Gentex Corporation (GNTX) Earnings Call Transcript & Summary

So moving along, I will be going into the first of fireside chat format here. In room, we have Gentex Corporation and their Chairman and CEO, Steve Downing. Gentex, I would call an automotive safety company, first and foremost, but there's a lot more going on here. It's headquartered in Zeeland, Michigan and it designs and manufacturers vision systems, dimmable devices, connectivity and sensing systems for global vehicle markets. Company is also manufacturing dimmable aircraft mirrors and we're going to talk about that as well. A terrific company, incredibly profitable and has been successful for a long time. The company has about 238 million shares, trades around $37, but has $8.7 billion equity cap. Terrific balance sheet, no debt. About $370 million in net cash, about $8.4 billion total enterprise value. So I am going to grab my notes and sit down here and Steve and I can chat. But Steve, thank you very much for being with us in Las Vegas and maybe while I'm moving around here, if you can give those in the room and maybe those on Zoom just a broad overview of Gentex as a business, that would be great.

Well, thanks for having us. Obviously, it's unbelievable to be in person. I think it's been almost 2 years since I've done an investor conference in person. So it's seems take it all for granted over a long period of time but this should be easy to look people in the eye and have a conversation, but it's becoming increasingly difficult. It feels good to be here. If you look at the company as a whole, our start is really as a technology company, thin-film coatings, glass, electronics. We basically make dimmable mirrors. That turned into an aerospace product that we launched about a decade ago for the Boeing 787 product. And since then, it's really been an evolution and really focused on the electronics side, sensing, machine vision cameras, really customized applications that very few suppliers do in the automotive space. And one of the things that we really pride ourselves on is the ability to solve complex problems with our technology product and offering.

One of the products that you've rolled out in recent years is the full display mirror, which if you purchase the car in the last few years, you effectively have a switch on your rearview mirror that provides a camera vision system, discuss that product and then we'll take it from there. I don't want to put any numbers that you can provide better, but how much more the consumer sees in the vehicle and just -- what that's provided for automakers?

Yes, absolutely. And the product itself is a pretty simple concept. And with most of the things we do, a much harder execution. Basically, it solves a problem. Obviously, with smaller roof lines and rear windows and vehicles to help with fuel economy, you get a smaller field of view out the back of a vehicle. We basically supplement that with a normal mirror, so it's our auto-dimming mirror technology, and you can switch between a mirror mode or a display mode. So I liken it all the time to a hotel room with a bathroom where you have a TV behind the mirror. I always joke that you end up with a terrible TV in a terrible mirror. What Gentex was able to solve on the thin-film coating side was the ability for when it's in display mode to not tell that there's a mirror in front of it all, very bright, very clear display. When it's in the mirror mode, you can't tell there's a display behind it. So that science problem is one that's difficult to solve. But more importantly, what that product allows us to do is sell that product globally to an OEM. Different requirements for whether or not you can drive a car with or without a mirror mean that you need a mirror solution in order to have a global execution. And because you can choose as a consumer, you can turn it on or off at your discretion. On the money side, a typical base auto-dimming inside mirror for us sells for about $20, kind of low 20% gross margin profile. Our full display mirror is anywhere from $120 to $160, $180 average sell price at corporate average margin profile.

We're reaching some maturation on those that -- like myself, I guess, that had a vehicle that had a full display mirror coming back for a second vehicle. Do you have any maybe anecdotal discussions with OEMs about the take rates for consumers that are demanding that product as they go for a second time around?

Yes, I would say it's one of the fascinating parts. I mean if you look at what we do with most of our mirror products, we joke all the time, it's one of the hardest sales in automotive. It's a silent feature, meaning if our dimmable technology is working, you don't have glare, you don't even notice it's working. It's very comfortable. You don't notice it until you don't have it. Full display mirror is one of the first products that we had where customers and OEMs saw, experienced it, and then had a very strong drive to wanting that feature again. If you look at some of the new surveys that are going out in the space, it's one of the highest-rated features in the automotive space right now from a consumer standpoint. I usually joke that we don't participate in funding those and we didn't. It just happens to be one feature that people, when they get a new vehicle once they've had it, don't want to drive that car without that feature again.

