Gentex Corporation (GNTX) Earnings Call Transcript & Summary

Okay. Moving along, we have Gentex Corporation, which is headquartered in Zeeland, Michigan. Very unique company, both from the product that they make and the profitability that they generate, along with their cash flow. They make vision systems, dimmable devices, connectivity and sensing systems for global vehicle markets, predominantly the automotive market. The company has roughly 300 -- I'm sorry, 235 million shares. Trades at roughly $26, about a $6 billion equity cap, great balance sheet, $240 million in net cash for about a $5.8 billion total enterprise value. We've got Steve Downing, the company's President and CEO, here today. Once again, I thank you for making the trip. I saw a bunch of Gentex associates here for the SEMA show, I'm sure. So we'll talk a little bit about what they're here for. So Steve and Josh, thank you very much for being here, and we'll get into Q&A. I'm not sure I gave Gentex enough of a buildup. Maybe, Steve, just take a couple of minutes to really kind of help our colleagues here understand that -- what you do and the value you provide for your customer base.

Yes, absolutely. If you look at the primary product that we deploy and we describe those primary products really as our geography in a vehicle, really auto-dimming mirrors, so the technical side of what that is, is basically a chemistry applied materials product and then obviously a lot of electronics and software that go with that. And so that's -- when we talk about market share and penetration rates, you'll hear us talk about our outside and inside auto-dimming mirrors. We have about a 90% market share in those 2 products. Our primary competitor is Magna. But the penetration rate of those products between the 2 companies is really on inside auto-dimming mirrors is really on about 35% of the world's vehicles. And so you have a lot of growth rate still in terms of the core product. Our outside auto-dimming mirrors, and really when you look at the entire market share between us and Magna, of which we have the 90%, it's only -- it's on less than 20% of the cars produced globally. And so you have this great kind of growth, organic growth story about transitioning basically from flipper mirrors or standard technology into our more expensive product and technology. And then from that, really, the growth in the company has been not only in those core products, but a lot of advanced electronic features that we've deployed, especially over the last 5 years. So about 7 -- well, that seems longer now. I guess, about 8 years ago, we acquired HomeLink technology. So if you have a car with 3 buttons, that's a proprietary technology used to open your garage door. We acquired that business from Johnson Controls. And since that time, it's been on a great growth trajectory really from a technology standpoint of what we were investing in it and then also in terms of the desire for those type of features in the automotive space. Beyond that, if you've driven a car recently where you've seen a digital display inside of the mirror, that's basically our product. We created that technology. We do our own rearward-facing cameras and then combined our auto-dimming technology with LCD technology. And what seemingly is like a pretty easy concept is really difficult from a physics standpoint. Most of you are staying in a hotel in Vegas. Some of you probably have a hotel room with a TV behind a mirror. My standard joke is you end up with a terrible TV and a terrible mirror. What's unique about our technology is that when it's in display mode, you cannot tell that there's a mirror in front of it. And when it's in mirror mode, you cannot tell there's an LCD behind it. And that's really due to the company's investment and the science behind what does it take on a proprietary coating stack to make those 2 seemingly opposed things capable of existing in the same place. Beyond that, there's a lot of other things that we do, obviously, on the high-end electronics side.

That's terrific. I appreciate that.

I think I passed out for a second.

Believe me, being up here for 2 days, it happens. If we think about this idea of the Full Display Mirror's adoption, if we get back towards $85 million, $90 million in global production, where are we from a penetration standpoint? And thinking about safety and other items, whether it's here, Asia, Europe, are there -- anything from a legislative perspective that would be a regulatory perspective that would increase adoption there?

No, I don't think regulation will drive it at all. And really, we don't want it to. And the reason why is our experience with regulation in our industry is that what happens is you end up with a much watered down version of a specification. And so when people are trying to meet just the bare minimum of that specification, it's really hard to get value out of that. Instead, what we pitch is a business case for our customers being the OEMs. In which case, you can buy a product from us -- typically, you're going to mark it up 2 to 3x that purchase price, and then resell it to the consumer. And so our business model really starts -- and that's why you'll see us at this show but also at Consumer Electronics Show all the products that we look at, we evaluate very hard to make sure that will the consumer, when they see them on a dealer's lot, value that product at a certain price point. And then how do we back up to build a business case not only for ourselves but for our OEM customers as well.

