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Gentex Corporation (NASDAQ:GNTX)

Q2 2012 Earnings Call

July 24, 2012 10:30 AM ET

Executives

Connie Hamblin – VP, IR

Steve Dykman – CFO

Mark Newton – SVP

Analysts

David Leiker – Robert W. Baird

Ryan Brinkman – JP Morgan

Steve Dyer – Craig-Hallum Capital Group

John Murphy – Bank of America

Rich Kwas – Wells Fargo

Jason Rogers – Great Lakes Review

Adam Brooks – Sidoti & Company

Brett Hoselton – KeyBanc Capital Markets

Elaine Kwei – Jefferies

Operator

Good morning, ladies and gentlemen, welcome to the Gentex Second Quarter 2012 Financial Results Conference Call. Today’s call is being recorded. I would now like to turn the meeting over to Ms. Connie Hamblin, Vice President of Investor Relations. Please go ahead Ms. Hamblin.

Connie Hamblin

Thank you. Good morning everyone. Thank you for joining us for the second quarter conference call. On the call today with me are Steve Dykman, our Chief Financial Officer; and Mark Newton, our Senior Vice President. I will go through a few routine items and then turn the call over to Steve.

This call is being broadcast live on the internet via an icon on the homepage at www.gentex.com. Auto playback of this conference call is also available on the website. All contents of Gentex Corporation’s conference calls are the property of Gentex Corporation. It may not 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.

Before we begin I’d like to remind you of our forward-looking statements. Gentex Corporation will make forward-looking statements in this presentation related to its financial results in the second quarter and first six months and beyond that are based on preliminary data and are subject to risk and uncertainties. These forward-looking statements are based on management’s belief, assumptions, current expectation, estimates and projections about the global automotive industry, the economy, the ability to control and leverage fixed manufacturing overhead costs, unit shipment and net sales growth, product mix, the ability to control ER&D and SG&A expenses, gross margins and the company itself.

All statements other than statements of historic facts or declarations that are or could be considered to be forward-looking statements and include terms such as anticipate, outlook, expectations, estimates, project, forecast and variations of such words and similar expressions. These statements do not guarantee future performance and involve certain risks, uncertainties and assumptions that are difficult to predict with regard to timing, expense, likelihood and degree of occurrence and actual results may differ materially from those in these forward-looking statements.

The company undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events or otherwise. We urge you to review the full Safe Harbor statement that is contained within the news release that is posted on our website.

At this time, I will turn the call over to Steve Dykman.

Steve Dykman

Good morning and welcome to our second quarter 2012 conference call. We are pleased to report another good quarter with a 15% increase in net sales. As we will review below, you’ll note that the company’s operating expenses are more in line with historic growth rates, however our gross profit margin declined in the second quarter and we are working to stabilize the margin going forward.

I’ll start with net sales. The company reported recorded net sales in the second quarter of 2012 of $280.3 million, a 15% increase compared with net sales of $243 million in the second quarter of 2011. Record net sales of $571 million for the first six months of 2012, a 16% increase compared to with net sales of $493.9 million in the first six months of 2011. We reported operating income in the second quarter of $57.5 million, an 8% increase compared with operating income of $53.2 million in the second quarter of 2011.

Operating income of $123 million for the first six months of 2012, a 9% increase compared with net sales of $113.3 million in the first six months of 2011. We reported second quarter 2012 net income of $40.8 million, a 6% increase compared with net income of $38.5 million in the second quarter of 2011. Net income of $87.1 million for the first six months of 2012 an 8% increase compared with net income of $80.8 million in the first six months of 2011.

We also reported second quarter 2012 earnings per diluted share of $0.28 compared with $0.27 per share in the second quarter of 2011. Earnings per diluted share of $0.60 for the first six months of 2012 compared with earnings per diluted share of $0.56 for the first six months of 2011. Next we’ll look at automotive net sales and auto-dimming mirror unit shipments. For the second quarter ended June 30, 2012 the total auto-dimming mirror units increased by 19% in the second quarter of 2012 compared with the second quarter last year.

The automotive net sales increased by 15% from $238.2 million in the second quarter of 2011 to $274.8 million in the second quarter of 2012. In addition, we are experiencing increased volatility with customer orders in the near-term. Auto-dimming mirror unit shipments increased by 33% in North America in the second quarter of 2012, primarily as a result of increased mirror unit shipments to the Japanese transplant and the Detroit Three automakers. North American light vehicle production increased by 25% in the second quarter of 2012 compared with the same prior-year quarter. However there was a lot of variability in vehicle production levels within certain domestic automakers ranging from flat to slightly up.

Auto-dimming mirror unit shipments to offshore customers increased by 10% in the second quarter of 2012 compared with the same quarter last year. The increase in unit shipments was primarily due to increased mirror unit shipments to certain Japanese automakers. Light vehicle production in Europe decreased by approximately 10% in the second quarter of 2012, and increased by 34% in Japan and Korea in the second quarter of 2012 compared with the same quarter last year.

