UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

 

For the quarterly period ended June 30, 2018

OR

 

 

For the transition period from             to             .

Commission File Number: 0-21810

 

GENTHERM INCORPORATED

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (248) 504-0500

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    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.

 

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 July 27, 2018, there were 36,462,906 issued and outstanding shares of Common Stock of the registrant.

 

 

 

 

 

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GENTHERM INCORPORATED

TABLE OF CONTENTS

 

 

 

 

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PART I. FINANCIAL INFORMATION

GENTHERM INCORPORATED

CONSOLIDATED CONDENSED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

 

See accompanying notes to the consolidated condensed financial statements.

 

 

 

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GENTHERM INCORPORATED

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

(In thousands, except per share data)

(Unaudited)

 

See accompanying notes to the consolidated condensed financial statements.

 

 

 

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GENTHERM INCORPORATED

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

 

See accompanying notes to the consolidated condensed financial statements.

 

 

 

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GENTHERM INCORPORATED

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

See accompanying notes to the consolidated condensed financial statements.

 

 

 

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

 

Note 1 – The Company and Subsequent Events

Gentherm Incorporated is a global technology and industry leader in the design, development, and manufacturing of innovative thermal management technologies. Unless the context otherwise requires, the terms “Company”, “we”, “us” and “our” used herein refer to Gentherm Incorporated and its consolidated subsidiaries. Our products provide solutions for automotive passenger comfort and convenience, battery thermal management, remote power generation, patient temperature management, environmental product testing and other consumer and industrial temperature control needs. 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.   We concentrate our research on the development of new technologies and new applications from existing technologies to create product and market opportunities for a wide array of thermal management solutions.  

New Strategic Plan

On June 25, 2018, Gentherm announced a new strategic plan intended to improve business performance and position the Company to deliver above-market growth and improved profitability to its shareholders. An important element of the strategy is the Fit-for-Growth initiative that focuses on purchasing excellence, rationalization of research and development activities, reducing selling, general and administrative expense, minimization or elimination of investments in non-core areas and developing a manufacturing footprint commensurate with the new plan. Non-core areas of investment so far identified under the Fit-for-Growth initiative are concentrated in the following areas of Gentherm’s industrial segment: California Advanced Research and Development, Gentherm Global Power Technologies (GPT) and Cincinnati Sub Zero’s Industrial Chamber business (CSZ-IC).  

The strategy also identified several product categories the Company will exit, including furniture, aviation, battery management electronics, industrial battery packs, automotive thermoelectric generators and other non-core electronics.

Fit-for-Growth

The Fit-for-Growth cost savings initiative began in January 2018. Consultant costs associated with the initiative, some of which were incurred during the first quarter of 2018, were reported in restructuring expenses for both the three and six-month periods ended June 30, 2018.  The total amount of consultant costs incurred during the six-month period ended June 30, 2018 is $1,499.  We expect to incur an additional $840 in consultant costs during the second half of 2018.  

Gentherm recognized $1,737 in one-time employee termination costs in restructuring expenses pertaining to Fit-for-Growth during the three and six-months ended June 30, 2018. Management cannot reasonably estimate the total amount of employee termination costs expected to be incurred from implementing Fit-for-Growth. Lastly, management recognized $11 in contract termination costs in restructuring expenses and does not anticipate additional contract termination costs in the future from implementing Fit-for-Growth.

Advanced Research and Development Rationalization and Site Consolidation

In June, Gentherm completed a 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 the three and six-month periods ended June 30, 2018.  

Gentherm also initiated a plan to consolidate advanced research and development operations, including the closure of two leased facilities located in Azusa, California. One of these facilities was vacated in June; the other facility is expected to be vacated at the end of the 2018 third quarter. During the three and six-month periods ended June 30,2018, Gentherm recognized $435 in contract termination costs in restructuring expenses related to the vacated facility, and expects to incur an additional $537 in contract termination costs related to the second facility during the third quarter.

Gentherm recognized $881 in one-time employee termination costs in restructuring expenses for employees whose termination was effective on or before June 30, 2018.  We expect to incur $166 in additional one-time employee termination costs for employees whose termination benefits are contingent on a continuation of service through October 2018.  

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 1 – The Company and Subsequent Events – Continued

Lastly, during the three and six-month periods ended June 30, 2018, Gentherm recognized $1,200 in restructuring expenses for the disposal of long-lived assets controlled and used in Azusa, California. We do not expect to incur additional asset disposal costs from our exit from Azusa, California.

GPT and CSZ-IC

Gentherm is in the early stages of developing a program to identify potential buyers for GPT and CSZ-IC. For the six-month period ended June 30, 2018, Gentherm recognized $210 in one-time employee termination costs in restructuring expenses relating to the planned divestitures. An estimate of the total cost expected from the divestitures could not be determined as of June 30, 2018.  

Restructuring Liability

A reconciliation of the beginning and ending restructuring liability is as follows:

 

The cumulative amount of restructuring expenses incurred and recognized in the automotive and industrial segments during the six months ended June 30, 2018 was $3,247 and $3,833, respectively.  See Note 5 to our 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.  

U.S. Tax Reform

The Tax Cuts and Jobs Act (the “Tax Act”) was enacted on December 22, 2017.  The Tax Act reduces the U.S. federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on all offshore earnings that were previously tax deferred and creates new taxes on certain foreign sourced earnings.  As of December 31, 2017, and in accordance with guidance provided by Staff Accounting Bulletin No. 118 (SAB 118), the Company had not completed its accounting for the tax effects of the Tax Act; however, in certain cases, as described below the Company made a provisional estimate of the effects on our existing deferred tax balances and the one-time transition tax.  For the year ended December 31, 2017, the provision for income taxes includes a provisional income tax expense of $20,153 related to items for which the Company was able to determine a reasonable estimate.  For the six-month period ended June 30, 2018, there have been no changes to the provisional income tax expenses booked in 2017. In all cases, we will continue to make and refine our calculations as additional analysis is completed.  In addition, the Company’s estimates may be affected as additional regulatory guidance is issued with respect to the Tax Act.  Any adjustments to the provisional amounts will be recognized as a component of the provision for income taxes in the period in which such adjustments are determined, but in any event, no later than the fourth quarter of 2018, in accordance with SAB 118.

Deferred tax assets and liabilities  

The Company remeasured its U.S. deferred tax assets and liabilities at 21%.  However, the Company is still analyzing certain aspects of the Tax Act and refining the calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts.  In the year ended December 31, 2017, the provision for income taxes included provisional income tax expense of $5,808 related to the remeasurement of deferred tax balances. For the six-month period ended June 30, 2018, there have been no changes to the provisional income tax expenses in 2017.

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 1 – The Company and Subsequent Events – Continued

Transition Tax on Deferred Foreign Earnings

The one-time transition tax is based on the Company’s post-1986 earnings and profits (“E&P”) that were previously deferred from U.S. income taxes.  In the year ended December 31, 2017, the provision for income taxes included provisional income tax expense of $23,923 related to the one-time transition tax liability of the Company’s foreign subsidiaries.  The Company has not completed its calculation of the total post-1986 E&P for these foreign subsidiaries.  Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets.  This amount may change when the Company finalizes the calculation of post-1986 E&P previously deferred from U.S. income taxes and the amounts held in cash or other specified assets.  For the six-month period ended June 30, 2018, there have been no changes to the provisional income tax expenses booked in 2017. A benefit of $9,578 was included in the provision for income taxes for the year-ended December 31, 2017 to offset the one-time transition tax related to the previous deferred tax liability that existed for the undistributed foreign earnings that were not permanently reinvested.  For the three and six-month periods ended June 30, 2018, there have been no changes to the provisional income tax benefit booked in 2017 related to this item. However, we continue to recognize a deferred tax liability related to foreign withholding tax that will be incurred for undistributed foreign earnings that are not permanently reinvested.

