Greetings. Welcome to the Gentherm Inc. Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note this conference is being recorded. I will now turn the conference to your host Yijing Brentano, Senior Vice President of Investor Relations. Thank you. You may begin.

Thank you, and good morning, everyone. And thank you for joining us today. Gentherm's earnings results were released earlier this morning and a copy of the release is available at gentherm.com. Additionally, a webcast replay of today's call will be available later today on the Investor Relations section of Gentherm's website. During this call, we may make forward-looking statements within the meaning of Federal Securities laws. Statements reflect our current views with respect to future events and financial performance and actual results may differ materially. We undertake no obligation to update them, except as required by law. Please see Gentherm's earnings release and its SEC filings, including the latest 10-K and subsequent reports for discussions of our Risk Factors and other risks and uncertainties underlying such forward-looking statements. During the call, we may discuss non-GAAP financial measures as defined by SEC Regulation G. Reconciliations of these non-GAAP financial measures to the comparable GAAP financial measures are included in our earnings release or investor presentation. On the call with me today are Phil Eyler, President and Chief Executive Officer and Matteo Anversa, Chief Financial Officer. During their comments, Phil and Matteo will be referring to a presentation deck that we have made available on our website at gentherm.com/events. After their prepared remarks, we will be pleased to take your questions. Now I'd like to turn the call over to Phil.

Thank you, Yijing. Good morning, everyone and thank you for joining us today. I'm pleased with the continued strong execution of the Gentherm team despite the unprecedented global supply chain disruptions and production volatility. The automotive industry continues to face semiconductor-related customer volume reductions and plant shutdowns, escalating freight costs, and other inflationary factors. In addition, all little changes in customer production levels are creating significant near-term challenges predominantly related to managing variable production costs. For example, light vehicle production in our key markets in the third quarter was 19% lower than what was expected just three months ago. While our automotive revenues declined 8% in the third quarter, excluding the impact of foreign currency translation compared to a year ago, we outperformed light vehicle production in our key markets by 15 percentage points. In addition, we continued our momentum on automotive awards securing $260 million in awards from global OEMs in the third quarter. On the cost front, we continued our disciplined approach to expense and working capital management, while increasing our R&D investments. In addition, we've been negotiating with our customers and suppliers on reimbursements and price increases to partially offset the near-term material cost changes that we're experiencing as a result of the supply disruptions. We are now starting to realize some financial benefits from these discussions. In spite of the significant supply chain headwinds on a year-to-date basis, we delivered adjusted EBITDA margin rate of 15.8% and generated $117 million in cash flow from operations, 60% more than the first nine months of 2020, and nearly 40% more than the first nine months of 2019. Matteo will provide more details on our financial results in a few minutes. Now, turning to the automotive highlights on Slide 4. In the third quarter, we launched our automotive solutions…

Thank you, Phil, and thank you to everyone joining the call today. So let me turn to Slide 7, to focus on the items that most significantly impacted our third quarter results. For the quarter, product revenue decreased by 6% compared to the same period last year, and if we adjust for the impact of FX, our overall product revenue decreased by 7%. Starting with the Automotive segment, revenue was $233 million, down by 7% compared to the third quarter of 2020 and adjusting for the impact of foreign currency translation, automotive revenue decreased by 8%. In comparison, according to IHS latest data, light vehicle production for our key markets of North America, Europe, China, Japan and Korea decreased by approximately 23% over the prior year quarter. And as Phil mentioned earlier, we outperformed light vehicle production by approximately 15 percentage points. The majority of our product lines were impacted by the OEM shutdowns related to the semiconductor shortage. And specifically, CCS revenues decreased 7% driven by lower production volume of Stellantis and GM trucks, and SUVs. Seat Heater revenue decreased 16% due to lower production of GM trucks and SUVs as well as lower production volume with Ford, Stellantis and BMW. Electronics revenue decreased 20% due to the lower deliveries of the memory seat module to Ford as a result of their production shutdowns. And this decline was partially offset by higher RV-related sales. These negative effects were partially offset by higher sales in the other product lines, and specifically, steering wheel heater revenue increased by 9% due to higher volumes with Tesla model X and Y and Great Wall. Automotive cable revenue increased by 3% due to higher volume with Bosch. BPS revenues increased by 6% due to higher sales of the 48-volt Mercedes C class and the…

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Luke Junk with Baird. Please proceed with your question.

