Kevin C. Nash - Chief Accounting Officer and Vice President of Accounting Steven R. Downing - Chief Financial Officer, Vice President of Finance and Treasurer Mark W. Newton - Senior Vice President, Secretary and Director.

David Leiker - Robert W. Baird & Co. Incorporated, Research Division Ravi Jani Richard Michael Kwas - Wells Fargo Securities, LLC, Research Division Steven L. Dyer - Craig-Hallum Capital Group LLC, Research Division Christopher Van Horn - FBR Capital Markets & Co., Research Division.

Good morning, ladies and gentlemen. Welcome to the Gentex Second Quarter Financial Results Conference Call. Today's call is being recorded. I would now like to turn the meeting over to Mr. Kevin Nash, Chief Accounting Officer. Please go ahead, sir..

Thank you. Good morning, and welcome to the Gentex 2014 Second Quarter Earnings Release Conference Call. I'm Kevin Nash, Vice President and Chief Accounting Officer. Thank you for joining us today. In this call, we will provide an overview of the Gentex 2014 second quarter business followed by questions.

I'm joined on the call today by Mike -- Mark Newton, Senior Vice President; and Steve Downing, Chief Financial Officer. This call is live on the Internet by way of an icon on the Gentex website at www.gentex.com.

All contents of this conference call are the property of Gentex Corporation and may not be copied, published, reproduced, rebroadcast, retransmitted, transcribed or otherwise redistributed.

Gentex Corporation will hold responsible and liable any party for any damages incurred by Gentex Corporation with respect to any unauthorized use of the contents of this conference call.

This conference call contains forward-looking information within the meaning of the Gentex Safe Harbor statement included in the Gentex Reports Second Quarter 2014 Financial Results press release from earlier this morning and, as always, shown on the Gentex website. Your participation in this conference call implies consent to these terms.

Now here's Steve Downing, the company's Chief Financial Officer, with the second quarter 2014 financial summary..

Thank you, Kevin.

For the second quarter of 2014, the company's net sales were $338.4 million, up 18% compared with net sales of $287 million in the second quarter of 2013, led by strength in market penetration for our newly acquired HomeLink applications, inside and outside electrochromic mirrors, as well as SmartBeam and Driver Assist camera systems, despite the headwinds created by the previously announced Rear Camera Display losses.

The gross profit margin in the second quarter of 2014 was 39.7% compared with a gross profit margin of 35.8% in the second quarter of 2013.

The improvement in the gross profit margin is due to the impact of the acquisition, improvements in product mix, purchasing-cost reductions and the company's ability to leverage fixed overhead costs, which were partially offset by annual customer price reductions.

Net income for the second quarter of 2014 was $76.8 million, up 47% compared with net income of $52.1 million in the second quarter of 2013. Earnings per diluted share in the second quarter of 2014 were $0.52, an increase of $0.16 or 44% compared with earnings per diluted share of $0.36 in the second quarter of 2013.

During the second quarter of 2014, the company benefited from incremental research and development tax credits related to its amended tax return filings for calendar years 2010 through 2012 in the amount of $5.5 million.

As a result, the effective tax rate in the second quarter of 2014 decreased to 27.4%, and the incremental impact to earnings per diluted share for the quarter was approximately $0.04.

Additionally, in the third quarter of 2014, the company expects to complete further studies relating to the 2013 calendar year and estimates the effective tax rate to be approximately 30.5% to 31.5% for the third quarter, which is based on current tax laws and the incremental benefits associated with research and development tax credits not originally included in the 2013 financial results.

Automotive mirror unit shipments in the second quarter of 2014 increased 12% compared with the second quarter of 2013, primarily due to increased unit shipments of both the company's interior and exterior auto-dimming rearview mirrors in all of the company's primary markets.

As a result, automotive net sales in the second quarter of 2014 were $329.6 million, up 18% compared with automotive net sales of $279.8 million in the second quarter of 2013.

Other net sales, which include dimmable aircraft windows and fire protection products, were $8.9 million on -- in the second quarter of 2014, up 24% compared with $7.2 million in the second quarter of 2013. Now Kevin Nash will provide some more details in regards to the Q2 2014 financial results..