Subsequent Events

We have evaluated subsequent events through the date that our consolidated condensed financial statements are issued.  No events have taken place that meet the definition of a subsequent event requiring adjustments to or disclosures in this Form 10-Q.

Note 2 – Basis of Presentation and New Accounting Pronouncements

Accounting Principles

Our unaudited consolidated condensed financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in the audited annual consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to those rules and regulations. In the opinion of management, all adjustments, consisting of normal recurring items, considered necessary for a fair presentation of our results of operations, financial position and cash flows have been included. The balance sheet as of December 31, 2017 was derived from audited annual consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. Certain reclassifications of prior year’s amounts have been made to conform with the current year’s presentation. Notably, results from asset disposals during the six-month period ended June 30, 2017 were reclassified from other income to cost of sales. Operating results for the six-month period ended June 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. These consolidated condensed financial statements should be read in conjunction with the financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2017.

Consolidation

The consolidated financial statements at June 30, 2018 and December 31, 2017 and for the six-month period ended June 30, 2018 and 2017, reflect the consolidated financial position and consolidated operating results of the Company. Investments in affiliates in which Gentherm would not have control, but would have the ability to exercise significant influence over operating and financial policies, would be accounted for under the equity method. Investment for which Gentherm is not able to exercise significant influence over the investee and which do not have readily determinable fair values are accounted for under the cost method. Intercompany accounts have been eliminated in consolidation.

Use of Estimates

The presentation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from those estimates and assumptions.

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 2 – Basis of Presentation and New Accounting Pronouncements – Continued

Revenue Recognition

Revenue is recognized from agreements containing enforceable rights and obligations when promised goods are delivered or services are completed, the price is fixed or determinable, and payment has been received or is collectable. The amount of revenue recognized is net of the Company’s obligation for returns, rebates, discounts, taxes, if any, collected from customers, and consideration that is paid to a customer, unless such payment is in exchange for a distinct good or service. The amount of revenue recognized from a contract with a customer reflects the amount of consideration expected to be received in exchange for the transfer of good or services.

Automotive Revenues

The Company sells automotive seat comfort systems, specialized automotive cable systems and automotive thermal convenience products under long-term supply agreements (“LTAs”) and, for arrangements that are less than one year in length, purchase orders. LTAs are multiple-year business awards to provide custom designed parts for a particular automotive vehicle program in quantities and at intervals of the customer’s choosing.  LTAs are often multiple-element agreements. The main element in LTAs are production parts; distinct promises from which the customer can benefit separately from other promises or elements in the contract. A second element in LTAs are production part purchase options that provide customers the ability to purchase additional parts at set prices in the future. Judgement is used to determine whether a production part purchase option represents a material right to the customer and should be accounted for as a separate performance obligation.  LTAs that provide customers with a purchase option discount incrementally higher than the range discounts typically given to automotive customers contain a material right. The magnitude of change in the year-over-year option prices and the total number of units expected to be ordered are important factors in the calculation of the option’s fair value and the allocation of transaction price.

The price for parts is set at the point in time the customer exercises its option to purchase additional parts from the Company. A firm order, stating the number of each production part to be delivered, is an independent contract with a discrete transaction price. Revenues are allocated to production parts based on the relative standalone selling prices observed on the LTAs. As a practical alternative to estimating the standalone selling price of an option that provides a customer with a material right, the Company allocates transaction price to options by reference to the production part volumes expected to be ordered and the consideration expected to be received. The Company satisfies its obligation to provide product parts to the customer upon shipment.

When an option to purchase additional production parts in the future represents a material right, the customer effectively is paying Gentherm in advance for production parts each time it exercises the option by placing a firm order commitment. Revenue from options containing a material right are recognized on the basis of direct measurement of the value of production parts transferred to date relative to the total number of production parts expected to be delivered over the life of the vehicle program. Judgement is required to determine the pattern and timing with which an option containing a material right is satisfied and the production part is transferred to a customer.

Industrial Revenues

Our industrial business unit generates revenue from the sale of products and services by our wholly-owned subsidiaries Cincinnati Sub-Zero (“CSZ”) and GPT. Industrial business unit revenues and medical business unit revenues discussed below are reported within the Company’s industrial reportable segment (see Note 5). Industrial business unit customers commonly enter into multiple-element agreements for the purchase of products and services.  Installation services, for example, are separate and distinct performance obligations that are often included in contracts to purchase customized environmental test chambers. Depending on the application, delivery of an environmental test chamber or remote power generation system to the customer’s place of business can range from two weeks to nine months from commencement of the contract. Installation services, while reliant on the specifications and timing from the customer, rarely remain incomplete more than two months after delivery.

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 2 – Basis of Presentation and New Accounting Pronouncements – Continued

Revenues allocated to environmental test chambers or remote power systems are based on the stand alone selling price of products themselves. Judgement is used to determine the degree to which early pay discounts and other credits are utilized in the calculation of standalone selling price, and only included to the extent it is probable that a significant reversal of any incremental revenue will not occur. Revenues are recognized at the point in time the chamber or power system is shipped to the customer. For contracts that also include a promise for installation, the portion of total transaction price allocated to the installation is recognized as revenue at the point in time the installation is complete.  

Revenues from our medical business unit are generated from the sale of products and equipment. Our medical product and equipment focus on body and blood temperature management. The Company sells medical products and equipment primarily through distributor and group purchasing organization agreements. These agreements allow member participants to the distributor or group purchasing organization to make purchases at discounted prices negotiated by the distributor or group purchasing organization.  A rebate is incurred at the point in time a member participant purchases product covered under these types of agreements. Rebates are accounted for as variable consideration, using an expected value, probability weighted approach, based on the level of sales to the distributor and the time lag between the initial sale and the rebate claim in determining the transaction price of a contract.  Revenue is recognized at the point in time the medical products or equipment is transferred to the customer.

Contract Balances

We record a receivable when revenue is recognized at the time of invoicing and unearned revenue when revenue is recognized subsequent to invoicing. For contracts where control of the goods or service is transferred to the customer over time, or whose terms require the customer to make milestone payments throughout the fulfillment period, the timing of revenue recognition is likely to differ from the timing of invoicing to customers.

The opening balance of our accounts receivable, net of allowance for doubtful accounts, was $185,058 as of January 1, 2018.

We record an allowance for doubtful accounts once exposure to collection risk of an account receivable is specifically identified. We analyze the length of time an account receivable is outstanding, as well as a customer’s payment history and ability to pay to determine the need to record an allowance for doubtful accounts.

Activity in the allowance for doubtful accounts was as follows:

 

Most of Gentherm’s unearned revenue pertains to LTAs containing a material right. In the early periods of an LTA containing a material right, when payments collected from the customer are greater than the standalone selling price of the production parts, revenue associated with the material right is deferred. In future periods, when amounts collected from customers as payment is less than the standalone selling price of the production parts delivered, the deferred revenue is reversed into revenue. For LTAs containing a material right and, thus, the timing of revenue recognition is likely to differ from the timing of invoicing to customer, the aggregate amount of transaction price allocated to material rights that remain unsatisfied as of June 30, 2018 is $2,681. We expect to recognize into revenue, 33% of this balance in the next 12 months, and the remaining 52%, 11% and 4% in 2019, 2020 and 2021, respectively.