I want to talk about it, I'm going to try and get through all your technologies because I think there's so much to your business now. Several years ago, you bought the HomeLink business from Johnson Controls. And talk about what that business is and how it's evolved? And then I want to get into some of the technologies that you're looking for in the next few years there?

Yes. It's one of those career-limiting moves I made. I was CFO for about 2 months when we announced I'd spent $700 million. So if you've never done that before, I don't encourage it. It turned out to be a great business. We knew what we had. We were a licensee of the technology from JCI already. So it was a good fit for us because we are already manufacturing about half of the HomeLink volume in the market. So basically, what we acquired was the IP and the other half of the business. Since that time, we've averaged about a 10% CAGR growth rate in the overall volumes of that business. So we knew we had a technology platform on our hands. What it lacked was the investment from JCI to actually take it to the next level, which is what we've done over the last couple of years. HomeLink is great. I mean most people know it as a garage door opener and it does do that. One of the things we've added now is cloud connectivity to be able to control all your home automation devices from a single button press.

It's remarkable some of the next-generation technologies that are coming from this. One of the other areas that probably have something to do with HomeLink, but also the technology that was embedded within Gentex is a tolling feature. And we talk a lot about electrification here and Gentex probably wouldn't come up in many people's thoughts as an EV company. But if we think about how vehicle -- the tax on gas right now, obviously, electric vehicles don't have gas. Don't utilize fuel in such a way. There's going to need to be some sort of user -- usage fee that potentially is applied in order to pay for that, tolling comes into play there. Talk about your tolling technology, and what technologies does it support and we'll start there?

Yes, the tolling feature is really similar. And the correlation to HomeLink is a good one that you make. First of all, it's a point-to-point communication device. Historically, RF in nature, but it's moving into other technologies. It's also like the HomeLink business in that you have all these tolling authorities all over the country tend not to get a long no share protocols. And so really, what HomeLink was, was it's a Switzerland kind of a concept where we're going to be a one-to-many relationship. Same thing with tolling. Basically, our tolling product commonizes feature sets and hardware so you can set up a single tolling account, basically drive your car anywhere in the country and automatically pay for tolls. To your point, with lower tax revenue being generated off fuel taxes, most states are going to struggle to keep up with infrastructure. We always show, okay, we're not that smarter guys. But as EVs start to roll out, how are states going to monetize that and make up for the road improvements that are going to still be necessary in a full BEV environment. We believe tolling is going to play an increasing role in that philosophy. And so this product is very unique. We partnered actually with Roper Technologies to help develop this tech and make sure all the specifications for the tolling authorities. And we actually have been shipping with Audi now for a couple of years, and we just announced that our second OEM is Mercedes launching in North America shortly.

Where -- is this a physical piece of the vehicle that is visible to us, let's say, if we're looking for it? Or is it something that's embedded already?

Yes, this is what -- that's what's great about the philosophy we've come up with is instead of having that normal toll tag hanging on your windshield, we embedded in our mirror product. So you have great line of sight to the infrastructure. We can actually do the back-end processing, either in the mirror or as a black box as long as the antenna has line of sight to the tolling, which is why our geography and location made us such a great fit for this tech.

Is there any sort of recurring revenue or subscription revenue do you think you can generate from this? Or are you just a systems provider?

What's beautiful about the tech right now is that, at the beginning, it's a purely a hardware play. What we know as OEMs are very interested in how they get more transactional with their customer base. And so as they start to handle the OEM or ourselves start to handle the transactions with the tolling authorities, it opens up the door longer term for us to help build those relationships to hopefully become part of that recurring methodology.

I want to move on, just -- I want to start with the technologies, and we've gone down some of the automotive, but aerospace is a growth avenue for this business. It's essentially been on hold because of the 787. Can you talk about your -- the window technology that you have, how it's applicable to potentially other platforms beyond the 787? And how you see that business rolling out?

