25%
19,623
5,727
913
5.21%
10,000
11,250
Total debt
99,623
139,890
Current portion
(2,500
(3,413
The scheduled principal maturities of our debt as of September 30, 2019 are as follows:
Year
U.S.
Revolving
Note
DEG
Vietnam
Remainder of 2019
1,250
2020
2021
2022
2023
2024
89,623
As of September 30, 2019, we were in compliance, in all material respects, with all terms as outlined in the Amended Credit Agreement and DEG Vietnam Loan.
Note 12 – Financial Instruments
Cash, cash equivalents and restricted cash
The Company has cash that is legally restricted as to use or withdrawal. A reconciliation of cash and cash equivalents on the consolidated condensed balance sheets to cash, cash equivalents and restricted cash presented on the consolidated condensed statements of cash flows is as follows:
2017
Cash and cash equivalents presented in the consolidated
condensed balance sheets
Cash, cash equivalents and restricted cash presented in the
consolidated condensed statements of cash flows
21
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. Market risks for changes in interest rates relate primarily to our debt obligations under our Amended Credit Agreement. Foreign currency exchange risks are attributable to sales to foreign customers and purchases from foreign suppliers not denominated in a location’s functional currency, foreign plant operations, intercompany indebtedness, intercompany investments and include exposures to the European Euro, Mexican Peso, Canadian Dollar, Hungarian Forint, Macedonian Denar, Ukrainian Hryvnia, Japanese Yen, Chinese Renminbi, Korean Won and Vietnamese Dong.
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. The maximum length of time over which we hedge our exposure to foreign currency exchange risks is one year. We had foreign currency derivative contracts with a notional value of $25,210 and $33,250 outstanding as of September 30, 2019 and December 31, 2018, respectively.
The maximum length of time over which we hedge our exposure to price fluctuations in material commodities is two years. No commodity swap contracts were outstanding at September 30, 2019 or at December 31, 2018.
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. For derivative contracts which can be classified as a cash flow hedge, the effective portion of the change in the fair value of the derivative is recorded to accumulated other comprehensive loss in the consolidated balance sheet. When the underlying hedge transaction is realized, the gain or loss included in accumulated other comprehensive loss is recorded in earnings in the consolidated statements of income on the same line as the gain or loss on the hedged item attributable to the hedged risk. We record the ineffective portion of foreign currency hedging instruments, if any, to foreign currency gain (loss) in the consolidated statements of income. See Note 14 for the amount of unrealized loss associated with foreign currency derivatives previously reported in accumulated other comprehensive loss that was reclassified into earnings during 2019. 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 an income approach to value derivative instruments, analyzing quoted market prices to calculate the forward values and then discounts such forward values to the present value using benchmark rates at commonly quoted intervals for the instrument’s full term.
Information related to the recurring fair value measurement of derivative instruments in our consolidated condensed balance sheet as of September 30, 2019 is as follows:
Asset Derivatives
Liability Derivatives
Hedge
Designation
Fair Value
Hierarchy
Balance Sheet
Location
Fair
Value
Net Asset/
(Liabilities)
Foreign currency derivatives
Cash flow hedge
Level 2
Current assets
Current liabilities
Information relating to the effect of derivative instruments on our consolidated condensed statements of income is as follows:
Three Months Ended September 30, 2019
Three Months Ended September 30, 2018
Nine Months Ended September 30, 2018
328
391
1,003
(214
Selling, general and administrative
75
Other comprehensive income
Foreign currency gain (loss)
(51
58
Total foreign currency derivatives
89
2,155
1,758
2,223
Commodity derivatives
145
Total commodity derivatives
(73
We did not incur any hedge ineffectiveness during the three and nine months ended September 30, 2019 and 2018.
22
Note 13 – Fair Value Measurements
The Company bases fair value on a 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: Inputs, other than quoted market prices included in Level 1, that are observable either directly or indirectly for the asset or liability.
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.
Items Measured at Fair Value on a Recurring Basis
Except for derivative instruments (see Note 12) and the held for sale disposal group (see Note 4), the Company had no material financial assets and liabilities that are carried at fair value at September 30, 2019 and December 31, 2018. The carrying amounts of financial instruments comprising cash and cash equivalents, restricted cash, accounts receivable and accounts payable approximate their fair values due to the relatively short maturity of such instruments.
Items Measured at Fair Value on a Nonrecurring Basis
The Company measures certain assets and liabilities at fair value on a non-recurring basis, which are not included above. For further information related to assets and liabilities measured at fair value on a non-recurring basis, see Note 3, "Acquisitions and Divestitures" and Note 4, “Assets and Liabilities Held for Sale”.