Gentherm often requires milestone payments for contracts to provide environmental test chambers or remote power systems to customers. Milestone payments do not provide the Company with a right to payment for the work completed to date and do not represent the satisfaction of a performance obligation. Milestone payments are deferred and reported within unearned revenue until construction is complete and the unit has been delivered or is installed. If the environmental test chamber contract includes a separate promise to provide installation services, any installation-related payments received from the customer are deferred until the point in time the installation is complete.

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 2 – Basis of Presentation and New Accounting Pronouncements – Continued

The total amount of unearned revenue associated with environmental chamber and remote power system contracts, including environmental chamber contracts that include a separate obligation to provide installation, as of June 30, 2018 is $3,087.  This entire balance is expected to be recognized into revenue during the next 12 months.

See Note 10 for information regarding the unearned revenue associated with these arrangements, including unearned revenue by segment and amounts recognized into revenue during the most recent six-month period ending June 30, 2018.

Payment terms for contracts with customers generally range from 30 to 120 days from the date of shipment of goods or completion of service or, if applicable, the scheduled milestone payment due date, and do not include components designed to provide customers with financing.

Assets Recognized from the Costs to Obtain a Contract with a Customer

We recognize an asset for the incremental costs of obtaining a contract with a customer if the benefits of those costs are expected to be realized for a period greater than one year. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in prepaid expenses and other assets and other non-current assets.

Recently Adopted Accounting Pronouncements

Revenue from Contracts with Customers

In May 2014, the FASB issued Accounting Standard Update (“ASU”) 2014-09, “Revenue from Contracts with Customers.” ASU 2014-09 was developed to enable financial statement users a better understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The update’s core principal is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those good or services. Issuers are to use a five-step contract review model to ensure revenue is measured, recognized, and disclosed in accordance with this principle. The FASB issued several amendments to the update, including a one-year deferral of the original effective date, and new methods for identifying performance obligations that are intended to reduce the cost and complexity of compliance.

We adopted ASU 2014-09 and related amendments effective January 1, 2018 using the cumulative catch-up transition method, which required us to disclose the cumulative effect of initially applying the update recognized at the date of initial application. We elected to apply the guidance in ASU 2014-09 to contracts that were not completed at January 1, 2018.

The most significant impact from adoption of ASU 2014-09 occurred within our Automotive segment and relates to our accounting for production part purchase options that grant customers a material right to purchase additional parts under long-term supply agreements in the future. Due to the complexity of certain of our automotive supply contracts, the actual revenue recognition treatment for customer purchase options will depend on contract-specific terms and could vary from other contracts that are similar in nature. Revenue recognition related to goods and services reported in the Industrial segment remains substantially unchanged.

The amount by which each financial statement line item was affected by application of ASU 2014-09 and related amendments during the three and six-month periods ended June 30, 2018 is as follows:

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 2 – Basis of Presentation and New Accounting Pronouncements – Continued

 

 

 

Adoption of ASU 2014-09 and related amendments had no impact to cash from or used in operating, investing or financing activities on our consolidated condensed statements of cash flows.

Statement of Cash Flows

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.”  ASU 2016-15 provides guidance on the classification of eight specific cash receipt and cash payment transactions in the statement of cash flows. The Company focused its evaluation on the following transactions to determine the effect ASU 2016-15 will have on the Company’s Consolidated Statements of Cash Flows:

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 2 – Basis of Presentation and New Accounting Pronouncements – Continued

We have adopted ASU 2016-15 and related amendments effective January 1, 2018. None of the cash receipt and cash payment transactions addressed by the update, including those that were not the focus of management’s evaluation, occurred during any of the periods presented in this report. Adoption of this update and related amendments did not have a material impact on the cash flows of the Company.

Income Taxes

In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.” ASU 2016-16 modifies the current prohibition to recognize deferred income taxes from differences between the tax basis of assets in the buyer’s tax jurisdiction and their cost resulting from an intra-entity transfer from one tax-paying component to another tax-paying component of the same consolidated group.  Under current GAAP, deferred income taxes for intra-entity asset transfers are not recognized until the asset is sold to an outside party.  ASU 2016-16 allows entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs.

ASU 2016-16 is effective for fiscal years and interim periods beginning after December 15, 2017.  The amendments in ASU 2016-16 should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to accumulated earnings as of the beginning of the period of adoption.  We adopted ASU 2016-16 and related amendments effective January 1, 2018 on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of such adoption date. As a result of the amendments in ASU 2016-16, a favorable adjustment of $31,645 was recorded directly to retained earnings during the six-month period ending June 30, 2018.  The new deferred tax assets will be recognized ratably over the useful life the applicable assets.

Accumulated Other Comprehensive Income

In February 2018, the FASB issued ASU 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” ASU 2018-02 provides a remedy to a narrow-scope financial reporting issue created by the Tax Act.  The Tax Act required entities to adjust deferred tax assets and liabilities to reflect the impact from newly enacted lower corporate income tax rates, and recognize the effect in income from continuing operations.  This requirement applied to all deferred tax assets and liabilities, even those which arose from transactions originally recognized in other comprehensive income.  The amendments in ASU 2018-02 allow adjustments to deferred tax assets and liabilities due to newly enacted lower corporate income tax rates to be recognized in retained earnings, if those deferred tax balances arose from transactions originally recognized in other comprehensive income.  

Income tax effects are released from accumulated other comprehensive income and recorded against the deferred tax balance in the consolidated balance sheet when the underlying activity is realized.  

ASU 2018-02 is effective for annual and interim periods beginning after December 15, 2018. Early adoption of the amendments in this update is permitted, including adoption in any interim period for which financial statements have not yet been issued. The amendments in ASU 2018-02 must be applied in the period of adoption or retrospectively to each period in which the effect of the change in U.S. federal corporate income tax rate in the Tax Act is recognized. We elected to early adopt ASU 2018-02 and related amendments effective January 1, 2018. An adjustment of $40 was recognized against retained earnings for effect of the change in the federal corporate income tax rate on deferred tax amounts. There are no related adjustments to the Company’s valuation allowance and no other income tax effects from the Tax Act on balances that remain in accumulated other comprehensive income were reclassified.  

Tax Act

In January 2018, the FASB released guidance on the accounting for tax on the global intangible low-taxed income (“GILTI”) provisions of the Tax Act. The GILTI provisions impose a tax on foreign income in excess of deemed return on tangible assets of foreign corporations. During the first quarter of 2018, the Company elected to treat any potential GILTI inclusions as a period cost.

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 2 – Basis of Presentation and New Accounting Pronouncements – Continued

Recently Issued Accounting Pronouncements Not Yet Adopted

Goodwill Impairment

In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” ASU 2017-04 modified the concept of impairment of goodwill to be a condition that exists when the carrying value of a reporting unit that includes goodwill exceeds its fair value. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, limited to the total amount of goodwill allocated to that reporting unit. Entities no longer will determine goodwill impairment by calculating the implied fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if the reporting unit had been acquired in a business combination.

ASU 2017-04 is effective for annual and any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption of the amendments in this update is permitted. The amendments in ASU 2017-04 must be applied on a prospective basis and in the initial period of adoption, entities must disclose the nature of and reason for the change in accounting principle. The Company expects adoption of ASU 2017-04 will reduce the complexity of evaluating goodwill for impairment.

