Gentherm Inc
NASDAQ:THRM
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Gentherm Inc
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Greetings, and welcome to the Gentherm Fourth Quarter and Year End 2022 Earnings Conference Call and Strategy Update. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the call over to Yijing Brentano, Senior Vice President of Strategy, Corporate Development and Investor Relations. Thank you. You may begin.
Thank you, and good morning, everyone, and thanks for joining us today.
Gentherm's earnings results were released earlier this morning and a copy of the release is available at gentherm.com. In addition to discussing fourth quarter and full year 2022 results, Phil Eyler, our President and CEO; and Matteo Anversa, our CFO, will also share Gentherm's strategic plan for 2023 and beyond.
You will be able to see the slides on your webcast screen when we advance through them here in the room. A copy of the complete slide deck will be posted under the Events tab in the Investor Relations section of gentherm.com immediately following the completion of Phil and Matteo's prepared comments.
In addition, an audio replay of this event will be available for 90 days. Additionally, a webcast replay of today's call will be available later today on the Investor Relations section of Gentherm's website.
During this call, we may make forward-looking statements within the meaning of federal security laws. Statements reflect our current views with respect to future events and financial performance, and actual results may differ materially due to a variety of important factors and risks. All statements that address future operating, financial or business performance or Gentherm strategies or expectations are forward-looking statements.
In making these statements, we rely on assumptions and analysis based on our experience and perception of historical trends, current conditions and expected future developments as well as other factors we consider appropriate under the circumstances. We undertake no obligation to update them except as required by law.
Please see Gentherm's earnings release and its SEC filings, including the latest 10-K and subsequent reports, for discussions of our risk factors and other risks and uncertainties underlying such forward-looking statements.
During the call, we may discuss non-GAAP financial measures as defined by SEC Regulation G. Reconciliations of these non-GAAP financial measures to the comparable GAAP financial measures are included in our earnings release or investor presentation.
After Phil and Matteo's prepared remarks, we will have a Q&A session.
Now, I'd like to turn the call over to Phil.
Thank you, Yijing. Good morning, everyone, and thank you for joining us today.
First, let me outline the agenda for our enhanced earnings call this morning. We will begin with a brief review of Q4 and full year 2022 results and 2023 guidance. We'll then review our mid-term strategic plan in detail and provide 2026 financial goals. We would encourage you to follow along on the webcast as we will kick off the strategy update with a short video. And finally, we'll conclude with a Q&A session.
Now turning to Slide 4 for some 2022 highlights. I am extremely proud of what the Gentherm team achieved in 2022 despite a continuously challenging operating environment. During the year, we closed the acquisitions of Alfmeier and Dacheng Medical, which expanded Gentherm's value proposition in both automotive and medical. We also achieved record revenue in the fourth quarter and for the full year 2022.
Of special note, we achieved record annual revenue for climate control seats, steering wheel heat and battery performance solutions in 2022. With the addition of Alfmeier and Dacheng, revenue grew 38% year-over-year in the fourth quarter or 43% excluding the impact of foreign currency translation. Adjusting for both foreign currency translation and the Alfmeier acquisition, Automotive revenues increased 23% year-over-year in the fourth quarter, outperforming actual light vehicle production in our key markets by nearly 20 percentage points.
For full year 2022, revenue rose 15% year-over-year or 23% adjusting for the impact of foreign currency translation. Adjusting for both foreign currency translation and the Alfmeier acquisition, Automotive revenues increased 11% year-over-year in 2022, outperforming actual light vehicle production in our key markets by over 600 basis points.
In addition, we secured new automotive business awards of $1.8 billion in 2022, setting another record in company history. Our milestone achievements on revenue and awards are strong proof points of increasing demand for our thermal and pneumatic massage and lumbar comfort solutions, especially in the EV market.
In addition, we continue to innovate with differentiated proprietary solutions such as ClimateSense and our thin foil cell connecting systems. These innovations are expected to significantly increase Gentherm's content per vehicle as electric vehicles expand in the market.
On the cost front, we continued our disciplined approach to managing operating expenses. After adjusting for restructuring, acquisition and divestiture expenses, operating expense as a% of revenue improved nearly 100 basis points from 2021 and over 500 basis points from five years ago.
Before I turn the call over to Matteo to briefly review the Q4 and full year results, as well as our guidance for 2023, let me touch upon a few key operational highlights in the fourth quarter on Slide 5.
In the fourth quarter, we launched our automotive solutions on 20 different vehicles across 11 OEMs, including CCS launches on the Chevrolet Trax, several Great Wall models, the Honda Pilot in the US, the Kia Optima, KX5 and Sportage. Since the announcement of the Alfmeier acquisition, our customers have resoundingly expressed support and excitement to see Gentherm further expand its value proposition beyond thermal, to include pneumatic solutions and comfort, health, wellness and energy efficiency.
Since the close of the acquisition, our teams have presented a number of technology days at multiple OEMs showcasing our latest innovations in both thermal and pneumatic comfort. It's clear that customer interest in our extensive product portfolio continues to grow.
In the fourth quarter, we secured $560 million of automotive new business awards, bringing us to $1.8 billion of wins in 2022, including three full quarters of Alfmeier, setting another company record. A highlight in the quarter was two important wins with our long-time customer Stellantis. We were awarded an intelligent closed cabinet neck conditioner and a conquest thermal electronics and software module, our first with this OEM, which we believe will open the door for many future opportunities.
We won multiple CCS awards, including on the Ford Mustang Mach-E, the Buick Enclave, Land Rover Defender and Li Auto's e-SUV. In the fourth quarter, we also received 12 steering wheel heater awards across seven OEMs. In addition, we won a significant multi car line award for our pneumatic, lumbar and massage solution with Volkswagen. This is another strong proof point of our ability to grow market share by winning business from competitors, as well as grow penetration of pneumatic comfort solutions into vehicles that do not offer the feature currently.
On the medical front, hospitals continue to face financial pressures and are carefully managing their capital spending. Medical revenue grew 4% ex FX year-over-year in the fourth quarter, primarily driven by our acquisition of Dacheng Medical. In the fourth quarter, the University of Colorado and Denver purchased 10 Blanketrol units to expand usage throughout their facility.
In addition, Meijer Heart Hospital in Lansing, Michigan, a part of Spectrum Health, has adopted our patient temperature management product based on resistive technology, ASTOPAD, in their cardiac operating rooms, replacing competitive air blankets.
And with that, I'll turn the call over to Matteo for a little more color on the financial results and to provide 2023 guidance.
Okay. Thank you, Phil. Let me turn to Slide 6 and focus on the items that most significantly impacted our fourth quarter results.
For the quarter, product revenues increased by 38% compared to the same period of last year, including the contribution from the acquisitions. If we adjust for the impact of acquisitions and FX, our overall product revenue increased by 21%.
Starting with the Automotive segment. Automotive revenues were $332 million, reflecting a 40% increase compared to the prior year period. Adjusting for the $58 million contribution from Alfmeier and foreign currency translation, Automotive revenue increased by 23% and this compares to a 2% increase in the actual light vehicle production in our key markets of North America, Europe, China, Japan and Korea. As Phil mentioned, we outperformed light vehicle production volume by nearly 20 percentage points. We have provided the detail on revenue growth by product category in our earnings press release and associated materials that are available on our Investor Relations website.
Turning to adjusted EBITDA. Adjusted EBITDA in the quarter was $38 million, up from $31 million in the prior year period. The adjusted EBITDA rate for the fourth quarter was 11.1%. This compares to 12.5% in the year ago period. The 140-basis points decrease was driven by higher material and wage inflation, negative impact of foreign currency exchange, primarily due to the appreciation of the US dollar compared to the euro, as well as the impact of Alfmeier, which has a lower profitability rate than the legacy business. These were partially offset by fixed cost leverage on higher sales volume as well as cost recoveries and negotiated price increases from customers.
It is worth noting that the dilutive impact to the adjusted EBITDA margin rate of Alfmeier in the quarter was approximately 170 basis points. Legacy Gentherm adjusted EBITDA margin rose to 12.8% in the quarter compared to the prior year.
Operating expenses were $66.2 million in the quarter compared to $45.5 million in the prior year period. If we adjust for impairment, acquisition and restructuring costs in both periods, operating expenses were $55.6 million, up from $45.1 million in the fourth quarter of last year. A year-over-year increase of approximately $10 million was primarily driven by the additional expenses from the acquired businesses. As a percent of revenue, the rate improved 200 basis points compared to the fourth quarter of 2021.
Finally, adjusted diluted earnings per share in the quarter was $0.47 per share compared to $0.61 per share in the fourth quarter of last year. Our adjusted earnings per share for total year 2022 was $1.82 per share compared to $3.01 per share in 2021.
Our effective tax rate in the year was approximately 36%, above our guided range of 31%, primarily due to the impact of the impairments related to the exit of the non-automotive electronic business.
Now, moving to the balance sheet on Slide 7. Our cash position at the end of the quarter was approximately $154 million, up from $139 million at the end of September. We closed the quarter in a net debt position of $81 million compared to net debt of $96 million at the end of the third quarter. The reduction in net debt was primarily driven by approximately $20 million of cash received from the sellers of Alfmeier in connection with the finalization and settlement of actual working capital adjustment. As a result, our net leverage decreased from 0.99 in the prior quarter to 0.63, well below our target of 1.5.