For the first six months ended June 30, 2012 total auto-dimming mirror unit shipments increased by 17% compared with the same six month period last year. Automotive net sales increased by 16% from $484.5 million in the first six months of 2011 to $560.5 million in the first six months of 2012. Auto-dimming mirror unit shipments increased by 25% in North America for the first six months of 2012 primarily as a result of increased mirror unit shipments to the Detroit Three as well as certain Japanese and European transplant automakers. North American light vehicle production increased by 21% in the first six months of 2012 compared with the same prior year periods. Again there was a lot of variability in vehicle production levels within certain domestic automakers ranging from flat to slightly up.

Auto-dimming mirror unit shipments to offshore customers increased by 12% in the first six months of 2012 compared with the same period last year. The increase in unit shipments was primarily due to increased mirror unit shipments to certain European and Japanese automakers. Light vehicle production in Europe decreased by approximately 6% in the first six months of 2012, and increased by 34% in Japan and Korea in the first six months of 2012, compared with the same period last year.

Other net sales for the company increased by 13% to $5.4 million for the second quarter of 2012 compared with the same quarter last year, primarily due to an increase in dimmable aircraft window net sales partially offset by decreased fire protection net sales. Other net sales increased by 10% to $10.5 million for the first six months of 2012 compared with the same period last year, primarily due to an increase in dimmable aircraft window net sales partially offset by a decrease in fire protection net sales.

The increase in dimmable aircraft window net sales for the second quarter and six months of 2012 was primarily due to increased shipments of dimmable windows for the Boeing 787 Dreamliner series of aircraft. Fire Protection net sales continued to be impacted by the relatively weak commercial construction market.

Next, we’ll look at the average selling price per auto-dimming mirror unit, which was $44.73 for the second quarter of 2012. The ASP of auto-dimming rearview mirrors was down slightly on a sequential basis to $44.73 in the second quarter of 2012 compared with $44.93 in the first quarter of 2011. The slight decline was primarily due to the impact of annual customer price reductions and a higher mix of base auto-dimming mirrors.

ASP decreased on a year-over-year basis to $44.73 in the second quarter of 2012 compared with $46.03 in the second quarter of 2011, primarily due to annual customer price reductions and a higher mix of base auto-dimming mirrors.

Based on IHS’ June 2012 light vehicle production forecast, we currently expect the third quarter 2012 ASP to be in approximately the same range as the second quarter of 2012 based on the anticipated product mix of base and featured mirrors in that forecast and annual customer price reduction. 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 declined on a sequential basis to 33.1% in the second quarter of 2012 compared with 34.7% in the first quarter of 2012. The decline primarily was due to the impact of annual customer price reductions and product mix, partially offset by purchasing cost reductions. The gross profit margin decreased on a year-over-year basis from 35.2% in the second quarter of 2011 to 33.1% in the second quarter of 2012, primarily due to the impact of the annual customer price reductions, and product mix partially offset by purchasing cost reduction.

We have been experiencing increased pricing pressures resulting in a sprout [ph] for the higher end of the 2% to 4% price reduction range that we have previously disclosed. The company currently expects that its gross profit margins for the third quarter of 2012 will increase sequentially by approximately 0.5 percentage point compared with the gross profit margin of 33.1% reported in the second quarter of 2012. This anticipated increase is primarily due to increased production efficiencies.

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 engineering cost reductions, supply chain constraints and manufacturing yields.

Next we’ll provide an overview of the company’s operating expenses. You will note that the rate of increase and expenses in both engineering and research and development as well as selling, general and administrative expenses are now at levels more in line with historic rates of increases for those areas. This is due to a focused effort to bring those expenses in line with the company’s revenues.

ER&D expense increased by 13% in the second quarter of 2012 compared with the same 2011 quarter. The primary reason for the increase in the second quarter of 2012 compared with the same prior year period was due to increased hiring of employees to support new product development projects and new program awards. ER&D expense increased 17% in the first six months of 2012 compared with the same 2011 period. The primary reason for those increases in the first six months of 2012 compared with the first six months last year was due to the increased hiring of employees and outside contract engineering development services to support new product development projects and new program awards. ER&D expense is expected to increase by approximately 10% for the third quarter of 2012 compared with the third quarter of 2011.

Selling, general and administrative expenses increased by 3% in the second quarter of 2012 and by 5% for the first six months of 2012 compared with the same prior-year period. The increase both for the second quarter and the six months period was primarily due to continued overseas office hiring to support overseas growth, partially offset by the impact of favorable exchange rates of approximately 5 percentage points.

SG&A expense is currently expected to increase approximately 5% for the third quarter of 2012 compared with the third quarter of 2011. This estimate is based on a stable foreign exchange rate.

Next I’ll provide some additional details regarding other income for the second quarter of 2012. Investment income for the second quarter was $634,000, other was $2,533,000 for total other income of $3,167,000. Total other income decreased in the second quarter of 2012 compared with the second quarter of 2011 primarily due to changes in foreign currency rate related to the company’s euro denominated account. Other income details for the first six months of 2012 were investment income at $1,230,000 and other of $5,224,000 for total other income of $6,454,000.

Total other income decreased for the first six months in 2012 compared with the same period last year primarily due to changes in foreign currency rate related to the company’s euro-denominated account and reduced realized gains on the sale of equity investments.