Leases  

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).”  ASU 2016-02 requires lessees to recognize on their balance sheet a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. Payments to be made in optional periods should be included in the measurement of lease assets and liabilities if the lessee is reasonably certain it will exercise an option to extend the lease or not exercise an option to terminate the lease.  While ASU 2016-02 continues to differentiate between finance or capital leases and operating leases, the principal change from current lease accounting guidance is that lease assets and liabilities arising from operating leases will be recognized on the balance sheet.  

ASU 2016-02 is effective for fiscal years and interim periods beginning after December 15, 2018. Early adoption of the amendments in this update are permitted.  Lessees are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach which includes a number of practical expedients, including the ability to use hindsight in evaluating lessee options to extend or terminate a lease.  An entity that elects to apply the practical expedients will be required to recognize a right-of-use asset and lease liability for all operating leases at each reporting date based on the present value of the remaining minimum rental payment that were tracked and disclosed under previous GAAP.  We are currently in the process of determining the impact the implementation of ASU 2016-02 will have on the Company’s financial statements.

Note 3 — Etratech Acquisition

Etratech designs, develops, manufactures and sells electronic control modules and control systems to customers across a range of industries, including automotive, recreational vehicles and marine, HVAC systems and medical, amongst others.  Each function is part of an integrated, customer-focused process designed to exceed customer expectations for product quality, reliability and cost. Etratech’s global manufacturing footprint will enable us to provide customers with scalable and flexible manufacturing solutions across a variety of application and geographies.

Results of operations for Etratech are included in the Company’s consolidated condensed financial statements beginning November 1, 2017.  Etratech contributed $15,201 and $30,389 in product revenues and $678 and $426 in net income for the three and six-month periods ended June 30, 2018, respectively.  

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 3 – Etratech Acquisition – Continued

Purchase Price Allocation

The purchase price of $65,009, net of cash acquired of $670, has been allocated to the values of assets acquired and liabilities assumed as of November 1, 2017.  The purchase price allocation was finalized March 31, 2018. The purchase price allocation as of November 1, 2017 was as follows:

 

 

The gross contractual amount due of accounts receivable is $12,654, all of which is expected to be collectible.  

Supplemental Pro Forma Information

The unaudited pro forma combined historical results including the amounts of Etratech revenue and earnings that would have been included in the Company’s consolidated statements of income had the acquisition date been January 1, 2017 is as follows:

 

The pro forma information includes adjustments for the effect of the amortization of intangible assets recognized in the acquisition.  This pro forma information is not indicative of future operating results.

Goodwill

We recorded goodwill of approximately $14,881 arising from the acquisition. The acquired goodwill represents intangible assets that do not qualify for separate recognition. It is estimated that approximately $8,651 of the goodwill recognized will not be deductible for income tax purposes.  

Intangible Assets

In conjunction with the acquisition, intangible assets of $33,362 were recorded. The Company’s estimate of the fair value of these assets at the time of the acquisition was determined with the assistance of an independent third-party valuation firm. As part of the estimated valuation, an estimated useful life for the assets was determined.

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 3 – Etratech Acquisition – Continued

Intangible assets, net consisted of the following (balances are lower as of June 30, 2018 than as of November 1, 2017, the acquisition date, due to fluctuations in foreign currency exchange rates totaling $1,027):

 

Amortization expenses of $889 and $1,847 during the three and six months ended June 30, 2018, respectively, were recognized in our consolidated condensed statement of income as follows:

 

Amortization expense for the prospective five years is expected to be as follows:

 

Property, Plant & Equipment

Property and equipment consist of the following:

 

 

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 4 – 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:

 

 

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.

 

Note 5 – 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. As discussed in Note 3, Gentherm acquired Etratech on November 1, 2017.

The Company’s reportable segments are as follows:

The tables below present segment information about the reported product revenues, depreciation and amortization and operating income (loss) of the Company for three and six-month periods ended June 30, 2018 and 2017. With the exception of goodwill, asset information by segment is not reported since the Company does not manage assets at a segment level. As of June 30, 2018, goodwill assigned to our Automotive and Industrial segments were $38,072 and $30,773, respectively. As of June 30, 2017, goodwill assigned to our Automotive and Industrial segments were $22,724 and $30,773, respectively.

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 5 – Segment Reporting – Continued

 

 

Total product revenues information by geographic area is as follows:

 

 

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 5 – Segment Reporting – Continued

 

 

Note 6 – Debt

Amended Credit Agreement

The Company, together with certain direct and indirect subsidiaries, have an outstanding credit agreement (as amended, the “Credit Agreement”) with a consortium of lenders and Bank of America, N.A., as administrative agent. The Credit Agreement provides the Company a revolving credit note (“U.S. Revolving Note”) with a maximum borrowing capacity of $350,000.  

All subsidiary borrowers and guarantors participating in the Credit Agreement have entered into a related pledge and security agreement.  The security agreement grants a security interest to the lenders in substantially all of the personal property of subsidiaries designated as borrowers to secure their respective obligations under the Credit Agreement, including the stock and membership interests of specified subsidiaries (limited to 66% of the stock in the case of certain non-US subsidiaries).  The Credit Agreement restricts the amount of dividend payments the Company can make to shareholders.

The Credit Agreement requires the Company to maintain a minimum Consolidated Interest Coverage Ratio and Consolidated Leverage Ratio. Definitions for these financial ratios are provided in the Credit Agreement.

Under the Credit Agreement, U.S. Dollar denominated loans bear interest at either a base rate (“Base Rate Loans”) or Eurocurrency rate (“Eurocurrency Rate Loans”), plus a margin (“Applicable Rate”). The rate for Base Rate Loans is equal to the highest of the Federal Funds Rate (1.91% at June 30, 2018) plus 0.50%, Bank of America’s prime rate (5.0% at June 30, 2018), or a one-month Eurocurrency rate (0.00% at June 30, 2018) plus 1.00%. The rate for Eurocurrency Rate Loans denominated in U.S. Dollars is equal to the London Interbank Offered Rate (2.09% at June 30, 2018).  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 Credit Agreement, the lowest and highest possible Applicable Rate is 1.25% and 2.00%, respectively, for Eurocurrency Rate Loans and 0.25% and 1.00%, respectively, for Base Rate Loans.

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”), is subject to semi-annual principal payments that began March, 2015 and will end September, 2019. Under the terms of the DEG China Loan, the Company must maintain a minimum Debt-to-Equity Ratio, Current Ratio and Debt Service Coverage Ratio, as defined by the DEG China Loan agreement, based on the financial statements of Gentherm’s wholly owned subsidiary, Gentherm Automotive Systems (China) Ltd.

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 6 – Debt – Continued

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 Current Ratio, 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 $250,934 as of June 30, 2018. The following table summarizes the Company’s debt at June 30, 2018 and at December 31, 2017.

 

The scheduled principal maturities of our debt as of June 30, 2018 are as follows:

Principal outstanding under the U.S. Revolving Note will be due and payable in full on March 17, 2021. As of June 30, 2018, we were in compliance, in all material respects, with all terms as outlined in the Credit Agreement, DEG China Loan and DEG Vietnam Loan.

Note 7 – 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 Credit Agreement. Foreign currency exchange risks are attributable to sales to foreign customers and purchases from foreign suppliers not denominated in the location’s functional currency, foreign plant operations, 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 $22,397 and $29,273 outstanding as of June 30, 2018 and December 31, 2017, respectively.  

