Gentex Corp Q1 FY2023 Earnings Call

Good day, and thank you for standing by. Welcome to the Gentex Reports First Quarter 2023 Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Josh O'Berski, Director of Investor Relations.

Thank you. Good morning and welcome to the Gentex Corporation first quarter 2023 earnings release conference call. I'm Josh O'Berski, Gentex's Director of Investor Relations, and I'm joined by Steve Downing, President and CEO; Neil Boehm, CTO; and Kevin Nash, Vice President of Finance and CFO. This call is live on the Internet and can be reached by going to the Gentex website and at ir.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 First Quarter 2023 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'll turn the call over to Steve Downing who will get us started today.

Thank you, Josh. For the first quarter of 2023, the company reported net sales of $550.8 million, compared to net sales of $468.3 million in the first quarter of 2022, which was an 18% quarter-over-quarter increase and a new quarterly sales record for the company. For the first quarter of 2023, global light vehicle production in North America, Europe, Japan, Korea, and China increased approximately 6% when compared to the first quarter of 2022. Many of the supply chain issues that held back the industry during last year have improved, and the demand for our products combined with the increased light vehicle production led to record revenue in the quarter. While light vehicle production is still below pre-pandemic levels, demand for the company's products resulted in a 12% outperformance versus the underlying market. For the first quarter of 2023, the gross margin was 31.7%, compared to a gross margin of 34.3% for the first quarter of last year. The gross margin was impacted by raw material cost increases and labor cost increases, which were partially offset by improvements in freight-related costs and price increases to customers. As compared to the fourth quarter last year, the gross margin increased sequentially from 31.2% as a result of the higher sales levels, improvements in freight-related costs, favorable product mix, and price increases to customers that carried forward into this year. These tailwinds more than offset the potential margin decline coming from the one-time benefit of cost recoveries in the fourth quarter and the higher labor costs that became necessary last year. Calendar year 2022 was marred with significant gross margin impacts from raw material cost increases, supply chain stresses, labor cost increases, volatility, and overall inflation that resulted in significant downward pressure on our margins and profitability. In the fourth quarter of last year, we began the process of stabilizing and improving gross margins by realizing one-time cost recoveries for calendar year 2022 and securing sustained price increases that carried into the first quarter of this year. Gross margins hit a low point in 2022 during the third quarter when they fell to 29.8%. But in the fourth quarter, we secured one-time cost recoveries that improved margins to 31.2%. In the first quarter of 2023, we further improved gross margins to 31.7% even without the benefit of any one-time cost recoveries. Our plan for margin recovery is based on a timeline that covers 2023 and 2024 and is designed to achieve a targeted margin profile of 35% to 36% by the end of 2024. Based on our progress in the last two quarters, I believe we are well on our way to accomplishing this plan. Operating expenses during the first quarter of 2023 increased by 8% to $61.5 million compared to operating expenses of $57.1 million in the first quarter of 2022. Operating expenses increased during the first quarter of 2023 primarily due to staffing and professional fees, which were partially offset by lower outbound freight expenses. Our operating expenses for the first quarter of 2023 are slightly below our forecasted range for the full year, but we plan for those expenses to ramp up throughout 2023 in support of our product development strategy, new business awards, VA/VE initiatives, and our expected growth rate for this year and next year. Income from operations for the first quarter of 2023 was $113.3 million, compared to income from operations of $103.3 million for the first quarter of last year. During the first quarter of 2023, the company had an effective tax rate of 15.9%, which was primarily driven by the benefit of the foreign-derived intangible income deduction. Net income was $97.6 million for the first quarter of 2023 compared to net income of $87.5 million for the first quarter of last year. The increase in net income was primarily the result of the quarter-over-quarter increases in net sales and operating profits. Earnings per diluted share for the first quarter of 2023 were $0.42 compared to earnings per diluted share of $0.37 for the first quarter of last year. I will now hand the call over to Kevin for financial details.