And Brian, to your question about the penetration rate...

Could you just maybe share the mic? I'm sorry.

Yes. So your question about the penetration rates. Globally speaking, North America, we're close to the mid 50s, even low 60s penetration. Europe is going to be in the low 40s. Japan, Korea is going to be in the teens, low 20s. And then China is our newest market and there, we're still in the single digits. So still a lot of growth opportunity there. But their fluctuations in vehicle volume production don't impact us as directly.

If we're thinking just about average selling price for a typical rearview mirror versus a Full Display Mirror, what do we think?

Yes. So it's interesting. If you look at our base auto-dimming inside or interior auto-dimming mirrors, they sell for the low $20 price point. They are below corporate average margin, so typically in the low 20s on a margin percentage basis. Once you start upgrading, whether that's HomeLink or Full Display Mirror, you get closer to corporate average margins. So call it, right now, we'll get into the margin conversation. But historically, in the mid-30s is kind of what our target range has been. And so any of our advanced feature electronics that we add on, you get not only the increase in penetration rate. You get also the higher ASP and then you get the higher margin profile. And so if you go to the far extreme of that, a full display mirror is typically in the high 100s to low $200 price point, so about 10x the average sell price.

That's incredible. Let's go back to this HomeLink business you bought from Johnson Controls. I would like to cover it in case we don't have the time. Talk about the evolution of HomeLink, about maybe what the business has been or what the business is now relative to maybe what you thought you were buying then and how that's evolved.

Yes, absolutely. So it's a long story. For any of you who have followed us for a while, I was CFO for about a hot second, maybe a week or 2, when we announced that I had spent $700 million on a business that no one had ever heard of or so. So there was some love mail and some nice notes that I received that turned out to be what people didn't understand in the company. Before I took over as CFO, had really done a terrible job of -- was explaining what this product was. We were already a licensee of it with Johnson Controls. That was a business relationship that I have had with JCI. And basically, what we acquired was about half of the business. At the time, through our license, we were already producing that product for our own use in mirrors. So what we acquired was about $130 million in revenue at the time. But with the acquisition of the revenue, what we got was a royalty reduction instead of -- now that portion of the business that we had, which is a little over $100 million as well, we got a significant savings on the cost side. Secondly, what we were getting, at about the time, let's call it maybe a combined $250 million in revenue between what we had organically through the license and what we acquired. Now we're probably closer to about $330 million in total revenue from that product.

We spoke last year about some tolling technology that you were developing. Maybe give an update on that. That was really kind of an interesting maybe segue to the discussion that we had a year ago.

Yes. And if you look at what HomeLink is, and it ties really well to this concept of what we call Integrated Toll Module or ITM. HomeLink basically is a one-to-many relationship. So if you have a garage door opener at your house, that's proprietary algorithms and code, and that's done for security reasons. You don't want people just randomly being able to open your garage door, obviously. We joke all the time, we live in the Midwest. So if you get in our garage, you're probably in our home. Very common way of living, especially in certain parts of the country. ITM is that same concept where we have access to every tolling authority in the country through a couple of partners, one of which is TransCore. And what we do through that relationship is we've commonized every tolling protocol in the country into one hardware and software set. We actually deployed this on Audi about 2.5 years ago. And as they roll this out across their product line and you buy a new Audi vehicle, you can register for either local, regional or national tolling and literally drive your car anywhere under one account. And so one of the reasons why we invested in this technology is we believe, especially with the move towards electrification, one of the things that we saw a few years ago that states really hadn't thought a whole lot about was there's a lot of incentives to move towards electrification. Obviously, revenue is going to drop significantly as it relates to road and infrastructure repair. Most states generate almost all of their revenue to help offset those through gas tax. And so one of the things we believe will be a movement throughout the country is more tolling. You've seen that in New York and some other places. We believe even in the Midwest and other parts of the country, it's going to be a trend towards adding more tolling.

Anything specific in them -- the infrastructure bill or any recent legislation that would help move this along?