Yes, absolutely. I mean if you look at what we did is our first play in aerospace. So we took our core electrochromic technology, moved into the windows on 787. So if you've ever been on one, basically instead of a shade, a mechanical shade that you move, it's a dimmable technology with electronic support. We supply all that to Boeing. It's been a great product for us. Obviously, the last couple of years in aerospace and Boeing in particular haven't been the most pleasant. But it's a great product, great revenue driver, unbelievable margin profile. We're excited about the expansion. We've actually been sourced now a product with Airbus as well as an additional Boeing aircraft. So we're excited to things to get back to normal in aerospace. But really, that was just the beginning of the play. And by that, what we've really been focused on is that core large area device, and that's kind of what we call our electrochromics in a large format. What we've done in aerospace, we believe, is going to be very applicable in automotive, whether it's sunroofs or panoramic roof, side windows, front and rear windshields, especially in a fully autonomous world, where you riding in this vehicle may want it completely dark, you may want it completely clear and be able to control anything in between those 2 variables. And so truly, from a pure technology standpoint, the concept of what we do with our electrochromics and darkening and creating an environment, we believe the automotive industry is ripe and it's probably one of the best growth opportunities we've ever seen as a business.

What do you think the revenue difference would be, let's say, legacy glass window versus an electrochromatic window that would be on, I would imagine, luxury vehicle first?

Yes. We think a normal-sized sunroof in a vehicle today, the average sell price to an OEM is probably going to be anywhere from $400 to $800 per unit.

At Gentex margin?

Yes, sir. If they had better be.

Think about -- going back to aerospace, and I think the technology here is really incredible. Is there a retrofit opportunity on the existing fleet that you might see ahead?

Yes, it's possible. Quite frankly, we tend not to go after aftermarket opportunities with this type of technology right away. And the reason why is the R&D and the payoff is way better in OEM value stream than it is in the aftermarket. Once you have it developed, however, that's when aftermarket opportunities make more sense. In other words, say you take any vehicle, right, a Cadillac or anything, that's been in production for 5 years. If you pick that up mid design cycle, and it's still the same size and format, once you've launched it on the OEM basis, then it becomes very easy to implement an aftermarket opportunity. But for us to go pick an aftermarket opportunity and try to design something just around that, typically, the return profile is just not as great.

Let's talk about the current environment. Obviously, incredible challenges from a supply chain perspective. Let's start there, talk about your visibility in your supply chain relative to a quarter ago, what do you think it's really going to take to unlock this loaded laggard production that we see?

Yes, I think if you back up 6 months ago, you would have heard us talking about this is way more severe. And then we are followed up by most of our customers telling the Street that it wasn't that big a deal. So as you can imagine...

When you report first out of everybody...

It tends to be that problem.

Yes.

Yes. As it turns out, we were unfortunately right. What I would also tell you, at the end of Q3, most OEMs were talking about how this was getting better. Our experience at the beginning of Q4 is it was not getting better. It's actually getting slightly worse. I believe we're in for another 6 to 12 months. And not that it's the end of the world or that we're not going to be able to get components, it's just that it's basically the equivalent bad analogy, but it's kind of a rolling brownout of supply where you finally get caught up on one piece and then that puts a constraint on something else. And then you have to redesign everything that you've done up until that point further then other changes. So we think this is what we're going to be facing for probably the rest of the year and into at least halfway through next year.

If we're thinking about the cost of goods sold aspect of this, there is raw materials, there's a purchase component, there's a labor piece that's factoring, we can talk about that. But just maybe talk about some of the inflation impacts that you're seeing there and your ability to have discussions with your customers about that?