Based on the trailing 12 month consolidated adjusted EBITDA ended December 31, we had approximately $265 million of remaining availability on our line of credit, and the total available liquidity as on December 31, 2022 was $419 million, up from $404 million at the end of September.
Now, let me turn to Slide 8 for our 2023 guidance. For comparison purposes, we included the actual results as reported for 2022, as well as the pro forma 2022 values if we had incorporated the result for Alfmeier since the beginning of the year. Additionally, starting with our 2023 reporting, we will exclude the impact of non-cash stock-based compensation from our adjusted EBITDA results. We are presenting comparable data for 2022 for your reference.
So, for 2023, we are expecting revenue to be in the range of $1.45 billion to $1.55 billion, assuming a euro to US dollar exchange rate of $1.05 and light vehicle production in our relevant markets to grow at a low-single digit rate in 2023 versus 2022. Adjusting for approximately 150 basis points of FX pressure year-over-year, the midpoint of our guidance implies an organic growth rate of 13%. Our guidance also assumes higher revenue in the second half compared to the first half as a result of new program launches.
Adjusted EBITDA margin rate is expected to improve to 11.5% to 13.5%. We do expect our profitability in the first quarter to be below our full year adjusted EBITDA margin guidance range. Due to the revenue cadence I discussed earlier and the impact of contractual price downs, which will be offset in the second half of the year by gradually increasing price recoveries, supplier cost improvements and productivity actions, we expect the adjusted EBITDA margin rate to steadily improve throughout the year. At the midpoint of our guidance, we expect our adjusted EBITDA dollars to increase nearly 3 times the revenue growth rate versus pro forma 2022, a strong proof point of our value creation for shareholders.
We expect our full year tax -- effective tax rate to be in the range of 28% to 32%, and capital expenditures to be in the range of $60 million to $70 million. This is higher than prior years due to the full year impact of Alfmeier and increasing investments for the ramp up of new capacity as a result of higher win rate of new awards.
With that, I'll turn the call back to Phil to start our mid-term strategy update.
Thanks, Matteo.
Before we get started with a detailed review of our mid-term strategic plan, we will show you a short video about Gentherm. We encourage you to join via the webcast. You'll be able to see the video and slides on the webcast screen when we advance through them here in the room. For those of you remaining only on the phone line, you'll hear just a few minutes of silence while the video is playing for the next couple of minutes.
[Video Presentation]
We will now start a detailed review of our mid-term strategic plan and 2026 financial goals, and will conclude with a Q&A session.
In 2018, we established our clear mission, creating and delivering extraordinary solutions that make meaningful differences in everyday life by improving health, wellness, comfort and energy efficiency. And we remained laser-focused. This has been our true north every day. We are truly a purpose driven company and we believe that our purpose differentiates us from the competition.
Health, wellness, comfort and energy efficiency drives everything we do from long-term strategy to daily execution. This mission drives our entrepreneurial innovation around the world. You will certainly remember us and our mission on those winter mornings when you experience our thermal solutions in your car or if you or a loved one are treated by our patient temperature management products in a hospital, and realize an improved outcome and faster recovery.
You're going to hear more today about the reasons why Gentherm is a compelling investment. And during the presentation, we'll walk you through more details on the points shown here.
We are a pure play leader in thermal and pneumatic technologies. We continue to sharpen our portfolio to capitalize on our core competencies. Significant tailwinds for growth remain through a massively underpenetrated market as consumers demand more of the features we offer. Our best-in-class innovative technologies not only improve consumer experience, but importantly play a significant role in improving power consumption in the electric vehicles, particularly with respect to extending driving range.
Our talented product development team has achieved some amazing results in creating new products and technologies that we believe will be in high demand on vehicles of the future. Our global reach is remarkable for the size of our company. We can support every customer who seeks our innovative solutions around the world.
Our execution is proven. For five solid years, we have delivered consistently on our milestones, while constantly pivoting to address unprecedented volatility. And on the cost side, we are proud of our ability to drive results in turbulent times. We have transformed the talent and culture at Gentherm through development and refreshment. Talent is a competitive strength.
And finally, our Board and executive team have partnered to continue our path forward, delivering results with strong governance. We have all certainly been tested in the storm and we are proven. This combination of attributes makes us poised for high-return growth outpacing the market.
Our diverse Board is highly engaged, bringing talent from multiple relevant domains to guide our strategy and provide sound oversight. There is a very prudent blend of highly-experienced Gentherm Board members, who helped us navigate the transformation of the company and the unprecedented challenges. In addition, several key positions were refreshed to assure strong governance and fresh oversight.
Our executive leadership team is highly talented with broad management experience from companies such as BMW, Pepsi, Infineon, General Electric, General Motors, Visteon, Sprint T-Mobile and HARMAN Samsung. This diverse team has together led a strong transformation of Gentherm and built the company with remarkable, resilient culture as we move to the next chapter.
While our broad penetration of global customers is a strong competitive advantage, we maintain that edge by assuring that we can support our customers with localized technical support, sales, engineering and local manufacturing and distribution. Our remarkable global footprint with 14,000 employees in over 30 locations was especially powerful during the extreme supply chain challenges over the past few years. Our team has quickly pivoted to support customers in real time, tapped into a multi-regional network, and adapted our local supply as needed regardless of the continent.
Over the past five years, our global ecosystem has led to an improved and balanced regional mix of revenues. For example, our revenue has grown to $1.3 billion, and Asia, including China, Japan and Korea, has grown from just over 20% in 2018 to nearly 28% of our company's revenue. We are extremely well positioned with our broad global reach to take our growth to much higher levels.
With our industry-leading technology and market share, we serve over 50 different OEM customers worldwide. Our list of customers continues to expand as manufacturers add thermal and pneumatic applications to improve comfort and battery efficiency. I'm very proud of our continued international expansion with customers in Asia and Europe.
Our strong and trusted relationships built on our innovative, value creating products continue to deepen with our customers as we've been a key partner to help them endure the global COVID disruptions and supply chain volatility. We certainly came through for our partners, and our customers recognize this. For example, General Motors has named us Supplier of the Year for two years in a row and Honda bestowed upon us their Excellence in Value award.
While our core Thermal Comfort solutions continue to be our most prevalent segment, we significantly diversified our product offerings over the past five years by adding solutions that help us provide value to our customers, while staying true to our mission. For example, in 2018, Thermal Comfort was 87% of our revenue, compare that to 65% today. As we progress on our journey, the additional product segments will provide incremental growth to support our aspiration.
Five years ago, we formalized our sustainability journey by building a people, planet and places framework and implemented it at every Gentherm location. Since then, we've enhanced that framework to also highlight our efforts in developing technologies that promote increased energy efficiency and driving range by reducing power consumption of an electric vehicle. Our framework is science-aligned and conforms to industry standards such as Sustainability Accounting Standards Board, or SASB, and the Automotive Industry Action Group.
While we're still at the early stages of our sustainability journey, we achieved our initial seven-year environmental targets in less than half the forecasted time. In addition, we are being recognized for our sustainability efforts. We've been named as one of America's Most Responsible Companies by Newsweek; one of Investor's Business Daily 100 Best ESG Companies; named to the Detroit Free Press's list of Michigan Top Workplaces; and the Top Employer for Engineering from Germany's Top Employers Institute, just to name a few.
At Gentherm, we strive to positively impact lives. I'll share more later in the presentation about how our products have a significant impact on sustainability. ESG is at the core of Gentherm's identity.
Our industry is going through a transformation and Gentherm works to exceed our customers' expectations, sometimes even before they are aware of them. Almost every major trend in our industry provides strong tailwinds for profitable growth for Gentherm. One of the most significant purchasing decision factors for automotive consumers revolves around the in-cabin experience. You don't have to look far to see OEMs touting their enhancements for entertainment, user experience, comfort, health and wellness, with the goal of differentiating for their customers on these most sought-after features.
Gentherm is clearly at the nexus of health, wellness, comfort and energy efficiency with our best-in-class thermal and pneumatic solutions. Our human-centric design approach along with the integration of software and intelligent algorithms makes us a very attractive partner to deliver personalization, which is the holy grail for the car of the future.
As electric vehicles take hold, our comfort and battery performance solutions with the proven ability to help reduce power consumption and extend EV range are positioned perfectly. And in the medical industry, more and more clinical studies are showing that maintaining patient temperature at the appropriate level can lead to improved outcomes, reducing recovery time and enhancing quality of life.
It will come as no surprise to you all that we are in the midst of an accelerating transition to electrification in this decade. In fact, S&P Global forecast that less than 20% of vehicles produced in 2030 will utilize non-electrified traditional internal combustion engines. And in fact, the vast majority are now expected to be high voltage, full EV or plug-in hybrid, as opposed to the 2018 estimate of higher concentrations of mild hybrid 48 volt. The need for efficient thermal solutions to support range extension and comfort will be dramatic.
I'm excited to share that our proactive transition over the past five years has resulted in a product portfolio that is highly aligned to benefit from the EV transition. We are already there. In fact, over 85% of our Automotive revenue is from products that can either enable or are specifically engineered to support electrified vehicles. We are already reaping the benefits in three ways: more vehicle platforms adopting our technology; higher penetration rates; and increased content per vehicle.