As of September 30, 2019, there were no additional significant assets or liabilities measured at fair value on a non-recurring basis.
Items Not Carried at Fair Value
The Company uses an income valuation technique to measure the fair values of its debt instruments by converting amounts of future cash flows to a single present value amount using rates based on current market expectations (Level 2 inputs). As of September 30, 2019, and December 31, 2018, the carrying values of the indebtedness under the Company’s Amended Credit Agreement and Credit Agreement, respectively, were not materially different than their estimated fair values because the interest rates on variable rate debt approximated rates currently available to the Company (see Note 11). Discount rates used to measure the fair value of the DEG Vietnam Loan and DEG China Loan are based on quoted swap rates. As of September 30, 2019, the carrying value and estimated fair value of the DEG Vietnam Loan were $10,000 and $10,213, respectively. As of December 31, 2018, the carrying value of the DEG Vietnam Loan and DEG China Loan were $11,250 and $913, respectively, as compared to an estimated fair value of $11,100 and $900, respectively.
23
Note 14 – Reclassifications Out of Accumulated Other Comprehensive Income (Loss)
Reclassification adjustments and other activities impacting accumulated other comprehensive income (loss) during the three and nine months ended September 30, 2019 and 2018 are as follows:
Defined
Benefit
Pension
Plans
Foreign
Currency
Translation
Derivatives
(2,339
(37,928
827
Other comprehensive income (loss) before reclassifications
167
(14,690
Income tax effect of other comprehensive income (loss)
before reclassifications
(36
(351
Amounts reclassified from accumulated other
comprehensive income (loss) into net income (loss)
(424
a
Income taxes reclassified into net income (loss)
91
Net current period other comprehensive income (loss)
(53,100
625
(a)
The amounts reclassified from accumulated other comprehensive income (loss) are included in cost of sales.
(2,406
(29,040
(397
1,586
(1,680
(491
(476
(45
(32,291
820
(37,157
(4
1,359
(14,095
(296
(785
(553
119
(15,943
629
24
Commodity
(2,366
(17,555
277
(800
Other comprehensive income (loss) before
reclassifications
2,048
(12,471
Income tax effect of other comprehensive income
(loss) before reclassifications
(615
(832
256
(69
(128
Net current period other comprehensive income
(loss)
(14,736
1,620
We expect all of the existing gains and losses related to foreign currency derivatives reported in accumulated other comprehensive loss as of September 30, 2019 to be reclassified into earnings during the next twelve months. See Note 12 for additional information about derivative financial instruments and the effects from reclassification to net income (loss).
Note 15 – Leases
The Company has operating leases for office, manufacturing and research and development facilities, as well as land leases for certain manufacturing facilities that are accounted for as operating leases. We also have operating leases for office equipment and automobiles. Excluding land leases, our leases have remaining lease terms ranging from less than 1 year to 7 years and may include options to extend the lease for an additional term equal to the original term of the lease. Land leases have remaining lease terms that range from 41 to 44 years and some which specify that the end of the lease term is at the discretion of the lessee. We do not have lease arrangements with related parties.
Accounting Policy
The Company determines whether a contractual arrangement is or contains a lease at inception. Leases that are operating in nature are recognized in operating lease right-of-use assets, current lease liabilities and non-current lease liabilities on our consolidated condensed balance sheets. While Gentherm is not currently party to any leases that qualify as financing leases, right-of-use assets and liabilities recognized from financing leases would be presented separately from the right-of-use assets and liabilities recognized from operating leases on our consolidated condensed balance sheet.
Lease liabilities are measured initially at the present value of the sum of the future minimum rental payments at the commencement date of the lease. Lease payments that will vary in the future due to changes in facts and circumstances are excluded from the calculation of rental payments, unless those variable payments are based on an index or rate. Rental payments are discounted using an incremental borrowing rate based on the Company’s credit rating, determined on a fully collateralized loan basis from information available at commencement date, and the duration of the lease term (the “reference rate”). Judgement is used to assess the importance of risk factor inputs during the computation of the Company’s credit rating. For significant leases at foreign subsidiaries denominated in U.S. Dollars, a risk premium associated with the borrower subsidiary’s country is added to the reference rate. For significant leases at foreign subsidiaries denominated in a foreign currency, the U.S. Dollar risk free rate with a duration similar to that of the lease term is subtracted from the reference rate and a corresponding foreign currency risk free rate with a duration similar to that of the lease term is added to the reference rate. Judgement is used to determine whether foreign subsidiary leases are significant.