Thanks, Steve. The R&D expense for the second quarter of 2014 increased 7% to $20.2 million compared to the second quarter of 2013, primarily due to increased staffing levels, which continue to support growth and development of new business as well as personnel additions that were part of the HomeLink acquisition.

SG&A expenses for the second quarter increased 17% to $14.2 million compared with the second quarter of 2013, primarily due to incremental employment cost and amortization expense related to the HomeLink acquisition, as well as increased professional fees related to the previously mentioned work on the research and development tax credits.

Other income for the second quarter was $5.8 million, an increase from $5.5 million in the second quarter of 2013, which was driven by slight increases and realized gains on sale of equity investments. Now to the balance sheet.

Cash and cash equivalents were $391.6 million, up from $309.6 million as of December 31, primarily due to cash flow from operations. Cash flow from operations for the second quarter was $44.4 million compared with $74.6 million in the second quarter of 2013.

It was driven up by a $24.6 million increase in net income, but it was more than offset by changes in working capital.

Compared with the second quarter of 2013, inventory and accounts receivable increased by $19.6 million due to the acquisition and increased sales levels, while accounts payable and accrued liabilities decreased by $35.7 million, primarily due to month-end timing and the timing of certain tax and wage payments versus the second quarter of 2013.

Year-to-date, cash flow from operations were $142.1 million versus $172.3 million, also driven by increases in net income, but was more than asset by working capital changes.

Accounts receivable, as I mentioned, increased $35.2 million versus December 31, 2013, primarily due to the higher sequential sales level as well as timing of the sales within the quarter. Inventories were $125.2 million, up from $120.1 million as of December 31, primarily due to increases in raw materials.

Long-term investments were $109.8 million, up from $107 million as of December 31, 2013, primarily due to increased unrealized gains on sales that were reinvested in the company's equity investment portfolio.

Accrued liabilities were $73 million, up from $63.5 million as of December 31, 2013, primarily due, again, to the timing of certain tax and wage payments. Capital expenditures for the second quarter were $13.8 million compared with $11.4 million in the second quarter of 2013.

The company continues to estimate that capital expenditures for calendar 2014 will be in the $75 million to $85 million range. In the second half of 2014, the company is planning to begin construction of a new manufacturing and distribution facility.

The total cost of this project is expected to be approximately $30 million to $35 million, of which, approximately $5 million to $10 million will be spent in 2014.

Depreciation and amortization expense for the second quarter was $19.8 million compared with $13.8 million in the second quarter of 2013, primarily due to amortization related to the HomeLink acquisition. The company continues to believe that depreciation and amortization for calendar year 2014 will be between $80 million and $85 million.

And lastly, on July 18, the company paid a quarterly cash dividend of $0.16 per share to shareholders of record of the common stock at the close of business on July 8, 2014. And now over to Mark Newton for a product update..

inside and outside mirrors with frameless and curved-glass applications; advanced mirror features including HomeLink compass, interior lighting, microphones, telematics displays, SmartBeam camera systems, Driver Assist camera systems; also, HomeLink modules in other areas of the vehicle outside the mirror; and now HomeLink for nonautomotive applications.

There is more to come. We look forward to further product announcements. Now back to Steve Downing for future guidance..

Thank you, Mark. Based on the July 2014 IHS production forecast and current forecasted product mix, the company estimates that net sales in the third quarter of 2014 will increase 15% to 20% compared to the third quarter of 2013, and estimates the gross profit margin to be 39.5% to 40%.

The company estimates that ER&D expense for the third quarter of 2014 will increase 5% to 10% compared with ER&D in the third quarter of 2013. SG&A expense is estimated to increase approximately 10% compared with the third quarter of 2013.

As we have previously stated, the company has been working over the last year to be more strategic about its approach to its equity investment -- and investment portfolio.

After a year of solid gains and rebalancing the portfolio where the company realized gains of approximately $22 million, our current expectation is that the realized gains will likely return to historical levels based on the current balances in the portfolio, market conditions and the remaining unrealized gains in the portfolio.

The company estimates that other income in the third quarter of 2014 to be in the range of $2 million to $3 million depending on specific market conditions. As a company, one of our main priorities is to maintain and grow our culture of humility.

But on the heels of the company's 40th anniversary, we'd like to spend just a few minutes to reflect on our history, the ups and downs, but most importantly, our successes as a business.