Now, I will provide an update regarding certain balance sheet items as of June 30, 2012. Accounts receivable $129.9 million, inventories $192.3 million, patents and other assets $12.9 million, accounts payable $53.5 million and accrued liabilities $52.5 million. Next we’ll provide an update regarding the effective tax rate. The second quarter of 2012 effective tax rate of 33% varied from the statutory rate of 35% primarily due to domestic manufacturing deduction. We currently expect that the tax rate for the 2012 calendar year will be approximately 33% based on current tax laws, primarily due to the domestic manufacturing deduction.

The company’s year-to-date cash flow from operations was $101.5 million. Now I’ll provide an update on capital expenditures and depreciation expense. Capital expenditures for the second quarter of 2012 were $29.6 million and depreciation expense for the second quarter was $12.4 million. The company continues to estimate that the 2012 capital expenditures will be approximately $130 million to $140 million, primarily due to increased production equipment purchases of approximately $60 million to $65 million and new facility related costs of approximately $70 million to $75 million to increase production plant capacity.

2012 capital expenditures will be financed from current cash and cash equivalents on hand and depreciation and amortization expense for 2012 is currently estimated at approximately $48 million to $52 million. Update on cash dividends. On July 20, 2012, 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 July 5. 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.

The company’s Board of Directors has authorized repurchase of a total of 28 million shares of the company’s stock. The criteria for repurchases is based on a number of different factors including markets, economic and industry conditions, a market price for the company’s current stock, the anti-dilutive effect on earnings using a normalized interest rate, available cash and other factors of the company deemed appropriate. The company did not repurchased any shares during the first six months of 2012.

Approximately 2 million shares remain authorized to be repurchased under the existing plan. The Board of Directors continues to evaluate this plan. It is an agenda item at every regular Board Meeting.

And now I’ll turn the call over to Mark Newton who is going to provide an update on our products.

Mark Newton

Update on Gentex SmartBeam and driver-assist camera products. Currently Gentex’ SmartBeam products are predominantly solid in Europe. Given the fact and based on the IHS June 2012 forecast for light vehicle production, we now expect that SmartBeam unit shipments will increase by approximately 20% to 25% in the calendar year 2012 compared with the calendar year 2011. This downward revision to our previous 2012 SmartBeam guidance is primarily due to lower take rates and packaging changes at certain European customers and declined in European light vehicle production on vehicle models that offer SmartBeam.

We do not believe that this is a long-term trend and there continues to be significant interest in our SmartBeam product globally. We also recently began shipping auto-dimming mirrors with a new camera-based driver-assist systems for the 2013 Ford Explorer. This new Gentex driver-assist system uses a multifunction camera combined with algorithm and decision making to perform automatic high beam control, lane keeping and driver alert functions. The system was developed in conjunction with Mobileye, the global pioneer in the development and vision based driver assistant systems.

This program was the first of a number of driver-assist awards that the company expects to announce this year. On June 25, 2012 American Vehicular Sciences filed four patent infringement complaints in the Eastern district of Texas each of which named Gentex and at least one or two of its customers as codefendant. The company has not yet been served with the complaint but we are currently evaluating the allegations of infringement and two of the four complaints AVS alleges that Gentex’ SmartBeam product infringes one patent owned by AVS. And the other two complaints AVS alleges that Gentex monitoring system products infringe two other patents owned by AVS. The company is uncertain of what impact if any the above claims may potentially have on our business.

Updating now Rear Camera Display. Gentex Rear Camera Display mirrors have always been sold to automakers who use multiple options for where they install the display for the rear camera. We have recently confirmed that four of our customers are changing the RCD display location from the mirror to radio display in the center console with two of those customer changes to materially impact Rear Camera Display mirror unit shipments negatively in the 2013 calendar year.

The Rear Camera Display changes that the other two customers will materially impact RCD unit shipments from negatively beginning in the 2014 calendar year. These location change decisions were primarily driven to reduce costs with the automaker. The radio location is expected to be the primary rear camera displace locations for each of these four automakers. The Kids Transportation Safety Act and the pending requirements of all new vehicles in the United States will be required to be equipped with cameras and Rear Camera Displays by September 2014 has now been delayed three times.

There is no change in our understanding that the rule currently resides at the office of management and budget and that the Secretary of Transportation currently forecast with final rule will now be ready by December 31, 2012. With these KTSA delays and the uncertainties that they will have created in the automotive market we continued to believe that RCD mirror unit shipments will be approximately flat for calendar year 2012 versus 2011.

Lastly an update on dimmable aircraft window programs. We’re currently shipping dimmable windows for the Boeing 787 Dreamliner and each passenger aircraft has approximately 100 windows. The first Boeing 787 was purchased by All Nippon Airways and Boeing has also expressed interest in utilizing dimmable windows for their aircraft. Gentex is also shipping dimmable aircraft windows for use on the passenger cabin windows of the 2010 Beechcraft King Air 350i, the first aircraft in general and business aviation with dimmable windows. Each King Air 350i has 15 windows.

Other aircraft manufacturers continue to have interest in this technology and we are working on those potential programs with PPG Aerospace. There recently was a news reports of All Nippon Airways was not satisfied with the darkness level of the aircraft windows that we supply with PPG Aerospace. That story was refuted the next day in a blog posted by airlinereporter.com.