Thank you, Steve. Automotive net sales in the first quarter of 2023 were $537.4 million, a 17% increase when compared to $458 million in the first quarter of 2022. Auto-dimming mirror unit shipments increased 16% during the quarter compared to the first quarter of 2022. Other net sales in the first quarter of 2023, which includes dimmable aircraft windows and fire protection products, were $13.3 million compared to other net sales of $10.3 million in the first quarter of 2022. Fire Protection sales increased by 10% for the first quarter, and dimmable aircraft window sales increased by 118% for the first quarter of 2023, both compared to the first quarter of 2022. Share repurchases: during the first quarter of 2023, the company repurchased one million shares of its common stock at an average price of $27.19 per share. As of March 31, 2023, the company has approximately 19.7 million shares remaining available for repurchase pursuant to its previously announced share repurchase plan. The company intends to continue to repurchase additional shares of its common stock in the future, in support of the previously disclosed capital allocation strategy, but share repurchases may vary from time to time and will take into account macroeconomic issues, market trends and other factors the company deems appropriate. Shifting over to the balance sheet. The balance sheet comparisons mentioned today are as of March 31 of 2023, as compared to December 31, 2022. Cash and cash equivalents were $215.5 million compared to $214.8 million. Short-term and long-term investments combined were $229.4 million, up from $202.3 million which includes fixed income investments as well as the company's equity and cost method investments. Accounts receivable was $332.9 million, up from $276.5 million due to the higher level of sales during the first quarter. Inventories were $401.8 million, down slightly from $404.4 million, and accounts payable increased to $166.9 million, up from $151.7 million. Looking at preliminary cash flow items for the quarter: first quarter 2023 cash flow from operations was $120.9 million, which was an increase from $115.9 million in the first quarter of 2022. CapEx for the first quarter was $42.8 million compared with $23.9 million for the first quarter of 2022 and depreciation and amortization for the first quarter was $24 million compared with $24.7 million for the first quarter of 2022. I'll now hand the call over to Neil for a product update.

Thank you, Kevin. In the first quarter of 2023, there were 18 net new nameplate launches of our interior and exterior auto-dimming mirrors and electronic features net of previously disclosed feature headwinds. The quarter was very strong in advanced feature launches, with over 70% of the net launches being advanced features. For the advanced features, Full Display Mirror and HomeLink were a significant portion of those launches. Now for an update on the Full Display Mirror. During the first quarter of 2023, we began shipping the Full Display Mirror on eight additional nameplates. These new vehicle nameplates are Lexus RZ, the Maserati GranTurismo, the Mazda CX-90, the Nissan Roox for the Japan market, the Toyota bZ4X and the new Toyota Crown for the Japan market, the Toyota Crown Kluger and the Toyota Grandia for China and other markets. The Mazda CX-90 Full Display Mirror is our first FDM shipping to Mazda and it can be found on their website when building a vehicle under the Accessories section. We're excited to be shipping to Mazda, and we believe the product will be successful in its initial introduction so that we can drive greater penetration over the long term. At the conclusion of the first quarter of 2023, we have now launched the Full Display Mirror on 94 nameplates across all regions of the world. This product continues to see strong growth and it's been extremely well received by our customers and consumers. As we look at the remainder of 2023, we are targeting at least 10 additional nameplate launches, and we expect our 2023 unit volume to be at least 300,000 units higher than our 2022 volume. The Full Display Mirror has been in production for over seven years now and in future quarters we will only be providing nameplate updates that have a significant growth or strategic impact. We'll continue to provide updates on our unit shipments and the progress toward the annual goal. During the first quarter of 2023, we've seen great improvement in supply chain constraints that have driven us to execute a significant number of redesigns. The team at Gentex has done an incredible job working through all of these issues and constraints to avoid OEM interruptions. I'm excited to get the team fully back and engaged on new products and launches, but some of our development team will continue to remain focused on new iterations of products to help us achieve our gross margin initiatives. I'll now hand the call back over to Steve for guidance and closing remarks.