25
Operating lease right-of-use assets are measured at the amount of the lease liability, adjusted for prepaid or accrued lease payments, lease incentive received, and initial direct costs incurred, as applicable. Periods covered by an option to extend the lease are initially included in the measurement of an operating lease right-of-use asset and lease liability only when it is reasonably certain we will exercise the option. Gentherm’s lease agreements do not contain residual value guarantees or impose restrictions or covenants on the Company.
For all classes of underlying assets, the Company accounts for leases that contain separate lease and nonlease components as containing a single lease component. The Company does not recognize lease right-of-use assets and lease liabilities from leases with an original lease term of 12 months or less and, instead, recognizes rent payments on a straight-line basis over the lease term in the Company’s consolidated condensed statements of income (loss). See Note 2 to our consolidated condensed financial statements for description of the impacts that resulted from the adoption of a new lease standard.
Components of lease expense for the nine months ended September 30, 2019 are as follows:
Lease cost:
Operating lease cost
Short-term lease cost
2,678
Sublease income
(91
Total lease cost
7,064
Weighted-average remaining lease term and discount rate is as follows:
Weighted Average Remaining Lease Term:
Operating leases
4.6
Weighted Average Discount Rate:
5.45
Other information:
Supplemental Cash Flow Information:
Gain on sale and leaseback transactions, net
207
Cash paid for amounts included in the measurement of lease
liabilities:
Operating cash flows from operating leases
4,539
Right-of-use lease assets obtained in exchange for lease
obligations:
3,339
A summary of operating leases as of September 30, 2019, under all non-cancellable operating leases with terms exceeding one year is as follows:
2019 (excluding the nine months ended September 30, 2019)
1,393
4,570
2,674
1,550
790
2024 or later
2,600
Total future minimum lease payments
13,577
Less imputed interest
(1,703
11,874
26
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. These forward-looking statements represent our goals, beliefs, plans and expectations about our prospects for the future and other future events, such as our ability to execute our strategic plan and Manufacturing Footprint Rationalization restructuring plan, our ability to finance sufficient working capital, the amount of availability under the Amended Credit Agreement and other indebtedness, our ability to continue to maintain or increase sales and profits of our operations, and the sufficiency of our cash balances and cash generated from operating, investing and financing activities for our future liquidity and capital resource needs. Reference is made in particular to forward-looking statements included in this “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 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 or as of the date specified herein and are based on management’s current expectations and beliefs. Such statements are subject to a number of assumptions, risks, uncertainties and other factors, which are set forth in “Item 1A. Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2018, and subsequent reports filed with the Securities and Exchange Commission, and which could cause actual results to differ materially from that described in the forward-looking statements. In addition, such forward-looking statements do not include the potential impact of any business combinations, acquisitions, divestitures, strategic investments and other significant transactions that may be completed after the date hereof, each of which may present material risks to the Company’s business and financial results. Except as required by law, we expressly disclaim any obligation or undertaking to update any forward-looking statements 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 consolidated 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, 2018.
Overview
Our automotive products are sold to automobile and light truck OEMs or their tier one suppliers. Inherent to the automotive supplier market are costs and commitments that are incurred 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 sub-systems. Revenues from these expenditures are typically not realized for two to three years due to this development cycle.
Reportable Segments
The Company has two reportable segments for financial reporting purposes: Automotive and Industrial. See Note 7 to the consolidated condensed financial statements for a description of our reportable segments as well as their proportional contribution to the Company’s reported product revenues and operating income. The financial information used by our chief operating decision maker to assess operating performance and allocate resources is based on these reportable segments.
Sale of Cincinnati Sub-Zero Industrial Chamber Business (CSZ-IC)
On February 1, 2019, as part of the Company’s Fit-for-Growth initiative to eliminate investments in non-core businesses, we completed the sale of the Cincinnati Sub-Zero industrial chamber business (“CSZ-IC”) and former Cincinnati Sub-Zero headquarters facility to Weiss Technik North America, Inc. for total cash proceeds of $47.5 million, including $2.5 million of cash proceeds placed into an escrow account for a period of up to one year as partial security for the Company’s obligations under the sale agreement. In connection with the sale, Gentherm entered into an operating lease agreement for a portion of the office and manufacturing building space purchased by Weiss Technik North America, Inc. The Company recognized a $4,970 million pre-tax gain on the sale of CSZ-IC during the nine-months ended September 30, 2019.
