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Gentex Corporation (NASDAQ:GNTX)

Q4 2012 Earnings Conference Call

Jan 29, 2013 10:30 am ET

Executives

Connie M. Hamblin – Vice President of Investor Relations & Corporate Communications and Corporate Secretary

Steven Dykman – Vice President of Finance and Treasurer

Mark W. Newton – Senior Vice President

Analysts

David Leiker – Robert W. Baird

Matthew T. Stover – Guggenheim Securities, LLC

John J. Murphy – Bank of America/Merrill Lynch

Ryan J. Brinkman – JPMorgan Securities

Steve L. Dyer – Craig-Hallum Capital Group

Richard Kwas – Wells Fargo Securities, LLC

Gregory W. Halter – Great Lakes Review

Adam Brooks – Sidoti & Company, LLC

Brett David Hoselton – KeyBanc Capital Markets

Operator

Good morning, ladies and gentlemen, and welcome to the Gentex Announces Fourth Quarter and 2012 Year-End Financial Results Conference Call. Today’s call is being recorded.

And I’d like to turn the meeting over to Ms. Connie Hamblin, Vice President of Investor Relations. Please go ahead Ms. Hamblin.

Connie M. Hamblin

Thank you. Good morning, everyone. Thank you for participating in our fourth quarter conference call. On the call with me today are Steve Dykman, our Chief Financial Officer; and Mark Newton, our Senior Vice President. All right, first, I will go through a few routine matters and then I’ll turn the call over to Steve for his comments on the Company’s financial results for the fourth quarter and calendar year, and Mark will also make some comments related to products and technology.

This call is being broadcast live on the Internet via an icon on the homepage at Gentex’s website at www.gentex.com. The auto playback of the conference call is also available there. All contents of Gentex Corporation’s conference calls are the property of Gentex Corporation and may not be copied, published, reproduced, rebroadcast, retransmitted or otherwise redistributed without the express written consent of Gentex. Gentex alone holds such rights.

While we understand that there may be companies that there may be companies that transcribe and redistribute our conference calls notwithstanding this warning, Gentex Corporation provides no authorization to do so and expressly disclaims any responsibility for any unauthorized use of the content. We advise that you should not rely on the content of any unauthorized transcript as Gentex Corporation will not be held liable for the content of any such transcript.

Gentex Corporation will hold responsible or liable any party for any damages incurred by Gentex with respect to any such unauthorized use. Your participation implies consent to our taping and to the foregoing terms. Please drop off this line now if you do not agree with these terms.

Before we begin, I’m going to give you a short forward-looking statement and you should go through our news release and look at the full statement. Gentex Corporation will make forward-looking statements in this presentation related to its financial results for the fourth quarter and calendar year 2012 and beyond that are based on preliminary data and are subject to risks and uncertainties.

These forward-looking statements are based on management’s belief, assumptions, current expectations, estimates and projections about the global automotive industry, the economy and the company itself. Words like anticipates, believes, confident, estimates, expects, forecasts, hopes, likely, plans, projects, optimistic, and should, and variations of such words and similar expressions identify forward-looking statements. These statements do not guarantee future performance and involve certain risks and uncertainties, and assumptions that are difficult to predict with regard to timing, expense, likelihood and degree of occurrence.

Therefore our actual results and outcomes may materially differ from what is expressed or forecasted. The Company undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events, or otherwise. Please refer to the news release for the full Safe Harbor statement.

At this time, Steve Dykman will make some remarks with respect to the quarter.

Steven Dykman

Good morning and welcome to our fourth quarter 2012 conference call.

We are pleased to report that our gross profit margin sequentially improved in the fourth quarter of 2012, despite relatively flat net sales. We are also pleased to illustrate the continued positive efficiencies we’re experiencing within our operating expenses.

The company reported fourth quarter 2012 net sales of $260.3 million, which was flat compared with the fourth quarter of 2011: net sales of $1.1 billion for calendar year 2012 or the 7% increase compared with net sales of $1 billion in calendar year 2011.

We reported fourth quarter 2012 net income of $39.6 million, which was down 2% compared with net income of $40.5 million in the fourth quarter of 2011. Net income of $168.6 million for calendar year 2012 was a 2% increase compared with net income of $164.7 million in calendar year 2011. Net income for both periods above includes the $5 million pre-tax litigation settlements with American Vehicular Sciences, which will be discussed later in these comments.

We reported fourth quarter 2012 earnings per diluted share of $0.28 compared with $0.28 per share in the fourth quarter of 2011. Earnings per diluted share was $1.17 for calendar year 2012 compared with earnings per diluted share of $1.14 in calendar year 2011. Earnings per share for both periods above also include the litigation settlement with AVS.