Building upon our success in internal combustion engines, where we've seen steady gains in content and penetration over the years, we expect an accelerated revenue growth opportunity with electric vehicles. Our thermal and pneumatic solutions help improve comfort, reduce weight and decrease power needed by the central HVAC system, which has proven to increase range. Thus, EV manufacturers are adding those solutions to more platforms, increasing applications as well as more seats per vehicle.
Our multi-function electronic control units, which operate both the thermal functions as well as the control motors and other actuators are increasingly in demand as OEMs look to combine ECUs and remove sensors to decrease weight and complexity. And the pinnacle for us is ClimateSense, which will transform one of the most inefficient functions in a car, but more on that in a bit.
ClimateSense can deliver up to four times the content of thermal products. Our innovative battery performance solutions will drive incremental content as well. And in total, we see the content per vehicle increasing from between $30 to $300 on ICE vehicles to $150 to $1,000 on electric vehicles.
And while we're passionate about our thermal solutions and the impact on human experience, health and wellness, don't just take our word for it. We have recently partnered with Escalent, a company well known in the automotive industry for consumer research. We wanted to know how consumers are responding to our products when they experience them in their cars. We surveyed about 3,000 people in North America, Europe and China, and the numbers speak for themselves. 90%-plus of people globally are very satisfied with heated and cooled seats, and heated steering wheels, and the vast majority of them want to see the product on their next vehicle.
Now, before we review our go-forward strategy with you, we wanted to take a moment to review our progress on the path we shared with you in June of 2018, as shown on slide 18. At that time, we articulated four major strategic imperatives: focused growth; extend our technology leadership; expand margins and return on invested capital; and finally, optimizing capital allocation. I'm proud to say that Gentherm has executed relentlessly on this strategy and delivered outstanding results.
This relentless execution was certainly not done within the context of a stable environment. The past few years, as you all know, have presented more volatility than most of us have seen in our careers. Ginter has been significantly impacted by all of the major macro events, COVID, semiconductor shortages, inflation, and both supply and geopolitical disruptions. And yet, we have remained strong and flexible, implementing aggressive measures along the way to de-risk the business and, most importantly, to continue to deliver on our strategic milestones. We are now more than ever a company with the resilience to deal with uncertainty ahead and deliver profitable growth.
The global headwinds have had a monumental effect on vehicle production compared to what was forecasted back in 2018. One key milestone year in our plan was 2021, where actual vehicle production came in a staggering 24% lower than was expected in 2018. And in 2022, it did not get much better. In fact, January forecast by S&P Global don't show a return to 2018 production levels throughout our current decade.
Despite the market headwinds and vastly reduced vehicle production, Gentherm delivered on our strategic milestones and generated industry-leading results. We grew our climate comfort thermal business significantly through take rates and expanded products. In fact, our climate control seat products are at the highest revenue levels in our history despite the lower vehicle production.
We significantly increased our revenue in Asia. For example, Hyundai has grown to be our second-largest automotive customer and we more than doubled our China revenue.
We successfully introduced a scalable ClimateSense platform and picked up the industry's first award to launch on the Cadillac CELESTIQ and followed by a second General Motors of EV in 2025.
We launched several new products that drove a seven-fold growth in our battery performance solutions segment with proprietary solutions. Through product portfolio expansion, we continue to grow our patient temperature management business. A great measure of our effectiveness is our growth versus vehicle production. If you look at the past three years, we have outpaced the market by an average of over 900 basis points.
Our steady commitment to investment in technology development led to several game-changing new product introductions, ranging from innovations in our core solution, such as our next-generation thermal electric-based CCS called iMTM, or Intelligent Micro-Thermal Module, ranging all the way to our revolutionary ClimateSense system. It's especially gratifying to see these new industry-best solutions with increased levels of electronics and software. We've really made a shift from component to system-level product engineering.
Some of you may recall, we instituted a program called Fit for Growth in 2018 to help us make strong moves in cost management and to reset the discipline for the future. I'm pleased to say that we have built this cost management and control into Gentherm's DNA. We've proven the ability to reach high-teens adjusted EBITDA margins. And while the impact of inflation and instability has been a significant challenge, our team responded, sustaining profitability and positioning us with a clear path to return to high-teens adjusted EBITDA margin in the mid-term.
We also clarified a decisive capital allocation strategy and we've used it to guide us. We weathered multiple storms while maintaining strong liquidity, funded our own innovative growth, returned capital to shareholders through repurchases, and made targeted key acquisitions. Matteo will cover more of this in detail in a few minutes.
As a result of consistent and dedicated execution of our strategy, shareholders have benefited with Gentherm delivering best-in-class total shareholder return. We delivered nearly 110% return since year-end 2017, and increased our market cap from $1.4 billion to $2.2 billion, significantly outperforming the market and peer averages in this five-year timeframe.
Now, let me transition to discuss our future, starting with Slide 25. Our journey to deliver on our mission continues to evolve. Our roots will always be our industry-leading innovative thermal technologies, where we began as a startup from Caltech University in 1991. We are now taking steps to expand our human-centric value proposition beyond thermal within comfort, health and wellness. Our first major step was the addition of pneumatic lumbar and massage comfort to greatly enhance the occupant experience, and we won't stop there.
Over the past five years, we've accelerated our company's transition from a world-leading thermal and electromechanical-driven device company to a more complete system solution innovator driven by software, algorithms and intelligence. This has all been built on the core science of the company, thermophysiology and physiotherapy. Our focus has always been not just on the car, but on the human beings in the car. Our OEM customers tell us that we are the only player in our space with this deep human-centric scientific expertise. As we progress, we will continue to evolve and expand these skills to generate incredible solutions in the car of the future and in operating rooms in hospitals.
I can certainly talk about the technical details of our product, which I certainly will in a few minutes. But I think the next three vignettes will better illustrate our vision for the future.
First, imagine you're on your way home from the gym or a tennis game or perhaps a round of golf, your tired and a little sore. We see a future where your vehicle activates contrasting temperature therapy that alternates between heating and cooling, plus pneumatic muscle massage, synchronize with uplifting music, soothing light and a refreshing scent. By stimulating five scientifically-proven comfort enhancing features, your future vehicle has the potential to aid in your recovery on the way home.
Next, during a rush-hour commute or traffic, it's common for drivers to feel stressed or anxious. With our ClimateSense technology, we see the opportunity to read the vehicle environment and instantly respond with heating or cooling to create individualized zones of enhanced comfort, combining scientifically-proven benefits of massage and thermal therapy to reduce stressed hormone cortisol and to induce a state of calm. You're likely to take a long way home.
The final scenario I'll share with you today is one that I'm sure we've all experienced at one time or another, and that's the feeling of drowsiness behind the wheel. Through a partnership, we see the opportunity for ClimateSense to work in coordination with future alertness features to stimulate the skin with cooler temperatures that increase brain wave activity and alertness. At the same time, rapid intermittent massage across the lower back stimulates the body, while the seat position tilts to alter the driver's posture, invoking alertness and restoring driver attention.
This is just the beginning of where we see our technology driving health, wellness and comfort in vehicles of the future.
And now let me dive into our strategy evolution. While we're proud of our company's progress, we know this is only the beginning of our journey and we must continue to evolve our plan to stay ahead of competition and drive above market performance for our customers, employees, communities and shareholders. Our 2023 and beyond strategic imperatives comprise four elements that are closely bound to help us create a flywheel of profitable growth.
First, through leveraging and expanding our world-class talent and culture, we will drive -- we will extend our technology leadership. This will drive focused growth in areas where we have a right to win, which will in turn deliver strong financial returns, and this will fuel the cycle again to further attract world-class talent. As we continue to execute on these four strategies, the flywheel will continue to gain momentum. Our growth aspiration is to get to over $3 billion in revenue by 2030.
Let me touch on each of these strategy elements, starting with talent. When I joined the company at the end of 2017, it was clear to me that several key elements of a winning culture already existed here. Most importantly, the culture of innovation, entrepreneurial spirit and a focus on science, all were the building blocks of a strong foundation. But as we move forward to transform the company, there were four areas that we needed to take to another level in order to build the capabilities and discipline, necessary to scale. [These four] (ph) winning culture behaviors are customer focus, employee engagement and inclusion, global mindset and performance and accountability.
And we have engrained these winning culture behaviors into the fabric of our company. We've seen a dramatic enhancement of talent through internal development and recruitment; we've established DE&I as a foundation of the company with remarkable results; we've implemented an industry-leading manufacturing culture and environment, this is illustrated by our best-in-class safety results and strong community outreach in all the locations where we operate; and finally, we've been recognized through the adoption of leading board and government's best practices. All of this has set up a strong foundation for future acceleration. We believe that companies don't compete, people do.
Now to strategy two on Slide 30. Technology and innovation are at the foundation of everything we do at Gentherm. In fact, it's where we came from. Our company was founded by a rocket propulsion scientist from Caltech University, which explains our obsession with science. We invented multiple product categories, such as heated and cooled seats and pneumatic seat massage. Our rapid growth was and continues to be driven by our significant investment in research and development.
There are five underpinning technology domains that are key to our ability to bring the very best solutions to market and help us move towards our systems vision. At the center of it all is our core thermal and pneumatic device innovation. Finding the next level solution that delivers comfort faster, more efficiently and less space is never ending. We constantly obsessed about how to become better at our core.