On September 23, 2019, the Company committed to a restructuring plan to improve the Company’s manufacturing productivity and rationalize its footprint. Under this plan, the Company will relocate and consolidate certain existing automotive manufacturing and, as a result, certain other activities, overall reducing the number of plants by two. The Company expects to incur total costs of between $20.0 million and $24.0 million, of which between $17.0 million and $21.0 million are expected to be cash expenditures. The total expected costs include employee separation costs of between $9.0 million and $11.0 million, capital expenditures of between $4.5 million and $5.5 million and non-cash expenses for accelerated depreciation and impairment of fixed assets of approximately $3.0 million. The Company also expects to incur other transition costs including recruiting, relocation, and machinery and equipment move and set up costs of between $3.5 million and $4.5 million. The actions under this plan are expected to be substantially completed by the end of 2021. The actual timing, costs and savings of the Plan may differ materially from the Company’s current expectations and estimates
During the third quarter of 2019, the Company recognized expense of $5.2 million for employee separation costs that will be paid pursuant to the terms of statutory requirements of the affected locations. Additionally, the Company recognized $1.6 million of accelerated depreciation and fixed asset impairment.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our consolidated condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. For discussion of our significant accounting policies, see Note 2, “Summary of Significant Accounting Policies and Basis of Presentation,” to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2018. With the exception of leases, there have been no significant accounting policy changes during the nine-months ended September 30, 2019. See Note 2 for information about the adoption of ASU 2016-02, “Leases”.
Results of Operations Third Quarter 2019 Compared with Third Quarter 2018
Product revenues. Product revenues by product category, in thousands, for the three-months ended September 30, 2019 (“Third Quarter 2019”) and 2018 (“Third Quarter 2018”) are as follows:
% Change
(9.7
)%
0.4
(8.1
(18.4
59.4
(6.8
14.6
(4.4
(20.6
(100.0
(1.3
(47.9
(8.2
Product revenues for the Third Quarter 2019 were $240.1 million compared with product revenues of $261.5 million during Third Quarter 2018, a decrease of $21.4 million, or 8.2%. The decrease included lower revenues in the automotive segment, which decreased by $10.6 million, or 4.4%, to $228.2 million, and lower industrial segment product revenues which decreased $10.8 million, or 47.9%, to $11.8 million.
Our automotive segment revenues decreased primarily due to unfavorable foreign currency, automotive volumes, and pricing. Unfavorable currency decreased revenues by $3.8 million, primarily attributable to the Euro, Chinese Renminbi and Korean Won. Unfavorable automotive volumes decreased revenues by $3.6 million, including the impact of the strike at General Motors which decreased revenues by approximately $3 million. Other reductions, primarily associated with reduced customer pricing, decreased revenues by $3.2 million.
28
Our industrial segment revenues decreased primarily due to the absence of revenue from CSZ-IC, which was sold on February 1, 2019, as well as lower revenue from GPT. Additionally, excluding the impact of the Stihler acquisition, Gentherm Medical revenue decreased approximately $1.5 million.
Cost of Sales. Cost of sales was $165.4 million during Third Quarter 2019 compared to $185.8 million during Third Quarter 2018, a decrease of $20.4 million, or 11.0%. This decrease was primarily associated with the sale of CSZ-IC in the first quarter of 2019, favorable currency impact, decreases in automotive volumes and operational performance improvements, including Fit-for-Growth. Additionally, the Third Quarter 2019 included a one-time benefit of approximately $1 million related to the release of an automotive warranty accrual upon resolution of a prior year quality issue. These items were offset by higher labor costs in Mexico, Macedonia and China.
The sale of CSZ-IC decreased cost of sales by $7.6 million. Operational performance improvements decreased cost of sales by $8.2 million, primarily attributable to decreases in overtime, expedited freight, material costs and quality costs. Favorable currency decreased cost of sales by $2.2 million primarily attributable to the Euro, Chinese Renminbi and Mexican Peso.
Net Research and Development Expenses. Net research and development expenses were $18.8 million during Third Quarter 2019 compared to $19.1 million during Third Quarter 2018, a decrease of $0.3 million, or 1.1%. The decrease in net research and development expenses is primarily related to lower incentive compensation costs and the Company’s focused portfolio and Fit-for-Growth cost reduction initiatives. These decreases in expense are offset by decreases in reimbursed research and development.
Reimbursed research and development totaled $3.2 million during Third Quarter 2019 compared to $5.5 million during Third Quarter 2018.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $26.9 million during Third Quarter 2019 compared to $35.1 million during Third Quarter 2018, a decrease of $8.2 million, or 23.4%. The decrease was primarily related to the sale of CSZ-IC on February 1, 2019, lower incentive compensation costs and the Company’s focused portfolio and Fit-for-Growth cost reduction initiatives. Additionally, Third Quarter 2018 included a $3.3 million mark-to-market charge on cash paid stock options that did not repeat in Third Quarter 2019.