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 7 – Derivative Financial Instruments – Continued

The maximum length of time over which we hedge our exposure to price fluctuations in material commodities is two years.  We had copper commodity swap contracts with a notional value of $0 and $404 outstanding at June 30, 2018 and December 31, 2017, respectively.

We do not enter into derivative financial instrument arrangements 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 income (loss) in the consolidated condensed balance sheet.  When the underlying hedge transaction is realized, the gain or loss included in accumulated other comprehensive income (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 gain (loss) in the consolidated condensed statements of income. See Note 9 for unrealized gains (losses) associated with derivatives reported in accumulated other comprehensive income as of December 31, 2017 that was reclassified into earnings during 2018. 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 June 30, 2018 is as follows:  

 

         Information relating to the effect of derivative instruments on our consolidated condensed statements of income is as follows:

 

We did not incur any hedge ineffectiveness during the three and six-month periods ended June 30, 2018 and 2017.

Note 8 – Fair Value Measurement

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.

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 8 – Fair Value Measurement – Continued

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.

Except for derivative instruments (see Note 7), pension liabilities, pension plan assets and a corporate owned life insurance policy, the Company had no material financial assets and liabilities that are carried at fair value at June 30, 2018 and December 31, 2017. The carrying amounts of financial instruments comprising cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair values due to the relatively short maturity of such instruments. 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 June 30, 2018 and December 31, 2017, the carrying values of the Credit Agreement indebtedness 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 6).  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 June 30, 2018, the carrying values of the DEG Vietnam Loan and DEG China Loan was $12,500 and $1,400, respectively, as compared to an estimated fair value of $12,200 and $1,400, respectively. As of December 31, 2017, the carrying value of the DEG Vietnam Loan and DEG China Loan was $13,750 and $1,919, respectively, as compared to an estimated fair value of $13,600 and $2,000, respectively.

Certain Company assets are required to be recorded at fair value on a non-recurring basis when events and circumstances indicate that the carrying value may not be recoverable. As of June 30, 2018 and December 31, 2017, the Company did not realize any changes to the fair value of these assets due to the non-occurrence of events or circumstances that could negatively impact their recoverability.

Note 9 – Reclassifications Out of Accumulated Other Comprehensive Income (Loss)

Reclassification adjustments and other activities impacting accumulated other comprehensive income (loss) during the three and six-month periods ended June 30, 2018 and June 30, 2017 are as follows:

 

 

 

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 9 – Reclassifications Out of Accumulated Other Comprehensive Income (Loss) – Continued

 

 

(a)The amounts reclassified from accumulated other comprehensive income (loss) are included in cost of sales.

 

 

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GENTHERM INCORPORATED

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(In thousands, except share and per share data)

(Unaudited)

 

Note 9 – Reclassifications Out of Accumulated Other Comprehensive Income (Loss) – Continued

 

 

We expect all of the existing gains and losses related to foreign currency derivatives and commodity derivatives reported in accumulated other comprehensive income as of June 30, 2018 to be reclassified into earnings during the next twelve months. See Note 7 for additional information about derivative financial instruments and the effects from reclassification to net income.

Note 10 – Unearned Revenue

Unearned revenue by segment was as follows:

 

Changes in unearned revenue were as follows:

 

Revenue allocated to remaining performance obligations represent 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.

 

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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 new strategic plan, our ability to finance sufficient working capital, the amount of availability under our 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,” and Note 1 to the consolidated condensed financial statements. 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 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, 2017, and subsequent reports filed with or furnished to the Securities and Exchange Commission, and which could cause actual results to differ materially from that described in the forward-looking statements.  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, 2017.

Overview

Gentherm Incorporated is a global technology and industry leader in the design, development, and manufacturing of innovative thermal management technologies.  Our products provide solutions for automotive passenger comfort and convenience, battery thermal management, remote power generation, patient temperature management, environmental product testing and other consumer and industrial temperature control needs. 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 in order to provide locally enhanced design, integration and production capabilities and to identify future thermal technology product opportunities in both automotive and other markets.   We concentrate our research on the development of new technologies and new applications from existing technologies to create product and market opportunities for a wide array of thermal management solutions.  

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.

The Company has two reportable segments for financial reporting purposes: Automotive and Industrial.  See Note 5 to our 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.

Etratech

On November 1, 2017, we acquired substantially all of the assets and assumed substantially all of the operating liabilities of Etratech Inc. (“Etratech”), an Ontario corporation and all of the outstanding shares of Etratech Hong Kong, an entity organized under the laws of Hong Kong, in an all-cash transaction.  Etratech manufactures advanced electronic controls and control systems for the automotive, RV and marine, security, medical and other industries. Etratech’s world headquarters and North American manufacturing operations are located in Burlington, Canada. See Note 3 to the consolidated condensed financial statements for additional information regarding the acquisition of Etratech.  

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New Strategic Plan

On June 25, 2018, Gentherm announced a new strategic plan intended to improve business performance and position the company to deliver above-market growth and improved profitability to its shareholders. An important element of the strategy is the Fit-for-Growth initiative that focuses on purchasing excellence, rationalization of research and development activities and expenses, reducing selling, general and administrative expense, minimization or elimination of investments in non-core areas and developing a manufacturing footprint commensurate with the new plan. Non-core areas of investment so far identified under the Fit-for-Growth initiative are concentrated in the following areas of Gentherm’s industrial segment: California Advanced Research and Development, Gentherm Global Power Technologies (GPT) and Cincinnati Sub Zero’s Industrial Chamber business (CSZ-IC).  

The strategy also identified several product categories the Company will exit, including furniture, aviation, battery management electronics, industrial battery packs, automotive thermoelectric generators and other non-core electronics.

See Note 1 to our consolidated condensed financial statements for information about our Fit-for-Growth initiative, related cost savings and related restructuring costs.

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. See Note 2 to our consolidated condensed financial statements for information about critical accounting policies, accounting standard updates adopted during the six-month period ended June 30, 2018 and their impact on the Company’s consolidated financial statements, and recently issued accounting policies not yet adopted.

Results of Operations Second Quarter 2018 Compared with Second Quarter 2017

Product Revenues. Product revenues for the three-month period ended June 30, 2018 (“Second Quarter 2018”) were $263.8 million compared with product revenues of $243.4 million for the three-month period ended June 30, 2017 (“Second Quarter 2017”), an increase of $20.4 million, or 8%.  Higher product revenues in the automotive segment, which increased by $25.0 million, or 12%, to $240.8 million, were partially offset by lower industrial segment product revenues which decreased by $4.6 million, or 17%, to $23.0 million.  The higher automotive segment sales included $15.2 million related to Etratech and a favorable effect from currency translation of $6.5 million. Etratech was acquired on November 1, 2017 and therefore no product revenue was reported for Etratech during Second Quarter 2017. On a pro-forma basis, Etratech revenue increased more than 7%.