In the second quarter of 2012, the company reported quarter-over-quarter revenue growth of 15%, but gross margins of 33.1% and operating margins of 20.5% that were at historical lows consistent with those seen in the recession of 2008 and 2009.

This became a significant moment for the company and became an inflection point because the data and trends showed that we needed to improve. The company has worked very hard over those last 24 months, and we are very proud of the improvements we have made in the top line and bottom line results of the company.

To put this quarter's performance in perspective, we looked over the last 10-year period in the company's history. And coincidentally, the second quarter of 2004 was the last time that the company posted profitability measures that were similar to the most recently completed quarter.

In the second quarter of 2004, the company announced an 11% increase in revenue to $129.6 million on a quarter-over-quarter basis, a gross profit margin of 42%, operating margins of 30.9%, net income of $28.9 million and earnings per diluted share of $0.18, post-split-adjusted.

Contrast that with the most recently completed quarter, where the company announced an 18% increase in revenue to $338.4 million on a quarter-over-quarter basis, a gross profit margin of 39.7%, operating margin of 29.5%, net income of $76.7 million and earnings per diluted share of $0.52.

Please keep in mind that all of the numbers presented in our financials are in compliance with Generally Accepted Accounting Principles. But in 2004, the company was not required and did not report the effective stock option expensing in its income statement.

What we're trying to illustrate today to the shareholders of the company is that throughout our history, Gentex has remained largely profitable not only in times of great growth, but also in times of slow growth.

The management team is very excited that we have the tools in place and, most importantly, the track record, especially over the last 2 years, to show that regardless of sales growth, we are focused on driving innovation and profitability in order to provide return on your continued investment in the company.

These successes are due primarily to the creativity, hard work, ingenuity and dedication of all of our associates worldwide, and we would like to thank all of them for their hard work. We can now proceed with questions. Thank you..

[Operator Instructions] And we'll take our first question from David Leiker with Baird..

I wanted to start and talk about the gross margin improvement. You called out HomeLink mix, purchasing and then the operating leverage.

Can you give us some context on the relative contribution of the -- each of those items?.

It's approximately 100 to 150 basis points each..

Each. Yes..

I mean, we -- you saw the big -- the improvement in the HomeLink, the step-up on a year-over-year basis. So that's up [ph] slightly larger, but the rest of the factors are....

100..

Yes..

And then if we look at the mix comment, it looks like interior mirrors were up 11%, exterior was up 13%. Usually, that's what's driving the mix comparison. They're relatively close together.

So was that much of an impact? Or is there something else that's become a factor here?.

No. When we talk about mix, we're talking about not only the relative mix between inside mirrors and outside mirrors, but also the mix of what type of inside mirrors are being shipped. And so the -- those 2 factors combined are what we're talking about when we talk about the mix improvement..

Okay. And then, the one last item here.

If we look at HomeLink, can you talk about what the performance of HomeLink has been since you purchased it? The relative growth rate, new business wins, any additional color in that regard?.

Sure. Like we said when we made the acquisition, we weren't going to provide product-specific financials. But what we have been talking about and communicating is when we made the acquisition, we gave that revenue range of $125 million to $150 million. We've been running at the high end of that range over the last few quarters on an annual run rate.

And what we would say is that the profitability in that information that we provided in post-acquisition and follow-up in the public communication, we've been pretty consistent with that financial performance. And so it's been in line, just slightly ahead of the gross profit margin as well..

And would you think going forward that, that grows at the same pace as the mirror -- as your auto-dimming mirror business?.

Yes. In fact, one of the things we talked about is we thought we could get that to a low double-digit growth rate in terms of the HomeLink products in the -- for the next foreseeable future..

And we'll move to our next question from John Murphy with Bank of America Merrill Lynch..

This is Ravi Jani in for John Murphy. Just a couple of quick ones.

One, it's been a couple of months now since the NHTSA ruling has passed, so I'm just wondering if you're seeing any change in your quoting activity or new business bookings now that OEMs have had some time to adjust to the ruling and also just see how it impacts their production schedules going forward?.

