Gentex Corporation (GNTX) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Gentex Reports Third Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's conference maybe recorded. I would now like to turn the call over to Mr. Josh O'Berski, Director of Investor Relations. Sir, you may begin.

Thank you. Good morning, and welcome to the Gentex Corporation Third Quarter 2018 Earnings Release Conference Call. I'm Josh O'Berski, Gentex Director of Investor Relations, and I'm joined by Steve Downing, President and CEO; Kevin Nash, Vice President of Finance and CFO; and Neil Boehm, Vice President of Engineering and CTO. 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 Third Quarter 2018 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, I will turn the call over to Steve, who will give the Third quarter 2018 financial summary.

Thank you, Josh. For the third quarter of 2018, the Company reported net sales of $460.3 million, which was an increase of 5% compared to net sales of $438.6 million in the third quarter of 2017. When compared with IHS Markit's mid-July forecast for the third quarter of 2018, actual light vehicle production was approximately 5% below forecast in our primary markets of Europe, North America, Japan and Korea. In addition, when compared to the third quarter of 2017, actual light vehicle production declined by approximately 3% in our primary markets. The lower levels of vehicle production were impacted by WLTP regulations in Europe which resulted in unit shipments and revenue that were below forecast for the quarter. The third quarter of 2018 began with vehicle production estimates pointing toward near double-digit revenue growth for the quarter, but actual vehicle production levels as we mentioned earlier came in considerably lower than anyone expected. Despite the difficult production environment, we are pleased with the 8% outperformance versus our underlying markets which was driven by growth in our core auto-dimming mirror business and launches and ramp ups in production of our Full Display Mirror. For the third quarter of 2018, the gross margin was 37.6%, which was down when compared to a gross margin of 39% in the third quarter of 2017. The gross margin during the quarter was negatively impacted by approximately 60 basis points due to the tariffs that became effective during the quarter. A detailed review of the gross margin performance in the quarter reveals a couple of interesting data points. First, the gross margin performed well during the quarter when accounting for the poor performance in vehicle production which resulted in lower than expected revenue growth. Second, when you consider the 60 basis point headwind that the Company experienced from the addition of tariffs, the gross margin during the quarter would have been 38.2%. Net of these new tariffs, the gross margin for the Company improved sequentially during each quarter of 2018. Operating expenses during the third quarter of 2018 were up 8% to $45.6 million when compared to operating expenses of $42.2 million in the third quarter of 2017, primarily due to increased staffing levels. Income from operations for the third quarter of 2018 decreased 1% to $127.4 million when compared to income from operations of $129.1 million for the third quarter of 2017, primarily due to increased operating expenses and lower gross margin percentage, which was partially offset by quarter over quarter sales growth. Other income increased to $3.1 million in the third quarter of 2018 compared to $1.8 million in the third quarter of 2017, primarily due to decreased interest expense and higher investment income. During the third quarter of 2018, the Company's effective tax rate was 14.7%, down from 31% during the third quarter of 2017, primarily driven by the impacts of the Tax Cuts and Jobs Act of 2017 and the tax planning initiatives undertaken by the Company. Net income for the third quarter of 2018 increased 23% to $111.3 million compared with net income of $90.2 million in the third quarter of 2017. Earnings per diluted share in the third quarter of 2018 increased 35% to $0.42, compared with earnings per diluted share of $0.31 in the third quarter of 2017, as a result of the lower effective tax rate and a reduction in diluted shares outstanding on a quarter over quarter basis. During the third quarter of 2018, the Company repurchased approximately 7.5 million shares of its common stock at an average price of $22.98 per share, for a total of $172.5 million of share repurchases. As of September 30th, 2018, the Company has approximately 12.2 million shares remaining available for repurchase pursuant to the previously announced share repurchase plan, which remains a part of the Company's broader, publically disclosed capital allocation strategy. The Company intends to continue to repurchase additional shares of its common stock in the future in support of such capital allocation strategy, but share repurchases may vary from time to time and will take into account macroeconomic issues, market trends and other factors that the Company deems appropriate. During the third quarter of 2018, the Company paid down the remaining principal on its credit facility of $23.1 million. The Company recently entered into a new credit agreement for a $150,000,000 senior revolving credit facility that will mature on October 15, 2023. I will now hand the call over to Kevin, with the third quarter 2018 financial details.