First wanted to ask about the guidance, and specifically, I don't know if you'd be able to outline any swing factors within the range. Just trying to think of what range of outcomes you're contemplating in the fourth quarter as we look at the low-end versus the high-end of guidance?

Hey, Luke, let me jump in real quick first and just kind of frame it and then we'll try to answer the specifics there. But I think it's pretty clear that the story of Q3 and then leading into the guidance for the remainder of the year is it's really around the supply chain volatility and especially related to semiconductors and the customer cancellations. I really want to emphasize that consumer and OEM demand continues to be very strong and growing for our product, for our thermal solutions product. We believe once the supply chain challenges are resolved, we're going to return to considerable revenue recovery and growth. And I believe a return to high-teen EBITDA margin rates. If you take a quick look at Q4 of 2020, Q1 of 2021, I think those are solid proof points of what we can deliver and what we expect to return to. But with that, let me just give a quick view of what's -- what hasn't is transpiring for us specifically in the industry. Looking back at Q3 the industry expectation and at that time the customer information we were getting with that we would expect to see a recovery in Q4. But certainly late Q3, up to the current moment, we've seen a rapid deterioration in the supply chain situation, especially related to semiconductors. And driven heavily for us by customer order cancellations. Customer volatility and shutdowns are even at a higher rate in Q4 than we've seen previously. This is even though our customer orders are really running high, and we feel we have to continue to assume that these cancellations will go on for the foreseeable future for us. Based on this, we really believe the IHS forecast for the fourth quarter is overstated. In addition, we're experiencing even higher volatility from our own semiconductor suppliers on our side. In fact, one of them very recently informed us of a supply gap to be expected in Q4, this could have a significant impact on our Q4 revenue as well. So our guidance is based on all these points that I just mentioned, which is, as of now the best information we have. We're continuously monitoring this, as you can imagine, really proud of our operations and supply chain team and global employees, led by Rafael Barkas they continually to find creative solutions that help us keep running. So although we expect this to continue for the foreseeable future, the information we're receiving from customers and our semiconductor suppliers would indicate that in 2022, we should return to a gradual improvement, and possibly a recovery by second half of 2022. So keep our fingers crossed that that maintains and now that we see things starts to turn around next year. Matteo, do you want to add anything to that?

So look specifically trying to narrowing down your question on the fourth quarter. So let me give you a little bit of color on what we are -- our thinking is. So if you look at the mid-point of the annual guidance that we provided, it would imply a fourth quarter revenue that will be slightly below what we have experienced in the third quarter, for the reasons that Phil just mentioned. So would imply a revenue of about $235 million, with an adjusted EBITDA rate of about 10% for the fourth quarter. So if you compare what we are expecting for the fourth quarter compared to the third, I think in terms of profitability in addition to the decremental margin that you will normally expect in relation to the decremental revenue, we also expect to have higher cost net of recoveries in the fourth quarter compared to the third, particularly as it relates to spot buy and premium freight. And also, I think an important point to note is that the recoveries that we received in the third quarter actually reflect a cumulative amount from the negotiations that actually occurred at the start at a couple of quarters ago. So there is always a time lag between when the costs are incurred by Gentherm and when the recoveries are actually negotiated with the customers. And quite frankly, we also follow purposely the sequence as we try to go to our customer with the best and most complete information that we can have, in order to actually maximize the amount of the recoveries itself. So that's a little bit the dynamics that are happening in the as far as the gross margin is concerned. And then one last comment I would make on the OpEx side, in line with what we have seen and also mentioned in prior calls, we are expecting the fourth quarter OpEx to be slightly above the third quarter and is going to be primarily again, around R&D, as we continue to invest in Battery Performance Solutions, in ClimateSense, and making sure that we have a successful launch on these awards that we secured in the prior quarters. Just a little bit idea the dynamics that we're seeing and what we have factored in, in the fourth quarter projection.

