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Edited Transcript of THRM earnings conference call or presentation 27-Apr-17 12:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Gentherm Inc Earnings Call

NORTHVILLE Apr 28, 2017 (Thomson StreetEvents) -- Edited Transcript of Gentherm Inc earnings conference call or presentation Thursday, April 27, 2017 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Barry G. Steele

Gentherm Incorporated - CFO, VP of Finance and Treasurer

* Daniel R. Coker

Gentherm Incorporated - CEO, President and Director

* Kathleen Bentley

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Conference Call Participants

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* Christopher Ralph Van Horn

FBR Capital Markets & Co., Research Division - Associate

* Gary F. Prestopino

Barrington Research Associates, Inc., Research Division - MD

* Matthew Butler Koranda

Roth Capital Partners, LLC, Research Division - Senior Research Analyst

* Steven Lee Dyer

Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst in the Equity Research Department

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Presentation

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Operator [1]

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Greetings, and welcome to the Gentherm Incorporated First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Kathleen Bentley of Prosek Partners. Thank you, Ms. Bentley. You may begin.

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Kathleen Bentley, [2]

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Thank you, operator, 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, representatives of the company may make forward-looking statements within the meaning of federal security laws. Statements reflect current views with respect to future events and financial performance, and actual results may materially differ. Please see the company's SEC filings, including the latest 10-K and subsequent reports, for discussions of various Risk Factors and uncertainties underlying such forward-looking statements.

During the call, the company 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 the company's earnings release.

On the call, we have Dan Coker, President and Chief Executive Officer; and Barry Steele, Chief Financial Officer. Management will provide a review of the results, after which there will be a Q&A period.

I would now like to turn the call over to Dan. Dan?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [3]

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Yes, good morning, and thank you. Thanks to everyone for joining us on our call. By every measure, the first quarter 2017 for Gentherm was a success. We're very pleased. All units are performing extremely well. Our operations have performed at an extremely high-level of efficiency. Our margins were strong. Our revenues nearly reached the $1 billion annual run rate in the first quarter at $249 million. And all units did well, particularly, our GSE -- excuse me, GS -- CSZ medical line. They did an extremely good job and are performing extremely well. And we saw a resurgence in the Global Power Technologies Group as well.

So we're going to go through our normal procedure. Barry is going to give you the intimate details in his presentation, and then we'll open the floor for questions. Barry?

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Barry G. Steele, Gentherm Incorporated - CFO, VP of Finance and Treasurer [4]

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Thanks, Dan. Good morning, everyone. Thanks for joining us today. Our quarterly results were positive, as Dan mentioned, in nearly all measures. Our quarterly revenue, for example, grew to $249.3 million, which is an increase of $33.6 million or about 16%, compared with the prior year. This increase was partially due to the CSZ acquisition. Although, on a pro forma basis, first quarter revenue represented a 26% increase for CSZ over its prior year revenue of about $16 million. Considering CSZ's 2016 first quarter revenue with Gentherm on a combined pro forma basis, our organic revenue growth for the first quarter was nearly 8%. The revenue increase was also the result of growth in all our other products as well. Automotive seat heaters and steering wheel heaters were particularly strong. In the case of seat heaters, our capabilities in electronic controllers is adding to our product's content and steering wheel heaters are being driven by higher penetration and more and more vehicle programs.

Even GPT, as Dan mentioned, which serves the energy market with its remote power generation product, mainly for gas pipelines, and which has had decreasing revenue for the past 5 quarters, contributed favorably to the strong quarterly revenue. We continue to forecast 2017 revenue growth of 5% to 10% despite a relatively flat automotive market. We knew headwinds from currency translation and changes in our climate seat technology and our seat vehicle models favoring the lower-priced heat/vent solution. The main drivers for growth will include continued organic growth for CSZ, continued penetration of our automotive products, some additional recovery for GPT and the first very small amount of shipments of the new Battery Thermal Management product at the very end of the year.

Another positive was a nice improvement in our gross margin, which increased by almost $17 million, and the gross margin percent, which was 34%, a nearly 10-year high and an improvement of 2.6% over the prior year gross margin percent. This increase resulted mainly from the higher revenue for CSZ and GPT, which have higher revenue gross margins, but also is supported by better fixed cost coverage from the higher sales levels and currency-related benefits.