Thank you, Steve. For the next few minutes, we'd like to spend some time discussing additional details of the third quarter, key factors that drove the results and points of consideration as we move through the remainder of 2018. Automotive net sales in the third quarter of 2018 were $449.2 million, an increase of 5% compared with automotive net sales of $428.2 million in the third quarter of 2017, driven by a 6% increase in auto-dimming mirror unit shipments and full display mirror launches and volume increases on a quarter-over-quarter basis. Other net sales in the third quarter of 2018, which includes dimmable aircraft Windows and fire protection products were $11.1 million, an increase of 6% compared to other net sales of $10.5 million in the third quarter of 2017. As we disclosed in our capital allocation press release in March of this year, one of the primary focuses of our strategy was a reduction in our target balances for cash and investments to approximately $525 million by the end of calendar year 2018. As we discussed during our previous calls, our approach was going to be part systematic and part opportunistic. As of September 30, 2018, the combination of cash, short-term and long-term investments, were $479.3 million, down from $779.9 million as of December 31. The primary drivers of the overall reductions were also part of the same capital allocation strategy, which included increased share repurchases and accelerated debt repayments in addition to capital expenditures and an increase to the Company's dividend rate earlier this year. The current mix between cash and investments may change on a quarterly basis related to changes in liquidity requirements, fluctuation in interest rates and fixed income investment maturities and reinvestments. Accounts receivable was $247.3 million as of September 30, up from $231.1 million as of December 31, primarily due to higher sales levels on a period-over-period basis. Inventories were $213.4 million as of September 30, down from $216.8 million as of December 31. Accounts payable were unchanged at approximately $90 million as of September 30 and accrued liabilities were $82.8 million as of September 30, down from $153.8 million as of December 31, driven by accelerated debt repayments. Now for some cash flow highlights. Third quarter of 2018, cash flow from operations was $105.8 million compared with $90 million in the third quarter of 2017, driven by increased net income and fluctuations in working capital. Capital Expenditures for the third quarter of 2018 were $16.9 million compared with $29.9 million for the third quarter of 2017. And lastly, depreciation and amortization for the third quarter of 2018 was $24.8 million compared with $24.4 million in the third quarter of 2017. I will now hand the call over to Neil for a product update.

Thank you, Kevin. To begin with, I would like to provide an update on our launch activity this past quarter. In the third quarter of 2018, there were 19 net new nameplate launches of our inside and outside electrochromic mirrors and electronic features. This launch freight was led by our outside auto-dimming mirrors, HomeLink and full display mirror launches. ur outside auto-dimming mirrors had a very strong growth rate of six net new nameplate launches. This level of launch activity is tied for the highest outside mirror launch cadence in the last two years. During the third quarter, the Company once again experienced increased launch levels in HomeLink and Full Display Mirror applications. For the quarter, we launched eight net new HomeLink applications, which is the highest HomeLink launch cadence since we acquired HomeLink in 2013. Also for the quarter, we continue to see growth in Full Display Mirror launches that we've been discussing over last few quarters. This was highlighted by five new Full Display Mirror launches in this past quarter. The final launch data point we'd like to discuss covers successful launches for domestic China OEMs. In Q2, we announced four new launches into the China market and during Q3, we had an additional three launches of our inside and outside auto-dimming mirrors with domestic China OEMs. Now for a more detailed update on our Full Display Mirror product. At our Analyst and Investor Presentation in Manhattan this past August, we announced three new vehicles that now have Full Display Mirror applications. These vehicles are; the GMC Sierra, the Chevy Camaro and the Toyota Crown for the Japan market. Now we'd like to provide an update on additional vehicles that are now offering our market leading Full Display Mirror technology. We're excited to announce that the Cadillac XT 4 the Subaru Forester for the Japan market, and the Lexus ES for the Japan market are all currently in production with our Full Display Mirror. In the Q2 conference call, we discussed that our launch cadence would have a shipping Full Display Mirrors on at least six additional nameplates through the second half of the year. To summarize, we announced three new name plates in August and an additional three new nameplates today, which means by the end of Q3, we have already accomplished our goal for the entire second half of the year. Based on this, we're ahead of schedule with our forecasted launches for the year and are on pace to achieve our target of 500,000 Full Display Mirror unit shipments in calendar year 2019. Full Display Mirror continues to be well received by our customers and we estimate that we will receive an additional award from an 8th OEM sometime toward the end of 2018. I'll now hand the call back over to Steve for 2018 and 2019 guidance and closing remarks.