Thank you both for that that was some really great color. Next question wanted to ask about this quarter's awards, Phil has mentioned both in the press release, and in your comments on the call here that 40% of those awards were for electric vehicles. And I'm just wondering if you could expand on what you're seeing in terms of specific products, packaging sector is similar to that. Essentially the question is, are you seeing a higher hit rate in more content per week on EVs or is it maybe too soon to tease that?

Yes. I think well, first of all, the quarter, the number of opportunities in front of us was a little bit lighter in the quarter just to get to the specific award number. And that's a result of OEMs kind of pushing off some of the decisions. And I think a lot of that's based on their own resource constraints with the supply disruptions. So Q4 looks pretty good and early part of next year, the pipeline of awards looks good. And definitely, as you say, a lot of EV opportunities in front of us, we're seeing that definitely a higher uptake of our climate solutions and a higher content for vehicle both on EVs. And there is this continuum that OEMs are looking at kind of a transition from certainly more thermal devices in the vehicle to help them manage the power consumption. And of course that leads all the way up to ClimateSense. Obviously that's the path we're actively working towards. But things we're seeing for example seeing more cars with interior heated door panels and armrests, definitely higher rates of the seat comfort product and the steering wheels. All these are helping them to reduce the amount of power needed for the HVAC system. So that's certainly the place. And of course, Battery Performance products self-connecting and battery heating, we mentioned air cooling products. So those all give us an added bit of content going forward.

And then, if I could just squeeze one more in, it's now been three months since you disclosed the first ClimateSense commercial contract. Just wondering Phil, if you could expand on your comments on the reaction that you're seeing in the market now, the customer has stepped forward and looking to commercialize that product. And in terms of your own capability set, also wondering to what extent you have capacity to take on additional development contracts, let's say to the extent that there is interest in the market?

So let me start with the production contract we're working on that is the momentum on that project is really building with that customer. In fact two weeks ago, we had 20 of the top executives from that customer in our tech center to do a deep dive on the product and the feedback we got was phenomenal. They're very excited about this, expect this to make -- to be a predominant feature in that vehicle when it launches. So that's really, I mean, we couldn't ask for better status on that project. When it comes to the development project, you're absolutely right. Now that we have a production project that's absorbing a lot of resources because we have to do that flawlessly, and we have to prioritize the opportunities that are out there based on the strength of interest and potential upside opportunities with those customers. Luckily we do have two customers that were pretty active with in terms of doing development projects, testing evaluations, and there appears to be some good promise with those. And that's pretty much maxing us out on resources, obviously, we're continuing to present our solutions to other customers and kind of build that cadence over time. But I think things are transpiring exactly as we'd like on ClimateSense at this point.

Okay, Phil. Thank you for all of that color. I'll go ahead and leave it there.

Thank you, Luke.

Thanks, Luke.

Our next question comes from the line of Ryan Sigdahl with Craig-Hallum Capital Group. Please proceed with your question.

Thanks for taking my questions. Phil, you mentioned there's more conservative industry production outlook for Q4 relative to IHS, helpful context there. Any sense for 2022 IHS forecasting about 10% production growth, any directional thoughts at least relative to what you're seeing across the industry?

Well, we kind of have this immediate short-term view, which is pretty tainted by repetitive constant order cancellations from our customers, and it's not slowing down into Q4. So that makes it very difficult for us to forecast how this is going to transition into the early part of 2022. So it's really too early for me to speculate on what vehicle production might look like. I can tell you that we get information obviously from our customers and from our semiconductor suppliers. And we're trying to triangulate that, there appears to be optimism heading into 2022 especially on the back half of 2022, and a gradual increase. But we have to be careful. We've heard that before. And so I'm little bit cautious. But we're certainly, I can tell you what we're thinking and how we're gearing up is we're going to make sure once that -- once the floodgates open that we're ready to deliver. And we've been very cautious about keeping our labor in place, keeping our facilities primed for when this volume kicks up. As I mentioned, the feedback we're getting from our OEM customers is that that their consumers continue to want our product and to expect this to continue to grow. We also have done consumer studies on our own, and the results on those are phenomenal. The folks who have our product in their vehicles basically refuse to have a vehicle without it going forward. So I think we're in a really good position and we just have to be careful that that we don't overreact on the cost side given the current situation and are ready to come out of the gates running.