Next, we'll look at automotive net sales and auto-dimming mirror unit shipments for the fourth quarter ended December 31, 2012.

Total auto-dimming mirror unit shipments increased by approximately 5% in the fourth quarter of 2012 compared with the fourth quarter last year. Automotive net sales declined slightly to $254.6 million in the fourth quarter of 2012 compared with $254.7 million in the fourth quarter of 2011. Auto-dimming mirror unit shipments increased by approximately 17% in North America in the fourth quarter of 2012, primarily as a result of increased mirror unit shipments for certain domestic and Japanese transplant automakers.

North American light vehicle production increased by approximately 10% in the fourth quarter of 2012 compared with the same prior year quarter. Auto-dimming mirror unit shipments to offshore automakers decreased by approximately 2% in the fourth quarter of 2012, compared with the same quarter last year primarily due to decreased mirror unit shipments to certain European and Japanese automakers.

Light vehicle production in Europe decreased by approximately 7% in the fourth quarter of 2012 and decreased by approximately 9% in Japan and Korea in the fourth quarter of 2012 compared with the same quarter last year.

For the calendar year ended December 31, 2012, total auto-dimming mirror unit shipments increased by 11% in calendar year 2012 compared with calendar year 2011. Automotive net sales increased by 7% to $1.1 billion in calendar year 2012 compared with $1 billion in calendar year 2011. Auto-dimming mirror unit shipments increased by approximately 22% North America and calendar year 2012 primarily as a result of increased mirror unit shipments for certain Japanese transplant and domestic automakers. North American light vehicle production increased by approximately 17% in calendar year 2012 compared with the same prior-year period.

Auto-dimming mirror unit shipments to offshore customers increased by approximately 5% in calendar year 2012 compared with the same period last year, primarily due to increased mirror unit shipments to certain European and Japanese automakers.

Light vehicle production in Europe decreased by approximately 5% in calendar year 2012, and increased by approximately 12% in Japan and Korea in calendar year 2012, compared with the same prior period last year.

Other net sales for the company increased by 3% to $5.8 million for the fourth quarter of 2012 compared with the same quarter last year, primarily due to increased dimmable aircraft window net sales, partially offset by decreased fire protection net sales.

Other net sales increased by 10% to $22.6 million for calendar year 2012 compared with calendar year 2011, primarily due to increased dimmable aircraft window net sales, partially offset by decreased fire protection net sales. Fire protection net sales continued to be impacted by the relatively weak commercial construction market.

Next, we will look at the average selling price per auto-dimming mirror unit, which was $43.88 for the fourth quarter of 2012. The ASP of auto-dimming rear view mirrors was slightly down on a sequential basis to the $43.88 in the fourth quarter 2012 compared with $44.12 in the third quarter 2012 primarily due to a higher mix of base auto-dimming mirrors.

The average selling price decreased on a year-over-year basis to $43.88 in the fourth quarter of 2012 compared with $46.39 in the fourth quarter of 2011, primarily due to annual customer price reductions and a higher mix of base auto-dimming mirrors.

Based on IHS’ January 2013 light vehicle production forecast, we currently expect the first quarter 2013 ASP to be down approximately 2% to 3% compared sequentially with the fourth quarter of 2012 based on annual customer price reductions and the anticipated product mix of base and featured mirrors in this forecast. As usual, there are uncertainties with the IHS production and sales forecast, customer orders and new product introductions.

Next, we’ll look at the gross profit margin. The gross profit margin increased on a sequential basis to 34.2% in the fourth quarter of 2012 compared with 33.6% in the third quarter of 2012, primarily due to production efficiencies, partially offset by the Company’s inability to leverage fixed overhead expenses on the lower sequential net sales.

The gross margin decreased on a year-over-year basis from 34.7% in the fourth quarter of 2011 to 34.2% in the fourth quarter of 2012, primarily due to the impact of annual customer price reductions and product mix, partially offset by purchasing cost reductions. The gross margin declined from 35.3% in calendar year 2011 to 33.9% in calendar year 2012, primarily due to annual customer price reductions and product mix, partially offset by purchasing cost reduction.

The company currently expects that its gross profit margin for the first quarter of 2013 will be slightly down sequentially compared with the gross profit margin of 34.2% reported in the fourth quarter of 2012, primarily due to annual customer price reductions.

The gross profit margin will continue to be impacted by annual customer price reductions, uncertain global automotive production levels, product mix, our ability to leverage our fixed overhead costs, purchasing and vis-à-vis cost reductions, and manufacturing yields.

Next, I will provide an update regarding the Company’s operating expenses; first we will look at ER&D expense. Our ER&D expense decreased by approximately 15% in the fourth quarter of 2012 compared with the same 2011 quarter, primarily due to reduced cost associated with outside contract, engineering, and development services.