Thank you, Neil. The Company's forecast for light vehicle production for the fourth quarter and full year 2018 are based on IHS Markit's mid October 2018 forecast for light vehicle production in North America, Europe, Japan and Korea. Based on the IHS Markit light vehicle production forecast, current forecasted product mix and expense growth estimates, the Company has updated certain of its 2018 guidance, which was included in our earnings press release from this morning. For the fourth quarter of 2018, the Company estimates that revenue will increase between 3% and 7% versus the same quarter of last year. As a result of the recently enacted tariffs by the Office of the United States Trade Representative, related to imports from China and tariffs enacted by China on imports from the United States, the Company currently expects additional cost increases of between $2.5 million and $3 million for the fourth quarter of 2018. Total cost increases related to all enacted tariffs are expected to be approximately $5.5 million to $6 million for the fourth quarter of 2018. These cost increases are expected to negatively impact gross margin and are reflected in the Company's updated margin guidance provided. The Company continues to monitor and evaluate the impact of such tariffs along with other potential import and export tariffs that may be implemented by other countries which may have application to the Company's raw materials and/or finished products. As we move into the fourth quarter, we are expecting to remain in a tough light vehicle production environment due to ongoing regulation issues in Europe and vehicle production levels that so far this year have been lower than the industry expected. Overall, we remain optimistic that the growth of our core auto-dimming mirrors and full display mirror launches will continue to provide growth rates well above vehicle production levels over the balance of 2018 and through calendar year 2019. Additionally, we will continue to work hard to offset the cost increases from the newly enacted tariffs. We continue to believe that our sales and margin performance throughout the year in combination with the execution of our capital allocation strategy has produced the results we were expecting, but that the market has not fully valued. We remain confident that our execution of the strategies we have put in place will continue to create value for our shareholders. In closing, we will be exhibiting at SEMA from October 30th through November 2nd and at CES from January 8th through the 11th. As always, please note that you're welcome to come CES at the show to experience our products and to see the progress we're making with our new technology. If you're interested in visiting us at either event, please feel free to contact Josh O'Berski to schedule a time. Thank you for your time today and we can now proceed to questions.

[Operator Instructions] Our first question will come from the line of Chris Van Horn with B. Riley FBR. Your line is open.

I just wanted to focus on tariffs a bit. Was it one product category that's really driving that or is it multiple? And then could you comment on the concept of alternative sourcing and then how do we think about these tariffs going forward as we head through -- as we head into 2019?

Thanks, Chris. The primary impact in the third quarter was mostly from list 1 that was published on July 6th, which is heavily electronic content, wiring harnesses, things of that nature. Our list 2 did come into impact in mid-August and so that was originally we talked a little bit higher about them, but that one is a little bit less than we originally estimated. Going into Q4, our list 3 as you know was effective on September 24th at 10% and that does jump up into 2019, and so we're modeling the impacts of that right now. Our engineering and purchasing teams are working through kind of scenarios on how we can -- can resource and I think we feel like there are some opportunities there. But some of that stuff is short run in nature and so Q4 really is kind of doing what we've been doing.

And so, Chris, if you look at the all three lists, you're going to cover everything from basically any type of an electronic sub-component, small parts to displays, pretty much anything on the electronics front is in purview of the tariff list.

Got it, got it. Great.

One quick last one is that China did retaliate and so some of our finished goods going into our distribution center into China are going to be impacted in the fourth quarter as well.

Okay, and that's all in the guidance?

It's all contemplated, yes.

Yep. Okay, great. Great. So ex-tariffs and despite this lower production environment, the gross margins were still pretty strong, I mean I think there is a thesis that gross margins with the lower production would be hit. So could you, it was a 30% growth in exterior mirrors in North America. Helping that, what was really the driver of your ability to do that?

When you look at a couple of factors like we talk about really starting at the midpoint of the year this year, we finally had a full benefit from our purchase components from our suppliers. So we got a full flow-through of that. You look at the growth rate in the business and you see the strong growth in outside mirrors in the second half and those are all contributing factors to the margin expansion net of tariffs.

Okay, got it. And then, sorry, just could you comment on that 31% growth in exterior mirrors in North America, anything big drive in that, just it seems like a big number?

Yes. There were some takeover programs that we experienced that launched in Q3 that helped that growth rate expand, and then some -- obviously, some new vehicles coming online in production during that as well to help that growth rate.

And if you also remember, last year Q3 was extraordinarily weak on outside mirrors in North America.

Yes. Got it, OK. Last one from me. I'll jump back in the queue. Obviously Full Display Mirror continues to track really well enough in a number of new launches. Could you just give us a sense of the customer feedback and what you're hearing on take rates and how the impact of Full Display Mirror is going from a customer perspective?

Yes, good morning, Chris, it's Neil. In general, the Full Display Mirror product across the customer base is -- continues to grow interest from our consumer side as well as from the OE side. I think take rates are probably depending on the vehicle, you're anywhere from 20% to probably 40% would probably be a pretty reasonable average, on some vehicles it's a little higher. I guess the consumer side feedback, the technology continues to change and evolve. One of the things that we look at from our advantage is, how quickly we can continue to make that product even better than what it was before. You will see that in some of the new launches that came out with our Generation 2 product, it's a much more esthetic product and it's -- the feedback from the consumer and the customers on it has been really, really positive.

Got it, got it. Sorry, just a quick follow-on, could you comment on any of the programs our camera and display versus just the display portion?

The new ones that we talked about are mostly display only, I think there is the one that is the camera that would be the Subaru is the camera and display, and the other ones are all display only.

Thank you. Our next question comes from the line of Richard Carlson with BMO Capital Markets. Your line is open.