Software and electronics are fundamental to our strategy. We have significantly increased our resources and competency from embedded devices to algorithm-driven connected solutions. And to move towards our vision of the future, we are advancing in systems engineering, the ability to integrate hardware, software, external inputs and sensors seamlessly into the vehicle architecture. We're building advanced sensing and machine learning expertise as well as partnerships to enable our systems to "close the loop with the occupant and the environment." This is key to platforms such as ClimateSense.
Finally, what separates Gentherm the most from our competition is our human-centric scientific practices of thermophysiology and physiotherapy. Thermophysiology is the science of human temperature regulation, and physiotherapy is a range of physical interventions that maintain, restore and improve human function and movement to improve quality of life. Our PhDs and scientists are engaged in our product development of today and tomorrow across both automotive and medical.
Gentherm is also perfectly positioned to empower the software-defined vehicle of the future. For those of you who are new to the concept of the software-defined vehicle, it's any vehicle that manages its operations, adds functionality and enables new features primarily or entirely through software. To illustrate the potential of Gentherm's suite of advanced technology capabilities, our vision is to bring our integrated devices and system solutions to the software-defined vehicle of the future.
A vehicle outfitted with our latest thermal and pneumatic devices will assure the most effective delivery of comfort and wellness to the body. The breakthrough will be that our software will enable countless features and therapies beyond basic comfort, wellness and refresh modes, mood enhancements, alertness response for safety, pain management and the list will keep on growing. Our system, when integrated with the connected vehicle, will allow post car sale delivery of these new modes as our scientists continue to develop them through over-the-air updates throughout the life of the vehicle.
Now, let me dive into how we will take our vision to market through our focus growth pillars. We continue to believe in a carefully selected mix of innovative and complementary product solutions to maximize our growth and returns based on clear differentiated strengths. We will continue to funnel our investments and resources to those areas where we have a strong competitive advantage, driving forward on our mission and delivering strong financial returns.
Pillar 1 is to accelerate growth in our core Thermal Comfort product lines. Thermal remains central to who we are and we will seek to accelerate this across our full continuum of solutions from seat heating, all the way to our crown jewel ClimateSense.
Pillar 2 is to grow pneumatic comfort. As a result of the Alfmeier acquisition, we are now the global leader in pneumatic, lumbar and massage solutions and we see strong opportunities ahead, particularly with combined thermal and pneumatic solutions.
And Pillar 3 is to drive battery performance solutions. We will do this with our unique technologies where we can add value for customers and produce strong financial returns.
And Pillar 4, we will continue to leverage our expertise in thermophysiology to further expand our patient thermal solutions in the medical device market, capturing incremental share with our innovative solutions.
All of this will be enabled by our ever-increasing digital and software content, allowing Gentherm to continue on the journey to a full system provider.
Now, let me dive into each of our growth pillars in more detail. First, our largest business, Thermal Comfort. This is the heart of our company. We offer customers some of the most innovative devices and solutions in the industry from seat heating, climate control seats, steering wheel heat, which is increasingly enabled with our hands on detection, net conditioning, radiant heating and many others. All of this culminating with our complete microclimate solution named ClimateSense.
As I mentioned, consumers are demanding more of these thermal technologies and OEMs are responding by rolling out more and more vehicle platforms that offer them. To illustrate the market tailwinds, our forecast is that the penetration of climate controlled seats and seat heating of the total share of vehicle production in our key markets will increase from 45% today to 65% by 2030.
Similarly, steering wheel heat penetration is expected to increase 16 percentage points by 2030 to approximately 35%. If you already have a heated steering wheel in your car like we do, you might be wondering what the remaining 65% of vehicle owners are waiting for.
Gentherm's market share in our core product line shows our global leadership as the largest independent innovator of thermal solutions with 50% market share of heated and cooled seats, 60% share of heated steering wheels, and 40% share of the more mature heated seats. We maintain this share through innovative, differentiated solutions and impeccable customer service.
With the growing penetration and content per vehicle of thermal solutions we have discussed, the forecast is a 9% compound annual growth rate of the total available market between 2022 and 2030. Compare this to the 2% compound annual growth rate of vehicle production in our key markets over that same time.
Let me discuss the key sustainable competitive advantages that allow us to maintain our leading market share. We are the largest independent supplier. And this independence is key and supports our selection by OEMs who direct source the majority of thermal awards as well as with key partner Tier 1 seat manufacturers. Regardless of customer, our focus on the most innovative, high value solutions provides us with a real competitive advantage.
Our solutions include our own design and manufactured electronics and software, a true differentiator. We have a long and proven track record of bringing the next generation of technologies to market. We have the broadest, deepest customer portfolio and relationships in our space. We are at the table when OEMs are working on challenging thermal problems in the cabin. Our industry leading R&D and manufacturing footprint are unparalleled, giving us the best scale and ability to flex quickly with our global or regional customers. Finally, our cutting-edge use of thermophysiology is at the heart of our human-centric designs.
Now, let me talk about the anchor to our future, our breakthrough ClimateSense microclimate solution. The traditional HVAC system is simply not sufficient going forward. Using high volumes of heated or cooled air to bring the temperature in the whole cabin to a desired level is highly inefficient. In fact, the HVAC system is the second largest power drain on an EV battery next to the actual drivetrain. The accelerated movement to connected and electrified vehicles is driving the need for much more efficient and personalized climate, specific for each individual occupant and only for the occupants in the car; why waste energy on an empty area of the cabin? And, we have anticipated this need for years and have created the solution, and it's ready now.
Our complete suite of thermal devices surround the body and are driven by our proprietary software ClimateSense algorithm based on thermal physiology principles and delivers heating or cooling to the optimal location of the body at the right time and for the right duration to assure the fastest times of comfort, but utilizing only the minimal power to get there. The benefits are significant. Reduced energy consumption, our customers have shown 70% reduction in the cold cycle correlating to an over 30% range extension and a 35% reduction in power in the hot weather cycle.
In addition to range extension, ClimateSense provides the best-performing thermal comfort available and the enablement of reduced size and cost of the central HVAC system leading to much greater cabin design freedom and weight reduction in the car. And we are thrilled that we will launch for the first time on the 2024 Cadillac CELESTIQ and follow soon thereafter with a second General Motors' electric vehicle. Customer interest continues to grow as the market sees the impact this technology.
I want to point out a critical design concept that we have implemented with ClimateSense. We've developed the solution as a scalable platform that can be incrementally integrated into today's EV architecture, or it can be unleashed for the next generation of heating and cooling visions for our OEM customers, who are ready to more completely update the heating and cooling architecture. Our proprietary Smart Effectors, which can be installed on a modular building block platform, will allow customers take advantage of a continuum of implementation based on their current EV migration and their product strategy. And this allows us to scale our content to support steady increases in energy efficiency and thermal performance from incremental all the way to the fully implemented ClimateSense content. Our thermal content can then grow to between 2 and 4 times our best systems on the market today.
So, how do we expect to capture above market growth for Thermal Comfort? First, we will continue to drive increased take rates. While the market tailwinds will certainly give us natural growth, we've developed a playbook to work with OEMs to increase take rates through initiatives, such as improved option packages and regional extensions.
Our constantly growing set of solutions that add wellness and comfort will also enable us to increase content per vehicle, such as additional seats using our technology, adding neck conditioning, surface heating, radiant heating and continued increases in electronics and software content. We will build on our strong global customer relationships to deepen our problem solving and value for these partners, [indiscernible] adoption by more vehicle nameplates offering our solutions, especially on lower priced mass market vehicles where we're seeing good momentum for additions. And we see opportunities to continue to add and extend our business with new customers, and grow where our take rate and content is low. This will primarily play out in Japan and China. I'm very excited about our momentum in these countries.
Finally, the game changer is ClimateSense, with 2 to 4 times the content, and potentially near 100% take rate on vehicles that will rely on the integration of ClimateSense as part of an overall vehicle climate architecture.
Now to Pillar 2, which is our newest growth vector, grow pneumatic comfort, capitalizing on what we believe is the next wave of momentum in health, wellness and comfort in the vehicle, physiotherapy through lumbar and massage technologies.
We acquired Alfmeier, an innovative market leader of automotive lumbar and massage comfort solution with a 50-year-old culture of innovation that often puts them one generation ahead of the competition with respect to technology. This has resulted in a strong IT leadership position with more than 200 patents, including significant coverage for advanced shape memory alloy technology, or SMA.
Alfmeier pioneered the use of SMA valve and pump actuator technology for automotive seat comfort systems, which delivers quiet, high speed pneumatic lumbar and massage performance. And we're excited to offer more compelling and high value solutions across complementary customer relationships, leveraging the combined technologies, teams and capabilities.
Alfmeier has built a strong customer portfolio, especially with European OEMs. Some of the customers that we both serve are BMW, Volkswagen, Mercedes Benz, Ford and Tesla. Similar to Gentherm, the majority of Alfmeier's business is direct sourced by OEMs. We are well positioned to increase our pneumatic comfort market share by capitalizing on Gentherm's market-leading customer base, especially in North America and Asia.