Restructuring expenses. The Company recognized $8.7 million in restructuring expenses during Third Quarter 2019 primarily associated with the Manufacturing Footprint Rationalization restructuring program. Total restructuring expenses included $6.7 million of employee separation costs, $1.6 million of accelerated depreciation and fixed asset impairment and $0.4 of other related costs.
Foreign currency gain. During Third Quarter 2019 we incurred a net foreign currency gain of $4.1 million which included a net realized gain of $0.5 million and a net unrealized gain of $3.6 million.
Impairment loss. During Third Quarter 2019, the Company recorded an impairment loss totaling $0.8 million associated with the Company’s plans to divest GPT. The loss is not expected to be deductible for income tax purposes.
Income Tax Expense. We recorded an income tax expense of $6.8 million during Third Quarter 2019 on earnings before income tax of $22.7 million. The pre-tax earnings amount included the non-deductible impairment loss of $0.8 million. Adjusted for the impairment loss, the effective tax rate was 28.8% for the Third Quarter 2019. During Third Quarter 2018, we recorded an income tax expense of $3.7 million on earnings before tax of $3.3 million. The pre-tax earnings amount included the non-deductible impairment loss of $11.5 million. Adjusted for the impairment loss, the effective tax rate was 24.9% for the Third Quarter 2018. The effective tax rate for Third Quarter 2018 differed from the Federal statutory rate of 21% primarily due to increased international provisions from the U.S. tax reform, such as global intangible low-tax income (“GILTI”), enacted in December 2017, partly offset by favorable excess tax benefits on stock option exercises and certain intercompany transactions which disproportionately benefited lower tax rate jurisdictions. The effective tax rate for Third Quarter 2019 was higher than the Federal statutory rate of 21% primarily due to the impact of higher statutory rates for our subsidiaries operating in foreign jurisdictions and effects from the U.S. tax reform, such as GILTI.
29
Results of Operations Year to Date 2019 Compared with Year to Date 2018
Product revenues. Product revenues by product category, in thousands, for the nine-months ended September 30, 2019 (“YTD 2019”) and 2018 (“YTD 2018”) are as follows:
(1.9
(7.1
(6.7
(14.4
67.2
(18.9
42.7
(3.3
(21.9
(88.8
13.3
(39.8
(6.5
Product revenues during YTD 2019 were $741.3 million compared with product revenues of $792.5 million during YTD 2018, a decrease of $51.2 million, or 6.5%. The decrease included lower revenues in the automotive segment, which decreased by $24.1 million, or 3.3%, to $700.3 million and lower industrial segment product revenues which decreased $27.1 million, or 39.8%, to $41.0 million.
Our automotive segment revenues decreased primarily due to unfavorable foreign currency and pricing offset by increased volumes. Unfavorable currency decreased revenues by $16.7 million, primarily attributable to the Euro, Chinese Renminbi and Korean Won. Favorable volumes increased revenues by $1.6 million. Other reductions primarily associated with customer pricing, decreased revenues by $9.0 million.
Our industrial segment revenues decreased primarily due to the sale of CSZ-IC on February 1, 2019, as well as lower revenue from GPT. These decreases were partially offset by increased revenue from Gentherm Medical.
Cost of Sales. Cost of sales was $518.6 million during YTD 2019 compared to $558.5 million during YTD 2018, a decrease of $39.9 million, or 7.1%. This decrease was primarily associated with the sale of CSZ-IC in the first quarter of 2019, favorable currency impact and operational improvements, including Fit-for-Growth. These items were offset by increased U.S. tariffs, automotive volumes and higher labor costs in Mexico, Macedonia and China.
The sale of CSZ-IC decreased cost of sales by $20.8 million. Operational performance improvements decreased cost of sales by $19.1 million, primarily attributable to decreases in headcount, overtime, expedited freight and material costs. Favorable currency decreased cost of sales by $10.3 million primarily attributable to the Euro, Chinese Renminbi and Mexican Peso.
Net Research and Development Expenses. Net research and development expenses were $57.0 million during YTD 2019 compared to $63.4 million during YTD 2018, a decrease of $6.4 million, or 10.1%. The decrease in net research and development expenses is primarily related to the Company’s focused portfolio and Fit-for-Growth cost reduction initiatives.