So, just the 3% to 7% growth for 4Q, I mean it seems a little wide for as much visibility as I think you'd probably normally have for the quarter, so maybe if you could talk about the some of the puts and takes that would get you to the 3% and the 7% range?

Sure. I mean the reason for the wider range this quarter quite honestly is what we've seen in Q3 and really throughout this year and that is -- there's been a lot of customer order changes at the last minute, especially in the last three to six months. And so, we're really looking at kind of what we feel like the forecast is and then looking at that variability that we've seen over the past three to six months, and saying, okay, we need to paint a picture that's reflective of what we've experienced.

And I guess at this point, are you expecting to perhaps benefit in 2019 from some of the European recovery?

We hope so. I mean that's the million dollar question, I think is, is this a one-time event, is it going to recover and pushed orders into Q4 and '19, or is this an opportunity for everyone to adjust to where demand is. Most indicators lead that there should be some push-out and pickup some of this volume between Q4 and Q1 or sometime in the '19, but we are not going to count those chickens quite yet.

And then on the share repo, I mean, very strong this quarter and your cash, your net cash is now below that target $525 million range. I mean, just looking at where your shares are now currently priced, it's usually the valuation range you guys getting a little more aggressive. Could we see you guys bring that $525 million down a little bit more?

Yes, I think it's, I think it's fair to say that the $525 million was the target and that we are going to be situational with share repurchases and obviously given the price that we're trading at right now, we do believe that the Company is undervalued versus what our projections are for '18 and '19. You see a little bit of gross margin pressure and a little bit of risk from the tariff side, but all in all, you look at a 23% step up in net income, 35% increase in EPS and you model that out over '18 and in the '19 and then you look at our historical PE and I would we look at this valuation and it just doesn't make sense. We think some of the concerns are here overdone.

Thank you. And our next question comes from the line of Rich Kwas with Wells Fargo Securities. Your line is open.

A finer point on the tariff. So it looks like list 2 and 3 were in the increment of $3 million at least on a quarterly run rate of 12% on annualized rate at 10% is that the right way to think about it?

Yes. The step up from Q3 to Q4, that's a fair assumption.

Okay.

And then, I remember list 3 -- list 3 goes up on January 1 as well.

Right. So, is kind of the worst case scenario that you just multiply that by 2.5 times and with no offsets and that would be the full impact that you would actually incur?

What we have been working on and what we've already modeled really kind of right now we feel like our worst case scenario is in that $25 million to $30 million range for 2019, because some of the things, we have done some things already, so list 3 may not be as impacted in Q1. We're working on a few other things that we think we can accomplish, but worse case, we think 25 to 30 is probably if you ballpark that, that's what we're modeling for our forecasts.

And that's assuming that we can't find any offsets.

Right, right. So that encompasses all three lists and encompasses list 3 at 25%.

Right. That's correct.

Okay. All right. And then just a couple of others on the '19 and I know you're ways out from giving more specifics around '19. But if we take the 5 to 10, and given where current mix is within that 5 to 10, if we strip out the tariffs, how should we think about gross margin in '19? If you look at it on a quote-unquote core basis. Would there be expansion there if you excluded the tariffs on that mix with -- of the 5 to 10?

No, I think if you, if you stripped out the tariffs, I think we assumed margins roughly in line with 2018 margins.

Okay. All right. So in line on a core basis and then you have to factor in tariffs. Okay. And then the CapEx adjustment lower, just curious, what -- was that a push out or is there something more structural there in terms of what you're spending on?

No, just looking at, I mean the first half of the year is a little higher. We are building a new distribution center, we have some other spending that happened, but really we're very tactical in terms of project-based in terms of CapEx. So basically, we look for a business case in everything and the quarter was a little lighter than we had anticipated, and we're still funding the business appropriately. So we feel good about that lower level of CapEx for the quarter and we'll continue to fund the business appropriately, but it would just turn out to be definitely a downturn -- a downtick, I should say, in the spending on CapEx for the quarter.

Would that -- some of that go fall into '19, then?

Yes, some of it could push out. A little bit into Q4, potentially and some into '19, but not all of it. And then -- don't think you'll see a step up from like what we've talked about before modeling it around kind of forecast in our sales growth and then like Steve said on a project-by-project basis, to run the business.

Yes, anything you're seeing from the customer base around delaying programs or adjusting the scope of programs at this point?

No, it's actually interesting, I mean, we look at it, we would use kind of the HomeLink and Full Display Mirror and outside mirror launches in the quarter as pretty good indicators. The immediate concern, obviously when this starts to happen is like you mentioned that you start to see evidence of a pullback or downturn, but in reality, our launches were very strong in Q3 and those tend to be a pretty good indicator of the next several years of what we're expecting on the business side. So right now, we're feeling pretty good about where we're at with the product cadence launch and how those are ultimately moving from launch and into volume.