Now I’ll turn this back over to Steve Dykman.

Connie Hamblin

Actually it was coming back to me. Okay, I’ll give you our net sales estimates for the third quarter of 2012. We currently estimate that net sales for the third quarter of 2012 is an increase of approximately zero to 5% compared with the same quarter in 2011 based on IHS’ June 2012 forecast for light vehicle production.

We continue to experience increasing volatility with customer orders within the 12 week customer release window with some of our customers including the tier-one mirror suppliers revising orders at the last minute. I’ll give the production numbers and forecasts from IHF, these are based on IHF’ June light vehicle production forecast. For the third quarter of 2012 in North America, IHF forecasts that light vehicle production will be 3.4 million vehicles which is an increase of 8% compared with the 3.2 million vehicles shipped in third quarter of 2011. European light vehicle production of 4.2 million vehicles which is down 8% compared with 4.5 million in the same quarter last year.

Japan and Korea, 3.5 million vehicles which is up 4% compared with 20.3 million vehicles last year’s third quarter. For calendar year 2012, IHS forecast in North American light vehicle production would be 14.9 million units which is up 13% compared with 13.1 million units last year. European light vehicle production 18.9 million vehicles, which is down 6% compared to 20.2 million vehicles. And Japan and Korea 14.1 million vehicles which is up 12% compared with 12.5 million vehicles.

As a reminder, all listeners should note that this call is being recorded by Gentex Corporation. All contents of Gentex Corporation’s conference call is the property of Gentex. No such content may be copied, published, reproduced, rebroadcast, retransmitted or otherwise redistributed without the expressed 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 transcripts 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 Corporation with respect to any such unauthorized use. Your participation implies consent to our taping and to the foregoing terms. Please drop off the line if you do not agree with these terms.

At this time we are going to open the call up for Q&A. And we respectfully request that you ask one single part question at a time so that everybody has a chance to participate. We appreciate your cooperation with us. Operator (Jessica), we’re ready to open this one to Q&A.

Question-and-Answer Session

Operator

Thank you. The question and answer session will be conducted electronically. (Operator Instructions). And we’ll first go to David Leiker from Robert W. Baird.

David Leiker – Robert W. Baird

Good morning.

Connie Hamblin

Good morning.

Steve Dykman

Good morning.

Mark Newton

Good morning.

David Leiker – Robert W. Baird

I want to focus on the comment here the disclosure on the RCD contract 2013 and 2014. Put it in a context of – we’re seeing in particularly across Toyota where your mirror – RCD mirrors in the vehicle upgraded infotainment, it’s in the center console and then there is still an option to put it in the mirror. Can you put any color on whether that potential opportunity exists for these four customers in 2013 and 2014?

Steve Dykman

Yes, there certainly is that potential as most of the automakers are utilizing a multi-pronged approach but more recently we have been notified by some of these customers of their intent to move to the radio display at a future day.

David Leiker – Robert W. Baird

Yes, I guess I am asking specifically on those that you’ve announced today are moving to radio display, do you also have a contract to provide an upsell option to put the display in the mirror?

Mark Newton

Our products the Rear Camera Display has generally always been sold as an option and that practice continues as we’ve always stated that – we’ve always competed with this product against other display options and the instrument panel and the console that continues here. And the Rear Camera Display mirror does continue as an option in many cases.

Connie Hamblin

David, the radio display is the primary location that they’ve chosen but they could upgrade to a mirror.

David Leiker – Robert W. Baird

I understand. What I am trying to understand is on those four of that you’ve announced today, do you have a contract where your product will be available as an option, as an upsell to the primary display being in the radio?

Connie Hamblin

On some of them, I mean it’s not – I mean we can’t say across the board with these but there are situation where did you could get it in the mirror.

David Leiker – Robert W. Baird

And then is there are any indication on what the expected take rate is going to be on those vehicles when that primary display becomes a console as opposed to the mirror?

Connie Hamblin

We have not the estimates [ph].

Steve Dykman

We don’t know at this time.

David Leiker – Robert W. Baird

Okay. I’ll circle back. Thanks.

Connie Hamblin

Thank you.

Operator

Our next question comes from Ryan Brinkman from JP Morgan.

Ryan Brinkman – JP Morgan

Hi, good morning. Thanks for taking my question.

Connie Hamblin

Good morning.

Steve Dykman

Good morning.

Ryan Brinkman – JP Morgan

On the margin compression front, are the higher customer price downs focused predominantly in one region which is Europe or they more widespread and is the margin compression more a function of price downs on existing products or the less quickly increasingly mix of value added additional products like SmartBeam or RCDs?

Steve Dykman

Okay. So if you think of the two negative factors I discussed it was the annual customer price reductions as well as product mix. Generally overall within all regions we’re seeing a trend of increased pricing pressure albeit it’s still within the 2% to 4% range that we’ve discussed. So it is trending towards the higher end of that. So it’s not really isolated to a specific region or a specific customer overall.