ER&D expense increased by 4% in calendar year 2012 compared with the calendar year 2011, primarily due to additional employee hiring for new product development projects and program rewards, partially offset by reduced costs associated with outside contract, engineering, and development services.

ER&D expense is expected to be down approximately 10% for the first quarter of 2013 compared with the first quarter of 2012, primarily due to reduced cost associated with outside contract, engineering, and development services.

Next, we will look at SG&A expenses. SG&A expense decreased by 8% in the fourth quarter of 2012 compared with the same prior year period. The decrease in the fourth quarter was primarily due to decreased overseas office expense. SG&A expense were approximately flat in calendar year 2012 compared with calendar year 2011 primarily due to increased overseas office expense offset by the impact of foreign exchange rates. The impact of foreign exchange rates was approximately 3 percentage point.

SG&A expense is currently expected to be approximately flat for the first quarter of 2013, compared with the first quarter of 2012 and is estimated based on stable foreign exchange rates.

Next I'll provide additional details regarding other income for the fourth quarter, investment income is $3.491 million, other $1.163 million, so total other income of $4.654 million and this compares to other income for the fourth quarter of 2011of $2.947 million.

For calendar year 2012, investment income was $5.307 million, other $9.863 million, so total other income of $15.170 million and this compares to other income for calendar year 2011 of $13.64 million. Investment income increased in the fourth quarter of 2012 compared with the fourth quarter of 2011 and in calendar year 2012 compared with calendar year 2011, primarily due to increased year-end mutual fund distributions in each of those periods. The increases in other income in both periods were primarily due to increased realized gains on sales of equity investments.

Now, I’ll provide an update regarding certain balance sheet items as of December 31, 2012. Accounts receivable $109.6 million; inventories, $160 million; patents and other assets $29.3 million; accounts payable $43.2 million; accrued liabilities, $44.8 million.

The Company’s rapid growth in 2010 and 2011 was compounded by electronics industry allocation of raw material and natural disasters with the Japan earthquake and the Thailand flood in critical areas of automotive electronic supply and resulted in significantly longer lead time commitments.

In the phase of these challenges, the Company deliberately determined to increase its raw material commitment to ensure that we did not shutdown our customers and to date we have not shutdown any of our customers.

Inventory levels declined by 15% in calendar year 2012 compared with calendar year 2011 and the company anticipates additional reductions in inventory levels in 2013, now that supply conditions have normalized.

Next, we’ll look at the effective tax rate. The fourth quarter 2012 effective tax rate of 32% varied from the statutory rate of 35%, primarily due to the domestic manufacturing deduction. In the calendar year 2012, effective tax rate was 32.5% and that varied from the statutory rate of 35%, primarily due to the domestic manufacturing deduction.

We currently expect that the effective tax rate will be approximately 31% in the first quarter of 2013 and approximately 32% for calendar year 2013 based on current tax laws. The reduced effective tax rate for the first quarter and calendar year 2013 is primarily due to the American Taxpayer Relief Act of 2012 and was signed in the law by President Obama in January of 2013, which retroactively reinstated the research and development tax credit to January 1 of 2012.

As a result, the 2012 tax credit benefit will be recognized in the first quarter of 2013, when the new legislation was enacted.

Next, we’ll look at cash flow. The Company’s year-to-date cash flow from operations was $257.8 million; capital expenditures for the fourth quarter was $19.9 million and capital expenditures for calendar year 2012 were $117.5 million. Depreciation and amortization expense for the fourth quarter was $12.6 million and for calendar year 2012 was $50.2 million.

The Company estimates that 2013 capital expenditures will be significantly reduced compared with 2012 capital expenditures at approximately $50 million to $60 million. Depreciation and amortization expense for 2013 is estimated to be approximately $56 million to $60 million.

An update regarding cash dividends. On January 18, 2013, the company paid a quarterly cash dividend of $0.13 per share to shareholders of record of the common stock at the close of business on January 7 of 2013.

The Company's cash dividend policy was established based on a number of criteria including current U.S. income tax laws that it’ll be meaningful and sustainable and that the dividend rate would increase generally in line with the Company's earnings and operating cash flow over time.

With respect to share repurchases, the Company did not repurchase any shares during the fourth quarter of 2012. The Board of Directors had previously authorized the repurchase of additional shares of the Company's common stock. Under the plan, the company may from time-to-time purchase shares of its common stock based on a number of factors, including market economics and industry conditions, the market price of the Company's common stock and other factors the Company feels appropriate.

The plan does not have an expiration date, but is reviewed periodically by the Company's Board of Directors and repurchases will be funded with available cash.

At this point, I'll turn the call over to Mark Newton, who will provide some product and technology updates as well as an update on AVS Litigation.