Thank you. Our next question comes from the line of David Leiker with Baird. Your line is open.

If we look at your -- the numbers that you put up here, it looks like obviously the build number was a little bit lower, but it looks like your growth relative to the market actually was better? Can you talk about what's behind that a bit?

Yes, I think it's just indicative of right now we feel like our products are right, the customers are interested in them and that the launches are pretty strong. So there obviously have been a lot of talk about how our features hold up and as the vehicles are changing and we see strength in that, if you look at our core auto-dimming mirror business, it's still growing very successfully. We're excited about those growth rates outside of our traditional markets if you look at the domestic China market. We've kind of pointed that out, the last two quarters to help drive home the point that we see growth opportunities in the China market. Even though the China market may not be performing as well as it has in the past and so when you look at the combination of the new technology like Full Display Mirror and then the growth in our core auto dimming business, we feel like we're positioned pretty well for growth.

Okay, great. And then if we look at some of these newer products, the more advanced technology products Full Display Mirror in particular, it seems like the Japanese market, local market is more aggressive in kind of -- in bringing this to the customers than others. I'm just curious, any thoughts behind what drives that?

Good morning, David. This is Neil. There's a couple of different factors that get into that, in the Japan market, would -- as you noticed, obviously there Japanese manufacturer is launching, they wanted to launch that in a local market in order to help support the execution to their consumer, based on the ability of the dealers to help provide a different service than what they'd get in other regions. But if you look at General Motors with Cadillac, I mean that's predominantly a North American launched system with -- and the Chevy as well, in the US with some exporting. So I think we spread out pretty well. But yes, some of the recent launches have been for the Japan market, but that's been more controlled based on where their dealers are located and the control of the dealerships are.

Okay. And then just one last item and just to follow up on kind of the take rates, which -- you did a great job in discussing. I'm more curious on how the product is being packaged for the consumer to be sold to the consumer and what that cost to the consumer looks like across the different customers.

If you look at the packages, they're always tricky, but if you look at GM, typically if it's on a full-size SUV or on a Cadillac-branded vehicle, there is usually anywhere from 3 to 4 different trim packages on those vehicles and we tend to be if it's -- if it's three or probably going to be standard on the top and then optional on the middle, if it's four, we're probably be standard on the top and optional on the second, maybe even the third. In terms of stand-alone features, it's a little tougher. You can build certain GM vehicles, and ultimately find Full Display Mirrors as a stand-alone option, and those tend to be priced anywhere near in the 350 to 450 range.

Yes, 475, since -- like it's been in some of the Cadillacs, and it just gets tied with different technology packages. So depending on the vehicle and the manufacturer, they tied in differently.

Thank you. And our next question comes from the line of Anthony Deem with Longbow. Your line is open.

So just a few. First, I appreciate the color on the gross margin. Outlook for 2019, I was wondering if you can give us some color on your operating expense growth outlook for 2019, is it pretty similar to your prior commentary? I'm just wondering, if additional staff you added here in '18 is sufficient to support the new business, you've sourced and are pursuing, or maybe we should expect another year of catching up from a personnel and cost standpoint next year?

Yes, I mean, our goal is obviously to try to keep total OpEx roughly in line with sales growth, but now in some of the new technologies that we're investing in and some of the new things we're working on, you might see that be slightly higher than the growth rate, but not significantly higher. And so, if you look kind of the top end of that growth rate range, that probably be what our target is for next year.

Okay. So, maybe we should model 10% operating expense growth next year.

If you did that would probably be pretty conservative, that would probably be -- on the R&D especially should be up there, the SG&A hopefully will be more in line with just sales growth, but the weighted average will be a little bit toward the top half.

Secondly, so you're clearly having some success in China bidding, I'm wondering, how do you see your revenue progressing over the coming years versus underlying production? Do you see the China market trending in line with corporate average growth versus market? Is it better or worse? Any color is appreciated.

Yes. If you look at it on a percentage basis, I mean, one of the things we haven't really done over the last couple of years is really give that color quite as well as we should have, so we're trying to do a better job of that now. If you look at the growth rates in China, it's been far above the corporate growth rate average -- really over the last several years, and so as the market starts to slow down there a little bit, we still believe it will outpace the normal corporate growth rate by a pretty wide margin.

And I apologize, if this is addressed in a prior question, but on Japan. Do you view this camera based side feature content as a niche or and is there strong take rates early on from maybe what you've observed. EFI penetration is pretty low in Japan from what I understand, on a relative basis versus other mature markets. So I'm just wondering if you see mirror penetration growth is still very significant or if you see this emerging risks as material headwinds.