Thanks, Neil. The company's current forecast for light vehicle production for the second quarter of 2023 and full years 2023 and 2024 are based on the mid-April 2023 S&P Global Mobility forecast for light vehicle production in North America, Europe, Japan, Korea, and China. Light vehicle production in these markets is expected to increase 14% for the second quarter of 2023 as compared to light vehicle production for the second quarter of last year. For calendar year 2023, light vehicle production in these markets is forecasted to increase 4% when compared to calendar year 2022. Based on this light vehicle production forecast, the company is making no changes to its previously provided estimates for 2023. Revenue for the year is expected to be approximately $2.2 billion. Gross margins for the year are expected to be between 32% and 33%. Operating expenses are expected to be between $260 million and $270 million. Our estimated annual tax rate is forecasted to be between 15% and 17%. Capital expenditures are expected to be between $200 million and $225 million, and depreciation and amortization is forecasted to be between $100 million and $110 million for 2023. Additionally, based on the company's current forecast for light vehicle production for calendar year 2024, the company expects calendar year 2024 revenue growth of approximately 10%, above the 2023 revenue guidance range of approximately $2.2 billion. Overall, the first quarter of 2023 performance was largely in line with our expectations as demand for our products was very strong, which ultimately resulted in record sales performance for the quarter. Our teams continue to perform diligently to avoid supply shortages and our focus on labor challenges has resulted in employment growth in recent months. We believe these increases in headcount will provide our operations team some much-needed relief from the hectic build schedules we have experienced much of last year and will be critical in supporting the aggressive growth targets we are forecasting throughout the remainder of 2023 and into 2024. Our larger team is also critical to create the opportunity to reduce overtime, scrap, and yield loss, which are needed to support our gross margin recovery initiatives. Obviously, there remains a tremendous amount of work to be done to achieve the targeted margin profile, but I'm pleased with the progress made so far, and I have complete confidence that the Gentex team has the capability, adaptability, and grit to accomplish our plans. That completes our prepared comments for today. But before we jump into questions, Josh is going to walk us through a short statement regarding our proxy.

Thanks, Steve. As you all know, we have entered into proxy season, and yesterday we received Glass Lewis' summary report of our proxy and we believe we need to address one concerning area in their report. Gentex is disappointed in Glass Lewis' recent recommendation to oppose the continued nomination of Ms. Leslie Brown to its board and strongly urges its shareholders to vote in support of Ms. Brown. Over the past six years, Gentex has remained focused on identifying and nominating qualified, capable, intelligent thought leaders to our Board. During this time, we have onboarded six new members to our board with a wide variety of backgrounds, capabilities, and experience. Of these six new board members, two have improved the Board's gender diversity and two have improved the Board's racial diversity. The obvious conclusion here is that with four of our last six board member additions improving diversity, we believe we've shown commitment and action toward a more diverse representation on our board. Glass Lewis' recommendation is based on the logic that it is the responsibility of the Chair of the Nominating and Corporate Governance Committee to achieve a 30% goal of gender diversity and clearly outline a timeline for improving the Board's diversity, specifically with a focus on gender diversity. It follows that without this timeline, Glass Lewis is recommending against supporting the Chair's nomination to the board. This recommendation therefore seeks to support gender diversity by advising a vote against one of Gentex's female Board members. In 2016, Ms. Brown was the first female board member in the company's history. And since that time, she has served with distinction, intelligence, and respect. In summary, we believe that while Glass Lewis' goals for Board diversity come from a good place, the recommendation against Ms. Brown shows a clear disconnect between their stated goals and any logical progress toward achieving said goal. In other words, we vehemently disagree with Glass Lewis' logic of abstaining votes for a qualified female candidate that has a successful record as a director for the company, as a means of supporting gender diversity. Ms. Brown has served on the committee since 2018. And in her new role as Committee Chair, Ms. Brown is uniquely capable and qualified to lead this committee and remain on our Board. We encourage our shareholders to vote in favor of Ms. Brown. Thank you for your time, and we can now proceed to questions.