As we've discussed, automotive customers are increasingly demanding features that enhance comfort and well-being. In addition to thermal, we see significant tailwinds for features that enhance the driving experience to allow occupants to leave the vehicle feeling better than when the drive started. While there was approximately 39% of vehicle production in our key markets that offer lumbar or massage solutions, the reality is that the vast majority, 34%, are mechanical or electromechanical mechanisms. These devices are heavy, take up significant seat space, and can use too much power. We are seeing fast growth in pneumatic solutions, which use low profile bladder networks and small-scale electronics and valve systems are much lighter, quieter and use less energy while increasing comfort.
The demand to grow and replace the larger mechanisms continues to build steam. A great example is Volkswagen, who is expanding the penetration of massage and lumbar and switching many vehicles, especially EVs, from the electro mechanical systems to Gentherm's pneumatic solutions. The market is approximately $1 billion today and we expect it to grow and to shift dramatically towards pneumatic solutions over the coming years.
Through our acquisition of Alfmeier, we are now the market leader in pneumatic lumbar massage. In fact, Alfmeier invented the category at 1995 on the Mercedes S-Class. Our innovative technology is leading the market. We introduced the shape memory alloy-driven valve system first to the market in 2005 and we continue to have the industry-leading technology and value creating solutions. Our software-driven modular platform can scale from a simple one bladder lumbar solution, all the way to a 50-plus bladder intense massage system. Our customers tell us this is the perfect architecture to scale across nameplates and trim packages.
As we think longer term, the benefits of system design, including thermal, pneumatics, electronics and software and our scientific expertise in thermophysiology and physiotherapy, in one efficient scalable platform will be Gentherm's gamechanger. Not only will we be able to address comfort, but the implications of increasing wellness therapeutics to support health and pain management of occupants will be unlocked.
To conclude on pneumatics, we see several avenues to outpace the market with growth initiatives. First, we will maintain a laser focus on delivering for our long-time customers where we continue to see big growth opportunities, such as with VW, BMW, Mercedes, Tesla and Ford.
Using the playbook we have introduced in our Thermal Solutions segment, we will proactively work with OEMs to increase take rates and content per vehicle. For example, we see the rear seat as a blank canvas. Our most significant near-term growth will come as we expand pneumatic comfort into Gentherm's vast customer portfolio, especially in North America and Asia, where Alfmeier only minimally participated previously. Our powerful relationships with North American customers and also our broad OEM base in Japan and Korea provide significant opportunity. We're already working with several customers on potential introductions.
Finally, we see the opportunity to launch proprietary technology in this space. Our next big thing is a pulsating massage solution called Pulse A. This proprietary game-changing Pulse A pneumatic system combines massage with high-frequency pulsation, which can stimulate muscles and alleviate pain and tension. We're excited and expect to see pneumatics grow at the save or even higher rates than thermal comfort in automotive.
Focused growth, Pillar 3, is driving battery performance solutions that help EV manufacturers improve efficiency and performance. The early growth for Gentherm in this area has been our PACE Award winning thermal electric battery thermal management system, which has helped our customers such as Mercedes and Jeep deliver 48-volt mild hybrid systems at high volume while assuring proper battery heating and cooling in extreme environments. We are very proud of this innovative product and it's given us strong credibility in the EV space.
While this is a great product, its growth will be limited in the future as a result of OEM's decision to jump ahead quickly to high-voltage plug-in hybrid and full-battery electric vehicles. Fortunately, we had anticipated this change in the market and we've been working hard to develop and launch a suite of products that add strong value to high-voltage battery systems. Most significantly, Gentherm has invented an innovative and proprietary thin foil flexible circuit product line that can be used either as a battery cell heater or a cell connecting device, opening up meaningful possible growth.
In addition, our portfolio of battery products includes intelligent battery air cooling devices and certain high-voltage battery cables. Our team has deep, proven expertise in battery thermal and connection systems that have been built, giving us strong credibility with the most demanding customer numbers.
Now, let me talk about our most important BPS development, our proprietary cell connecting technology. This product takes advantage of the industry's first mechanical structuring process to create a thin multi-purpose flex foil. This mechanical structured flex foil has significant advantages when compared to the state-of-the-art on the market today, which are complex cable harnesses and chemically-etched flex circuits. Our technology is fully automatic with industry-leading production speed and very low production complexity.
Our flex foil technology allows OEMs or battery makers more flexibility in material selection. For example, aluminum is a desirable choice compared to copper and we can deliver this. In fact, aluminum is the solution chosen by our first launched customer BMW, which launched on the BMW 7 Series plug-in hybrid EV. While the technical performance of this product is compelling, it's our incredible sustainability impact that is truly transformative. Our solution is environmentally friendly with essentially all waste fully recyclable.
In a study performed by the Fraunhofer Institute, our solution improved environmental impact by 99% compared to chemically-etched solutions. Now, let me put this in perspective. If 1 million vehicles replaced chemical etch with our aluminum flex foil solution, it would save over 186,000 tons of greenhouse emissions. Just for perspective, that's equivalent to all the emissions made by 40,000 gasoline-powered cars driven for a year.
In addition, this flex foil technology works very well for conductive battery cell heating solutions. This flex foil quickly conducts heat to the battery cell and challenging designs to assure proper battery performance and longevity in cold environments. The quick heating also can benefit rapid charging as a pre-warm battery can be charged at a higher rate. And we're proud to see our proprietary flex foil battery heater launch on Jeep programs and soon to follow with launches on Renault EVs.
So, how will we continue to drive battery performance solutions? We are still in the early stages of adoption of our flexible circuit cell connecting, but we're convinced of its differentiated technology to solve the needs of electric vehicles. The launch on BMW vehicles will give us much needed credibility. We have several interested customers and are selectively engaging in quotations. While we're confident in the value of this cell connecting product, which falls into a category with a multi-billion future total addressable market, we are also only pursuing projects with appropriate financial returns. We believe the favorable environmental impact and material flexibility of our solution is superior, and we'll look for customers who value this and are willing to partner with us.
As we look to the future for flex foil battery cell connecting, we're developing concepts that move intelligent battery health monitoring closer to the cell, mounting these to the flex foil. We call this eCCB and have been partnering with Datang NXP on early concepts. In fact, these early tests, especially around impeded spectroscopy, which can detect early thermal issues in a battery has shown promise.
Finally, we see incremental growth with our high-quality battery air cooling solutions and our high-voltage battery cables. While we are very selective in these projects based on differentiation and margin profile, we've been approached and are launching with customers such as Rivian, Porsche and Nikola.
Gentherm's only non-automotive growth pillar is number 4 on the list, expanding patient thermal solutions within the medical device market. This product line is in the medical device vertical. The space is attractive and has meaningful synergy with our core Automotive Thermal Comfort technology.
Why do we see it as attractive? The market is large and highly fragmented at over $2.5 billion total addressable market. This market has been ripe for our disruption, especially with our industry-leading broad product portfolio encompassing more modes of thermal delivery than any competitor. The medical business has a superior contribution margin compared to our core automotive business. That coupled with consistent and sustainable demand should help offset some of the seasonality of the Automotive business. The investment required for growth is low relative to our Automotive business, which can drive superior returns.
Most importantly of all, synergies with our Automotive business are significant and differentiate us from the competition. Our deep understanding of the human body and thermophysiology utilized to help save lives in the hospital is directly brought to bear on our automotive thermal solutions for comfort and wellness. This brings remarkable credibility with OEMs. We are the only company in the industry with this capability.
As I mentioned, Gentherm has expertise in all three modalities: liquid, resistive and air. This extensive selection of products offer medical practitioners the most flexibility in the operating room. We can provide solutions at every stage of the patient experience, seamlessly maintaining temperature from the pre-op all the way to hospital discharge.
We're excited about our growth opportunities in medical and will leverage key initiatives. In partnership with our automotive research and development team, we have a compelling pipeline of new product and technology. We will take share with our differentiated, resistive warming, which can reduce airborne infection risk. We will expand in Europe and China through our acquisitions of Stihler and Dacheng in those respective regions. And we're working to diversify our go-to-market channels, such as utilizing OEM direct sourcing, white label and equipment rentals.
And now, I'd like to transfer to Matteo, who will walk you through the details of our strategy four, deliver financial excellence.
Thank you, Phil.
Let me start the financial section on Slide 59 by taking a step back and look at where we have been.
As Phil mentioned earlier, in the middle of 2018, we launched our Fit for Growth initiative centered around a few key strategies. Overall company simplification, which resulted in the disposition of non-profitable businesses as well as the [halting] (ph) of expenses in areas that were not part of our core strategy. Footprint rationalization, which led us to the restructuring of our electronics manufacturing, and the closure of a few facilities in North America and Asia, sourcing and manufacturing excellence and SG&A rationalization, which resulted in a reduction of operating expenses by 15%.
The Fit for Growth program was extremely successful and generated more than $75 million of growth savings that allowed us to improve the profitability of the business up to high-teens adjusted EBITDA rates at the end of 2020. On a balance sheet standpoint, we significantly improved our cash conversion through working capital optimization and tighter controls on capital expenditures. We generated approximately $370 million of free cash flow over the 2018-2021 period, deploying the cash towards strengthening the balance sheet and opportunistic share buybacks.
2022 was a year of transition for the company. We entered the year in a net cash position of approximately $150 million, which allowed us to successfully weather the supply chain disruptions around the semiconductor shortages and build inventory to protect our customers. Our strong balance sheet enabled us to play offense and complete the Alfmeier and Dacheng acquisitions in the summer of last year, and we were able to mitigate the impact of the supply chain disruptions and material inflation through tight cost control on SG&A and more than $20 million price recoveries from customers.