On March 31, 2014, with the National Highway Traffic Safety Administration issuance of the final ruling requiring rearview video systems in U.S. light vehicles by May 1 of 2018, with a phase-in schedule requirement of 10% of vehicles after May 2016, 40% of vehicles after May 2017 and 100% of vehicles after May 2018.

NHTSA also included an estimation that we confirm to be generally accurate that 57% of model-year 2014 vehicles in the United States today, 57% already have a rearview video system. And that even without a final rule, 73% of vehicles sold in the United States would have already included a rearview video system by 2018.

With that, the NHTSA ruling, as those percentages generally indicate, does not provide an immediate opportunity for new rear camera display applications. Customer opportunities may exist by the time the 100% requirement is in place, but no new material guidance is available from us at this time.

The company's Rear Camera Display mirror application meets all the technical requirements of the NHTSA final ruling when installed in a vehicle and appropriately paired with OEM-specified camera. And so we're basically still at that point in this.

If you've noticed in our -- we also did, with our shareholders' meeting from May, an updated product video. That was in reply to other questions related to what technologies we had in development.

And in it, at the end of that video shown on our website, you'll see new advances in displays, including a full display, electrochromic advanced-feature mirror in that.

We've had this technology for, basically, over 6 years in availability, and our intention with that video was to give indication that we also had applications we'll be defining materially coming in the future. So there are advances in the technology coming with video displays.

We just announced a video camera designed specifically for increasing applications in this space. We do have new technology applications coming forward, but nothing materially that we'll add today..

Got it. Okay. And then one quick one on the balance sheet. You said on the last call that you'd reevaluate your capital allocation for the second half of the year once we got here.

So now that it's July, how do you think about allocating capital between paying down debt or potentially accelerating some share repurchases in the second half of the year?.

Sure. Like we stated before, that was in our planning process for the second half. So really, what we're here to talk about today is the first half results. And that's kind of what we've summarized so far. So that is still in the works for the second half of this year in terms of our position on our capital allocation..

And we'll take our next question from Rich Kwas with Wells Fargo Securities..

Mark, just on the new camera technology. So I guess, new camera technology and then the additions here in HomeLink.

What's the timing of launches here? When should we think about this actually hitting revenue? And just how material should we be thinking about in terms of contribution to the overall company over the next few years?.

Excellent question. On our -- the new seamless imager, our camera system-enabled SmartBeam and Driver Assist camera system products, we will be beginning shipment near the end of this year in those applications. The video camera, when we announced it in May, we pointed out that we had actually been shipping it.

It was selected as the top-performing product by Audi, and we began shipping that in 2012 on development vehicles in this. So product is shipping on development vehicles now. It's not at a materiality point where we've been defining it.

But we went ahead and added more emphasis to it in that announcement because we do have the potential opportunities that we'll be announcing, targeted at 2016-model-year basic applications.

On the new HomeLink products, our primary story, and what we announced in May at the shareholders' meeting for battery-powered HomeLink and what we just announced in this call with the application space outside of automotive, this is an effort we have in place to make more use of the technology availability.

We immediately, as part of the acquisition, always intended to, right away, expand it to more markets. HomeLink 5, as a product, works and ships and -- today. So we wanted to immediately work to address new markets in it. So we created right away after the acquisition. Formerly Gentex OEM accessory used aftermarket channel in the business.

We then immediately did an active sales and engineering effort to new customers outside of automotive in this space. What we're signaling today is we've been successful in that. And so shipping, this would begin effectively in the second half of 2015 from what we're emphasizing right now.

However, the capability in the product exists to be applied potentially even quicker. And so those are basically start dates. We are engineering launch on these developments. On materiality, we will look forward to begin to quantify that in the future.

We, this year, wanted to try to do a better effort in response to a lot of input from people like you, talking to you more about what we're doing in product development earlier in the process..

And then you've listed a number of different areas where HomeLink can be applied to outside auto.

Could you give us any, on these 2 contracts, where we should be thinking about of that list that you provided?.

The varying applications right now do apply in areas of motorcycles and other agricultural vehicles effectively as a starting place, to give you a general idea without giving any specifics before we're ready to specifically announce the beginning of production..

Okay, okay. And that's helpful. And then just -- could you just take a step back with the video and the camera technology? Now with -- Mobileye will be going public here shortly, and I know that you have the camera technology and they have camera technology.