Reimbursed research and development totaled $12.0 million during YTD 2019 compared to $12.5 million during YTD 2018.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $91.7 million during YTD 2019, a decrease of $14.1 million, or 13.3%, from $105.8 million during YTD 2018. The decrease was primarily related to the sale of CSZ-IC on February 1, 2019 and the Company’s focused portfolio and Fit-for-Growth cost reduction initiatives.
Restructuring expenses. The Company recognized $11.8 million in restructuring expenses during YTD 2019 primarily associated with the Manufacturing Footprint Rationalization restructuring program and other discrete restructuring actions which represented $6.8 million and $3.4 million, respectively. Total costs for the YTD 2019 included $8.2 million of employee separation costs, $2.0 million of accelerated depreciation and impairment charges and $1.6 million of other related costs.
Foreign currency gain (loss). During YTD 2019 we incurred a net foreign currency gain of $3.5 million which included a net realized loss of $1.0 million and a net unrealized gain of $4.5 million.
Gain on sale of business. On February 1, 2019, as part of Company’s Fit-for-Growth initiative to eliminate investments in non-core businesses, we completed the sale of the CSZ-IC and former Cincinnati Sub-Zero headquarters facility to Weiss Technik North America, Inc. for total cash proceeds of $47.5 million, including $2.5 million of cash proceeds that were placed into an escrow account for a period of up to one year. The Company recognized a pre-tax gain of $5.0 million on the sale of CSZ-IC during the nine months ended September 30, 2019.
Impairment loss. During the YTD 2019, the Company recorded an impairment loss totaling $21.2 million associated with the Company’s plans to divest GPT. The loss is not expected to be deductible for income tax purposes.
Income Tax Expense. We recorded an income tax expense of $19.2 million during YTD 2019 on earnings before income tax of $46.3 million. The pre-tax earnings amount included the non-deductible impairment loss of $21.2 million. Adjusted for the impairment loss, the effective tax rate was 28.5% for the YTD 2019. During YTD 2018, we recorded an income tax expense of $9.8 million on earnings before tax of $39.1 million. The pre-tax earnings amount included the non-deducible impairment loss of $11.5 million. Adjusted for the impairment loss, the effective tax rate was 19.4% for YTD 2018. The effective tax rate for YTD 2018 differed from the Federal statutory rate of 21% primarily due to the impact of discrete adjustments, including favorable excess tax benefits on stock option exercises and certain intercompany transaction which disproportionately benefited lower tax rate jurisdictions which were partially offset by the international provisions from the US tax reform, such as GILTI, enacted in December 2017. The effective tax rate for YTD 2019 was higher than the Federal statutory rate of 21% primarily due to the impact of higher statutory rates for our subsidiaries operating in foreign jurisdictions and effects from the U.S. tax reform, such as GILTI.
Liquidity and Capital Resources
Cash and Cash Flows
The Company has funded its financial needs primarily through cash flows from operating activities and equity and debt financings. Our new strategic plan sets forth a capital allocation strategy that includes a targeted debt-to-earnings leverage ratio and allows for some of our cash flows to be paid back to investors through Common Stock repurchases. On June 25, 2018, our Board of Directors increased the Company’s stock repurchase authorization to $300 million, of which $88.6 million of availability remained as of September 30, 2019. This authorization expires on December 16, 2020. Based on its current operating plan, management believes cash and cash equivalents at September 30, 2019, together with cash flows from operating activities, and borrowings available under our credit agreement, are sufficient to meet operating and capital expenditure needs, and to service debt, for at least the next 12 months. 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 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 acquisition or several smaller acquisitions. There can be no assurance that such capital will be available at all or on reasonable terms, which could adversely affect our future operations and business strategy.
The following table represents our cash and cash equivalents and restricted cash:
Cash, cash equivalents and restricted cash at beginning of
period
Cash provided by operating activities
Cash provided by (used in) investing activities
Cash used in financing activities
Foreign currency effect on cash and cash equivalents
31
Cash Flows From Operating Activities
We manage our cash, cash equivalents and restricted cash in order to fund operating requirements and preserve liquidity to take advantage of future business opportunities. The following table compares the cash flows from operating activities during YTD 2019 and YTD 2018:
Change
(2,218
Non-cash adjustments to reconcile net income to cash
provided by operating activities:
(5,440
5,091
(1,092
(535
Provision for doubtful accounts
(38
(1,954
9,730
Net income before changes in operating assets
and liabilities
91,349
88,109
3,240
Changes in operating assets and liabilities:
7,685
(2,002
17,461
(11,473
(1,460
13,451
Cash provided by operating activities during YTD 2019 was $84.0 million, representing an increase of $13.5 million from cash provided by operating activities during YTD 2018, which was $70.5 million. The following table highlights significant differences between the operating cash flows for the nine months ended September 30, 2019 and 2018, respectively:
Net cash provided by operating activities during YTD 2018
Decrease from lower net income before changes in operating assets
Changes in working capital, net
20,493
Changes in other assets and liabilities, net
(10,282
Net cash provided by operating activities during YTD 2019
Net cash provided by operating activities before changes in operating assets and liabilities increased during YTD 2019 due to non-cash impairment losses of $21.2 million, partially offset by a $5.0 gain recognized on the sale of CSZ-IC. Additionally, working capital, net provided unfavorable cash flows related to accounts payable and accrued liabilities and favorable amounts related to accounts receivable, inventory and prepaid expenses and other assets.