Switching over to the auto awards, you mentioned Next-Gen, Dodge Ram, CCS and Seat Heater awards and exclusivity across that. How does that compare to the previous program? And then is the CCS, is that an active heat coolers that will be back?

That's a ventilated solution. We have the CCS previously. We did not have the heat only. So now we've taken that entire package for the ramp.

Got it. One other one on the auto awards, you mentioned one award stayed with an incumbent, which impacted the win rate, but seems a bit surprising I guess to go from call it 90-ish percent down to 70% from that one award. Is that -- is there anything else to call out there?

Yes, it was a good size award with that excluding that we would have been well north of 80% that that quotation was with a new customer. We kind of shoehorned our way in to that discussion with the customer, got them excited about our product, and they allowed us to quote kind of last minute. We did a great job. They loved the product, they loved our pricing, but in the end, they looked at their timeline and said that they didn't have resources and really, they didn't feel like that at the time in the development process to move to us. So the good news is we've really improved our relationship with that customer. And I think it's going to produce opportunities going forward, but we're very transparent if we don't win an award. We keep track of that.

And Phil, maybe a point of clarification, is that a dollar value win rate or is that just a pure quantity of opportunities?

Yes, dollar value.

Got it. Last one for me. And then I'll turn it over to others. You have a growing and large amount of net cash on the balance sheet, any updated plans on how you plan to utilize that?

Well, yes, I mean, we kind of have following our same strategy. Number one is, make sure we're cautious and protective of the balance sheet, because the world is so volatile as we all see. So that's priority number one. And as I mentioned, we're definitely on the lookout for potential acquisitions that could help us accelerate our growth within our focused growth strategy in the core areas that we're working on. And that continues, we're very active there and we're hopeful that we can find some potential partners that we could fold in that would help us add to our technology, portfolio, expand our scale a little bit and certainly look at regional expansion. So those are all areas we're looking at and pretty excited that we're in the position that we can move on things like that. Certainly we're watching the stock price and if it makes sense, we'll execute on our approved buy back authorization.

Our next question comes from the line of Matt Koranda with ROTH Capital. Please proceed with your question.

So Phil, I think you had mentioned in response to one of the earlier questions that there's a potential supply gap from a semiconductor supplier that could have an impact on 4Q revenue. So just wanted to double check, is that factored into the low-end of the revenue guide for -- so it's implied in 4Q. And then just any more detail on the component that's seeing the most challenges, I guess?

Yes. First part it is built into the low-end. And I can't give you a whole lot of detail, but it's clearly a critical semiconductor in one of our ECUs that we use. And we're actively working with that supplier trying to find solutions. We're looking at redesign and alternative chips and actively engaging with our customer as well. They're scouring their landscape to find solutions, there are some options that are starting to pop-up, but it's a little bit too early to tell if we're going to be able to fill that void.

Okay, that's helpful. And then any other detail on other components where you're seeing the most tightness, I guess in your supply chain would be helpful?

Not really that many to be honest with you in terms of our supply tightness, and obviously, we're seeing inflationary pressures. And a lack of willingness by some suppliers to negotiate price balance and value improvements right now. Everybody is swamped with just trying to keep things moving. So those are the biggest pressures we're seeing, but not a whole lot. Most of it is semiconductor related.

Okay, that makes sense. And then just one for -- one question on the guidance, so on the adjusted EBITDA margin cut, wondering maybe Matteo if you could just bracket out how much is coming from gross margin erosion versus sort of a bit more OpEx. I know you mentioned earlier that probably a step-up in R&D spending related to all the new programs that you're working on so just wondered if you could maybe help us out on that front. And then I think the also groups, gross margin headwinds, at least in the release into kind of three primary buckets. So I think they were like supply chain, price reductions, and then wage and material inflation. So just wondering maybe if you could do the same for what's kind of driving the gross margin outlook, that's implied in the remaining guidance for 4Q?