Well, I think the e-mirror side of the business on Japan, we view that as more of a niche application, if you look at how it's executed, what we've seen is the consumers tend to find it interesting, but the execution isn't as robust as what we believe needs to happen. So, one of the things that we're focused on is try to provide solution that matches the needs of the driver today and what an OEM is looking to do for the future. That's why we believe our hybrid solution that we showed at CES last year is a superior execution. That doesn't mean OEMs are going to try lower volume applications. Our first take of what we understand about that vehicle in particular is that those take rates are incredibly low, and obviously, it's only available in the Japan market. So one of the things that we're focused on is trying to show alternative products that are -- offer up the same type of functionality in a more robust design.

Okay. If I could sneak one last one in here. Reasonably large cut in CapEx here, can you provide us with some color on some of the projects being cut back on or is this more a reflection of weaker in near term backdrop in production or maybe related to some of your long-term opportunities? And thanks again for taking my questions.

Sure. There is no fundamental message being sent there with that CapEx reduction. All that is, is really for us as we build our projects based on -- and obviously the largest things that move CapEx in any quarter are brick and mortar projects. We've been working on one, that's our new distribution center. It's actually opening right now and we except it to be operating out of that during Q4. Beyond that, what we're really doing is kind of modeling out the entire year, and then, every CapEx project obviously has a return analysis associated with it. And so, as projects come up, we're looking at the financial benefit of those projects, and if they make sense we do them. It's not about a lack of demand, it's really about we've front-loaded the first half of the year a little bit and we're able to take a little bit of a breather in Q3, and probably go back to our normal pace in Q4 and into '19. So there is not any lack of demand that's driving that reduction. It's more just a tactical approach to making sure we're spending money appropriately.

Thank you. [Operator Instructions] Our next question comes from the line of John Murphy with Bank of America Merrill Lynch. Your line is open.

A lot of my questions have been answered, but I've got two sort of unique ones. I think, first on the Lexus ES in Japan, that's a vehicle it sounds like it's got your Full Display Mirror, but the side view mirrors have been replaced with cameras in displays. So I'm just curious as you seek to have that progression to move for some automakers to cameras and displays, what sort of the content opportunity is on vehicles like that? And if as we sort of see this replacement, will we still see the Full Display Mirrors in the middle of vehicles as far as you understand?

Yes. The Lexus ES is a very interesting example. So first, kind of -- just to make sure everybody understands what that -- and not everyone might have seen the announcement on that vehicle. But we have a Full Display Mirror application available on that vehicle, and it's actually on a several different trim levels for that car. The e-mirror system is provided by a different supplier and that basically removes outside mirrors and replaces it with cameras and displays on the pillars. And basically, our product has a higher penetration and take rate than that e-mirror system. That e-mirror system based off what we understand so far is expected to be incredibly low take rate in volumes. We believe and obviously, it's an expensive system, when we look at -- when we look at our take on that vehicle, we've executed similar prototypes and POCs following that type of model. We do believe there are some significant limitations and drive ability and usability for the consumer. And that's why we've developed our hybrid solution as an alternative to that. There is a tremendous amount of upside. Obviously, if this type of digital or hybrid system were to take place, and that's why we're investing in that product and trying to show an alternative that we believe is more consumer-friendly. I'm might have [Multiple Speaker] John, did I?

Yes. So if you think about the content potential and margin potential and something like that for you, may I understand that you guys don't have the outside e-mirror system on that vehicle, but if we saw that kind of system come into play, is that a big -- is that a big content positive for you and potentially margin positive?

Sure. So our -- what we've seen so far is that someone go into this type of model tends to view our Full Display Mirror as kind of center point of that. And so assuming that we already have Full Display Mirror, the incremental content for e-mirror system for us, you'd look at probably about $50 per camera and then depending on how the OEM wanted to execute graphics processing, there could be another $30 to $50 in content, depending on how much video processing they wanted to accomplish or manipulation of that video image.

Got it. Okay.

And that's just the incremental piece of it.

And I'm sorry, that $30 includes the small screens that go along with it, is that correct or no?

No, that's just the cameras. The screens themselves if you add those would probably be -- probably be another $50 per display. I would assume or more.

So you say it's $50 per camera, if $30 for the image processing, and then it's another $50 for the screens. Is that roughly…

Yes, probably $50 to $75 depending on how big of screens they wanted to use for the displays.

And then just the second question, meaning, as you look at what's going on with tariffs you know, around the world and there is some extreme uncertainties still based on all the noise that we're all hearing. I mean, is there the potential for you to establish another manufacturing base either in Europe, in China for your mirrors to deal with this long-term?

Yes. Absolutely, I mean, when we look at -- when we look at how we respond to our customers, we know it's imperative that we deliver a product to them, that's cost effective and builds a business case for them. So given how new this is and how early on in the cycle we are, our position right now is we've been studying and looking at alternatives to make sure we are prepared to make that decision if and when it needs to happen. We're just not that -- at that point yet, we still believe there is a period here that this may get negotiated and settled in a more favorable way, if that happens, obviously it will be the most efficient or cost-efficient for us to have been a little patient. So, what we would do is, we work on modeling the plans and we prepare and if this looks like it's going to continue for an extended period of time, then we'll have to look at alternatives.