Yes. It's -- there's no doubt. I mean the pricing power belongs in the hands of the micro providers right now. So that's going to cause some headwinds for the business. Now typically, because of our margin profile and what we do, we tend to not try to be on the bleeding edge of going to our customers first and talking about price increases for a couple of reasons. Number one is it's good to let someone else that's in a more desperate position kind of be on the tip of that spear. Number two is this isn't over. And so what you don't want to do is go in and negotiate a deal that addresses the problems you have and then come back in, in 3 months to address additional. And I would say the last approach that we take has worked out really well for us. You have a whole lot of factors happening at one time. So price increases on the electronic supply, you have existing annual price reduction agreements and you've got new books of business that you're negotiating. And so we tend to look at all those in concert together and say, how do we negotiate the best deal for our shareholders, given all 3 of those aspects. Sometimes it's a price increase. Sometimes it's just a delay or a deferral of that annual price reduction that you're already committed to that someone -- an OEM may be able to live without in this environment. And so we're just going to look at this, take our time, make sure we fully understand the market economics before we go in and try to have an initial negotiation.

I asked this question to Stoneridge, will probably I ask it to every supplier. Has -- what's transpired from a supply chain perspective changed your thoughts about working capital, the amount of safety stock you want to have and how you go about sourcing components?

Yes. And I will tell you, we were always been very conservative on the raw material side, and we use cross-car line components for most of our electronics side. So we weren't afraid of inventory. We thought we had more than enough. Honestly, some of the sub-suppliers will leave you a little bit jaded in this environment. And the reason why I say that is the business side of how they handled the communication of when they were going to short you left a lot to be desired. So even when we thought we were okay, a truck was supposed show up with 0.5 million parts on it, you'd come in, it would be 50,000, right? So you're scrambling at the very last minute. Luckily, given our org structure, we move faster than most. So we were able to redesign products, completely redesign circuits, revalidate and make decisions that help keep us alive with our OEM customers. We did miss some FDM shipments in Q3, things that would have been better for the margin and sales profile.

FDM for everyone?

Full Display Mirror, sorry. We speak in acronyms because we're not very smart. But if you look at what happened there, about 90% of the lost sales in Q3 were really driven by supplier shutting down the OEM and the OEM not hitting their production requirements. There was only 5% to 10% of the sales shortfall that was really us not having the components we needed.

When supply does come on back online 6 months out, 12 months out, do you expect this ranch to be more content-rich for you? Or is this something now that maybe what's lagging maybe something that's a little bit lower down the value spectrum?

Yes, I think the next 2 years are actually going to be much more feature rich. And the reason why I think that as OEMs are coming back online, they're still not going to have necessarily the electronic supply they need to build 100% of what consumers are looking for. And so this is going to be a bleed in process where OEMs are going to be looking at how do I build. And the nice part about this, I would tell you is that they've learned how to maintain profitability by building higher-end vehicles even though the total volumes aren't there. And I believe it's something that the industry has needed to do for a while. And I think OEMs are starting to latch on to and realize I can make just as much money by building fewer vehicles if I focus on the right content and the right consumer.

We're definitely going to talk about that with the dealer groups that come along and how the OEMs are going to be thinking about inventory. You mentioned new designs that might minimize chip impact going forward. So obviously, there's some R&D aspect of this that's impacting Gentex. Talk about the give and take from a product standpoint, functionality, et cetera? What you can do without by potentially reducing the amount of chips that you need?

Yes. It's really tough in the short term to pull that one off. Longer term, it's something that the industry is going through as a philosophy to looking at centralized processing, what does that mean, does that help, does it hurt, how do we, as a supplier, make sure we're meeting that OEM's requirements for what they're trying to accomplish? So one of the things on the base mirror side and around the lower end feature side, we've had very little on the supply side, that's been a challenge there. So worst-case scenario, we're able to ship you a mirror, but we can't slip -- we're able to ship you a mirror. The problem is it may not be the one we had intended to ship you. And so one of the things we're focused on is making sure that we have redundancy built in. I think most of the industry probably did a poor job of having as much redundancy on the supply side is what it actually needed.

The last piece of really the bite on margins and Gentex having industry-leading margins is and what a benefit that is right now is labor. And so maybe talk about that, you're a little bit unique in that you're effectively a tech provider. And so maybe talk about some of the challenges or opportunities that you're seeing from a tech perspective?

Yes, I would say...