Mark W. Newton

Thank you, Steve. Update on American Vehicular Sciences Litigation. As previously disclosed on June 25, 2012 American Vehicular Science’s filed four patent infringement complaints in the United States District Court in the eastern district of Texas, which named the company and one of two of its customers as codefendants.

On December 28, 2012, in the ordinary course of business the company entered into a settlement license agreement with AVS, settling all pending litigation. The cost associated with the agreement was accrued by the company and is reflected in its financial results as of December 31, 2012. As a result of the agreement, the United States District Court in the Eastern District of Texas has ordered that Gentex is dismissed with prejudice as a defendant in the complaints filed by AVS.

Product and technology update. In the fourth quarter of 2012, the company successfully began shipping a number of auto-dimming mirror production applications with several automakers with advanced technologies including SmartBeam, driver-assist, Rear Camera Display, telematics, wireless control systems, compass, and various combinations of these features.

Unit shipments of SmartBeam and driver assist camera products increased by approximately 12% in calendar year 2012 compared with calendar year 2011, in the face of challenging European market conditions, which did have a negative impact on product mix and option take rates.

In calendar year 2013, SmartBeam and driver assist unit shipments are estimated to increase by approximately 10% to 15% compared with calendar year 2012, based on the IHS January 2013 forecast for light vehicle production, which includes a 3% decline annually in European light vehicle production with larger forecasted percentage decreases in the mid-size luxury class vehicle model market, which currently is one of the primary markets for these features.

RCD Mirror unit shipments decreased by approximately 8% in calendar year 2012 compared with calendar year 2011. In calendar year 2013, RCD Mirror unit shipments are estimated to decrease by approximately 25% to 35% compared with 2012, which incorporates estimated reduced RCD Mirror unit shipments to automotive customers who have previously notified the Company of their plans to have the display for the rear camera and the radio instead of the rear view mirror. While the company continues production launches of RCD mirrors on new vehicle models in 2013, we continue to experience volatility in customer orders for this feature in the phase of the Kids Transportation Safety Act which did not meet the scheduled December 31, 2012 deadline for implementation making this the fourth such delay for KTSA.

All other mirror products and technologies continue to result in new awarded business and development and launch now our interior auto-dimming mirrors with new frameless designs, lining applications with new optoelectronics; new digital microphones, many different displays in new sizes with faster processing and increased graphics capabilities, new wireless control systems that send and receive signals from garage doors, gates, lights, locks and security systems; SmartBeam with advanced detection for tunnels, curves, fog and for use on all technologies for headlamps including halogen, xenon and LED; driver-assist systems with new objective detection capabilities and exterior auto-dimming mirrors with new curved glass application.

Next, I'll summarize net sales estimates for the first quarter of 2013. We currently estimate that net sales for the first quarter of 2013 will decrease by approximately 5% to 10% compared with the first quarter of 2012 based on the HIS January 2013 forecast for light vehicle production, including declines in Japanese and Korean and European and North American regions as well as our 12 week customer release schedule. Forecasting with degree of accuracy in this environment is very challenging.

Additionally, all European production is expected to decline by 10% in the first quarter of 2013. The forecast also includes higher percentage decreases in mid-size luxury class vehicle models, which currently are one of the primary markets for these futures. We continue to be concerned about the deteriorating macroeconomic environment, particularly in Europe, which is our largest shipping destination.

We also continue to experience volatility with customer orders within the 12 week customer release window with some of our customers including the tier 1 mirror suppliers revising orders.

Now, I will turn this back over to Connie.

Connie M. Hamblin

I will give you a few numbers. These are related to IHS’s production forecasts, this is for the first quarter of 2013. Light vehicle production in North America is expected to be $3.9 million, which is down 2% compared with $4.0 million last year. Europe is expected to decrease by 10%. It’s from $4.7 million versus $5.2 million in the first quarter of 2012. The Japan and Korea markets are expected to decline by 13% at $3.3 million and that compares with $3.8 million last year.

For the calendar year, North American light vehicle production is expected to increase by 3% for North America at 15.9 million vehicles versus 15.4 million last year. European light vehicle production is expected to decline by 3% at 18.6 million versus 19.2 million last year and Japan and Korea are also expected to decline by 9% to 12.7 million compared with 14.0 million last year.

As a quick reminder, all the listeners should note that this call is being recorded by Gentex, all contents of Gentex’s conference call are property of Gentex, no such contents may be copied, published, reproduced, rebroadcast, retransmitted or otherwise redistributed without the express written consent of Gentex Corporation. Gentex Corporation alone holds such rights.

While we understand that there may be companies that transcribe and redistribute our conference calls notwithstanding this warning, Gentex Corporation provides no authorization to do so and expressly disclaims any responsibility for any unauthorized use of the content.