32
The following table illustrates changes in working capital during YTD 2019:
Working capital at December 31, 2018
267,679
Increase in cash, cash equivalents and restricted cash
6,340
Impairment loss on assets classified as held for sale
Foreign currency effect on working capital
(5,044
Increase in accounts receivable
6,454
Decrease in tax receivables
(9,137
Increase in inventory
6,376
Decrease in prepaid expenses and other assets
(3,110
Decrease in accounts payable
2,591
Increase in accrued liabilities
(5,780
Decrease in working capital due to the sale of a business
(42,530
Increase in net current assets classified as held for sale
6,505
Increase in working capital from acquisition of new company
5,203
Working capital at September 30, 2019
214,341
The following table highlights significant transactions that contributed to the increase in cash, cash equivalents and restricted cash during the nine-months ended September 30, 2019:
(in Thousands)
Repayments of Debt
Borrowings from U.S. Revolving Note
Stock repurchases
Proceeds from the exercise of common stock options
Proceeds from the sale of CSZ-IC
Cash paid for acquisition of subsidiary
Other items
(8,249
Increase in cash
In addition to these transactions, working capital was impacted by increases in accounts receivable, inventory, accrued liabilities, and decreases in prepaid expenses and other assets, accounts payable, and tax receivables. The changes in current assets and liabilities reflect the classification of additional assets related to GPT (disposal group) as held for sale during YTD 2019. All assets and liabilities of the disposal group are classified as held for sale within current assets and current liabilities, respectively, on the Company’s consolidated balance sheet as of September 30, 2019. See Note 4 to our consolidated condensed financial statement for additional information about the assets and liabilities classified as held for sale.
Cash Flows From Investing Activities
Cash provided by investing activities was $14.5 million during YTD 2019, reflecting cash proceeds of $47.5 million related to the sale of CSZ-IC, offset by the acquisition of Stihler for $14.8 million and the purchases of property and equipment related to the expansion of production capacity, totaling $18.3 million.
Cash Flows From Financing Activities
Cash used in financing activities was $86.2 million during YTD 2019, reflecting payments of principal on the U.S. Revolving Note, the DEG China Loan and the DEG Vietnam Loan totaling $69.0 million in aggregate partially offset by additional borrowings on the U.S. Revolving Note totaling $29.5 million. As of September 30, 2019, the total availability under the U.S. Revolving Note was $385.1 million. Cash was also paid in YTD 2019 for the repurchase of Common Stock totaling $58.0 million, financing costs incurred with for the Amended and Restated Credit Agreement totaling $1.3 million and cancellations of restricted stock awards totaling $1.2 million, partially offset by proceeds from the exercise of common stock options totaling $13.9 million.
Off-Balance Sheet Arrangements
33
We use letters of credit to guarantee our performance under specific construction contracts executed by our subsidiaries, GPT and Gentherm Medical. The expiration dates of the letter of credit contracts coincide with the expected completion date of the contract. Extensions are normally made if performance obligations continue beyond the expected completion date. At September 30, 2019, we had outstanding letters of credit of $72 thousand, a decrease from $455 thousand at December 31, 2018.
34
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, 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 Amended Credit Agreement. Foreign currency exchange risks are attributable to sales to foreign customers and purchases from foreign suppliers not denominated in a location’s functional currency, foreign plant operations, intercompany indebtedness, intercompany investments and include exposures to the Euro, Mexican Peso, Canadian Dollar, Hungarian Forint, Macedonian Denar, Ukrainian Hryvnia, Japanese Yen, Chinese Renminbi, Korean Won and Vietnamese Dong.
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. The maximum length of time over which we hedge our exposure to foreign currency exchange risks is one year. We had foreign currency derivative contracts with a notional value of $25.2 million and $33.3 million outstanding at September 30, 2019 and December 31, 2018, respectively.
