Earnings Call
Gentex Corp (GNTX)
Earnings Call Transcript - GNTX Q3 2021
Operator, Operator
Good day and thank you for standing by. Welcome to Gentex Reports Third Quarter 2021 Financial Results Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today, Josh O'Berski. Please go ahead, sir.
Josh O'Berski, Director of Investor Relations
Thank you. Good morning and welcome to the Gentex Corporation third quarter 2021 earnings release conference call. I am Josh O'Berski, Gentex Director of Investor Relations, and I am joined by Steve Downing, President and CEO; Neil Boehm, Vice President of Engineering and CTO; and Kevin Nash, Vice President of Finance and CFO. This call is live on the Internet and can be accessed through 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 call contains forward-looking information in line with the Gentex Safe Harbor statement included in the Gentex Reports Third Quarter Financial 2021 press release from earlier today, 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 Downing, who will get us started today.
Steve Downing, President and CEO
Thank you, Josh. Hopefully, your phone is not broken. You just dropped it on the floor. Well, the third quarter of 2021, the company reported net sales of $399.6 million, compared to net sales of $474.6 million in the third quarter of 2020. On a quarter-over-quarter basis, global light vehicle production in the company’s primary regions of Europe, North America, Japan, Korea, and China decreased 23% when compared to the third quarter of 2020. Additionally, when compared to the mid-July 2021, IHS Markit light vehicle production forecast in the company’s primary regions, actual light vehicle production during the third quarter of 2021 declined in excess of 3.1 million units or 19% as a result of the ongoing industry-wide part shortages and global supply chain constraints. The largest shortfall in light vehicle production for the third quarter of 2021 came from the European and North American markets, which together experienced actual light vehicle production levels that declined by approximately 27% compared to the third quarter of 2020. The reduction in light vehicle production compared to forecast was led by several OEM customers that deploy high levels of the company’s product content, including both interior and exterior auto-dimming mirrors and other electronic features, such as Full Display Mirror and HomeLink. While we have been dealing with the impacts of supply chain constraints throughout the first half of 2021, the effects of the electronic component shortages worsened during the third quarter of this year. In fact, the change in OEM schedules during the quarter was estimated to have negatively impacted demand by at least 2.5 million mirrors during the quarter. We estimate that the lost revenue on these units was approximately $125 million. Despite these challenges, our team has done a remarkable job of securing components, as well as providing unique solutions for our customers that included complete redesigns in order to avoid constrained components to help minimize the impact to OEM production schedules. For the third quarter of 2021, the gross margin was 35.3%, compared to a gross margin of 39.7% for the third quarter of 2020. Compared to the third quarter, the gross margin was primarily impacted by the lower sales level stemming from the 23% quarter-over-quarter decline in light vehicle production in the company’s primary regions. However, the gross margin was also impacted by lower than expected price reductions on raw materials, increases in freight and other supply chain related costs, as well as some component cost increases. While the gross margin for the third quarter of 2021 was below our original forecasts, we were pleased with the overall performance of the company, given the significant reduction in sales versus our forecast coming into the quarter. Since the beginning of the pandemic, we have worked hard as an organization to reduce overhead costs, which helps stabilize our profitability in the third quarter, despite this unpredictably large change in revenue. In fact, our estimates show that had the sales level been in the range of our original forecast for the quarter then our gross margins would have been very close to our previous guidance for the second half of 2021. Operating expenses during the third quarter of 2021 increased by 7% to $52.7 million, compared to operating expenses of $49.4 million in the third quarter of 2020. Income from operations for the third quarter of 2021 was $88.2 million, compared to income from operations of $138.9 million for the third quarter of 2020. During the third quarter of 2021, the company had an effective tax rate of 15%, which was primarily driven by the benefit of the foreign-derived intangible income deduction and discrete benefits from stock-based compensation. Net income was $76.7 million for the third quarter of 2021, compared to net income of $117.1 million in the third quarter of 2020. The change in net income was primarily the result of the quarter-over-quarter change in sales, gross margins, and operating profits. Earnings per diluted share for the third quarter were $0.32, compared to earnings per diluted share of $0.48 for the third quarter of 2020. I will now hand the call over to Kevin for third quarter financial details.