I don't think there's anything too specific inside of the infrastructure bill itself that would move this along faster. What it has done, though, is raised a lot of interest and people are starting to ask the questions about what does this mean, what -- how are we going to maintain infrastructure longer term, and then how do we take advantage of the fact that people are moving about and there's a lot of underutilized assets across the country. And so I think just the fact that it came up and it hit so much prominence, a lot of states started reaching out. They're starting to look at how are they going to offset this revenue shortfall over the next 5 to 10 years.

Moving along, maybe towards what has been in front of you for the better part of the last 2-plus years is sourcing and supply chain. You are one of the -- maybe the most profitable auto supplier that exists. So theoretically, if you're the highest up, you've got the most room to fall. Talk about maybe some of the sourcing challenges you faced and whether you've taken a look at supply chain inventory stocking. Anything along those lines where you're making any material changes to how you run your operations?

Yes, absolutely. One of the things you'll notice over the last 18 months. From a balance sheet standpoint, we took a lot of cash, deployed it into raw materials inventory to try to secure. As you can imagine, with 90% market share, we have a lot of exclusive arrangements with customers. The worst thing you can do in this scenario is violate those by not being able to produce or ship. It's been absolutely insane 18 months. I think about a year ago even -- we posted earnings. One of the questions on the call was, hey, how bad is it? I said, it's actually way worse than people think. This is before everyone knew about it. I think 2 weeks later, Mary Barra told the world that it wasn't that bad. So we got a lot of calls saying, why are you here and GM is over here? I said, well, she's Mary Barra and I'm Steve Downing, so I would listen to her if I were you. But I think the harsh reality was a lot of Tier 1s thought they had this handled. What we were seeing from the supply base, being an electronic -- a large electronics purchaser directly, we were starting to see the beginning of this well in advance. So we tried to accumulate as much as we could, even that wasn't enough. As it stands right now, about 30% of our engineering effort on the electronics side is going to product redesigns, trying to avoid shortfalls and supply issues. It was hundreds of parts every couple of weeks that you were concerned about or causing problems. The total number of components has dropped. The problem is the severity of only one component can still bring you to your knees, especially on products like our Full Display Mirror, which are very heavy electronics bill of materials. And so it's been a crazy 18 months. I think we're probably 6 to 9 months away from it not being as big of an issue on the supply side. And then we just have to -- now we're left with the issues of fighting through the economics of what the scarcity did to pricing in the industry.

Thinking about that and maybe thinking about some of the advanced products that you have, the Full Display Mirror, is there any concern that pricing is going to get to the point where take rates are going to decline?

Yes, I would say it's absolutely a possibility. I think what's more of a possibility than that is actual borrowing rates. I think interest rates are going to drive -- and it's not going to change the entire mix. What you've seen for the last year, however, is because of scarcity and lack of vehicles, consumers are buying upgraded vehicles. If they could get their hands on a vehicle, even if it was maybe packaged higher than what they would have chosen, they would take it because there wasn't a lot of availability. As we move through the next 12 to 18 months, I think consumers will become a little bit more able to find a vehicle at the price point they want. And so I think that could be the biggest risk factor is, what does affordability look like as interest rates climb.

I think -- if you just move the microphone a little bit closer on the next question. Before we get into some of the profitability aspects of your business, and I also want to remind our colleagues here, certainly an open forum. Please ask questions if you -- Brian, for the Zoom, why don't you wait? I'll ask a question and then we can go from there. So aerospace was a business that was supposed to take off literally and figuratively, and there was truly no pun intended there. For you, the issues with the 787 maybe paused that. Maybe talk about that business really quickly, what you're making there and where you think that business can be down the road.

Yes, absolutely. That was our first product actually we put into the aerospace industry. And really what it was, was taking our core electrochromic or darkening dimming technology and putting it into an aerospace application. So when the 787 launched, Boeing was looking for proprietary kind of new technologies, what else could they do on that plane? Besides being all carbon, it didn't have a lot of things that touched the consumer. And so what they did, we replaced mechanical window shades with our dimmable panel so it's an electromechanical product -- I mean, electric product instead of mechanical product. And so that business took off. We were standard fit on the 787. Over the course of the first 5 years of production, that had gone to about 10 or 12 planes per month. Obviously, during the last few years, the need for planes had dropped significantly. One other thing that's hurting Boeing a little bit on the 787 is wide-aisle planes have slowed. The trend has been towards more narrow-body planes. So call that Airbus A330, A320 type products versus, say, A350s. We did get a second sourcing with Boeing. We're on the 777 now. It is not standard fit. It is optional. But we've also been fully -- and I should mention, when we entered aerospace, we needed a partner. We weren't certified in aerospace yet as a Tier 1. Since that time, we're fully certified not only at Boeing but also at Airbus, and we also received our first Airbus award in the last 2 years. And we've just started production shipments for Airbus recently.