We advise that you should not rely on the content of any unauthorized transcript as Gentex Corporation will not be held liable for the content of any such transcript. Gentex Corporation will hold responsible or liable any party for any damages incurred by Gentex with respect to any such unauthorized use. Your participation implies consent to our taping and to the foregoing terms. Please drop off the line now if you do not agree with these terms.

At this time, we’re going to open this call for questions-and-answers. We do respectfully request that you plan to ask one single part question at a time so that everyone has an opportunity to ask questions and participate.

Thank you. We appreciate your cooperation. Operator?

Question-And-Answer Session

Operator

(Operator Instruction) And we’ll take our first question from David Leiker with R.W. Baird.

David Leiker – Robert W. Baird

Good morning everyone.

Connie M. Hamblin

Good morning.

Mark W. Newton

Good morning.

David Leiker – Robert W. Baird

I wanted to start with some of the technology trend that we’ve been seeing in the industry at the Consumer Electronic Show, and then in Detroit particularly around the active safety driver information. Do you talk at all about the technology that you have in that space today? What’s your – how much of your business might be coming from that today? And what the order book looks like in level off and just for that type of technology?

Mark W. Newton

Thank you David, this is Mark. The Company’s products generally for automotive from our basis in auto-dimming mirrors has an application based in the safety. The advanced technology that we have in Rear Camera Display, in SmartBeam and driver assist technology also comply in these areas.

The mirror has been used heavily in Gentex’s history as an information resource in the vehicle in addition to the instrument panel and it has been one of the keys to our growth. So with technologies that are increasingly improving today, there has always been a general component of electronic safety applications in addition to our auto-dimming mirror applications and our Side Blind Zone applications for outside mirrors. I would estimate that generally we participate with all of our products in this area. And growth that we’re experiencing now and for the future in the electronics arena continues to be in this area, that’s part of what SmartBeam, driver assist and these other technologies.

David Leiker – Robert W. Baird

Then I guess I am trying to go one step further to lane departure warning, collision warning and those types of technologies that’s using more of a finer image sensor going forward as well?

Mark W. Newton

The driver assist systems that I referred to in my comments and that we have in our press release with new object detection capabilities are in the areas of lanes, lines, vehicles, pedestrians, consistent with what you’re seeing in the industry generally.

David Leiker – Robert W. Baird

Okay. And then just to close the loop on that. What does the order activity or business activity look like from your customers for those types of technologies?

Mark W. Newton

As we’ve indicated from our growth numbers from 2012 and 2013, we continue to grow in expansion of the SmartBeam capability as we’ve spoken in the past year adding capabilities for dynamic forward lighting, adding capabilities for all headlamp technology types and then additionally doing driver assist systems, which also include camera based lane detection, traffic sign recognition and has new object detection capabilities I indicated further. This is a growth area for us.

David Leiker – Robert W. Baird

Okay. Thank you.

Connie M. Hamblin

David, I think it’s important to note that the lead times on these technologies are pretty long. It’s not like you can just pop one of these on a vehicle in a year, so I mean they have two to three year lead times.

David Leiker – Robert W. Baird

Okay, thanks a lot.

Steve Dykman

With that, this is a lot of what you are seeing in our ER&D explanation when we referred multiple times in the call and in our press release about the improvements in ER&D, primarily coming from replacement of contract and outside engineering resources as we are able to hire our own resources. This is in response to awarded growth in technology areas that have longer lead times with the new technologies that I described earlier.

David Leiker – Robert W. Baird

Okay, thank you very much.

Mark W. Newton

Thank you.

Operator

And we will take our next question from Matt Stover with Guggenheim.

Matthew T. Stover – Guggenheim Securities, LLC

Thanks for taking my call. I have a question just regarding the KTSA legislation and rulemaking. There have been some reports out of Washington that suggested that perhaps there may be some news on this front and I am just wondering if you share the opinions of those reports and can you give any color as to the status of that rulemaking from your perspective?

Mark W. Newton

With the fourth delay December 31, we know all the information we believe that generally the rest of the public does in this, we right now don’t see any definitive indication of when this might be applied. Connie, do you have any further comments?

Connie M. Hamblin

I haven’t seen anything. Matt, have you recently seen something they’re talking about?

Matthew T. Stover – Guggenheim Securities, LLC

It was in an interview with (inaudible).

Connie M. Hamblin

Recently?

Matthew T. Stover – Guggenheim Securities, LLC

Yeah. I’ll pick it up and pass it on to you.

Connie M. Hamblin

Okay, yeah. I know that they were talking a lot at the end of the year and they actually said that they had intended to meet the requirements by the end of the year and obviously that deadline was a myth, so...