Without the benefit of the currency translation and adjusting for the Etratech acquisition, automotive segment product revenue would have increased by 2%. This increase occurred despite lower automotive production volumes in North America, our most important geographic market.  These increases were partially offset by annual price reductions totaling $6.5 million and from a lower average selling price of climate controlled seats (“CCS”) resulting from certain vehicle programs changing technologies from the higher priced active cooling application to heated and ventilated seating technology. In North America, which represented approximately 47% of our automotive revenue during Second Quarter 2018, automotive production decreased by 2.5% during Second Quarter 2018.  Lower production significantly impacted two important customers in Second Quarter 2018.  Automotive production at Ford, representing 11% of our product revenues, was down more than 13% in North America and production for Hyundai, representing 8% of our product revenues, was down by 5% in Korea and down 10% in North America.  These lower production volumes disproportionately impacted our CCS products more than our other products. All of our other automotive products had higher revenue despite the weak production volumes.  Battery Thermal Management products (“BTM”), which includes the actively cooled version launched this year, grew by $4.6 million, or 170%, to $7.2 million due to the launch of the second vehicle program with actively cooled BTM on the Jeep Wrangler in addition to the first ever actively cooled BTM launched on the Mercedes S-Class during the 2018 first quarter.  Other programs showing significant growth included Steering Wheel Heaters which increased by $3.0 million, or 21% to $17.5 million, automotive cable systems which grew by $3.7 million, or 17%, to $25.6 million and automotive seat heaters which grew by $6.4 million, or 9%, to $80.2 million.  On a combined basis all automotive product revenue, adjusting for currency translation and the Etratech acquisition and excluding CCS, grew by nearly 10%.

Product revenues from Gentherm Global Power Technologies (“GPT”), included in the industrial segment, totaled $5.2 million which represented a decrease of $2.3 million, or 31%.  This decrease was mainly due to significantly lower custom project revenue. Custom projects, which typically represent more than 50% of GPT’s product revenue, tend to vary significantly period-to-period due to timing of the relatively large per unit revenue.  Revenue for Cincinnati Sub-Zero Products, LLC (“CSZ”) during Second Quarter 2018 was $17.8 million, representing a decrease of $2.3 million, or 11%.  This decrease was mainly due to lower product revenue on climate testing chambers offset partially by higher product revenues of medical products.  The climate chamber product revenue decrease of $2.7 million, or 20%, was primarily due to unusually high product revenues during Second Quarter 2017 which benefited

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from the shipment of several large custom projects.  CSZ’s medical product revenues increased by $386 thousand, or 5%, during the Second Quarter 2018.

Cost of Sales. Cost of sales increased to $189.3 million during Second Quarter 2018 from $165.1 million during Second Quarter 2017. This increase of $24.2 million, or 15%, was due to the higher product revenue and a lower gross margin percentage.  The gross margin percentage during Second Quarter 2018 decreased to 28.2% from 32.2% during Second Quarter 2017 primarily due to changes in product mix, timing differences between annual customer price decreases compared to supplier cost reductions, lower margin on BTM associated with the launch phase of the new actively cooled technology programs and the lower margin of Etratech, partially offset by fixed cost leverage from higher unit volume.  An unfavorable shift in product mix largely was due to lower sales for higher margin products including CCS and GPT.  Annual price reductions start in the first quarter and are expected to be offset by lower supplier and other costs as those programs begin to take effect throughout the year.  The new actively cooled battery thermal management product being launched in our Macedonia facility is anticipated to generate annual revenue in the range of $50 to $60 million but is still in the early phase with only $4.5 million in product revenues during the Second Quarter 2018.  Lower gross margin on this product during this period is due to launch related expenses and higher fixed overhead costs, including depreciation expense, being incurred in anticipation for the much higher expected volumes.  We expect that higher revenues of BTM units will offset these expenses in future periods.

On July 6, 2018, tariffs announced by the Office of the United States Trade Representative (USTR) under the Section 301 Action went into effect. All items identified as classified under the Harmonized Tariff Schedule of the United States (HTSUS) with a country of origin of China are subject to a 25% duty upon importation into the United States. Gentherm purchases raw material components, including products manufactured in our China facilities, that are subject to the tariff.  As a result, we estimate higher raw material expenses ranging from $3 to $5 million during the second half of 2018. This estimate includes the 25% duty effecting identified items under HTSUS, plus an additional 10% duty on a second statement of goods that has been proposed but has not gone into effect. We are working with our suppliers and customers to mitigate the impact from these tariffs to the Company’s operating results.

Net Research and Development Expenses. Net research and development expenses were $21.0 million during Second Quarter 2018 compared to $21.4 million in Second Quarter 2017, a decrease of $385 thousand, or 2%. Higher research and development reimbursements totaling $3.0 million was partially offset by higher research and development expenses.  These increased expenses were primarily driven by higher costs for additional resources, including personnel, focused on application engineering for new production programs of existing products, development of new products and a program to develop the next generation of seat comfort products.  The increase also included approximately $712 thousand in foreign currency translation and the net research and development expenses of Etratech totaling $630 thousand.  New product development included automotive cooled storage devices, automotive interior thermal management devices, medical thermal management devices, battery thermal management devices, battery management systems, advanced automotive electronics solutions and other potential products. We expect that the new strategy announced on June 25, 2018 will result in a decrease in research and development expenses and a reallocation of certain resources to products that meet the requirements of the new focused growth strategy.

Research and development reimbursement totaled $4.6 million during Second Quarter 2018 and $1.6 million during Second Quarter 2017.  This increase was mainly attributable to development expense reimbursements paid by customers for products launched during the period and the addition of Etratech.

Selling, General and Administrative Expenses. Selling, general and administrative expenses were $31.6 million during Second Quarter 2018, a decrease of $134 thousand from $31.8 million during Second Quarter 2017.  Increases in selling, general and administrative expenses associated with the acquisition of Etratech totaling $1.3 million, mark-to-market adjustments on cash settled stock options totaling $889 thousand and foreign currency translation totaling $392 thousand, were more than offset by lower expenses associated with the early cost reduction activities of the Company’s new strategic initiatives.

Foreign currency gain (loss).  During Second Quarter 2018 we incurred a net foreign currency gain of $5.2 million which included a net realized gain of $632 thousand and a net unrealized gain of $4.5 million.  The unrealized gain is primarily the result of holding significant amounts of U.S. Dollar (“USD”) cash at our subsidiaries in Europe which have the European Euro (“EUR”) as the functional currency and due to certain intercompany relationships between these European subsidiaries and our U.S. based companies.  During Second Quarter 2018, the USD strengthened relative to the EUR.  If the USD begins weakening, we will likely have unrealized currency losses whereas if the USD continues to strengthen we will likely have additional unrealized gains.  Second Quarter 2017, we had a foreign currency loss of $13.3 million.  In comparison to Second Quarter 2017, the foreign currency impact in Second Quarter 2018 was lower due to a smaller change in currency exchange rates during Second Quarter 2018 as compared to Second Quarter 2017.

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Income Tax Expense. We recorded an income tax expense of $3.1 million during Second Quarter 2018 representing an effective tax rate of 16% on earnings before income tax of $19.7 million.  During Second Quarter 2017, we recorded an income tax expense of $2.4 million on earnings before tax of $10.9 million, or 22%. The effective tax rate for Second Quarter 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 transactions which disproportionately benefited lower tax rate jurisdictions which were partially offset by the international provisions from the U.S. tax reform, such as global intangible low-tax income (“GILTI”), enacted in December 2017.  The effective tax rate for Second Quarter 2017 was lower than the U.S. Federal rate of 34% primarily due to the impact of lower statutory rates for our subsidiaries operating in foreign jurisdictions. 