Sure. So let me start maybe from the last part of your question, just taking the third quarter numbers. So the 330 bps decline in the gross margin rate year-over-year, when you compare the third quarter of 2021 versus the third quarter of 2020. Let me start with a negative. The supply chain disruptions accounted for almost 390 bps. And this includes obviously the decremental margin and decremental revenue, plus the higher cost of goods sold as I mentioned in my prepared remarks due to premium freight, lost productivity at the factories, and the spot buys. We had the usual annual customer price reduction which is about 190 bps and then wage and material inflation, which is about 70 bps. These are the negatives, and then these were partially offset by the recoveries that I mentioned, which is about 170 bps. And then we had other supplier cost reductions, which accounted for about 100 bps positive. So that gives you the landscape of what happened in the third quarter gross margin rate. And actually, I would stress the fact that the -- if you exclude the impact, the net impact of the supply chain disruptions from these results, we would have actually achieved gross margin rate between 30% and 31%, which is what Phil mentioned, in one of the earlier question, what you would expect, and what we actually proved that we can deliver in a more normal, more normal environment. So this is the breakdown for the third quarter. Now, as far as the fourth quarter is concerned, I think the primary driver of the reduction on the EBITDA rate is around again centered on the gross margin rate. And that's primarily due to the reasons that I just mentioned. Okay. And again, reiterating one point that I made earlier that we expect in the fourth quarter to have, when you look at the cost of premium freight, lack of productivity at the factories and spot buys, net of the recoveries, this cost will be a little higher in the fourth quarter compared to the third, just due to the timing of the recoveries. Overall, we have been able right now to recover approximately 50% of our non-inflationary costs. And we are working through with suppliers and customers to hold or increase this level of recoveries moving forward.

Thank you. Our next question comes from the line of Scott Stember with CL King. Please proceed with your question.

Phil, you said that fourth quarter IHS, you view obviously think that they're being overly aggressive probably. What are you baking into your guidance how far off do you think they could be at the end of the day, in particular, when you take into account some of these supply gaps that you talked about?

Well, I think it's difficult to say exactly where we think it's worse than third quarter kind of the way we're thinking about it. And that's all based on the orders we're looking, at the rate of order cancellations that we're seeing, the abrupt cancellations kind of building that in. So I would use slightly worse than third quarter as a proxy for our thinking.

Okay, got it. And then just lastly on negotiations for price increases, I know this is always a difficult process over the years, do you feel that you will be able to get all the relief that you need, eventually?

Unlikely to get all of it. We're gradually chipping away and trying to get more kind of taking a four-pronged approach to it, Scott. One is obviously reimbursements for one-time costs, such as expedited freight and spot buys. Those tend to be a little bit easier and more discreet. Definitely looking at selective customers and methodologies to get price increases for inflationary pressure, that's much harder to do, especially given our contractual obligations to customers in certain cases. But where we can, we're using that. And the last two areas that are a little bit more long-term, but areas we find to be a little more successful. And those would revolve around negotiating lower annual price reductions in the next years. That's something that customers are more open to discussing and then achieving better terms on New Business Awards. So what that mean possibly higher prices, leading to better margins on those and better terms overall. So those are the four ways we're approaching it. It's -- there are a lot of difficulties in the discussion, which have led us only be about 50% successful so far. But I expect that to start opening up, especially as the situation starts easing, because think about the automotive, customer purchasing organizations, they're absolutely fairy, just trying to keep their plants running. And so, being able to setup meetings to discuss these complex, recovery discussions is not easy.

Ladies and gentlemen, we have reached the end of the question-and-answer session. I will now turn the call over to Phil Eyler for closing remarks.

Great. Thanks everyone for joining our call today. The results of the third quarter I believe demonstrate our continued focus on innovation, operational excellence, and cash flow generation. While we expect continued industry headwinds for the foreseeable future, our momentum in new awards, along with expanding demand for our new technologies and our continued focus on productivity position us really well to deliver significant long-term shareholder value. We appreciate your interest and support and look forward to keeping you apprised of our progress.

Thank you. This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation. Have a wonderful day.