And so how do you -- when you look at the competitive landscape right now going out, how do you characterize your product? And what should we be thinking about in terms of opportunities for you considering some of the competition out there?.

Outstanding question. As we've previously publicly announced, we have been shipping, for the past 2 years, Mobileye integrated into our rearview mirror.

The Mobileye product, uses a commercially available camera -- video camera together with Mobileye algorithms and software applications that are the same for all competitors that integrate using Mobileye. We have an increasingly growing business where we do Mobileye at customer request.

And those -- all our customers that also use our Gentex SmartBeam product for high-beam assist if they're not using the Mobileye multiple-function camera application. Now as we introduce the new CMOS imager, our new camera, we have increasing capability and are now adding features that also can apply in that Driver Assist space.

So the Mobileye solution is a widely applied industry solution, the same from all integrators who supply it to automakers, us and everyone else. In ours, we, specifically, are the only one that integrates it with the mirror, with the Mobileye camera integrated with our mirror mount and the electronics that control it inside our mirror.

Everyone else who competes in this does this in a separate electronics box on the windscreen. We do it in the mirror. That's our primary differentiation. The rest of it is basically functioning the same.

Now with our imager, our algorithms and software, our optics, our system, the SmartBeam product, we have continually, in the SmartBeam, added features through the life of the product.

With this new camera that we have, when we go to production this year on, we had more features, and those features include the basis for Driver Assist, which is object detection. And object detection is roads, lines, lanes, trees, vehicles, pedestrians. Those kinds of capabilities are things that we increasingly have, also, in this.

So we have basically a multipronged approach as to how we're doing this, to satisfy the customer requests.

Because when we have such a higher market share of electronic mirror applications and such a long and successful history with our SmartBeam product, our SmartBeam customers come to us, and we have competed and we have been in production on Mobileye for higher-end systems.

It's important to point out that still today, in spite of increasing amount of press that we see on autonomous driving and increasing applications of Driver Assist, the multiple-function Driver Assist applications are still a high-end, very costly option package in this, and it has a take rate that's considerably lower than what our SmartBeam application is, since we're doing both.

So we're a little unique in that we are working to satisfy our customers, either with our customizable solutions or with Mobileye, when we're requested to do so..

Okay. That's helpful.

And then just on tax rate, should we be thinking about this lower tax rate in future quarters out in the next year and beyond?.

No. I mean, what you're looking at is you're seeing, basically, work that we've done to go back and clean up some prior year periods. And so those are what we would guide to longer term as our historically average kind of tax rate. And obviously, there's always federal laws and policies that can affect that.

But for the most part, we expect it to be in the range of our norm..

Okay.

So beyond Q3, we should go back to the 32.5%?.

Yes, assuming that there is no -- there has been no -- the government hasn't passed the research and development tax credit law for 2014. So if that were to come into play in the fourth quarter, then you would see a variance, but we're not guiding to that. That is one thing that would be different on it -- potentially, in the fourth quarter..

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

As it relates to ASP, ASP for the core mirror product has been sort of trickling down the last several quarters.

I'm just kind of wondering, as you talked about all this sort of additional functionality on the mirrors, is there a point sort of where you see that being able to grow again, kind of in excess of the price-downs each year?.

Well, so the big thing we talk about, and the reason why we kind of went away from using ASP as it relates to guidance is because it's not something that we actively manage, too, here internally. And the reason for that is a couple things.

First, if you look at outside mirrors, they typically are below average ASP, but they tend to do very well on the margin side. And so one of the things we look at is we don't want to send a message to the market that would confuse things. Growing outside mirrors is an absolute goal and objective of the company.

And if we're successful in growing our outside mirrors faster than the rest of the business, that will drive down ASPs. And that's what you've seen over the last few quarters is that outside mirrors have outpaced inside mirrors in terms of their increases. And when that happens, you're going to see lower ASP.

The other factor there is that the loss of RCD that we've been going through for almost 12 months now has been a very negative impact on ASPs as well.

And so behind the scenes, what you're not seeing, because of those 2 bigger trends, is that we do have pickups in the rest of our inside mirrors that have improved ASP, but they're being overwritten by those 2 previous trends..