If we're thinking about just if you can put some numbers to that, what that business could be? We obviously know and we cover the aerospace industry as a firm for -- since inception, really, the need for plane replacement for the next 20 years. And obviously, this isn't a business that is going to generate a ton of revenue for you for the next 5 but maybe 10 years down the road.

Yes, absolutely. If you look at before the pullback in aerospace, we're averaging about $25 million or so a year in revenue from the aerospace division. That was on just the 787. We truly believe, if you fast-forward 10, 15 years, this should be anywhere from $50 million to $100 million business that's well above corporate average margin profile.

Brian?

Going back to the pipeline, with regard to the supply chain. So you mentioned because I think one of the previous companies mentioned something similar that you have these disruptions. And as the disruptions abate, you have to see what happens in the underlying pricing. So I guess the question -- I mean, from your perspective, is there any historical precedent that will these -- will prices stick? Or is there some type of reversion as the underlying challenges abate?

Yes. I think what you're looking at is probably like a 3- to 5-year recovery back to where we were pricing. If you look at the high-end electronics market, it's typically moved in -- about a 3% to 5% deflationary per year market is pretty much what electronics have moved at for all time. I think you see a one-time step-up increase. And when I say one-time, I mean it's going to be over a couple of year period. It started last year. It will probably go for another 6 to 12 months. And then I think we're going to get back into a deflationary market. Obviously, the supplier is going to try to hold on as much as possible. I think the big thing that you've seen and what we're starting to see is consumer electronics are about 90% of the electronics industry. Automotive is really only 5% to 10%, and so we're the tail on the dog, unfortunately. But what you're starting to see is consumer electronics demand has begun to drop, and that may be a sign, one of the leading indicators of what we're facing from a macroeconomic standpoint over the next several years. But once that demand starts to drop on the consumer side, typically, you'll start to see the automotive prices start to drop right after that. Now they'll hold on as long as they can, obviously, to that higher pricing. But I think it will probably take another year to 18 months before we get down into a deflationary market again.

Yes, go ahead.

Yes, just you're here 4 years from now, what products would you have introduced? And where would we see those first? What trade shows or what?

Yes. So this week, we'll be showing some new technology for the aftermarket. And also, we tend to take the show to do a little bit more focus on OEMs as well. Aftermarket itself isn't a huge part of our business. But what we know is it's a great way to test new product concepts with consumers, especially gear-heads and car people. January at CES is when we go all out in new technology. And so typically for us, that's great -- it's a target-rich environment from an OEM standpoint. You have CTOs, chief engineers that are out looking for new tech and so we tend to go very heavy on new tech. And one of those things we'll be showing this year is -- we showed it last year but attendance wasn't great at CES, but driver monitoring and cabin monitoring. We acquired a software company in Tel Aviv called Guardian. This is an AI-powered system that can do driver monitoring and cabin monitoring. What we love about it though is the feature set is actually way better than just a normal driver monitoring system. In other words, what they can do is you can do things with cameras and you can replicate, follow body movements, eye gaze, those types of feature set, which a lot of people can do with software. But more importantly, what they had is a structured light concept. Structured light allows you to do micro vibration analysis to look for a child left behind, even in a rearward-facing car seat, by picking up very small micro vibrations anywhere in the vehicle. But it can also do mass notification. In other words, I can look and measure mass of the passenger and start to control airbag deployment and distance from airbags and create a safer environment in the vehicle using that type of technology.

Terrific. Just how much of your $2 billion in revenues is non-U.S. Europe? And how do you hedge the currency?

Yes, about 60% of our revenue is exports out of the U.S.

Exports. As opposed to manufactured?

Correct.

You price in dollars or are you pricing...

95% of our revenue is in U.S. dollars.

As the former CFO, given all of the dynamics you saw, are you able to price on LIFO? I'm not talking about inventory. I'm talking about the costs coming in and pricing at that time. Is there -- how big a lag effect? And will that change in the future?