Now with respect to the product mix impact and those two negative factors equally contributed in the quarter on a sequential basis add. We’ve talked before that our gross profit margin don’t differ that significantly within interior mirrors, however there is generally some variation within with respect to interior mirrors. Now we’ve also talked about with respect to exterior mirror auto-dimming mirrors that their margins are a little bit higher than interior mirrors because the electronics are in the interior mirror.

Ryan Brinkman – JP Morgan

Okay. And do you want to update us on how you think about share repurchases given the stock reaction today?

Steve Dykman

Well I think that it’s certainly something that our Board and the company continues to evaluate, part of the Board’s evaluation are looking at overall business and economic conditions as well as volatility in the market and obviously as we mentioned in the last several months, the Board has spent more time evaluating repurchase program and with the more recent pullback in our share price today, they will continue to evaluate that.

Ryan Brinkman – JP Morgan

Okay, thanks. I’ll hop back in the queue.

Operator

Our next question comes from Steve Dyer from Craig-Hallum.

Steve Dyer – Craig-Hallum Capital Group

Thank you. I am wondering if you could kind of breakout in terms of the gross margin and a couple of 100 basis points lower than sort of your historical average. So the price down seemed to be on a high end. How much of a factor is the excess capacity you guys have added in the lower gross margin?

Steve Dykman

Well there is a lot of moving parts within the margin line as we’ve talked and some of the other factors aren’t significant in enough itself on a single item but other negative factors did impact the margin on a sequential basis where with a little bit lower revenues, we did not leverage our fixed overhead costs. There were some production line moves that created some production and efficiencies. So those were not significant in enough themselves. Specific to your question on planned capacity, we’ve talked about the four expansion projects. Two of which are pretty much completed in the second quarter or the end of the second quarter but on a planned capacity side of things it was right around one to two-tenths [ph] if that affect our margins.

Steve Dyer – Craig-Hallum Capital Group

Okay. And then going back to the loss RCD business, are you able to quantify that? I am assuming you know the customers and what they represent this year, what are your estimate that the dollar loss to be next year?

Steve Dykman

Well provide the updated guidance in our fourth quarter call with respect to 2013. We haven’t provided any details with respect to next calendar year yet.

Steve Dyer – Craig-Hallum Capital Group

Okay. And then just kind of updated thoughts on adding capacity in light of losing some of this additional business?

Mark Newton

Well I think as we previously discussed facility or plant capacity have added on a step function basis and so the four existing expansion projects have not reflected any anticipated volumes with respect to KTSA, so they are based on program awards and work that we are conducting at this point in time. So four expansion projects are moving along as I mentioned, two of them are completed as of the end of the second quarter, one of them is expected to be completed by the end of the third quarter with the final one by the end of calendar year 2012.

We’ve talked about some land infrastructure work that’s being performed in some property that we have, but we have not made any decision to proceed with a facility on that property at this point in time.

Steve Dyer – Craig-Hallum Capital Group

Thank you.

Operator

And we’ll now go to John Murphy from Bank of America.

John Murphy – Bank of America

Good morning guys.

Steve Dykman

Good morning.

Mark Newton

Good morning.

John Murphy – Bank of America

Just wanted to catch up on these four OEMs. I mean is there any way that you guys could tell us who these companies are? I’m just trying to understand whether the mass market guys, the luxury companies, I am not sure they would really be too concerned with you announcing that they are making this kind of a switch so I am not sure why you couldn’t name them?

Mark Newton

Yes, two of the four are North American automakers and we’re not allowed to specifically name. So two are North American automakers and two are overseas customers. And you can probably look at the listing and make some assumptions.

John Murphy – Bank of America

Okay. So if we were to think about these four, forget about sort of prospective 2013 but to think about the base year of 2012. As these four automakers move out of the base and are usually – are almost largely not using any RCDs from you, would that create a very significant or material decline from your shipments for RCDs for calendar year 2012?

Mark Newton

There would be declines on a year-over-year basis but you have to also keep in mind that we are taking up some other business albeit that may not be to the same degree, some of these vehicle models are rolling off. And some of this is going to be somewhat dependent on the KTSA final ruling and mix of vehicle production on the vehicle models that we do have.

John Murphy – Bank of America

Got you. And then just on SmartBeam, it sounds like you guys had a big change in your view there and it sounded like the bulk of the change from up 40 to 45 to up 20 to 25 was more function of a mix in take rates as opposed to any changes in volume because I don’t think IHS’ changed their outlook for volume expectations this year all that much in Europe where this is predominant. I am just curious what was going on there? I mean is there other competitors or competitive products that are being put in place or is it’s just a change literally in model level mixes?

Mark Newton

What we’ve seen to-date in this is the contributors as we stated since the majority of our customers are in Europe is due to European production down. The changes in mix are not necessarily a loss to other technologies and we don’t see this as a trend because as we said it earlier in the call with our year ending expense increase primarily due to development of new products and program awards, we continue to see strong development with this product.

John Murphy – Bank of America

But if we look at the IHS schedules from the May release to the June release, I mean they are still down about 6% give or take, it wasn’t a real material shift. There must have been something with model level mixes or just take rates, I mean I am just trying to understand what exactly you think is going on there?