Our operating expenses were again higher with the prior year and totaled $50.3 million, for a $12 million or 31% increase. However, they were almost $2 million or 4% lower than the prior sequential quarter, the fourth quarter of last year. Part of the year-over-year increase was due to the CSZ acquisition, which had operating expenses of about $7 million or just a little over half of the operating expense increase. As in the last 3 quarters, the rest of the increase comes in the form of investments or higher development costs from many new product initiatives, some of which we have announced like the Battery Thermal Management and electronics products and some we have not announced, yet offer strategic improvements to our business systems. The sequential decrease is partly due to a $2 million management organization expense during the 2016 fourth quarter, which was a one-time cost and which also helped to reduce recurring costs for the current and future quarters. Our net earnings of $25.4 million was about $0.59 per share. On a non-GAAP basis, adjusting for acquisition-related amortization and unrealized currency losses, the earnings were about $0.70 per share. This compares to a similarly adjusted non-GAAP amount of $0.73 per share during the first quarter of 2016. The prior year amount also being adjusted for a one-time tax charge of about $10 million related to a reorganization of our North American operations under the -- under Gentherm Europe, formerly known as W.E.T. Automotive.

During the first quarter, we had negative operating cash flow of about $21 million. This negative amount was primarily due to tax payments made in conjunction with that same North American reorganization, totaling $34 million. Without this unusual payment, our operating cash flow would have been favorable and about $10 million. Also because of this payment and due to about $8 billion in debt repayments, our cash of $134 million was $43 million lower at the end of the quarter as compared to the beginning. Outstanding debt was $163 million at the end of the quarter, which brings our net debt position to $29 million. Available borrowing capacity under revolving credit facility is now $203 million, which brings our total available liquidity along with the cash to $337 million. A quite nice quarter, Dan. I turn it back to you.

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [5]

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Thanks, Barry. I appreciate it. And this was a very good quarter, and we did have an advantage in that the CSZ group was not counted in last year's 2016 first quarter numbers. So the strong 16% growth that you saw in our year-over-year revenue gain was partially due to that. We do not expect a 16% increase in revenues in the future quarters. Although, we do expect business to continue to grow and be -- to be solid. But that does not mean that we're going to continue seeing anything above 15% growth per quarter. It's a good quarter. We think it's a very good beginning to a year, and we're very excited about the prospects.

So for right now, we'd like to open the floor for questions. Operator, we're ready to address any questions anyone may have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Christopher Van Horn from FBR.

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Christopher Ralph Van Horn, FBR Capital Markets & Co., Research Division - Associate [2]

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So just first on the gross margins. I mean, obviously, I think there were some tailwinds here from the CSZ and GPT revenues. Could you give us an update on maybe your expectations on where you see margins in the latter half of the year?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [3]

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Well, as we've continually targeted, the low-30s are our target. We see variations from quarter to quarter. A lot of that's based upon a group of variables, one of which is a very high revenue numbers, very good for our margins. And our operations are performing at pretty close to peak efficiencies right now. So we would still say that our gross margin target is in the low-30s. This quarter, we hit something closer to the mid-30s. But we would say somewhere between 32% and 34% is what you should plan for and see for the rest of the year.

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Christopher Ralph Van Horn, FBR Capital Markets & Co., Research Division - Associate [4]

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Okay, great. Got it. And then it seems like the rear seat penetration of heated seats is starting to ramp up a little bit. Could you just comment maybe a little bit on the pipeline? Or what the conversations you're having with the OEMs? Because on our checks, we obviously see a proliferation of more heated seats in the back. I'm just curious what the -- what your customers are kind of talking about in terms of the future pipeline there?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [5]

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Well, it's a continuation of comfort objective that the car companies have. They're trying to put 4 seat positions into, expand the ability to each passenger in a car to individually customize their position. So we do see a trend toward more rear seat applications for seat heaters. But we also are seeing an increased revenue because of additional content. We're beginning to see a few customers allow us to ship controlling devices for seat heaters of our own production, and that's helping quite a bit as well on the revenue ramp for heated seats. So we're getting additional positions, in that we're getting the rear seats as well more and more, but we're also getting additional content from the controller.