I don't think -- I mean, it would be interesting to pull it off in the industry. Unfortunately, our customers struggle with how to handle the regression of what an alternative pricing model would look like. Instead for us, what we tend to do is when we do have prices structured either in U.S. dollars or in foreign currency, because our -- 2/3 of our customers are operating in foreign currencies as their normal MO, what we have to do is get creative on exchange rates. So typically, what we do is we're pricing contracts with bands. In other words, if it's inside of that band, neither -- we just lay down weapons. We're not going to call each other. The last 6 months have started to get more interesting, obviously, with FX taking a more prominent role. Each one of those situations create, obviously, a risk factor but an opportunity. What I would tell you is because of our patience with our customer base, we've been able to negotiate very favorable deals in exchange for short-term pain that they feel when there's FX issues.

Moving along just to -- and we have -- I think we have time for a couple more questions here. The balance sheet. Since I've known you, since I've known the company, you've been through the 4 GM bankruptcies, you've seen everything that could have gone wrong in the industry probably go wrong at various points. You're still very much in a net cash position. Any thoughts to the idea that if you were to -- even if you were to put a turn of debt on the balance sheet, that's an extra $900 million of cash that can be deployed. And any thought on -- or what are your thoughts on leverage then?

Yes. Well, first, thanks for the reminder of how bad the industry is. And thank God, windows don't open in this town, right? But it's -- what I would say is we have been through it, we've seen a lot. I would tell you that our balance sheet is less about conservative position to weather a storm out of fear and more about an aggressive position. So if you look at the HomeLink acquisition, for instance, with our own balance sheet and then open line of credits that required zero information for investment bankers. And no offense to the bankers in the room, but we were able to move on that asset without a whole bunch of people finding out what we were after, what we were paying or what we were acquiring. And so if you see us, we're not the largest supplier in the space. And so when we see an asset we want, we feel the need to be able to move on our own. And that's created a lot of advantages for us, not only on the acquisition side in smaller acquisitions recently, but also in terms of our finished goods and our raw materials inventory position. Given the balance sheet, we were able to expand our raw by about $140 million in the last 1.5 years to help protect ourselves and our customer base and our reputation as a reliable supplier. As we move from where we're at now going forward, and so you saw a slowdown on share repurchases a little bit during that as we were expanding the inventory base. But if you look at the price point we're trading at right now versus what we believe the trajectory is for the company, not only from a growth standpoint but also recovering those cost impacts and getting back to the margin profile we believe we're worth, we believe that the price just doesn't support where we're going to end in 2 years. And so you'll probably see us get a little more aggressive on the repurchase side as well. And just to be clear, we typically have anywhere available from $150 million to $250 million, $300 million on line of credit that we can deploy any time. Very little carrying costs. And one thing about the balance sheet that does allow us to do is obviously have access to that at very low cost.

Conversation has been great. What have I missed? What am I missing from a question perspective?

Well, I think the one, if I would be remiss if I didn't talk about, last quarter, we just posted last week. That was obviously a cathartic experience for us. The one thing I like to remind everyone is it happened in '08, '09. In 2012, '13 when I took over as CFO, we had gotten down to about a 32% gross margin. We actually rebuilt it over the course of those next couple of years. We know what it takes to actually rebuild the margin profile. We deliberate took a slower position with our customers, and we did not want to be in the first wave of people asking for cost increases, primarily for 2 reasons. Number 1 is we're not a solvency problem. So you don't want to be the guy begging for money when your -- when everyone knows what we make in the industry. But then Number 2, we believe we are in the early stages of this game, and we knew what we wanted to do was try to get to 80%, 90% knowledge base before we started negotiating. We know the customers will struggle if you're coming in 5, 6, 7 times, asking every day for more and more and more. So what we're trying to find is that optimal time to go in and push for the right level of price increases in combination with the right level of future sourcing for growth, and we believe we're in that time period now. So over the next 5 quarters, you're going to see us take a more aggressive stance with our customer base in terms of pricing and making sure that we're getting at least some relief on the raw economic side.

Well, I appreciate the clarity and the accountability, and I look forward to seeing the recovery as well. Thank you very much for being here. Appreciate it.

Thanks, Brian. Thank you.