Thank you. Our first question comes from Ron Jewsikow with Guggenheim Securities. You may proceed.

Good morning, team. Just a couple of questions from me. How big of a benefit was mix this quarter taking things on the product side like, lower base anterior mirror shipments to China maybe an increase in HomeLink and ITM and anything else you'd highlight?

Yes, it's a combination. When we discuss mix, we refer to two aspects. There is the overall mix of products, such as the ratio of advanced features to base models or inside versus outside. Additionally, the overall growth rate plays a role. The benefit from mix is approximately 50 basis points.

Okay. And then, second half of last year increased you increased wages quite a bit and I think had quite a bit of net hiring as well. Has that begun to have any benefits on the gross margin line in the form of reduced overtime or lower expedited freight or is that something we should think about as a source of upside maybe later this year and into 2024?

Labor costs have an impact on gross margins, with most benefits reflecting in overhead and operating expenses since expedited freight to customers is recorded as sales expense. Generally, while increased labor can reduce gross margins, it offers some advantages in operating expenses. Currently, we are seeing about a 100 basis points margin headwind year-over-year due to higher wages. We have noticed a decline in overtime, and the most immediate benefit has been a reduction in freight expenses. As freight costs decrease, we will be able to cut back on overtime as we are currently using it to build extra inventory to shift from air shipments to surface shipments, which will further decrease freight costs and ultimately lead to lower overtime.

That's super helpful. And maybe just sneak in one more related to FDM for both you and Neil. Has your ability to secure new business wins has been negatively impacted by the supply chain environment over the last several years, and with that starting to improve do you think we could see an acceleration in new customer wins and announcements?

I don’t believe the supply constraints have adversely affected our customer awards. It has been more about our capacity to produce enough parts to meet demand. As we move past these supply constraints, we are seeing steady growth and progress with our Full Display Mirror product, not just in the execution of launches but also in overall volume, as evidenced by the 94 launches we have completed.

Yeah, I'd say, the single biggest impact wasn't in awards to Neil's point it was more in take rates. So over the last 18 months there's been a lot of desire from OEMs to increase take rates and we just haven't been able to support that until now. Right now, we're sitting up in a really good spot when it comes to advanced electronic content, especially for FDM. So we're in a much better spot right now to support higher volumes than what we were this time last year.

Super helpful color. Thanks, guys, and congrats on the quarter.

Thanks, Ron.

Thanks, Ron.

Thank you. Our next question comes from James Picariello with BNP Paribas Exane.

Good morning everybody.

Good morning.

Good morning, James.

I wanted to ask about the first quarter unit volume shipments right at $12.7 million, a quarterly record for you guys. What really drove that or does that reflect kind of max capacity within your current footprint, or is this kind of set the stage maybe for you've invested, right? You've had capacity investments. Does this kind of set the stage for a new established bar going forward here for the rest of the year and beyond?

Yes, we're very close to our maximum capacity at this level. We can increase output a bit more with some additional overtime. The key investment this year, along with a rise in capital expenditures, and likely continuing at higher levels for another year, will allow us to develop the necessary facilities and equipment. We anticipate significant increases in our overall capacity over the next 18 months. We have more equipment coming online this year, and our brick-and-mortar projects over the next 18 months to two years will significantly enhance our company's overall capacity.

Got it. And just on that topic is your light assembly plant in China I don't know if you want to call it a plant, but your footprint there is that also helping drive this quarter's unit volumes in any way?

Yes, we are currently focusing on final assembly in the China market for domestic production. This has led to an increase in headcount and equipment, which is improving our production levels. While the increase is still relatively small, we have plans for expansion and are exploring third-party assistance to address labor challenges and enhance the flow of parts to and from our facilities more efficiently.