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Christopher Ralph Van Horn, FBR Capital Markets & Co., Research Division - Associate [6]

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Great. Just a follow on to that, because I think, the controller's obviously very interesting part of the story. Is that a market share gain for you? Or is that -- did the OEMs in-source some of that before? Like how is -- what is -- where were you standing in kind of the competitive space around the controllers?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [7]

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Well, for us, in places where we're now selling the controller and we weren't, obviously, it's a penetration gain. And the customers, a few of them do provide from their own internal sources, but most of them buy from other sources. So when we're allowed now to sell a complete seat heater system including the controller, yes, that's a penetration gain and a new segment for us.

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Operator [8]

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The next question is from the line of Matt Koranda from Roth capital.

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Matthew Butler Koranda, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [9]

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Nice quarter. In terms of gross margins, just wanted to touch on that one more time. So if I try to back in the gross margins for CSZ and GPT, and I assume automotive revenue is tracking kind of at your historical corporate average in the low-30s, then I get to something in the mid-40s for CSZ and GPT. So one, is that a fair assumption? And two, do you think you can sustain those levels through the remainder of 2017?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [10]

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Well, we won't be speculating on your assumptions and you're backing around into our P&L. But you're essentially correct in that our group objectives are to achieve a 32 -- low-30s, 32% minimum type of gross profit. In occasional quarter, we have business units or product mixes that shift that, in some cases, dramatically. The businesses, we have diversified into typically have higher gross margin percentages than the traditional automotive businesses have. So for us, it's a matter of mix as -- and efficiency when we look at our gross margins.

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Matthew Butler Koranda, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [11]

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Okay. And then is there a way to quantify? I think, Barry, you mentioned, there might have been an FX benefit or a small one in the margin. Could you help us understand that?

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Barry G. Steele, Gentherm Incorporated - CFO, VP of Finance and Treasurer [12]

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It was fairly small. In the top line, we gave up about $2 million in revenue year-over-year. But the gross margin was probably increased just a little bit, maybe $500,000-or-so just because of currency benefits and Mexican peso primarily.

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Matthew Butler Koranda, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [13]

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Okay. Got it. And then just following up on the seat heater discussion that you guys had, maybe just digging into it a little bit more. Was kind of curious if you could maybe quantify for us what percentage of your current seat heater programs are using your electronic controllers currently?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [14]

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I have no clue to be honest with you. But I'm not sure we would announce that publicly anyway. But more and more of our seat heater customers are allowing us to ship full systems.

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Matthew Butler Koranda, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [15]

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Okay. Yes, maybe the other way to ask it is, on the incremental, when you win a new seat heater program, is there a way to kind of think about the attach rate for your controllers there?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [16]

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We're getting a significant amount of traction with our new electronics divisions being able to support a broader range of activities in the electric controllers. So electronic controllers are a big target segment for us. It adds additional content and it allows us to control more precisely our product -- our complete product up and down the line, and of course, it allows us to make a fair profit on the (inaudible).

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Barry G. Steele, Gentherm Incorporated - CFO, VP of Finance and Treasurer [17]

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Maybe I could help a little bit by pointing out that, we would say that there is good growth still potentially in our future, because of this continued penetration of electronics for seat heaters. I want this to come all in one quarter, but it is a -- one of the many ways we'll continue to grow faster than the industry.

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [18]

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They're not just for the seat heaters, although, that's a key significant factor in the seat heaters business. But yes, that's true.

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Matthew Butler Koranda, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [19]

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Okay. Got it. And then just last one in that would assume as you alluded to that, that mixes up the margin profile of the seat heaters as well. Does that bring it up sort of towards that corporate average? Is that a fair assumption?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [20]

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Everything helps.