Matthew T. Stover – Guggenheim Securities, LLC

Okay, thank you very much.

Connie M. Hamblin

We didn’t know [about the] announcement.

Matthew T. Stover – Guggenheim Securities, LLC

Okay. Thank you very much.

Connie M. Hamblin

Thanks.

Operator

And we’ll take our next question from John Murphy with Bank of America, Merrill Lynch.

John J. Murphy – Bank of America/Merrill Lynch

Good morning guys. I missed it in the beginning of the call. So I apologize if you’ve covered this. But I am just curious, as you look at the efficiencies that you gain from manufacturing in the fourth quarter that helped out the gross margin. Just wondering if you could just expand on some of the specifics there and just sort of help us understand if that’s a lot of manufacturing efficiencies or are you maybe getting better margins on your core mirrors and your – on the RCD, so as the RCD would fade. You actually just get a margin lift. I am trying to understand the specifics around the efficiency versus the mix impact that we may have seen the fourth quarter and going forward?

Mark W. Newton

Yeah. Specifically, with respect to the production efficiencies, they are really surrounding manufacturing cost reduction process improvements as well as some direct labor efficiencies and some improvements with respect to overtime related costs. And I think as we look forward, our guidance for Q1 was a slight decline as we previously discussed that the first quarter is one of the larger quarters for annual customer price reduction activities and the other thing to keep in mind as we look forward to calendar year 2013. We have the new facility related cost coming online, so that will be a little bit of a headwind as we look forward to coming year.

John J. Murphy – Bank of America/Merrill Lynch

Okay. So you think these are repeatable, but they are going to be a little bit to work by price downs in the first quarter, is that some of the correct characterization?

Mark W. Newton

Yes.

John J. Murphy – Bank of America/Merrill Lynch

Okay. And then just kind of follow-up on the ER&D, I mean the savings or the declines that you are talking about, they are pretty extreme and are very unusual. They really are all a function of bringing these engineers or these engineering resources in-house and really getting this is as net saving?

Steven Dykman

Yeah. I mean that’s the most significant component of that. As market indicated, to some degree there has been a lot of launch activity and then certain milestones have been met, some of the contract engineers are needed. But the biggest component is as we replace them with permanent hires, that’s had a much lower cost. So we are gaining efficiencies. I think when you look at the guidance for Q1, Q1 of last year was really kind of a peak level of ER&D spend as well. So just keep that in mind.

Mark W. Newton

Relating to that, the large sales growth that we were fortunate to experience in 2011 also had a component of strong growth and awards and with that increased development of launch much of it in new technologies with long lead times. These resources for electrical design and software development is two of the typical things that companies like Gentex have to go get. These are two to three times and more extensive of standard staffing and as we are able to recruit permanent resources to replace those which we were able to transition to in 2012, as you watch that improvement begin in Q3.

We’re pleased now that we’re operating without those resources, the outside contract engineers. So you will hopefully continue to see the improvements we’ve indicated in ER&D.

With that, our product and technology development commitment is strong as it ever was; this improvement is as Steve indicates in the area of replacing temporary resources with permanent plot.

John J. Murphy – Bank of America/Merrill Lynch

And most of those engineers are in Zeeland, Michigan or are they around the world?

Mark W. Newton

They’re well in – majority are in Michigan.

John J. Murphy – Bank of America/Merrill Lynch

Great. Thank you very much.

Connie M. Hamblin

And an interesting note, I just got an e-mail saying that Secretary of Transportation Ray LaHood is leading the administration. So I don’t know if that’s good news or bad news.

Operator

And we will take our next question from Ryan Brinkman with JPMorgan.

Ryan J. Brinkman – JPMorgan Securities

Hi, good morning. Firstly, congratulations on the quarter. It’s great to see a bit of gross margin traction now in addition to the excellent cost control.

Mark W. Newton

Thank you.

Ryan J. Brinkman – JPMorgan Securities

So I think you’ve done a good job addressing margins which were part of my multi-part question, so really I will just ask one single question and keeping with your policy. Just on share repurchases. Last quarter I think we saw what most investors interpreted as a modest but symbolically significant step in the right direction on this front. Of course you didn’t repurchase shares this quarter and I know you are setting uncertainty regarding fiscal cliff and industry and macro environment in Europe and that’s well understood. But I think still we’re pointing out that your cash and short and long-term investments are something on the order of magnitude of 50% of 2012 annual sales which compares to an average of 8% for the 14 other US auto part supplier stocks that we cover at JP Morgan. And likely you are doing from the operating prospective within the context of the head winds you faced but can you understand maybe why it’s hard for investors to understand, but if you are so conservative why couldn’t you just go out there and get a sizable revolver for back up liquidity purposes which would almost certainly remain undrawn even as you repurchase potentially 100’s of millions of dollars of stock.