Got it. My last question relates to the availability of chip supply and how it affects your integrated toll module and FDM. Is the chip capacity limited, or is it primarily your own production and staffing capabilities that are influencing this?

I would say that until the end of calendar year 2022, component availability was our biggest challenge. Now we feel optimistic about our electronics situation. Currently, the only limiting factors are capital equipment and internal labor. We are able to meet the demand from OEMs without any constraints affecting our FDM shipments. Having successfully navigated one of the largest quarters in our company's history and the biggest from an FDM perspective, we are confident in our ability to meet FDM demand throughout the year.

Understood. Thanks. Thanks guys.

Thank you.

Thank you. Our next question comes from Luke Junk with Baird. You may proceed.

Good morning. Thanks for taking my question. To start, Steve, hoping you could and on what might be some of the less obvious aspects of the gross margin recovery initiatives at the company, such as overtime that you already discussed, but also things like scrap and yield loss that you're muscling up to address. In other words maybe if you could just touch on the part of this journey that's not just the price recovery part, the part that is within your control really?

Yes, there is a segment of our strategy focused on price recovery that will continue to be a goal for the remainder of this year. However, the more significant factors that influence us are the increased revenue levels, which enable us to better leverage our overhead. We managed to achieve this with less overtime compared to previous years, even with our growth. This indicates that we are gaining some efficiencies. Additionally, as our team expands, we have faced challenges with scrap and yield loss, which affected our operating conditions in the first quarter. Nevertheless, this situation presents an opportunity over the next nine to twelve months, as our new employees become more comfortable and gain the necessary skills. We believe we can enhance the management of scrap and yield loss, ultimately leading to better margins. Onboarding the team is just one step; training them to feel confident and effective in their roles takes approximately three to six months. We are optimistic about our team and believe that, with time and the commitment of our operations team, we can make further improvements in these areas.

One more detail Neil pointed out in his part of the call is the VA/VE aspect. The redesign efforts aimed at lowering bill of material costs through reengineering products not only help reduce material usage or improve tooling pricing, but they also enhance the margin compared to just decreasing component costs.

Yes. And that will be really more like end of 2023 and taking us into 2024 the focus on further improvement through VA/VE activities. And that's why we talk about 2023 and 2024 as our total timeline to get back to that targeted margin profile.

Thank you for that. And then my follow-up maybe for Neil just to making the sense. Bigger picture innovation seems really now to be happening at a breakneck pace in the China market if we look at what was coming out at the Shanghai Auto Show this month. How do you think about leaning into that in terms of FDM in China more richly contenting base mirrors or even emerging product categories for the Chinese market? Thank you.

Yes. The Chinese market changes very rapidly. We have been focusing on improving our presence there over the last couple of years by executing our base mirrors strategy. In this quarter, we launched additional base mirrors in the China market. Our approach involves introducing base mirrors first and then enhancing them with features and content. The Chinese market is evolving quickly, and our team is dedicated to adjusting our products to extend our reach beyond just the joint venture OEMs we have been collaborating with, aiming to tap into the domestic market more effectively. This process involves careful consideration of time, resources, and the financial aspects to develop the business we envision. There is a lot of activity and change occurring in this space, and we are taking the necessary time to ensure we do it correctly. With the end of the component shortage, we are now looking to enter this next phase.

Thank you. I leave it there.

Thanks, Luke.

Thanks, Luke.

Thank you. Our next question comes from John Murphy with Bank of America. You may proceed.

Hey, John?

John Murphy, if your line is on mute, please unmute. Our next question comes from Josh Nichols with B. Riley. You may proceed.

Yes. Thanks for taking my question and great to see the record sales for the quarter. Just looking here I guess you're almost near the low end of the gross margin guidance for the year here in the first quarter. Is there much further action that you really need to take to kind of get to the targets that you have for this year? And then other things that you're doing as you try and move towards a more normalized gross margin profile for the end of next year that could further enhance it?