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Matthew Butler Koranda, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [21]

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Got it. Okay. Maybe just one more from me and then I'll jump back in queue. Do you guys have any updated view on when you might expect to see that CCS category kind of growth kickback in there? Are you getting any better visibility from customers on program launches in the coming quarters? Or are we still kind of in a period of stasis here?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [22]

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We're -- nothing happens in the auto industry in the blink of an eye. And so there's going to be a long period of time where the transition occurs. We're seeing some transition from heat/cool to heat/vent and that's beginning to happen now, will happen for a period of years actually, as the car company platforms age out. But we are -- as we have indicated, we see a very big opportunity for CCS in many of the markets, especially, the European market. That's the area where we're going to see the growth in heated and cooled seats begin to take off again to levels that we're more satisfied with. Initially, that will probably start off in the form of heat/vent systems, and then as customers decide to upgrade for their luxury brands, they'll add heat/cool as well.

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Matthew Butler Koranda, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [23]

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And just to clarify that, Dan, you're talking kind of over a period of multiple years though in Europe, not just this year in particular?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [24]

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I am. It's a long-term gain.

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Operator [25]

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The next question is from the line of Steve Dyer from Craig-Hallum.

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Steven Lee Dyer, Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst in the Equity Research Department [26]

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Just kind of following up on Matt's question. As it relates to heat/cool, that was obviously on the scene, I think, even earlier 15, 20 years ago than heat/vent. I guess, what has sort of changed such that heat/vent has become -- it seems like other than little bit lower price tag, but is there still opportunity, it sounds like for growth there? Or is heat/cool sort of becoming the de facto standard, I guess, for CCS product?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [27]

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Well, there's a couple of factors that would lead a OEM to decide to use heat/vent or heat/cool. The main advantage over heat/cool is that the system is independent of the HVAC system, and it allows a very rapid response time, in particularly, in a warm condition when you're adding cooling energy to the occupant through the seat, a independent thermal electric device creates cool air and directs it to the human very, very quickly. So time to comfort is our biggest advantage with the heat/cool system. The luxury market was the target for this all along and continues to be our target. And there are plenty of luxury vehicles, specifically, the European luxury vehicles that have yet to introduce this even to the high-end customers. So the opportunity for CCS remains strong. We're in a period right now where we're not seeing the type of growth we like, part of that is being impacted by some of the previous customers, who have been using the heat/cool systems for their mid-range vehicles, are now converting over to the heat/vent system, which has advantages itself. It is less power to drive the system and it costs slightly less than the heat/cool system. So we released a heat/vent system, targeting specifically the mid-range vehicles around the world. Now there are many times more mid-range vehicles built than luxury vehicles, obviously. So the market opportunity for heat/vent is extremely large and is relatively untapped at this moment. So we see a big opportunity for new penetration in the heat/vent systems in the mid-market and there will be some continued migration from heat/cool to heat/vent for those customers who had adopted heat/cool systems for their mid-range vehicles in the past. So I think that there's still good strong growth for both categories. But we see, in particular, a lot -- a longer-term of growth for the heat/vent systems as that penetration to the mid-range market begins and pushes out over the next few years.

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Steven Lee Dyer, Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst in the Equity Research Department [28]

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Okay. And then in your press release, you had mentioned some opportunities for stand-alone electronic production being kind of an early 2019 event, did that slip at all? I guess, I had sort of anticipated maybe we'd see something a bit sooner, but I'm not sure if I misread things at some point?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [29]

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No actually. Well, I think, we've been saying early '19 all along. There may have been some indication at some point that it might have been late '18, but it's pretty well right on target. We're quite pleased with the team's response to our customers' demand. It's a new category for us and it's a new classification of qualification for our factory. So it's a big step up for us to become a electronic control supplier to an OEM. And that takes a lot of time to get ready, it takes a lot of time on the OEMs basis to properly evaluate and test us and make sure that we're ready to join the very select fraternity of people who are allowed to connect in to their networks on the cars.