Mark Newton

That is what we had stated earlier in the call is yes, within models and product mix, we do see changes. That’s been common for us particularly in our history and SmartBeam product launches primarily because it’s with our European customer base and if you go and try to purchase a BMW in Germany, the way options are applied is more all apart than in the United States you buy different features and package them together. And whenever we launch new product awards as we are with the SmartBeam product, we have always found that there is a settling phase between what was originally forecasted with the launch of the program and actual take rates in this. We are seeing adjustments like that as part of this issue here.

John Murphy – Bank of America

Got you. And then just lastly on the AVS case, I mean you guys are great at patent litigation in protecting your patents and you know the stuff inside out. It is just really more of a nuisance and sort of noise around the edges, I mean it seems like that’s the way things has been in past with patent litigation because you’re so good at it, I am just curious what your thoughts generally are on this?

Mark Newton

Right now we’re still very early because we haven’t been served in the evaluation process, so we’re going through the diligence right now. We take all of these obviously seriously but this is not a company that manufacturers products. And so we’re still evaluating at this point.

John Murphy – Bank of America

Okay, great. Thank you very much.

Operator

We’ll now go to Rich Kwas from Wells Fargo.

Rich Kwas – Wells Fargo

Hi good morning.

Steve Dykman

Good morning Rich.

Connie Hamblin

Good morning.

Rich Kwas – Wells Fargo

Just following up on John’s question with the patent. Your understanding is on the second generation SmartBeam because I would think that – with SmartBeam being out for number of years at this point, the first gen, you would have heard about this earlier but is this related to second gen or what do you know if you know anything right now?

Mark Newton

No, not at this point. We don’t have specific knowledge and we’re still early as I said and confirming what all this applies to in the diligence and the research. So we don’t have information that indicates that.

Rich Kwas – Wells Fargo

Okay. And then Steve, just following up on earlier question on capacity, so is it the volume on RCD, it’s not going to affect your capacity expansion plans and you have business on the books or contract on the books to fill this out of capacity, is that correct?

Steve Dykman

Yes, that is correct.

Rich Kwas – Wells Fargo

Okay. And then on the margin – for gross margin, so the thing that I am struggling with is back in April you guided to flat sequentially and you said customer price downs are worse than or the higher end of what you originally thought but what else was (inaudible) because you had production, you got some lift from the Japanese, while you noted that there has been some volatility within overall production schedules. It just seems like the miss on the margin side has something, there is something else going on there. I don’t know if you could provide any additional color?

Steve Dykman

Sure. I mean the new item obviously touched on the area of customer price reductions with the increased pressures so that’s an additional headwind that contributed to the sequential decline. The product mix variability also negatively impacted the margins and some other less significant factors as I mentioned related to some production efficiencies within the quarter when we had some production line move and so there is less efficiency within the production area within the quarter.

And so when we’re discussing – when we’re looking guidance with respect to Q3, part of that margin improvement is the anticipated production efficiencies we’re expecting.

Rich Kwas – Wells Fargo

Okay. And then so you’re assuming price downs are going to be pretty consistent at the high end of the range going forward?

Steve Dykman

Yes.

Rich Kwas – Wells Fargo

And then product mix is going to be uneven?

Steve Dykman

That’s variability that I mean we have a forecast at the beginning of a quarter but that obviously can change as we progress through any given reporting period.

Rich Kwas – Wells Fargo

All right. And then just lastly on the product mix front with the (inaudible) going over Board here with the questions but just on the German OEMs, RLE [ph] was out a few days ago saying they are really not seeing much change with the German OEMs and they are seeing good visibility, early stage [ph] of visibility right now. So on the product mix, this sounds like it relative rather than it’s just platform changes, there is substantial changes within the platform production that this is more take rate associated or take rate issue with some of your products.

Mark Newton

Well a mix of products that are being built by any given customer within a vehicle model.

Rich Kwas – Wells Fargo

Right, so the trim levels are varying versus that?

Mark Newton

Yes, right.

Rich Kwas – Wells Fargo

Okay, all right. Thanks so much.

Connie Hamblin

Thanks.

Operator

And we’ll now move to Jason Rogers from Great Lakes Review.

Jason Rogers – Great Lakes Review

Just looking at RCD as far as the customers that use the console as the primary display location versus a mirror. Is it generally cheaper for those customers to have the camera inside the console versus the mirror?

Mark Newton

As we’ve stated earlier in the call, the potential for the radio now to include a display that will show the camera image and the instrument panel particularly due to the volume potential of a radio in a vehicle versus our option of a Rear Camera Display in the mirror, it is as we stated a lower cost option for the automaker. If the feature is going to be mandated particularly as KTSA indicates.

Jason Rogers – Great Lakes Review

And are you seeing more – with your customers seeing more entry level trends using the console as a primary display location?

Mark Newton

I don’t believe we can state that we’re seeing that as a trend. With the potential indication of what Kids Transportation Safety Act provided originally where this would be a mandated feature, anytime those types of things occur, it invites a greater evaluation and increased competition and as we succeeded with the Rear Camera Display mirror product based on quality and technology as an option product and we’ve had good success in growing it, with it becoming a mandated feature, automakers it has to be on every vehicle, we’ll evaluate as many options as possible. And you do face cost pressures and technologies like this.