Yes, you're absolutely right. There will be significant efforts from now until the end of the year aimed at improving margins. This is why we wanted to discuss the progress expected over the next 18 to 21 months. While improvements may not be completely linear, our goal is to enhance performance each quarter. We have numerous action steps planned, including operational improvements as the team is trained to reduce yield scrap costs and decrease overtime. On the customer side, we still need to work through pricing with our customer base, which should positively impact our margin profile. We anticipate that these improvements will not happen all at once and expect a gradual process throughout the year as we navigate those negotiations. Looking toward 2024, we foresee some economic shifts related to pricing towards the end of this year or early next year. We remain hopeful of transitioning back to a more normalized environment, moving away from rising costs to a decline in material expenses.

Yes. Thanks for clarifying. And then I guess the last question for me. Growth in the first quarter right come in above, right the percentage that you're looking to 15% or so that you're looking for this year and then 14% light vehicle production expected in 2Q as well bodes well. I guess, like how are you thinking about the second half versus the first half, do you expect a material slowdown later this year, or are you just becoming increasingly confident that you're going to be able to beat or surpass that 15% growth target this year? I'm just waiting for a little bit better visibility before potentially revisiting that?

I believe there is definitely potential for growth. The real question is what risks we might face. Are we looking at a small downturn or a significant one in the latter half of the year? Higher interest rates could affect the market for high-priced vehicles. One positive aspect is that we've seen more consistent orders lately, marking the first time in over two years that order volatility from customers has improved. After a long period of chaos, it has been challenging to plan effectively. Thankfully, the team is starting to get a better grasp on things. While we're not back to pre-pandemic operational stability, we are making progress. The production environment in the second quarter may appear exaggerated due to last year's turmoil during the same period. I’m not sure our strong performance will fully align with what happened then since our sales are ahead of the vehicle production timeline. However, it's encouraging to see original equipment manufacturers beginning to increase their capacity, which is a positive development for us. It’s not only about supply chain components—OEMs have also struggled to regain their pre-pandemic capacity. We're witnessing some improvements there, which is exciting. We're just hopeful that economic factors won't heavily impact the latter half of the year. By the time we report Q2, we will have more clarity on what to expect for the second half. I believe there is a chance we could exceed our earlier forecast, but given the unpredictability of the last few years, there's also a significant possibility of things being worse than anticipated. After dealing with numerous setbacks, we're grateful for a strong sales quarter and remain hopeful about Q2, while also being curious about what the second half will bring.

Well, fair enough. Thank you. Great to see the supply chain environment improving and the opportunity for stuff like FDM to get back to normal or above normal trends. Thank you.

Thank you.

Thank you. Our next question comes from Frederico Morandi with Bank of America. You may proceed.

Hey, guys. It's John Murphy. Can you hear me?

Yes. We got you.

I apologize for the technical difficulties earlier. One statement you made was particularly interesting; you mentioned that a larger team is necessary to reduce costs, which is contrary to the common belief that fewer people should do more work. Could you discuss the current overtime costs, the extent of scrap issues, and yield loss in comparison to historical data? If you cannot provide specific dollar amounts, a general overview of the overtime you’re incurring, the current scrap situation relative to history, and yield performance compared to past figures would be helpful.

Yeah. So I'll start kind of with a generic answer and I'm sure Kevin will jump in with some details. But if you look at over time really over the last 18 months, we've been running probably at about two times the amount of overtime that we would have normally expected. So there's a healthy amount of overtime. Obviously, there are certain amount of employees who like that over time and there's a certain amount of it that helps you take advantage of CapEx in your footprint. Unfortunately, over the last 18 months, it's been way beyond that. And so that's why we look at overtime as one of the key drivers of savings over the next 12 months.

I think it's important to focus on that. We have added nearly 400 to 500 team members in hourly production over the past year. If we're short on staff, our sales target is in the range of $450 million to $500 million per quarter. Last year, we were offering incentives that involved paying overtime premiums of 2 to 2.5 times. This resulted in higher costs per unit. Currently, we are mostly dealing with straight overtime due to the increased headcount. Once we improve productivity, we can return to typical 45-hour work weeks, which is where the real opportunity lies.