Mark W. Newton

Well that’s a good question and as you are aware, the company has been conservative from a financial perspective and that’s been a fundamental view of the Company’s board as well as our CEO and that has enabled us to run the business from a longer-term perspective especially given the financial crisis and the economic downturn back in 2008, 2009 and we acknowledge that we have additional cash and investments on our balance sheet and since the board has focused a little bit more recently on the uncertainty and the overall economy and industry and some of those decisions and the other think to keep in mind is we do not repurchase shares during the Company’s overall blackout periods and during that blackout periods, we have the lowest points of share prices in the fourth quarter, but it is a good question and it is something our Board continues to monitor and determining decisions for repurchases going forward.

Ryan J. Brinkman – JPMorgan Securities

Okay. I think that’s very well stated. Now, I would just additionally point-out that I believe that you’re free cash flow positive in 2008 and 2009, which was a good accomplishment and again congratulations on the quarter.

Mark W. Newton

Thank you.

Operator

And we will take our next question from Steve Dyer with Craig-Hallum.

Steve L. Dyer – Craig-Hallum Capital Group

Thanks. Good morning.

Connie M. Hamblin

Good morning.

Mark W. Newton

Good morning.

Steve L. Dyer – Craig-Hallum Capital Group

With respect to RCD, what quarter this year or quarters are those are the two customers who are rolling off going to roll off?

Connie M. Hamblin

It’s spread throughout the year. It’s not significantly impacting one quarter over another.

Steve L. Dyer – Craig-Hallum Capital Group

Is it start in Q1 and just kind of go throughout or does it start later in the year?

Connie M. Hamblin

Q1.

Mark W. Newton

It starts in Q1 and covers through the year of the four previously announced customers who had notified us of an intention to change from the mirror to radio, the two largest occurring in 2013.

Steve L. Dyer – Craig-Hallum Capital Group

In 2013, okay. And then with respect to this IP settlement, I think it was last quarter, you indicated that you are going to be paying basically a 50 basis point licensing agreement, I think this is the same agreement. Does that mean that the settlement of this would then be a 50 basis point tailwind going forward?

Mark W. Newton

No. The other agreement that was discussed in our prior quarter conference call is a separate agreement and at that time, we indicated that license agreement was estimated to have a negative impact on margins going forward of above 35 basis points. The AVS litigation is a settlement and there is not a margin impact in the fourth quarter or going forward.

Steve L. Dyer – Craig-Hallum Capital Group

Okay. So I got those two mixed up, so did you realize that 35 basis points improvement in that in Q4? I am sorry, not improvement. . .

Mark W. Newton

Yeah.

Steve L. Dyer – Craig-Hallum Capital Group

Yeah, okay I’ll hop back in the queue, thank you.

Operator

And we’ll take our next question from Richard Kwas with Wells Fargo.

Richard Kwas – Wells Fargo Securities, LLC

Hi, good morning everyone.

Mark W. Newton

Good morning.

Connie M. Hamblin

Good morning.

Richard Kwas – Wells Fargo Securities, LLC

Question on the ER&D, so Steve, the comp a year ago, there is a big growth in spending, obviously for the guidance here for Q1 2013, [there] pretty big decline exist? Do you think of the decline in the ER&D being the most significant Q1 when we think in terms of the full year?

Steven Dykman

Yeah. If you look at the trend line in 2010 and 2011 sequentially, we were experiencing increases in ER&D spent and it really kind of peaked in Q1, Q2 of 2012. So in recent quarters, you will notice a sequential change in ER&D spend hasn’t been a significant. So as you look at the trend going forward on a percentage basis, the beginning of 2013 is going to experience larger declines year-over-year than as we grows through the year.

Richard Kwas – Wells Fargo Securities, LLC

Okay. And then how far long are you in terms of bringing these engineers in-house versus outsourcing, I mean is it mostly complete with this first quarter run rate and the ER&D represent really the post that has gone?

Mark W. Newton

We have completed this. We are operating now all within house resources. We completed the last of that in the fourth quarter. So what you will see as we forecasted for the first quarter of 2013, you will see those improvements reflected in 2013. We now have removed all of the outside consulting services.

Richard Kwas – Wells Fargo Securities, LLC

Okay.

Connie M. Hamblin

We then continued to look for engineers in different disciplines with good histories and….

Richard Kwas – Wells Fargo Securities, LLC

Okay, okay. And then just the last one in terms of the manufacturing with the new facility, if I recall from back five, six, seven years ago at this point with the other facilities, you last launched, I think that was, I want to say 25 basis point to 50 basis point headwind to gross margin in the first year. So and that was up in running, I might be wrong on the exact number, but what’s the assumption here for 2013 in terms of the headwind in the gross margin from you’re ramping up at the new facility?