Industrial Segment Operating Loss. The Industrial segment, which includes CSZ, GPT and our advanced research and development activities, reported an operating loss totaling $7.9 million and $2.7 million during Second Quarter 2018 and Second Quarter 2017, respectively. We incurred these losses for several reasons. First, the advanced research and development activities, the total cost for which were $3.1 million and $3.3 million, during Second Quarter 2018 and Second Quarter 2017, respectively, are focused on products and technologies that are currently not generating product revenues.  Second, in conjunction with the Fit-for-Growth initiative, some of these advanced research and development activities have been curtailed or ceased and a process has been started to consolidate our advanced research facilities into few locations.  These changes are expected to lead to lower spending rates in future periods.  Because of this, the industrial segment operating loss included a portion of the restructuring charge totaling $3.7 million.  We expect that the remaining advanced technology projects will generate profitable revenue in future periods.  Next, CSZ’s $1.2 million of expenses associated with a new direct sales force is not yet fully offset by a corresponding increase in the amount of revenue and related operating income. We continue to believe that the direct sales force will lead to higher CSZ product revenue in future periods that will generate operating profits in excess of the costs for the direct sales team.

Results of Operations First Half 2018 Compared with First Half 2017

Product Revenues. Product revenues for the six-month period ended June 30, 2018 (“First Half 2018”) were $525.7 million compared with product revenues of $492.6 million for the six-month period ended June 30, 2017 (“First Half 2017”), an increase of $33.0 million, or 7%.  Higher product revenues in the automotive segment which increased by $44.2 million, or 10%, to $481.8 million were partially offset by lower industrial segment product revenues which decreased by $10.2 million, or 19%, to $44.8 million.  The higher automotive segment sales included $30.4 million related to the acquisition of Etratech and a favorable effect from currency translation of $17.0 million. Etratech was acquired on November 1, 2017 and therefore no product revenue was reported for Etratech during First Half 2017. On a pro-forma basis, Etratech revenue increased by 13%.

Without the benefit of the currency translation and adjusting for the Etratech acquisition, automotive segment product revenue would have been unchanged during First Half 2018 as compared to First Half 2017.  Growth measured on this basis during Second Quarter 2018 was fully offset by decreased revenue in the 2018 first quarter.  

Product revenues from GPT, included in the industrial segment, totaled $9.73 million which represented a decrease of $5.2 million, or 35%.  This decrease was mainly due to significantly lower custom project revenue. Custom projects, which typically represent more than 50% of GPT’s product revenue, tend to vary significantly period-to-period due to timing of the relatively large per unit revenue.  Revenue for CSZ during First Half 2018 was $35.1 million, representing a decrease of $5.0 million, or 12.5%.  This decrease was mainly due to lower climate chamber product revenue which decreased by $2.7 million, or 12%, to $20.5 million as a result of unusually high product revenues during First Half 2017 which benefited from the shipment of several large customer projects.  CSZ’s medical sales also declined by $2.3 million, or 13%, to $14.6 million mainly due to a $2.6 million decline in sales of the blood heater-cooler product that was higher during First Half 2017 due to the regulatory disruptions impacting a competitive product.

Cost of Sales. Cost of sales increased to $372.7 million during First Half 2018 from $329.2 million during First Half 2017. This increase of $43.5 million, or 13%, was due to the higher product revenue and a lower gross margin percentage.  The gross margin percentage during First Half 2018 decreased to 29.1% from 33.2% during First Half 2017 mainly as a result of timing differences between annual customer price decreases compared to supplier cost reductions, increased manufacturing expenses, changes in product mix favoring lower margin products and lower margin on BTM associated with the launch phase of the new actively cooled technology programs and the lower margin of Etratech, partially offset by fixed cost leverage from higher unit volume.  Annual price reductions start in the first quarter and are expected to be offset by lower supplier and other costs as those programs begin to take effect throughout the year.  Increased expenses included labor expense inflation at our Ukraine factory, and factory launch expenses for the new advanced battery thermal management product in our Macedonia facility. An unfavorable shift in product mix largely was due to lower sales for higher margin products including CCS, GPT and the medical products of CSZ.

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Net Research and Development Expenses. Net research and development expenses were $44.3 million during First Half 2018 compared to $40.9 million in First Half 2017, an increase of $3.4 million, or 8%.  This increase was primarily driven by higher costs for additional resources, including personnel, focused on application engineering for new production programs of existing products, development of new products and a program to develop the next generation of seat comfort products.  The increase also included approximately $1.5 million in foreign currency translation and the net research and development expenses of Etratech totaling $1.3 million.  These amounts were partially offset by $3.1 million in higher research and development reimbursements.  

Research and development reimbursement totaled $7.0 million during First Half 2018 and $3.8 million during First Half 2017.  This increase was mainly attributable to development expense reimbursements paid by customers for products launched during the period and the addition of Etratech.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased to $65.4 million during First Half 2018, an increase of $2.8 million, or 4%, from $62.6 million during First Half 2017.  This increase includes approximately $1.4 million in higher expenses related to currency translation and $3.2 million in selling, general and administrative expenses of Etratech.  These increases were partially offset by lower mark-to-market adjustments on cash settled stock options totaling $706 thousand and by lower expenses associated with the early cost reduction activities of the Company’s new strategic initiatives.

Foreign currency gain (loss).   During First Half 2018, we incurred a net foreign currency gain of $600 thousand which included a net realized loss of $294 thousand and a net unrealized gain of $890 thousand.  The unrealized gain is primarily the result of holding significant amounts of USD cash at our subsidiaries in Europe which have EUR as the functional currency and due to certain intercompany relationships between these European subsidiaries and our U.S. based companies.  During First Half 2018, the USD strengthened relative to the EUR.  If the USD begins to weaken we will likely have unrealized currency losses whereas if the USD continues to strengthen we will likely have additional unrealized gains.  In First Half 2017, we had a net foreign currency loss of $14.6 million.  In comparison to First Half 2017, the foreign currency impact in First Half 2018 was lower due to a smaller change in currency exchange rates during First Half 2018 as compared to First Half 2017.

Income Tax Expense. We recorded an income tax expense of $6.1 million during First Half 2018 representing an effective tax rate of 17% on earnings before income tax of $35.7 million.  During First Half 2017, we recorded an income tax expense of $9.6 million on earnings before tax of $43.5 million, or 22%. The effective tax rate for First Half 2018 differed from the Federal statutory rate of 21% primarily due to the impact of discrete adjustments, including a favorable excess tax benefit on stock option exercises, certain intercompany transactions which disproportionately benefited lower tax rate jurisdictions and the impact of lower statutory rates for our subsidiaries operating in foreign jurisdictions offset by the international provisions from the U.S. tax reform, such as GILTI, enacted in December 2017.  The effective tax rate for First Half 2017 was lower than the U.S. Federal rate of 34% primarily due to the impact of lower statutory rates for our subsidiaries operating in foreign jurisdictions. 

Industrial Segment Operating Loss. The Industrial segment, which includes CSZ, GPT and our advanced research and development activities, reported an operating loss totaling $14.6 million and $5.1 million during First Half 2018 and First Half 2017, respectively. We incurred these losses for several reasons. First, the advanced research and development activities, the total cost for which were $6.9 million and $7.3 million, during First Half 2018 and First Half 2017, respectively, are focused on products and technologies that are currently not generating product revenues.  Second, in conjunction with the Fit-for-Growth initiative, some of these activities have been curtailed or ceased and a process has been started to consolidate our advanced research facilities into few locations.  These changes are expected to lead to lower spending rates in future periods.  Because of this, the industrial segment operating loss included a portion of the restructuring charge totaling $3.8 million.  We expect that the remaining advanced technology projects will generate profitable revenue in future periods.  Next, CSZ’s $2.4 million of expenses associated with a new direct sales force is not yet fully offset by a corresponding increase in the amount of revenue and related operating income. We continue to believe that the direct sales force will lead to higher CSZ product revenue in future periods that will generate operating profits in excess of the costs for the direct sales team.