Okay. And I promise, actually last question, when you look at what happened with schedules through the course of the quarter, like when we started when you're looking at this April, May and June. How fast did the schedules change and how -- how different were they versus your original expectations? Because I think there's kind of this view that we certainly have and most folks have that, you know, quarter started up looking like it was going to be up 4% globally, and this is the global IHS numbers, but it looks like it finished down 2%. I'm just curious when you look at sort of the runs and the releases that you're getting on your schedules, 30 days and 45 days out, was the swing really that extreme sort of the 6% global and then the 5%, which is focused on what you're looking at or when you were looking at your individual runs, was it maybe a little bit less disruptive?

Well, that was the problem with this quarter was. It's easier to handle and adjust for when it is that kind of one-time event where also my schedules get adjusted and that never happened. Instead, it was on a weekly basis OEMs would have said, hey, we're going to take X amount of parts, and by the time the week happened, they were taken 4% to 5% less than they -- than they had anticipated taking. And it was just like -- it was like that week upon week for really a good portion of the quarter. So, unfortunately we really didn't get any advanced warning of that change. It was more just cumulatively over the entire quarter, and that makes it really hard to plan and makes it obviously not the most efficient manufacturing environment either.

Thank you. Our next question comes from the line of David Whiston with Morningstar. Your line is open.

I wanted to say with these order changes for a second, we -- I assume it's primarily cancellations, but is it almost entirely from WLTP or are there other things going on?

There were others as well, I mean, really North America, Japan and Korea they had the same incident rate. I mean, it really was on a percentage basis pretty similar, it did vary by OEM somewhat, but there was a pretty significant change in production obviously in North America, Japan and Korea markets as well.

Okay. And you did keep your 2019 revenue growth percentage rates unchanged, obviously of a slightly lower base. But if there is no, you talked earlier about whether we get this bounce back in Europe is a million-dollar question. If there is no bounce back in Europe, is your 2019 revenue guidance pretty much toasted at that point, or do you think you could still maintain it?

Yes, it's right, it'll just be toward the bottom end of the guidance, but obviously, I think, I think the midpoint is what we feel pretty comfortable with, borrowing any unforeseen changes. And obviously it would -- it would shade toward the bottom end, if there's no push back or push out of some of these additional volumes that were dropped in Q3.

And finally, are there any upstream tariffs or any upstream supply issues with electronic components that you're trying to get that you're having a hard time getting?

Yes. There is -- the entire industry is going through a bit of a tough spell when it comes to passive components, the demand is higher than capacity right now in a lot of places, that's driving some cost increases for a lot of suppliers and a lack of availability. We're working hard to try to make sure that doesn't affect our overall margin profile, but it is a tremendous amount of work we've been going through really for the last six months and we know it's not going to end anytime soon. So, it's something that we keep paying attention to and working really hard on to try to make sure we have the right suppliers and the right arrangement set up with each of them to make sure we can get the components we need at a price that's fair.

And are those suppliers asking you for more money right now to make that happen?

Yes, some of them are. Yes, there is some of the passes are overbought and that's obviously drive -- driven them to go to the market looking for some price increases.

And is it fair to say as long you think you can have it at a reasonable price, you'd be willing to pay a slight increase?

Just depends, I probably wouldn't say that publicly ever on anything -- but if you look at, if you look at availability and the right supplier, I mean, obviously, we are trying to negotiate fair deals and have partners of suppliers that we want to work with. So, it's obviously in the wheelhouse or in the conversation. It's just making sure that we have a long-term plan with each of those suppliers of how to -- how to make sure they're investing in the right infrastructure and give us the trajectory we need not only on availability components, but on the price of those components.

Thank you. And our next question comes from the line of David Stratton with Great Lakes Review. Your line is open.

Really quick since most of the stuff has been answered already, I just wanted to touch on your dimmable light -- dimmable windows that you've highlighted in your concept vehicle and then you're also referenced in the autonomous vehicle magazine recently. And just if you're getting any traction there, as this -- any detail you can give around what you're seeing, what you're hearing from customers about the potential application of that would be great.

Hi, good morning. This is Neil. I think the general aspect, I've covered at a very high level, there is a great market interest for dimmable devices from a -- take the sun roof as an example, there are used cases out there that exists, that people are looking to change how the -- vehicle style and how the -- the esthetics of it. And when you look forward to autonomous, they're looking for ways to changing environments, so there is interest, there's a lot of discussion. There's a lot of development that still needs to occur. I think we've talked about it earlier this year at CES that it's a -- it's a five year process to get this technology to a state where it can we put into the automotive environment and actually be durable and reliable to last till the life of the vehicles. So, we're working really hard on it, but we've got time if there is a three, four year period here where we're still going to be in a development stage to make it successful.