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Steven Lee Dyer, Craig-Hallum Capital Group LLC, Research Division - Partner and Senior Research Analyst in the Equity Research Department [30]

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Got it. And then as it relates to your -- to the rest of your guidance, I'm assuming that, that sort of takes into consideration all of the downtime at GM for the K2 program in the back half of the year. So that implies pretty flat, not year-over-year, but just a level similar to Q1 revenues. Is that sort of how you see it? And then also OpEx seems to have sort of found a comfortable level. Is that a good number to use give or take going forward for the rest of the year?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [31]

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Yes, generally speaking, I think, you're right on all of those points. Yes, we see -- in the automotive sector, we see a similar growth pattern to what we have seen in the first quarter. We'll see continued strength, particularly, CSZ, we think they're performing very, very well and their market is receptive to the products that we're offering there. We're taking steps to add our own direct sales force and technical field sales support. And that's going to continue to perform well during the year. But I think, we're going to have a good year, but we still maintain that we'll be growing somewhere between 5% and 10% for the full year on the revenue line.

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Operator [32]

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(Operator Instructions) The next question is from the line of Gary Prestopino from Barrington Research.

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Gary F. Prestopino, Barrington Research Associates, Inc., Research Division - MD [33]

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Couple of questions here. I would assume that solid results at Cincinnati Sub-Zero. You haven't got the full sales force or the full infrastructure in yet, correct?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [34]

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That is correct. It's a building process. We suspect that we'll have everybody in place and trained probably by the second half of this year. The training part is what takes the most effort to make sure that these folks are ready to go out and represent our products.

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Gary F. Prestopino, Barrington Research Associates, Inc., Research Division - MD [35]

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Okay. And historically, Dan, as Cincinnati Sub-Zero had strong first quarters and strong fourth quarters. I'm just trying to get an idea of how that shakes -- how that would shake out.

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [36]

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Yes, I don't think there's a lot of seasonality to their product lines. Although, I would say probably the industrial environmental chamber business is somewhat affected by capital purchasing strategies as people push. That would indicate there's probably a bigger chance for a stronger fourth quarter than first quarter. But in general, I don't think that there's a lot of seasonality to their business.

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Gary F. Prestopino, Barrington Research Associates, Inc., Research Division - MD [37]

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Okay. And then, there's a lot of questions around these electronic controllers on your seat heaters, that obviously you don't want to answer in terms of the percentage. But maybe you could help us out and just talk about how much do those controllers drive an increase in your content per vehicle? Can you help us out with that?

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [38]

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Well, the cost vary with complexity. They can be anything from a few dollars to $10. And that's a significant piece of some of the cost of a resistance heater. But for us, it's an opportunity to provide an additional service to our customers. We provide a full system without them having to have additional vendors qualified and supplied to be able to deliver a product. And that's a good thing for us, because it allows us to have complete control and match a controller with a device, and if we know it's going to perform exactly as designed. And that also provides a level of comfort for the OEM as well.

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Gary F. Prestopino, Barrington Research Associates, Inc., Research Division - MD [39]

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Okay. I mean, I'm trying to recall if this is the first time you really called that out on an earnings release or not, but it seems to me that if this is really the first time, there should be solid runway here as we go forward.

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [40]

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It's not the first time that we've called that out. That's actually the reason that we've got into the electronics business to be able to provide full system content and additional content and get better control of our systems overall. But this particular quarter, there was a significant increase in some of the businesses. And we've seen growth in the heater business in the past, and part of that has been the addition of new content in the form of electronic controls for us.

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Operator [41]

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There are no further questions at this time. I would like to turn the floor back to Mr. Dan Coker for closing comments. Over to you.

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Daniel R. Coker, Gentherm Incorporated - CEO, President and Director [42]

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Thank you. And thank you, everyone, for joining us for our first quarter review. Again, by all measures, it was a very solid quarter and a great beginning to a year. We don't believe that the revenue growth percentages are going to continue, but we believe that the revenues themselves will continue to be strong throughout the year. And we have great confidence that we'll be able to achieve our projection of 5% to 10% revenue growth and a very solid earnings performance for all of our businesses. We have lots of exciting things coming in the future. We've been very hard at work for the past couple of years, really, but really in the last year or so, getting ready for the launches of some very significant new products including Battery Thermal Management systems, that we think are going to really change the way that our businesses operate and provide new opportunities and new paths for growth for us. So again, we thank everyone for your time and attention. We'd like to congratulate our team on a global basis for a great first quarter. And thank you, everyone, and goodbye.

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Operator [43]

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Thank you very much. This concludes today's teleconference. You may disconnect your lines at this time. Thank you all for your participation.