Jason Rogers – Great Lakes Review

Okay. And then finally just to understand the SmartBeam guidance. Is it more a function of the lower take rates versus the option package changes, I mean this is in case where SmartBeams being removed from the different option packages that the automakers in Europe, correct?

Mark Newton

This is more – from what we’re seeing right now it’s difference in option packages as they are being applied. No, we’re not seeing a trend to remove SmartBeam from these vehicles on any of our European customers.

Jason Rogers – Great Lakes Review

Okay, thanks.

Operator

And we’ll now go to Adam Brooks from Sidoti.

Adam Brooks – Sidoti & Company

Good morning, just a few quick things, one on SmartBeam guidance. Can you give us a sense first half of the year versus second half? I am guessing second half of the year growth slows down?

Steve Dykman

Well the first quarter was strong. We started seeing some of these trend changes as Mark mentioned with respect to take rates and packaging here as we progressed through the second quarter and as reflected in the balance of the year as well.

Adam Brooks – Sidoti & Company

Okay. And then could we talk a little bit about driver-assist maybe any traction or gaining with new OEMs or even with four just maybe any update there as far as new announcements come out over the next few months?

Mark Newton

We do anticipate as we said earlier, more announcements come and get this year on that product. It has been in the engineering area where I work, significant area of development for us and we have strong activity, we look forward to those announcements later this year and in the future?

Adam Brooks – Sidoti & Company

All right, thank you.

Connie Hamblin

Adam we can’t talk about any type of customer approves us [ph], we’re just talking about them.

Adam Brooks – Sidoti & Company

Okay, thank you.

Connie Hamblin

Yes.

Operator

Our next question comes from Brett Hoselton from KeyBanc.

Brett Hoselton – KeyBanc Capital Markets

Good morning guys.

Connie Hamblin

Good morning.

Steve Dykman

Good morning.

Connie Hamblin

How are you?

Brett Hoselton – KeyBanc Capital Markets

Good gentlemen. RCD, I want to make sure I understand what’s taking place here. It sounds like for your 10 customers are making any wholesale shift of all of their platforms towards using some sort of a radio base display and may offer the RCD in the mirror as an option. Is that a correct assessment or is this just a matter of one or two platforms for each of these different customers?

Mark Newton

Not wholesale from what we know at this point as we indicated earlier in the call and we’re dealing [ph] so large part of your request was to provide more information on this. We talked about radio display, I believe in the last quarter and increasing as another option for automakers to consider in this. The Rear Camera Display mirrors do continue and they continued to be marketed and sold honestly as we always have. They’ve always been an option versus other displays in the vehicle.

With the indication that it was going to be mandated by KTSA even though that has not come to pass, it has increased automaker evaluation and how they would apply standard feature. So we still remain suppliers in this mix. We’re working now just to be more informative to you on where we have been affected based on comments that you’ve been making to us recently.

Brett Hoselton – KeyBanc Capital Markets

So not necessarily the wholesale shift but am I correct am I understanding that this is not necessarily just one platform for each of these four customers that it’s at least one maybe more platforms for each customer?

Steve Dykman

That’s correct.

Connie Hamblin

That’s correct, yes.

Brett Hoselton – KeyBanc Capital Markets

And then do you have any incremental RCD contracts which are going to be kicking in, in 2013, 2014 timeframe? My question was during your last earnings call was that everything was on hold that you did not really have any incremental businesses coming online kind on that timeframe. Is that – am I correct in that, is that still the case or is there some additional business which is likely to offset some of this loss businesses you move into 2013, 2014? I am asking about contracts do you have in hand at this point.

Mark Newton

Rear Camera Display, the new awards do continue. And the product does continue at other automakers to have new contracts awarded. As far as how that impacts material in 2013, I think we would stay consistent of what Steve just said is that we’re not providing any forecast and guidance yet at this point, is that correct, Steve?

Steve Dykman

Yes.

Brett Hoselton – KeyBanc Capital Markets

Okay, thank you very much.

Operator

We’ll now go to Elaine Kwei from Jefferies.

Elaine Kwei – Jefferies

Hi, thanks so much for taking my question. I was (inaudible) just going back volatility in order cancellation, is that something you’re seeing more on base auto-dimming mirrors or with the higher RCDs and SmartBeam and what is the operational response and strategy in reaction to those lower orders is the plan to (inaudible) ER&D, SG&A, manufacturing, just any color there would be helpful?

Connie Hamblin

Elaine, we could barely hear what you said for the first half of that so you have to repeat it and speak louder if you can.

Elaine Kwei – Jefferies

I am sorry. Is this better?

Connie Hamblin

Much better.

Elaine Kwei – Jefferies

Okay, I am sorry, there is a phone issue here. Just so going back to the increased volatility in last minute order cancellations, is that something that’s more on the base auto-dimming mirrors or with the RCD and SmartBeam and then what’s the operational response or strategy you have in plan for lower orders? Is it to just ER&D, SG&A, workforce?