Just a quick jump onto that, if you look at this week we were at the NBAA show, so the business jet Aerospace show in Orlando and the team was down exhibiting and showing those customers kind of the -- some of the changes that were made to that product on the aerospace side, and we believe there is a tremendous amount of opportunity longer term in aerospace, not only in business jets, but also in commercial airline. A lot of that business development effort is focused on that industry right now because we know -- we know how to and we have successful program in the Boeing 787 that we're trying to leverage off of to help drive growth in the Aerospace Group. And then additionally, at CES, in our closing comments we mentioned at CES, we welcome everyone to come at the booth we're hoping to show some improvements in iteration and the design of those products beyond just the IPD that you saw at CES and hopefully moving into some more tactical executions and showing that it's beyond just a proof-of-concept that we're starting to make progress on the manufacturer ability. Right, and then really quick back to the automotive application, would you say that the interest that you are seeing is more from like you said the sun roof aspect or more from autonomous vehicle manufacturers who have that in the pipeline?

Well, it's exciting, as we believe this technology as relevant in the car of today, not just the car of the future and that's why the investment, and that's why the work that we're doing as a team to try to make sure we can show what we believe large area devices can represent not only today, but in the car of the future.

Thank you. Our next question comes from the line of Glenn Chin with Buckingham Research. Your line is open.

Hello. So, just a quick question, I apologize -- I apologize if I missed it, but just a quick question on gross margins. So, the gross margins, they contracted 140 basis points year-over-year, but even it exceed tariff impact, or still down 80 basis points. Can you guys quantify the various factors that cause the compression, it's somewhat counter to what one would expect given your shipment growth in the quarter?

Well. Thanks, Glenn. The biggest driver as we always talk is annual customer price reductions on a year-over-year basis that, if we can offset those, through our purchasing cost reductions, which we've had some constraints earlier in the year, and then, if you look at our sales growth rate that's the other big piece, right, we were -- first half of the year and even in the third quarter we were at low single-digit growth rates and in order for us to leverage that we need between 5% and 10% growth rate to help leverage the investments we're making in automation and capacity expansion and so those are the primary factors. But as we get into the back half of the year, like Steve mentioned earlier, we are getting more benefit from our purchasing cost reductions and our margins have actually expanded if you go from ex-tariffs from the first half and then through the third quarter, and if you back off kind of the impact to tariffs, what the fourth quarter looks like, you would imply that tariff margins are going to improve from there sequentially as well. So, we're pretty excited about the fact that margins have actually moved up throughout the year in this tough environment.

One, I would -- I would add one other factor in that is the mix changes. So, as we talk about the China market and our growth into the China market, those are primarily with base auto-dimming mirrors that are below corporate average and so there's been a tremendous amount of growth in our core base auto-dimming technology and that growth rates are a headwind to overall corporate gross margin, but they are indicative of the fact that our products are interesting, relevant and wanted by our customers.

Yes. Okay, so that's still a factor, Steve?

Yes, exactly. Our base auto-dimming mirrors have been growing pretty quickly and that is a negative mix for us.

Okay. And so, Josh, you mentioned the annual price downs. Can you tell us what those are running at? And is that any different from what they've been historically?

No, they're -- right now at 2% to 3% range, probably in the mid-point of that pretty stable, I think a couple of years back, we were in the low-end, but this year it's really been right in the midpoint of that range, and a lot of that's due to forward contracts. I mean, some of that's due to where -- we are willing to give a little bit more to some customers, let's say if we have contract types of new business in the future.

So a lot of that -- a lot of those are like Kevin mentioned a lot of those are indicative of the success we're having with products like new technologies like full display mirror, and so those commitment from OEMs typically come with a response from us. That means we're negotiating slightly larger price decreases on current products in exchange for that future business and that's pretty common business practice for the Company.

Okay. Very good. Sorry, Kevin, I thought that was Josh. What about raw materials, any impact from raw materials?

Yes, there was some this year as well, like the -- like we were talking about in -- I think it was the previous call, some of the passive components and some of the electronics did move down quite as much this year as they have in the past, and so that caused from the beginning of the year, kind of the mark -- beginning part of that margin squeeze both the product mix on the sales side and the cost side from our suppliers caused that step down to beginning of the year. What we have done is improve each quarter from the beginning of the year.

Thank you. And I'm showing no further questions at this time, I would now like to turn the call back to Mr. Josh O'Berski for any closing remarks.

Great, thank you everyone for your time today. As Steve mentioned, we are happy to host investors at CES and SEMA, and we've already been setting up meetings with those shows with our analysts. So feel free to join on one of those groups or contact me directly in the coming weeks as we get close to those shows. As always, thank you and have a great weekend.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have great day.