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 fourth a capital allocation strategy that includes a targeted debt to earnings leverage ratio and allows for some of our cash flow to be paid back to investors though common stock buybacks.  On June 25, 2018 our board increased the Company’s stock buyback authorization to $300 million under which we had $274 remaining as of June 30, 2018.  This authorization expires on December 31, 2020. Based on its current operating plan, management believes cash and cash equivalents at June 30, 2018, together with cash flows from operating activities, and borrowing 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

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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 a number of 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 short-term investments:

 

Cash Flows From Operating Activities

We manage our cash, cash equivalents and short-term investments in order to fund operating requirements and preserve liquidity to take advantage of future business opportunities. The following table compares the cash flows from operating activities during First Half 2018 and First Half 2017:

 

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Cash provided by operating activities during First Half 2018 was $32.5 million, representing an increase of $26.4 million from cash provided in operating activities during First Half 2017, which was $6.1 million. The following table highlights significant differences between the operating cash flows for the periods ending June 30, 2018 and 2017, respectively:

 

Net cash provided by operating activities before changes in operating assets and liabilities increased during First Half 2018 due to higher revenue offset partially by higher expenses.

In addition, operating cash flows were lower due to income tax payments related to reorganization transactions of our North American business operations (the “Reorganization”).  As part of our original integration plan to eliminate redundancies associated with the 2011 acquisition of Gentherm GmbH (formerly named W.E.T. Automotive Systems AG), the Windsor Operations were consolidated into our existing European and North American facilities.

Related to these reorganization transactions, the Company declared intercompany dividends, incurred and paid withholding taxes to the Canadian Revenue Agency of $7.6 million during 2016.  Additionally, the Company incurred income tax expense of $2.5 million related to the intercompany dividends. These amounts incurred are expected to cover all future intercompany dividends needed to distribute the remaining earnings of the subsidiary to its parent in conjunction with the potential future liquidation of the subsidiary. 

In addition to the $7.6 million of withholding tax and $2.5 million of income taxes, the Company was required to make a one-time income tax payment of approximately $32.6 million.  The one-time income tax payment was accrued during the first quarter of 2016; however, the Company also recorded an offsetting deferred charge for approximately the same amount because the one-time income tax payment will result in tax deductions against income taxes in future periods. Therefore, the income tax payment did not have a material impact on the Company’s earnings during the first quarter of 2016 nor any subsequent quarter. The withholding tax payment was paid entirely in 2016. The income tax payments of $2.5 million and $32.6 million were paid during the first quarter of 2017.  

   Other changes in working capital, net primarily consist of favorable cash flows related to accounts receivable, prepaid expenses and other assets and unfavorable amounts related to inventory and accounts payable.

Working Capital

The following table illustrates changes in working capital during First Half 2018:

 

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Our working capital decreased due to a net repayment of a portion of the Company’s outstanding debt balance, cash paid to the buy back Common Stock and a decrease in accounts payable, partially offset by three significant increases, including currency translation, an increase in accounts receivable and tax receivable, and non-cash adjustments from the adoption of new accounting standard updates.  During First Half 2018, management repaid $45.0 million of the outstanding U.S. Revolving Note balance, $1.2 million of the outstanding DEG Vietnam Loan and $0.5 million of the outstanding DEG China Loan from cash from operations and cash repatriated from foreign subsidiaries. The currency impact of $2.8 million on working capital is mainly the result of the currency translation of working capital at our European subsidiaries. At June 30, 2018, the U.S. Dollar/European Euro exchange rate was $1.17 as compared with an exchange rate of $1.23 at December 31, 2017. Approximately 20% of our product revenues are generated in Europe. Working capital was also impacted by an increase in account receivable, which was driven by higher sales in June 2018 as compared to December 2017.  Our sales are typically lower in December each year due to temporary factory holiday shut-downs at our automotive customers. During First Half 2018, Gentherm recognized an increase to current tax receivables related to timing of required payments to tax authorities. Lastly, working capital was impacted by the adoption of Accounting Standard Update 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory” and Accounting Standard Update 2014-09, “Revenue from Contracts with Customers (Topic 606).”  See Note 2 to our consolidated condensed financial statements for information about these accounting standard updates and their impact on the Company’s consolidated condensed financial statements.

Cash Flows From Investing Activities

Cash used in investing activities was $21.5 million during First Half 2018, reflecting purchases of property and equipment related to the expansion of production capacity, including at our newest facilities in Mexico, Vietnam, Macedonia and our Etratech facility in Canada.

Cash Flows From Financing Activities

Cash used in financing activities was $47.9 million during First Half 2018, reflecting payments of principal on the U.S. Revolving Note, the DEG China Loan and the DEG Vietnam Loan totaling $46.7 million in aggregate.  As of June 30, 2018, the total availability under the U.S. Revolving Note was $250.9 million. Cash was also paid for cancellations of restricted stock awards totaling $882 thousand, and for the repurchase of Common Stock totaling $20.2 million.

Off-Balance Sheet Arrangements

We use letters of credit to guarantee our performance under specific construction contracts executed by our subsidiaries, GPT and CSZ.  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 June 30, 2018, we had outstanding letters of credit of $66 thousand, a decrease from $141 thousand at December 31, 2017.  

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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 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 $22.4 million and $29.3 million outstanding at June 30, 2018 and December 31, 2017, respectively.

The maximum length of time over which we hedge our exposure to price fluctuations in material commodities is two years.  We had copper commodity swap contracts with a notional value of $0 and $404 thousand outstanding at June 30, 2018 and December 31, 2017, 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 income (loss) in the consolidated condensed balance sheet.  When the underlying hedge transaction is realized, the gain or loss included in accumulated other comprehensive income (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 gain (loss) in the consolidated condensed statements of income. Though we continuously monitor the hedging program, derivative positions and hedging strategies, foreign currency forward exchange agreements have not always been designated as hedging instruments for accounting purposes.

The Company uses 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 June 30, 2018 is set forth in Note 7 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 US dollars ($USD) or European Euros (€EUR), as indicated in parentheses.

June 30, 2018

 

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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.

June 30, 2018

 

(a) Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this quarterly report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2018, our disclosure controls and procedures were effective to ensure the information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods prescribed by the Securities and Exchange Commission, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

(b) Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2018 that have materially affected, or are reasonably likely to materially effect, our internal control over financial reporting.

 

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PART II OTHER INFORMATION

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 three or six months ended June 30, 2018.  

Rising threats of international tariffs, including tariffs applied to goods traded between the United States and China, could materially and adversely affect our business and results of operations.

Since the beginning of 2018, there has been increasing rhetoric, in some cases coupled with legislative or executive action, from several U.S. and foreign leaders regarding the possibility of instituting additional tariffs against foreign imports of certain materials and products.  In March and April of 2018, the U.S. and China have applied tariffs to certain of each other’s exports. The institution of trade tariffs both globally and between the U.S. and China specifically carries the risk of negatively impacting overall economic conditions, which could have negative repercussions on the Company. Furthermore, imposition of tariffs has caused and could cause further increases in the costs of our raw materials, which we may not be able to pass on to our customers, which would directly and negatively impact our business.

There were no other 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, 2017.  You should carefully consider the risks and uncertainties described therein.

Issuer Purchases of Equity Securities During Second Quarter 2018

 

 

 

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Exhibits to this Report are as follows:

 

*   Indicates management contract or compensatory plan or arrangement

** Documents are furnished not filed

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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.

 

 

 

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