Mark W. Newton

Yeah. So back in 2006, and we added that new facility, the headwind on margin in the first year was approximately 50 basis points. And so we have talked about the more recent facility expansion plans. We are anticipating an impact on margins in the initial year, slightly less than the 50 basis points. And part of the reasons for that is our primarily additions to existing facilities, and so we are not in a position, we have to duplicate a lot of resources like you would with a typically new facility.

Richard Kwas – Wells Fargo Securities, LLC

Okay, so that’s in terms of your Q1 guidance, that started, that’s already partly early, partly incorporated.

Mark W. Newton

Okay.

Richard Kwas – Wells Fargo Securities, LLC

Yeah, okay. All right, thank you.

Connie M. Hamblin

Thanks.

Operator

And we’ll take our next question from Greg Halter, with Great Lakes Review.

Gregory W. Halter – Great Lakes Review

Yes, thank you and good morning.

Connie M. Hamblin

Good morning.

Mark W. Newton

Good morning.

Gregory W. Halter – Great Lakes Review

That was a good segway into my question on the plans, just wondering what your capacity is now before interior and exterior mirrors?

Mark W. Newton

Okay. So we have talked about the various expansion projects and they have for the most part been completed as 2012 calendar year progressed. The conductor or bridge facility that we’ve talked about is running into the first quarter of 2013 a little bit here, but upon completion of that for interior auto dimming mirror capacity will be 21 million mirror units to 23 million mirror units annually and exterior mirrors capacity is approximately 10 million mirror units annually.

Gregory W. Halter – Great Lakes Review

All right, thank you.

Operator

And we’ll take our next question from Adam Brooks with Sidoti & Company.

Adam Brooks – Sidoti & Company, LLC

Good morning guys. Lot has been asked, but just kind of a question as far as an update maybe on conversations with customers regarding [where stances] are placed for a active safety, just that you being in the mirror versus on the wind shield, are you getting any headwind as far as the European OEMs?

Mark W. Newton

Our application for all of our camera based products is incorporated with the mirror we compete against others who do cameras outside of the mirror and we’ve had strong success with that in our history, as our advantage with it. Our growth, as indicated in the SmartBeam and driver assist, that is all with the camera incorporated with the mirror and the electronics controlling in beside the mirror and so we continued to grow with this with our European customers and other customers worldwide.

Adam Brooks – Sidoti & Company, LLC

And just kind of maybe a follow-up on those, as far as just strictly drivers that outside of SmartBeam lane to (inaudible) who would not, can you give us a sense as far as price, how you are compared to your competitors that are not in the mirror?

Mark W. Newton

We believe as we continue to compete in this market and as we’re growing that we’re competitive in this, there are still many, many suppliers in this area, because we have such a large application base as a camera supplier to the automotive industry based on SmartBeam and they have a long history being among the first to do this in automotive. We’re competing with all automakers worldwide on this with a good reputation. We do this in a mirror-based application and as our continued forecasted growth in case we continue to grow, so we believe we’re competitive.

Adam Brooks – Sidoti & Company, LLC

All right, thank you.

Connie M. Hamblin

Thanks. We have time for one more question.

Operator

And we’ll take our last question from Brett Hoselton with KeyBanc.

Connie M. Hamblin

You made it.

Brett David Hoselton – KeyBanc Capital Markets

Yeah, just barely, how are you? I think I am going to ask you a couple of questions in some tailwinds here, but the first question I have is your RCD guidance are down 25% to 35% in 2013; last year you basically said, look we’re going to have a material decline in RCD in 2013 and an additional material decline in 2014 and my question is simply, 25% to 35% is clearly material. Does 2014 look like that?

Mark W. Newton

Our largest decline that we see clinically based on the current forecast is 2014.

Brett David Hoselton – KeyBanc Capital Markets

All right. And then my second question is what would need to change from where we are currently at today for you to actually repurchase shares?

Mark W. Newton

Well, I think as we indicated the Board has at least in the fourth quarter taken a look at more on the industry and overall economic uncertainty that’s out there, the fiscal cliff situation. Obviously that uncertainty is beyond us. However there is a lot of volatility and uncertainty in Europe that is on the minds of the Board and had the discussions for the respective repurchases occur. So there is a number of factors that the company takes into in making those decisions, but some of the uncertainty in Europe certainly is on the forefront of the line.

Brett David Hoselton – KeyBanc Capital Markets

Okay. Thank you very much.

Mark W. Newton

Yeah.

Connie M. Hamblin

Thank you. This wraps up our conference call. We will be around if you have questions. Thank you for participating. Have a good day.

Operator

That concludes today’s conference call. We appreciate your participation.

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