As we look forward, our goal is to return to high-teens adjusted EBITDA rates as we fully integrate Alfmeier and bring the combined entity to the level of profitability our legacy business used to enjoy prior to 2022. We will focus on strong cash flow generation by improving Alfmeier working capital and continue to maintain a strong balance sheet.
Now, let me walk you through the details in the next few pages. On the revenue side, we are projecting to grow on an organic basis with a mid-teens compound annual growth rate between 2023 and 2026, continuing to outpace the production growth in our relevant market. The majority of the growth will come from Thermal Comfort. We are expecting to grow faster than automotive production by continuing to drive increased take rates, launching new products that will increase our content per vehicle and driving the adoption of our new microclimate solution, ClimateSense.
Pneumatic comfort will grow in the range of $75 million to $125 million for two key reasons: first, continued growth with existing Alfmeier customers, such as BMW, VW and Tesla; as well as second, through the extension of pneumatic comfort solutions into the broader Gentherm customer portfolio across Asia and North America.
BPS growth will be driven by our proprietary flex foil cell connecting where we have good visibility to our pipeline with several selected customers.
In medical, we'll grow organically due to new product launches and a diversification of our go-to-market channels.
As a result of all these factors, we expect to generate revenues between $2.05 billion and $2.35 billion by 2026.
In addition to the volume leverage from the revenue growth, we have outlined the building blocks of our profitability improvement program over the next three years to achieve high-teens adjusted EBITDA margin [increase] (ph) on Slide 61. We expect to capture $80 million of increased profitability net of inflation at the midpoint through three specific initiatives.
First, $30 million to $50 million savings from manufacturing productivity through automation on our product lines; leveraging lean best practices across our network; continuing to reduce material usage and scrap, particularly in Alfmeier; taking cost out of our bill of materials through value engineering; and reassessing our manufacturing footprint by moving production to best cost companies.
Second, we will deliver $20 million to $40 million savings from our sourcing excellence program by focusing on design to low cost; establishing multi-sourcing strategies to increase negotiating power, flexibility, supply continuity and resilience; as well as implementing continuous cost reduction initiatives.
Finally, we will deliver $10 million of cost synergies from the Alfmeier acquisition by consolidating supply base, primarily on electronics, footprint rationalization and SG&A reduction. We will continue to look for opportunities beyond synergies to improve Alfmeier profitability to be closer to the company average.
Slide 62 summarizes the impact on the adjusted EBITDA margin of all the initiatives that I just talked about. And as you can see, fixed cost leverage from revenue growth will be the largest driver of margin expansion. As we are assuming a normalization of the supply chains, we are expecting to face a more challenging pricing environment compared to what we faced in 2022. Conversely, the sourcing savings and productivity actions will more than offset the annual price downs and will help us expand our margins as we have historically done. We will continue to manage cost tightly and we will deliver $10 million of Alfmeier cost synergies.
Through the initiatives that I just described, we are expecting to achieve high-teens adjusted EBITDA rates by 2026.
Now, moving to the balance sheet on Slide 63. We have historically maintained a conservative balance sheet and we plan to continue to do the same in the upcoming years. In 2018 through 2021, we focused on reducing our debt through superior cash flow generation, which allowed us to enter the pandemic in a net cash position and opportunistically deploy the cash to acquire Alfmeier and Dacheng Medical. During the 2024 to 2026 plan period, we expect to strengthen our free cash flow conversion, while increasing capital expenditures to 4% to 5% of revenue in order to fund capacity growth and innovation projects.
Finally, on capital allocation, in the last four years, we have been balanced in our approach by focusing on debt pay down first, deploying $220 million towards strategic acquisitions and $165 million towards organic growth. We have also returned $204 million of cash to our shareowners in the form of opportunistic share repurchases, while maintaining our net leverage well below our target of 1.5 times. In the future, we will continue to thoughtfully balance the allocation of capital between funding organic growth, considering select M&A opportunities, opportunistic share buybacks, and maintaining appropriate leverage.
On the M&A side, our priorities have not changed. As we successfully done in the last couple of years, any future acquisition would fit within the focused growth strategy by expanding our content per vehicle and technology capabilities, enhancing our regional presence and expanding our technology in medical. In addition to the above, we have set high financial and process hurdles that have to be met before executing an M&A transaction, including a compelling financial profile and line of sight to integration benefits in addition to the strategic fit that I just mentioned.
I am extremely pleased with the improved talent and process discipline Gentherm has developed, especially related to due diligence and integration processes. And we will remain disciplined in our M&A strategy.
So, now let me summarize on Slide 66. Over the next four years, we will focus on returning to high-teen adjusted EBITDA margin, strengthening free cash flow conversion, maintaining a strong balance sheet, and a balanced capital allocation.
And with that, I will turn the call back to Phil for the wrap up.
Thanks, Matteo.
Now, let me close. I believe Gentherm presents a strong investment thesis. Simply put, our best-in-class innovative technology, industry-leading manufacturing, our deep customer relationships and proven execution create a sustainable competitive advantage for the company. As I pointed out, the market is large and underpenetrated, and we're going to capitalize on our independent market-leading position and our capabilities to drive high-return growth outpacing the market. And finally, we will leverage our operational excellence to deliver strong cash flow and shareholder returns.
With that, I'm going to turn the call over to the operator to start the Q&A.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first questions come from the line of Luke Junk with Baird. Please proceed with your questions.
Great. Thank you, and good morning. Thanks for taking the questions. I want to start with the question on '23 guidance and then I'll ask a couple of strategic questions. And first one, maybe for Matteo, if you could just unpack the 2023 EBITDA margin assumption, I'm thinking in terms of gross margin, incremental investments, underlying leverage in the business, can you just help us understand some of the key drivers '22 into '23 and the EBITDA margin? Thank you.
Hi, Luke, thanks for the question. Good morning. So, let me start with EBITDA. So, if you look at the pages that we posted, our pro forma 2022 EBITDA rate was about 10.4%. So that's our starting point. If I look at the midpoint of our guidance, we are on the revenue side projecting a 13% organic growth. The S&P Global right now has a growth of about 3% to 4% for our relevant market. And so that equates the flow-through of about 30% of gross margin, about 190 basis points expansion on our EBITDA rate due to the volume. Then, we are expecting about 70 basis points of margin expansion from pricing activities. So, very similar to what we have accomplished in 2022 with some of the recoveries. About 70 basis points improvement also coming from manufacturing productivity, value engineering net of the labor inflation. So, these are the positive side.
Then, on the pressures, we are assuming about 120 basis points pressure due to material inflation, which we are still seeing being pretty high, particularly entering the year considering that we were able to push out some of the material inflation out of '22. And then, FX is a drag of about 120 bps. So, that's how you get to this at the midpoint of guidance the 200-basis points EBITDA margin improvement compared to where we closed on a pro forma basis 2022.
Maybe on your question on the capital -- sorry, go ahead, Luke.
No, sorry. I didn't mean to interrupt.
I think you asked a question on capital and investment. So, let me talk maybe first on the income statement on the operating expenses. So, we are assuming operating expenses to be in total still at about 16% of revenue, very -- pretty much in line with the pro forma of 2022. And primarily, this is driven by investments on the R&D as we continue to fund new programs on BPS, on ClimateSense and some of the new technologies of Alfmeier. And then, we also have to manage labor inflation, which is not only impacting the variable cost, but this applies also to the operating expenses.
And then, on CapEx, so we guided a little higher than our normal run rate and that's again driven by some of the investment that we have to make in order to fulfill the high win rate that we had on awards in the recent months.
That is all very helpful. Thank you for that. And then, pivoting to a longer-term view, Phil, maybe if we could just kind of put a capstone on all the strategic updates this morning, and I'm just kind of want to think about the evolution as a market since you last gave a strategic update in 2018 in terms of consumer expectations changes post COVID, changes that we've seen competitively, a lot has changed since 2018. As we kind of line up the world today with respect to the mid-term revenue target that you're implying in the guidance, can we just talk about a little bit more about how you lean into those dynamics and specifically the changes in the company's strategy today that maybe you want to spike out with a little more emphasis relative to [four] (ph) years ago?
Sure. Well, I think that we're really excited as we look to the years ahead. The one area that I think has accelerated pretty dramatically is the momentum towards full EV as we proceed. And I think that's a big benefit for us. And really kind of highlights -- when we look at thermal especially and, to a similar extent, pneumatic product, four growth vectors for us that we're really doubling down on.
If you get the basic -- the first pillar is production. So that's what most of us look for is vehicle production growth. Of course, it's not huge, but that's the first one.
The second one is adoption. One thing we're seeing with EVs and, to a similar extent, a high volume mass market vehicles is more nameplates adopting thermal and pneumatic technologies. And this is, I think, driven by a couple of factors. Consumers are demanding it. We talked a little bit about the consumer studies that we've done and those are clear to the OEMs. But then there's the energy efficiency benefit that EVs will see across the board. And of course, we've got the full continuum from adding devices all the way to ClimateSense. So that's clearly driving our strategic initiatives.