Got it. And the yield loss, I mean, how bad are yields as a result of that or other inefficiencies?

Yeah. They're not, it's not like horrible, but when you're talking about the last couple of percentage points of yield or a yield loss in this case. On revenue of this size, you start to talk about a couple of million dollars or a few million dollars in savings potential that are out there. And so these are the types of things that we need to get really good at and make improvements in to get back to that kind of ideal state on the margin profile side.

Okay. And then just lastly on the international shipments, can you tell us how many or what portion is in China at this point and maybe what it was last year in the first quarter just so we have an idea because it does sound like that's a huge opportunity for you over time.

It's still right around 8% to 10% of total shipments, total revenue for the company. Shipments continue to be higher because it is a higher mix of base. So that's probably closer to the 10% revenue is probably closer to 8.5%. But it's really driven by the outside mirror growth is driven in a lot of the growth with Tesla and then some of the other EV manufacturers growing outside mirror volumes in that market. But it's still kind of at 9% of revenue because it's primarily base mirrors.

That’s very helpful. Thank you, guys.

Thank you, John.

Thanks, John.

Thank you. Our next question comes from David Whiston with Morningstar. You may proceed.

Hello. Thanks. Good morning. For Steve, I think you were hinting in an accounting difference. I just wanted to clarify is expedited freight and COGS and then regular freight is in SG&A?

No, the incoming shipment is included in the cost of goods sold. However, when you ship to your customer, it is recorded as a selling expense.

Yeah.

Okay.

So when we're talking about freight improvements, when we're talking freight improvements, you're talking about freight on the incoming side which will improve gross margins but the selling expense will show up in operating costs not in bill materials.

Okay. You had improvement in both you said?

Yes. We did have improvements in both, yes.

Okay. On the press release you called out an increase in staffing and also in professional fees. Is the staffing increase more on the ROE versus corporate side, or is it balanced? And then, what type of professional fees are you increasing spending on?

Yeah. There were increases in both but the statement that you're reading there is in relation to operating expense. So that's really on the professional side. So it's more about engineers development teams and outside consulting as well to help keep up with the launch rate and some of the new products we're working on.

Okay. I have one more question. Given the ongoing macro uncertainties, there are mixed signals; some things are good, and some are bad. Are your customers still focused on next-stage products that we haven't seen in vehicles before, like much larger dimmable surfaces? Or are they being more cautious and concentrating on the present due to fears surrounding the macro environment?

We haven't observed a decrease in our clients' interest in new technology despite concerns about a recession. On the contrary, there has been an increase in interest and engagement as OEMs return to the office, which has enhanced our research and development discussions. During the pandemic, it was particularly challenging to present new product prototypes or even discuss the future concepts for vehicles when people were working remotely. That created a tough selling atmosphere, but I believe that situation has significantly improved. We are now able to resume customer visits, and many OEMs have come to Zealand to tour our R&D facilities and explore some of our new product ideas. So far, we have not experienced any negative impacts related to recession fears affecting new R&D or product initiatives.

Okay. And just lastly on the airplane window growth, it was really good. Is that primarily more Airbus production starting or any growth from Boeing?

There was a significant presence of Boeing. We were always careful about including that percentage since it was nearly zero around this time last year. However, it has improved considerably, which is a positive sign. Currently, we are maintaining consistent production in our aerospace sector. It's encouraging to see that segment recovering and returning to production levels. Airbus has begun to increase production a bit, but the majority of those sales are still related to Boeing.

Okay. Thanks.

Thank you.

Thanks, David.

Thank you. This concludes the Q&A session. I'd now like to turn it back over to Josh O'Berski for any closing remarks.

This concludes our call. Thank you everyone for your time and questions. And have a great weekend.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.