That's helpful. As it relates to gross margin, kind of looking forward, you guys seem to be pretty comfortable in that 39.5% to 40% range.

Is that a sustainable level? Can you grow from there as some of these HomeLink, some of these additional products come on? Or how do you think about the longer-term trajectory there?.

I mean, we look at that -- we look at anything in the 39% range or above as kind of in a sweet spot for us. It's really tough once you get above -- try to get above that level.

And so we view it as -- if you look at the -- like we mentioned in our comments, if you look at the 2-year period over the last 2 years, especially where we've moved from 33% to 39%, we believe we've accomplished most of what we can see in terms of margin improvement inside of that 6 percentage point -- over 6 percentage point improvement range.

And so we're not looking out beyond this year saying, "Hey, we see a 41% or 42%." It just doesn't -- we don't see a path to get there right now with the current volume and product mix that we're shipping. But like I did mention, anything above 39% we feel comfortable with, and we feel like we can manage the business in around that range..

Great. And then last question. As it relates to operating expenses, I think x HomeLink, it looks like you guys are growing some work, having the -- maybe mid- to high- single-digit range, and OpEx has kind of grown in that range or faster over the years, generally, even though you've historically kind of grown revenue faster.

If you kind of net out sort of in that 5%, 6%, 7% revenue growth range in a flattening sour [ph] how do you think generally about the operating leverage in the business in terms of can you keep OpEx flat or close to flat? Or will that still sort of grow high single digits to 10%?.

Well, our goal is always to try to keep our operating expenses in line with our sales growth levels. And that's -- when Mark and I talk about the last 2 years in particular, that's what we're referencing, is the discipline that it takes to try to control that OpEx expense at or below the sales growth level.

Now that's not always possible, especially when you're launching new programs that may not hit revenue for a couple of years, but that is always our goal..

And we'll move to our next question from Chris Van Horn with FBR Capital Markets..

Just could you provide any color around some of the programs or brands kind of leading the sales growth? And then, kind of as an add-on to that, any kind of regions around the world that you can point to as really driving some of the growth here?.

Well, historically, if you looked over the last few quarters, what we've been seeing is a lot of strength in our foreign markets. So for us, we refer to that as our European and Asian customers.

But if you look at this last -- in Q2 of this year, what you see is there is strength in North American segment us well for us, especially in our outside mirror portion of our business. They were roughly consistent between North America and Europe and Asia.

And so when we look at the last year, let's say, we've seen a lot of growth in Europe, especially, and in Asia. When you look at this quarter in particular, we're actually pleased with our growth in all regions..

Okay, great. Kind of shifting to R&D.

How should we kind of think about the future spending in R&D? And kind of is it more product enhancement? Is it continuing to work on new products? Is it kind of a split between the 2? How do you guys kind of think about the spending in R&D?.

Well, it's all of the above. I mean, one of the things we are focused on, like Mark mentioned in his product comments, is making sure we take these new product concepts, that we engineer them for production and get them ready for the programs that we have. So that's the portion of the R&D spend, obviously.

Additionally to that, though, there's always -- in Gentex culture, there's always a strong trend towards working on new products, new concepts and new things that we haven't announced yet. So that will -- has been, and it will continue to be a portion of our R&D spend..

Okay, great. And then finally, since you guys kind of cited it, could you just give a -- give me a general sense of how the tone of your customer price reductions have been going and what you have been kind of seeing there? Not the specific numbers, but just kind of general, how those conversations have been playing out..

Sure. Well, you know the industry. I mean, it's -- and it's pretty well known what OEMs request. The pressure hasn't dropped at all. I mean, it changes geographically from time to time and depending on which OEMs are leading the charge in terms of pressure.

What I will say is -- and from the numbers standpoint, historically, over the last several years, we had been running probably -- we've always guided in that 3% to 4% range. We've actually updated that guidance in the last 12 months to be more in the 2% to 3% range.

And where we would plan -- look in our forecast and our plans and what negotiations we have going, we believe we're solidly in that range..

[Operator Instructions] And at this time, there are no further questions in the queue..

With that, then, we want to thank everyone for participation today. I know we have scheduled a number of direct calls with analysts and investors after this, and we look forward to those. So thanks, everyone, very much and have a good day..

That does conclude today's conference. Thank you for your participation..