Steve Dykman

It is not isolated to the specific product. It’s an overall trend that we’re seeing so that certainly increases and provides some challenges for us as we schedule and try and run the manufacturing area in an efficient manner. In enough itself it is not really change in our resources within the ER&D area as those resources are on future product developments and orders that are dropping out at the last minute are really just more volume related on existing programs and platforms.

Elaine Kwei – Jefferies

Okay. Great, thanks so much.

Operator

We’ll now go to David Leiker from Robert W. Baird.

David Leiker – Robert W. Baird

A couple of things that have rolled out I want to follow-up on. In your first quarter call I believe you have made the comment that you – it’s been a year since you have to received a new contract for RCD mirrors (inaudible) what I think I just heard is that since that time you’ve been awarded some new contracts.

Connie Hamblin

We have talked about that we had been awarded any new business that we have new business to announce, I mean we a have a number of RCD contracts that we’ll be announcing that had been awarded prior to that.

David Leiker – Robert W. Baird

Okay, so since the first quarter conference call you’ve been awarded new contracts?

Connie Hamblin

Yes.

David Leiker – Robert W. Baird

Okay. On the price downs, what we’re seeing here with your price downs going to the high end and what the range has been, is that what you characterize returning to normal type of events after the last three years where things were obviously in disarray or is that something where there is higher demands, greater demands for larger price downs from your customers?

Mark Newton

I think it’s a trend back tour. This is a normal historical range. Obviously the pricing pressure has been pretty consistent over a very long period of time. We are just seeing an overall trend of some increases and so I think your first point was a little more accurate.

David Leiker – Robert W. Baird

And those are contracts that you negotiate that kicked in here in the second quarter or...

Mark Newton

Yes, the increased trends started in the second quarter and we expect that to continue.

David Leiker – Robert W. Baird

Okay. And is it across all other customers or is it just here and there?

Mark Newton

I would say it’s more recently than in the recent quarters was hit or miss but it’s becoming more of a consistent trend today which is why it’s become more meaningful.

David Leiker – Robert W. Baird

Okay. And then in the past you’ve done a great job obviously struggled the last six quarters with all the external things but you historically have done a great job in taking up costs down more than the price downs and that’s been a challenge here I believe. I recall in the first quarter that the reader’s idea went through to take the swap up components and things like that, that those efforts were done and that you could refocus your efforts on cost reduction programs? Have that happened or is there something there that’s not kicking in?

Steve Dykman

Yes, there is couple of things. One the comment in the first quarter on the engineering redesigns being on the tail end was based on the ER&D expense growth and that we’re starting to see some efficiencies that are gained within that line item as resources can be redirected now that a lot of that activity is completed. With respect to the margin line, we still have very aggressive purchasing cost reduction program that continues to be successful. However, more recently it is being challenged to keep up for the pace of the annual customer price reductions. So we are still very positive about the future of purchasing cost reduction program and our purchasing group continues to work with the objective of offsetting the annual customer price reductions, but with the recent trend that increase currently is not.

David Leiker – Robert W. Baird

And again bringing that new capacity online should help you with productivity gains and help offset some of those as well?

Steve Dykman

That is our objective, yes.

David Leiker – Robert W. Baird

Okay. One last item, you breakout your revenue mixes geographically, but how much of your revenue going over to Europe is priced in euro versus dollars today?

Steve Dykman

For calendar year 2012 it’s about 8% so it’s not that significant.

David Leiker – Robert W. Baird

Would it be fair to assume that that’s the portion of your revenue that’s sold in the Europe that stays in Europe and the rest is exported?

Steve Dykman

Yes. Generally speaking, yes.

David Leiker – Robert W. Baird

And then how much of your SG&A do you think is in euro today?

Steve Dykman

A good portion of it. I would say maybe half.

David Leiker – Robert W. Baird

So do you think you’re at the point that a weak euro that your cost come down more than the profits and the revenue that a weak euro might actually be positive for profits?

Steve Dykman

Okay, yes.

David Leiker – Robert W. Baird

Okay, thank you.

Connie Hamblin

We have time for one more question.

Operator

And our final question will come from Ryan Brinkman from JP Morgan.

Ryan Brinkman – JP Morgan

I was just wondering if you could elaborate a little bit more on what you mean by volatility in near-term orders? Does this primarily relate to Europe and is it an indication that near-term productions schedules of European automakers are maybe tracking significantly worse than expected? Thanks.

Mark Newton

It’s not specifically isolated to Europe. We’re seen it in other regions with other customers as well that I think it is due to lot of the uncertainty in overall economic conditions as well as some customers are using it as a safe guard. We believe that some of our customers are over ordering parts at the beginning of each quarter to ensure they are protected in the event there is another issue that causes some form of the part shortage as we’ve been in the environment for a couple of years.

And so then they drop these orders out just prior to when they are expecting to ship the product and that’s created some additional volatility and we’re anticipating that this trend might continue here in the near-term.

Ryan Brinkman – JP Morgan

I see. Thank you.

Connie Hamblin

Thank you. At this point we’re going to wrap the call up. Thank you everyone for participating. We remain positive about the business that Gentex has. We have a good company and we will work to make it a better company. We will be here if you have additional follow-up questions. Thank you.

Operator

This concludes today’s presentation. Thank you for your participation.

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