The third one is take rates. So, we're really optimistic and excited to see what customers have done in the past year or so and especially what we see in the coming couple of years that vehicles that offer our product are increasing the take rates for the same reasons I just mentioned.
And then, the fourth one is content per vehicle. And we've launched a lot of new technologies and new products that are, we think, perfectly positioned to enhance both the consumer experience and efficiency. And some examples are intelligent neck conditioner. The neck conditioner we think is a gamechanger and it's very, very low penetrated so far, and the interest is very high.
Electronics and software, we mentioned earlier, our strategic win with Stellantis is our first thermal ECU win with them and we see more communities coming as our expertise in software becomes recognized. Add to that, beyond the feet, steering wheel, radiator panels, surface heating, foot well, there's a lot of areas for us to increase content per vehicle.
And then, of course, you add in the pneumatic side of the business, which is we think is kind of a wave that's following how thermal has grown. More and more opportunities to enhance the consumer experience in the car through physiotherapy. Of course, there's the comfort side of that. And as we discussed several times in the strategy review, we see the opportunity that's really unique to us to utilize our scientific expertise and we're investing really heavily in this to develop therapies and treatments that support the ability for consumers to feel better after they leave the car than they did when they enter.
And if you look at our pneumatic business, I also want to just highlight the area that we're focused on, and that's making sure that our product not only performs well, but it's light. Doesn't take up a lot of space and can help OEMs replace the motorized mechanical lumbar and massage systems, which really aren't going to be a great fit for electric vehicles.
You add into that modest medical revenue from an absolute standpoint to growth between now and 2026, I think we've got some great opportunities with multiple vectors to achieve that growth. So, I think that's what gives us the confidence to hit that target.
Great. And then if I could just ask one more question. Phil, in the video, clearly a focus on ClimateSense. And one of the things in the video, many more partnerships with OEMs. Sure to follow and hoping you could just put a finer point and maybe a little bit of a state of the union on ClimateSense in terms of your current engagement with customers and what your line of sight is beyond the two vehicles that you've already booked in terms of near-term development, say, in the next 12 months to 18 months on the business development...
Well, obviously, we're extremely focused on launching successfully with General Motors. It was our largest customer, and this is -- and we're so honored to be partnering with them on these types of technologies, and clearly Cadillac CELESTIQ is critical to us. And then, we've got a follow-on award past that, and we want to keep building that partnership who we perceive as one of the most ambitious EV companies out there. And clearly, they're excited about the technology. So, that's a big part of our focus and I don't want to downplay that.
That said, the Cadillac CELESTIQ announcement in a lot of the press that has come from GM and from us has opened up even more interest from other potential customers. So, we're selectively doing development projects, assessing potential vehicle rollouts and, obviously, we're excited about opportunities to come with new customers.
And one area, I think that positions us pretty well and this is why we highlighted it so much in the strategy chat was that we've created a scalable platform. It's kind of like a building block migration to the full-blown ClimateSense. And I think that's relatively new development for us and it's really coming together.
If you look at the mid-term plan to '26, it's certainly -- I would say we have pretty modest expectations for ClimateSense growth from a full system perspective in there. But what we do see and where we expect pretty good fuel to our growth rate is adding the Smart Effectors that come from the scalable platform and more content per vehicle as we see OEMs make the migration to full-blown ClimateSense.
Great. Thank you for all that. And I'll go ahead and leave it there for now.
Thank you, Luke.
Thanks, Luke.
Thank you. Our next question is coming from the line of Matt Koranda with Roth. Please proceed with your question.
Hey, guys. Good morning, and thanks for all the detail with the strategy update. I'll do a couple near-term ones and then a couple of long-term as well.
So, maybe just, Matteo, maybe I missed it, but just could you maybe break out the drag on EBITDA margin in '23 from Alfmeier? Just sort of how we should be thinking about that headwind to versus core EBITDA improvement in '23? And then, maybe also just speak to the progression of EBITDA margin throughout the year. You did mention first quarter below sort of the full year, but maybe any finer points you could put on that first quarter number? And then, just is it a steady progression sequentially each quarter throughout the year or is there a step change somewhere in the back half of the year?
Sure. So, let me start with the first question. So, Alfmeier today, if you look at where we closed 2022 is in the low-single digit EBITDA rate. And we're expecting that to improve throughout the year to about mid-single digit EBITDA rate. And then the further improvement will come as we [indiscernible] the full synergies and continue to work also on productivity projects that are included in the mid-term strategy and financials that we provided this morning. But that's mid-term EBITDA rate -- mid-single digit EBITDA rate would be what we have factored in our guidance for 2023.
In terms of your cadence, question, you're right. I mentioned that regarding the first quarter, I think, let me break this down for you. I think it's important to start where we finished 2022. So, if you look at the fourth quarter profitability that we had in 2022, that profitability benefited from portion of the pricing recoveries that were actually negotiated earlier in the year. So, if we normalize the pricing recoveries and exclude also the impact on the non-cash stock comp, the EBITDA rate in the fourth quarter would be around 10%. So, this is how we enter 2023.
The other aspect that I think, Matt, we always have to consider is that our earnings tend to be seasonal. So, in the first half of each year, our margins are negatively impacted by the annual price downs. All the cost recoveries and pricing actions are negotiated throughout the year. So, the impact, the positive impact of those generally come later in the second half. And the same applies actually with some of the sourcing savings. If you think about volume rebates from suppliers, they always tend to come in the third -- in the fourth quarter.
So, I would also add one other thing that I think everybody is currently facing, which is labor inflation, which is still pre elevated both at the factories on the variable side as well as on the salary side.
So, when you combine all these aspects, right, that's why we expect our profitability in the first quarter to be below our annual guided range for EBITDA. And then, the adjusted EBITDA margin rate from there will steadily improve throughout the year as the impact of price recoveries, price negotiations, productivity at the factories and supplier cost reduction will kick in later in the year.
Okay, very helpful. And then, just shifting to the longer-term outlook and strategy presentation, just wondering if you can provide a few concrete examples of the content per vehicle shift. One of the slides I think you had shown -- shows sort of a $30 to $300 current opportunity versus like upwards of $1,000 in [BEV] (ph). And I'm just curious how much of that shift relies on the underlying mix of vehicles changing toward full battery electric? And how much of the, I guess, the '26 outlook in terms of growth takes a view on sort of the mix shift in sort of battery electric versus price in the car part?
Sure. I'll take that one. Let me talk about first of all the building blocks to get the increased content. I think what we typically look at on an ICE is as our full suite is kind of two seats of CCS and a steering wheel. And where we see that gradually building in the transition to full EV is adding rows, so more seats in the vehicle. That's a clear adder.
Obviously, the different effectors that help not only with comfort, but help to stepwise improve efficiency, and those I mentioned earlier, neck conditioning, footwell conditioning, heated interior surfaces, potential radiation. And then you add in when we get to ClimateSense, more electronics and more software, and you can start to get a sense. And then, of course, you add in the pneumatic side on top of that, and you start to get a sense of all the potential component additions that you get on the comfort side. And then, on top of that, of course, our battery performance solutions, if we were able to get the full-blown cell connecting suite in the EV and then also there's the potential for battery heating. So, you can just kind of add all those pieces up and that's what can get you to the $1,000 per vehicle.
When you look at the '26 rate, we basically built in the cars in our pipeline that we know of, it's the way -- '26 is, if you think about it, an awful lot of that is either already awarded or we have a very clear path for the RFQs that will come in the next 18 to 24 months. And those are what's built into our growth rate. So, there's not a lot of speculation to be honest with you. Obviously, we have to execute and we have to drive a lot of wins or at least a fair number of wins in that time period. But I think '26 is fairly well known. And then, the acceleration then beyond '26 to 2030 is where we start to see more ClimateSense, deeper penetration of BPS and continued scaling content per vehicle.
Okay. Makes a lot of sense. And then, just lastly, maybe for Matteo, wanted to talk about the EBITDA bridge over the next couple of years. And you have a pretty decent size assumption in there for manufacturing productivity of $40 million. Just curious if you could maybe speak to, does that require any manufacturing footprint shifts? What kind of capital investments do we need to pencil in to assume you hit the $40 million in manufacturing productivity? And then, any concrete examples on the purchasing cost savings, the $30 million that you got penciled in there, would be very helpful.
Sure, Matt. So, let me start with the productivity side. So, really, we are looking at this $30 million to $50 million savings net of inflation, we have a couple of -- this is how I will break it down. 60% of it -- of the savings will come from pure manufacturing productivity. This is in the form of material usage optimization, process flow, lean improvements across all our networks. Fixed cost reduction as well as heavy focus on manufacturing automation in some of our key lines. So, that's about 60% of the benefits. 15% roughly is coming from value engineering, so really taking cost out of the bill of material. And then, the remaining 20%, to your second part of your question, is really coming from the footprint optimization that we talked about in the prepared remarks.
So, for your second part of your question in terms of CapEx, so we will expect CapEx in the next throughout the planning period to be between 4% and 5% of revenue. And this is how we indicated in the prepared remarks and this CapEx includes any investments that are related to capacity that will be required to fund the growth that we have on the top-line.
Okay, great. And then, just on the...