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. For derivative contracts which can be classified as a cash flow hedge, the effective portion of the change in the fair value of the derivative is recorded to accumulated other comprehensive loss in the consolidated condensed balance sheets. When the underlying hedge transaction is realized, the gain or loss included in accumulated other comprehensive loss is recorded in earnings in the consolidated condensed statements of income on the same line as the gain or loss on the hedged item attributable to the hedged risk. We record the ineffective portion of foreign currency hedging instruments, if any, to foreign currency (loss) gain 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 an income approach to value derivative instruments, analyzing quoted market prices to calculate the forward values and then discounts such forward values to the present value using benchmark rates at commonly quoted intervals for the instrument’s full term. Information related to the fair values of all derivative instruments in our consolidated condensed balance sheet as of September 30, 2019 is set forth in Note 12 to the consolidated condensed financial statements included herein.
Interest Rate Sensitivity
The table presents principal cash flows and related weighted average interest rates by expected maturity dates 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) or Euros (€EUR), as indicated in parentheses.
September 30, 2019
Expected Maturity Date
(In thousands except rate information)
Liabilities
Long Term Debt:
Variable Rate (€EUR)
Variable Interest Rate as of September 30, 2019
1.25
Variable Rate ($USD)
3.29
Fixed Rate ($USD)
10,213
Fixed Interest Rate
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
$U.S. functional currency
Forward Exchange Agreements:
(Receive MXN/Pay USD$)
Total Contract Amount
10,726
14,484
25,210
Average Contract Rate
20.98
20.71
20.83
ITEM 4.
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018, we identified a material weakness related to Information Technology General Controls (“ITGC”) at our wholly owned subsidiary, Gentherm Medical, LLC (formerly, Cincinnati Sub-Zero Products, LLC), which did not operate in a way to appropriately restrict elevated access and address segregation of duty conflicts at both the information technology and end user levels.
During the nine months ended September 30, 2019, in response to this material weakness, the Company implemented a remediation plan which included development of enhanced risk assessment procedures and controls over the monitoring of elevated access and segregations of duty conflicts. We completed our testing of the operating effectiveness of the enhanced controls and found them to be effective as of September 30, 2019. As a result, we have concluded that the material weakness has been remediated as of September 30, 2019.
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, 2019, our disclosure controls and procedures were effective.
(b) Changes in Internal Control over Financial Reporting
Except for the changes in connection with our implementation of the remediation plan discussed above, there were no changes in the Company’s internal control over financial reporting during the three months ended September 30, 2019, that have materially affected, or are reasonable likely to materially affect, the Company’s 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 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 nine months ended September 30, 2019.
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, 2018. You should carefully consider the risks and uncertainties described therein.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities During Third Quarter 2019
Period
Total Number
of Shares
Purchased (1)
(b)
Average
Price Paid
per Share
(c)
Repurchased
as Part of
Publicly
Announced
Plans or
Programs
(d)
Approximate
Dollar Value
That May
Yet Be
Purchased
Under the
Programs (2)
July 1, 2019 to July 31, 2019
213,565
40.20
104,974,519
August 1, 2019 to August 31, 2019
225,398
37.77
96,463,515
September 1, 2019 to September 30, 2019
195,662
40.50
88,559,879
All shares were purchased on the open-market in accordance with Gentherm’s Stock Repurchase Program, including, in part, pursuant to a plan adopted by the Company in accordance with Rule 10b5-1 promulgated by the U.S. Securities and Exchange Commission.
(2)
The Stock Repurchase Program authorizes Gentherm to repurchase shares up to $300 million. The Stock Repurchase Program expires on December 16, 2020. The authorization of this Stock Repurchase Program does not require that the Company repurchase any specific dollar value or number of shares and may be modified, extended or terminated by the Company’s Board of Directors at any time.
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*
Employment Contract between Gentherm GmbH and Thomas Stocker, effective [September 1, 2019]
X
31.1
Section 302 Certification – CEO
31.2
Section 302 Certification – CFO
32.1**
Section 906 Certification – CEO
32.2**
Section 906 Certification – CFO
101.INS
Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH
Inline XBRL Taxonomy Extension Schema Document.
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
* Indicates management contract or compensatory plan or arrangement
** Documents are furnished not filed
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/ PHILLIP EYLER
Phillip Eyler
President and Chief Executive Officer
(Principal Executive Officer)
Date: October 29, 2019
/s/ MATTEO ANVERSA
Matteo Anversa
Executive Vice President, Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)