I'm sorry, from a labor perspective.

Yes. On the labor side, it's a difficult environment. There's no doubt. And we're not immune from that. We are nonunion workforce, and we have very good relations with our employees. That being said, there's no doubt people have been leaving the workforce over the last 12 months and so trying to get employees. So there's a good side to the chip shortages, not only are we short chips, we're also short labor. Hopefully, they come back at the same time. But the team's responded incredibly well to that environment. To put this in perspective, our labor as a percent of sales is industry low. It's 5.5%, roughly 5.5% of sales. So even with some variation in labor costs, we feel like we can maintain margin profile very well.

And those margins are industry leading. I want to talk to you about your balance sheet. Since I followed Gentex and it's been 14 years now, I guess I'm happy to say. You've always carried considerable net cash in the balance sheet. Let's take a history lesson here. You've been through the Ford and GM bankruptcies, the global financial crisis, a global pandemic and a massive part shortage coupled with supply chain constraints. You've weathered it so well, any thoughts that you may be able to become somewhat less conservative with the balance sheet?

Well, first of all, that's one heck of a recruiting pitch you just gave on why one should not work in automotive, but it is -- if you've noticed, we've actually have gotten a little more aggressive on the balance sheet side. I mean first and foremost, back up 5 years, the company lacked a coherent strategy that it stated clearly about what its actual capital allocation strategy even was. So we are very deliberate about making sure we explain that and then executing to it. If you noticed in Q3, we actually got more aggressive on the share repurchase side given the retrenchment of the stock. We're going to continue to do that. The one thing, though, as we move forward, I'd always want to be prepared for us the HomeLink deal, for instance, was a prime example. We didn't have -- we didn't need a whole lot of banking help to pull that deal off and we're able to move quickly. We're not the largest guys in the industry. And so typically, when we find an asset we want, we want to move quick before it becomes public knowledge of what we're after. And unfortunately, bankers have a tendency to also share information as well. So we tend to like to come in and say let's move, let's move quickly and get our deal done. And so we always want to be prepared for that. And right now, the last 5 years, I would tell you, valuations have been pretty high on the technology space for automotive. Hopeful that there will be some opportunities in the next couple of years. And by that, we're going to get the balance sheet ready to go in case some of those opportunities do present themselves.

Okay. Without letting any bankers who probably aren't on this call know what you're looking for, what are the technologies that you think are most important to capture by Gentex that you may be able to develop in-house, but also may be able to augment with some M&A?

Yes. I think, first and foremost, one of the things we like to talk about is our philosophy as a company. Most of the industry has been chasing the concept of driving a car itself. So really focus on the autonomous vehicle. We've looked at it and said there's too much capital and too many people with a lead to go make any type of sustainable margin return in that area. Instead, what is the vehicle going to need from a sensing standpoint once the vehicle is driving itself. And so we've been very focused on that. We made a small acquisition of a technology company called Vaporsens. Vaporsens is a nanofiber sensing company that we believe is going to help solve some of those problems. We believe there's a tremendous amount of other technologies that are going to be necessary in a vehicle environment in order to really accomplish the -- whether it's a ridesharing, robotaxi or even just a personal vehicle, to be able to look at control and make sure you're monitoring that vehicle environment, not just to make sure everything is functioning properly, but also to make sure that the air quality and everything else inside of that vehicle has been handled. Obviously, COVID reinforced that with everyone, I think, the need for understanding what is the environment itself and how do we sense that and then handle that in an autonomous way.

Sure. I mean just as a provider of vision technologies, just safety within an autonomous vehicle, making short and the sensing there in and making sure that the last person that was in the AV before it was summoned left, things like that. And we were out with GM a few weeks ago talking about the Cruise and the Cruise Origin when that rolls out and some of these issues. So I think that there are some real opportunities there for a company like Gentex.