Sorry. Then, you had another on the purchasing. Sorry. I was forgetting the purchasing portion, Matt. For the purchasing side, I think the majority of the savings really will be generated through design to low-cost initiatives, multi-sourcing strategies, particularly in electronics and connectors, for example, that's where we're looking at, localization of suppliers for materials such as fleece and plastics, and then continuous cost improvements activities such as e-auctions and carousels that we do with several of our suppliers. So that's what -- these are the building blocks of the sourcing savings that we talked about.
Okay, great. I'll jump back in queue guys. Thank you.
Thank you. Our next question is coming from the line of Ryan Sigdahl with Craig-Hallum. Please proceed with your question.
Good morning, guys.
Hey, Ryan.
One on 2026 business plan. Curious how much of that has been awarded versus anticipated new business? And then, secondly, if you've factored any acquisitions into that, both 2026 and 2030 targets, or if that's all organic?
Sure. Yes. When you look at the award rates, it's over 60% awarded for '26. If you look at our core business, the thermal business, it's over 70%. Obviously, with pneumatic, there's a lot of activity with new customers. When I say new customers, Gentherm's traditional customers that aren't currently customers for pneumatic. So, we're building in a reasonable win rate for that. And then, BPS, of course, is less awarded between now and then. Great news though, we do have a clear pipeline of bids that we're going for there. So that's kind of the picture there.
When you look at 2026, there's no -- that's pure organic. There's no M&A built into the 2026 plan. And frankly, when you look at the 2030, $3 billion-plus goal that we have, that's assuming organic growth as well.
And then, maybe just a follow-up. What's the timeline from award to production on pneumatic and BPS? Is it similar to kind of core auto awards, where it's a two to three year, or is it shorter, longer, et cetera?
It's the same. It's two years. If you get some with 18 months and some a little bit longer, but around about two years.
Maybe one just higher level one and -- but curious on the timing to give the strategic update 2026, 2030, et cetera, targets this morning, given the macro uncertainties, everything we're dealing with. I guess just talk through management's thoughts around timing now.
Yes. It's been five years plus since we did it last time. And there's been so much evolution of our strategy and direction. To be honest, we postponed it a couple of times because of the same reason the macro environment, and we just felt that at some point we just had to make a decision and lay out our vision for the future. So that's what drove this.
Great. Maybe one more if I can sneak it in. Is there any ClimateSense included in the 2026 besides the two GM awards?
There is, but it's conservative.
Thanks all. Good luck, guys.
Thank you, Ryan.
Thank you. Our next question is coming from the line of Glenn Chin with Seaport Research Partners. Please proceed with your questions.
Great. Thank you, and thanks for all the detail folks. So, first just on the near term. In the press release, there wasn't really much mention of supply chain issues. I don't presume they're behind you. Can you just give us an update still on what developed in the quarter, and then what you see going forward?
Yes. It's still a volatile time, Glenn. It's not as volatile as it has been, especially if you look a year ago, but we're still seeing a couple of areas that are presenting challenges and that has led even into the first six weeks of the current fiscal year. Customer order volatility is still meaningful, but we're especially seeing that in Europe.
And when I talk about that, I mean orders that come in, we ramp up our plants, put our people in place and then the orders are canceled. That causes productivity, causes overtime, causes inventory bubbles. We see that still to a maybe a little bit lesser extent in North America and Asia. But those are still challenges and we see those as being tied mainly to still occurring semiconductor shortages and also some market issues.
Obviously, China was a significant impact in the fourth quarter and in the early part of the year with the impact of shutdowns and that -- COVID-related shutdowns. Of course, that's been opened up now. I know we did see a little bit of an extension in terms of demand shortfall with the Chinese New Year celebrations. Good news is we're starting to see that pick back up.
And then, semiconductor shortages in general. Although thankfully, it's not nearly to the magnitude as it was, it's still a constrained environment with certain nodes of semiconductors. And we faced those. Our team still is in taskforce mode on many -- with many suppliers. And we still see OEMs run into shutdowns related to semiconductor shortages. So, it's certainly not behind us. We are planning for and continue to, number one, see from our perspective and hear from our customers steady improvement over the course of the year, and the year being 2023.
Okay. Very good. Thank you. And then kind of a related question, maybe for Matteo. So, in your 2026 outlook, you talked about improving free cash flow conversion. So, what can we expect, Matteo, with respect to the inventory buildup? When might that unwind or do you not see unwinding between now and 2026? And just more broadly in 2023, any other working capital puts and takes we should keep in mind?
Sure, Glenn. So, the -- if you look at -- historically, if you take the last four to five years, our free cash flow conversion over adjusted EBITDA has been roughly in the mid-40%s. Now, 2022 was an exception obviously due to the supply chain disruptions that we faced. So, when I talk about going back to the conversion rates, what we are expecting is that we will return to a free cash flow conversion in the mid-40%s in the planning period.
Now the geography is going to be a little different from what we've done in the past. You will see an increase in CapEx as a percentage of revenue, as we discussed earlier. And this will be offset by a higher cash flow from operations. And really, this is going to be coming from two key areas. Number one, improvement on the inventory terms, and then negotiating better payment terms with suppliers. So, these are the two key areas that we're focusing on the mid-term plan, and I think that this would apply also for 2023.
Okay. Very good. Thank you. And then, longer-term, Phil, now that you guys are had Alfmeier, you have these four growth pillars, any other pillars you think you'd want or need?
Well, obviously, we feel really good about the pillars we have at the moment and it's keeping us very busy. But I would say, as we've been consistent over the last several years, we're really focused around our mission and our mission is around health, wellness and comfort in the car, it's in the cabin to improve the lives of passengers, and then, obviously, in operating room in hospitals. So, if we see opportunities that we think we can add a lot of value and fall into the M&A strategy, that Matteo mentioned, certainly, we feel like we're in a position from a balance sheet standpoint that we could make those moves, but those will be very, very selective.
Okay, very good. And then, just one last one. In the presentation, you mentioned software numerous times. Any thoughts on what percent of revenue that may comprise for you guys as a percent of total in the future?
You mean software itself?
Yes.
Yes. We don't break that out. I would call software more a part of our complete system solutions. There definitely are cases where we have customers interested in purchasing software to embed in other electronics, and a lot of that revolves around the specific algorithms that we've developed. But for the most part, we see it more as an enabler of our full system. And obviously, it differentiates our product and our solution, and we expect that to drive higher margins for our products.
Yes. Okay. Fair enough. Thank you.
Thanks, Glenn.
Thank you, Glenn.
Thank you. I will now turn the call back over to Yijing Brentano for the webcast question-and-answer session of today's call.
We have time for one question from the webcast, and here's the question. How should I think about the cadence of revenue growth and profitability improvement from 2023 to 2026? And what gives you confidence that you can achieve your 2026 financial goals?
Okay. Well, maybe I'll start with the revenue side and I'll turn it over to Matteo for the profitability.
A couple of things on the 2026 side, and I'll talk specific and then more high level. First of all, if you look at the revenue for 2026, a lot of that's coming from either awarded business and I mentioned the percentages, and the known pipeline. That entire buildup was created around what we know is ahead of us. So, it's a fairly short timeframe between now and 2026. And then, the factors that give us confidence in the outperformance over that timeframe are really the four vectors that I mentioned earlier, especially with thermal and pneumatic.
The first one is production growth. The second one is adding new nameplates. And that's what we're seeing in the pipeline between now and 2026 is a healthy rate of new nameplates, new cars that we will be able to launch on. The third is take rates. I mentioned this many times throughout our last couple of hours together is more and more consumers are demanding thermal technologies and that's accelerating with the transition to electric vehicles. And finally, content per vehicle. More of the opportunities in front of us are beyond our climate-controlled seats to include devices that surround the body. And those are all going to enhance the experience of consumers as well as add more efficiency to electric vehicles.
So, those core vectors are really important. I'll throw on a couple of others that are really incremental. The BPS is clearly incremental growth for us we pick up more wins with our cell connecting. And on the pneumatic side, beyond the four vectors I mentioned, there is a replacement process that's happening where pneumatics will transition and take over more of the share from the motorized mechanical lumbar massage. And, of course, modest medical growth on top of that. So, a lot of areas for us to drive that growth between now and 2026.
So, turning to talk about the profitability side of the question, I think -- so first of all, at a high level, I think we have proven through our Fit for Growth initiatives that we were able to deliver $75 million to $80 million of savings through Fit for Growth. So that's why we feel comfortable that we can deliver the $80 million of cost out actions that we talked in the prepared remarks.
And also quite frankly, if we look at the execution over the last five years, which have been, for sure, one of the most difficult operating environments that the company has faced, we were able to really work with our customers to bring innovative solutions, to grow, but at the same time to negotiate price recoveries and also to really manage cost very tightly.
So, I think the combination of the anticipated revenue growth and the productivity progression that we talked about will allow us to really continue to grow the company both on the top-line and on the bottom-line in the next few years.
Specifically on the cadence question, I would say that on the revenue side, we expect somewhat the cadence to be pretty linear, maybe with just the exception of BPS, which will probably be a little bit more back-end loaded. In terms of profitability, the leverage from the revenue increase will follow the revenue growth. There are a couple of actions that I mentioned to achieve the $80 million cost improvement, such as the footprint optimization and the Alfmeier synergy, which will come a little later in '25 and '26. But that's how I would model the profile.
Thank you. I will now hand the call back over to Phil Eyler for any closing remarks.
Great. Thank you everyone for joining our strategic update this morning.
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