Yes, we were fairly quiet about this acquisition, but we actually acquired a small Israeli start-up that was focused on driver monitoring, cabin monitoring and using some unique technologies. We really like their tech primarily because it wasn't just focused on driver monitoring per self itself, which you could do really with just a camera and some software, but it was also looking at overall cabin monitoring and beyond just driver looking at other -- and beyond just vision systems looking at other high-end sensing solutions. So we're pretty excited about that tech and what it can mean for us over the next 5 to 7 years.

Chris, I think we have one from the -- from Zoom. Yes, there's one from Zoom. Have you thought about electrochromic windows for buildings?

Yes, we have actually looked at it. The one issue, and we tend to joke a little bit that we like plane, trains and automobiles. They tend to get a higher -- much higher price per square foot than say a commercial application. The risk factors are also very difficult. And quite honestly, that we just couldn't figure out the return profile right now. When you look at the full R&D, the cost of manufacturing, what Windows manufacturers want to pay for that type of tech, it doesn't mean it can't happen. But up to this point, what we've seen is, is the markets already eroded quickly with only 2 competitors in the electrochromic space and commercial applications. We don't see a return profile that meets our needs.

And just with respect to the comments you made in the supply chain, seeing things actually get worse here in the fourth quarter. I guess there are 2 parts. One, I mean, what -- in your view, what is the biggest bottleneck at this point? And then secondly, is there a potential unlock out there that could more quickly change this for the positive?

Yes. I think there's lots of opportunities out there. I mean, one of -- the most obvious one is a change in demand. So right now, demand hasn't changed at all, whether on the consumer electronics side or the automotive side. And so if something were to change on the consumer electronics side, it would free-up capacity for automotive, which would help. There are some compelling technologies out there that could help TSMC, for instance, is started on the foundry side in Southeast Asia before anyone else really has started to put capital in place. So that could all help. But as of right now, most of those plants are 18 to 24 months out yet. And so it's going to be a while before pure capacity increases enough. You asked another part of that question in there, and I blanked on it.

It's largely...

Oh, yes. Well, I would say one thing I'd like to remind people of is when you talk about a chip, it's overly simplistic to think of it as a building or a plant that's the problem. So it's a flow process. It starts with a foundry and then it moves into a dice probe area at a different location and then into a packaging facility. Most of the locations are in China are actually packaging facilities. The problem is they were the first to shut down, but they were at the end of the process. The other problem you had during those shutdowns during COVID is basically anything in process at a foundry got scrapped. So you got 20, 30 days' worth of inventory that got thrown out during that. They were also the last to then shutdown. So the shutdowns happen in the opposite order of which the supply chain needed to move. And so the issue is you didn't lose 20 or 30 days during the shutdown, you lost the 20 or 30 plus the compounding effect of not having the raw that was needed in that plant at the time. So I believe we are actually facing much more of a 90-, 120-day issue backlog from starting last year. And unfortunately, these plants run at about 95% of capacity. So as much as we talk about the theoretical 110% of capacity, that's not actually a reality. And so trying to take that last 5% and make up for a quarter of the year that you lost is really the challenge that's facing the industry. Once we have made that up, it shouldn't be a problem keeping up and with the additional capacity that's coming on in the next 12 to 18 months, we should be in a much better spot.

Steve, as I look out 3 or 4 years from now, what you're doing is going to generate significant earnings per share. Trying to figure out what the headwind to the multiple is when you look at what some of your other "techy competitors" can get? So are we buying the stock today because you think you get a 20 multiple in 2025 earnings?

Absolutely. If you look at it, we had a fundamental problem and that was a marketing problem. Unfortunately, given our Midwestern values, we tend to say, all shucks a lot and don't necessarily beat the drum as hard as we need to. So one of the things we're trying to get better as explaining who we are, where we're going, and we believe we do deserve a multi-industrial valuation, not an automotive valuation.

I think we'll wrap it up there. I think you're doing an excellent job of not quite being off shucks here. There's value in humility and it certainly worked for Gentex for the last since I've been covering the company. So Steve, we thank you very much for being here, and I appreciate you being in person and look forward to seeing what the company is going to do over the course of the next 6 to 12 months.

Appreciate it. Thank you.

Thank you very much.