Kevin Nash, CFO
Thanks, Steve. Automotive net sales in the third quarter were $391.3 million, compared to $464.7 million in the third quarter of 2020. Auto-dimming mirror unit shipments decreased 7% during the quarter compared to the third quarter of last year. Other net sales in the third quarter of 2021, which includes the dimmable aircraft windows and fire protection products, were $8.3 million, compared to other net sales of $10 million in the third quarter of 2020. And dimmable aircraft windows sales decreased by 34% for the third quarter of 2021 when compared to the third quarter of 2020. The company continues to expect that the dimmable aircraft windows sales will be negatively impacted until there is a more meaningful recovery of the aerospace industry and the Boeing 787 aircraft production levels improve. Share repurchases, during the third quarter of 2021 the company repurchased 2.83 million shares of common stock at an average price of $32 per share for a total of $90.6 million. As of September 30, 2021, we have approximately 25.4 million shares remaining available for repurchase pursuant to our previously announced share repurchase plan and we intend to continue to repurchase additional shares of 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, including the impact of the COVID-19 pandemic and supply constraints, market trends, and other factors the company deems appropriate. Shifting gears a little bit, let’s look at the balance sheet. The balance sheet items mentioned today are values as of September 30, 2021, and are compared to December 31, 2020, unless otherwise noted. Cash and cash equivalents were $269.9 million, down from $423.4 million, primarily due to share repurchases, dividend payments, and capital expenditures that more than offset cash flow from operations. Short-term and long-term investments combined were $211.6 million, up from $189.2 million. Accounts receivable was $24.2 million, down from $284.9 million due to the lower sales in the current period. And inventories were $292.6 million, which increased from $226.3 million, the majority of this change in raw materials and primarily within electronics. Accounts payable increased to $100.5 million, up from $84.8 million, primarily due to increased purchases, as well as month-end payment timing. And quickly let’s take a look at the cash flow statement. Third quarter 2021 cash flow from operations was $47.1 million, compared with $138.6 million in the third quarter of 2020. Operating cash flow was impacted by the lower net income quarter-over-quarter, as well as shifts in working capital and deferred taxes. The year-to-date cash flow from operations was $299.4 million, down from $329 million for year-to-date 2020. CapEx for the third quarter of 2021 was $13 million, compared with $8.2 million for the third quarter of 2020, and year-to-date capital expenditures were $44.4 million compared to capital expenditures of $37 million in 2020. Lastly, depreciation and amortization for the third quarter of 2021 was $23.6 million, compared with $25.1 million for the third quarter of 2020. And year-to-date D&A was $75.2 million, compared to D&A in 2020 of $78.5 million. I will now hand the call over to Neil for a product update.
Neil Boehm, Vice President of Engineering and CTO
Thank you, Kevin. In the third quarter of 2021, there were 12 net new nameplate launches of our interior and exterior auto-dimming mirrors and electronic features. Of these 12 net new nameplate launches, approximately 75% were advanced features, with HomeLink and Full Display Mirror leading the way. Also in the third quarter of 2021, there were several new base auto-dimming mirror launches, and of these, 40% were for the China domestic market. This is evidence of the continued growth for our baseline technology in this growing market. During the third quarter of 2021, we began shipping Full Display Mirror to our 10th and 11th OEM customers on light commercial and passenger vans. We are excited to announce that both Fiat and Mercedes are now shipping Full Display Mirror on their vehicles. For Fiat, we are shipping on the Fiat Ducato and at Mercedes, we started to ship Full Display Mirror on the Mercedes Vito. These vehicles offer a new market opportunity for us as a company. Over the last few years, we have shown examples of our technology that can be deployed in the commercial van market and these FDM awards and launches are helping us find new opportunities for growth. In addition to these new OEMs launching FDM, we are excited to announce that we began shipping Full Display Mirror on the Jeep Grand Cherokee L and the Jeep Grand Wagoneer. Our OEM and consumer feedback continues to be very strong regarding Full Display Mirror technology and with the addition of these new nameplates, we are currently shipping Full Display Mirror on 60 vehicle nameplates around the world. On another technology front, we are excited to announce that we began shipping Integrated Toll Module to our second OEM customer Mercedes. Mercedes has introduced the ITM technology on the EQS, and we are looking forward to seeing how the consumers will continue to adopt this technology going forward. Tolling in North America continues to evolve, and we see the ITM technology as a great way for an OEM to take a step into the transactional vehicle of the future while helping to keep the aesthetics of the vehicle intact. Despite all of the chaos caused by component shortages and supply constraints, the launch and development activities have never been busier. The Gentex team has done an amazing job balancing the immediate needs of the shortages and the longer-term needs of developing new products and technologies that will drive our future growth. I will now hand the call back over to Steve for guidance and closing remarks.
Steve Downing, President and CEO
Thanks, Neil. The company’s current forecast for light vehicle production for the fourth quarter of 2021 and full years 2021 and 2022 are based on the mid-October 2021 IHS Markit forecast for light vehicle production and North America, Europe, Japan, Korea, and China. Light vehicle production in the company’s primary markets is forecasted by IHS Markit to decrease 20% for the fourth quarter of 2021 compared to last year. It is important to note, however, that this vehicle production forecast for the fourth quarter represents a sequential increase in light vehicle production of 2.5 million units in our primary markets when compared to the third quarter. Forecasted vehicle production volumes for the fourth quarter of 2021 and calendar years 2021 and 2022 are included in our press release. Based on this light vehicle production forecast and the actual results of the third quarter of 2021, the company is providing updated guidance estimates for the second half of the year. The company’s current estimate is that net sales for the second half of 2021 will be between $770 million and $840 million. This revenue forecast is based on the combination of the third quarter actual revenue, as well as the company’s opinion that component shortages and supply constraints will continue to drive production below the IHS Markit light vehicle production forecast shown in our press release. Our revenue guidance includes manual adjustments to account for the company’s estimates of the impact that the global supply constraints will have on overall light vehicle production. The company has also updated its costs and profitability models to include the estimated impacts stemming from these expected lower vehicle production levels, elevated raw material prices, freight expenses, and labor costs. The updated financial guidance for the second half of 2021 replaces all previous guidance for the second half of 2021 and is as follows. Revenue for the second half of 2021 is expected to be between $770 million and $840 million. Gross margins for the second half of the year are expected to be between 35% and 36%. Operating expenses for the second half of 2021 are forecasted to be approximately $105 million to $108 million. Our estimated tax rate for the second half of 2021, which assumes no changes to the statutory rate, is forecasted to be between 15% and 16%. Capital expenditures for the second half of 2021 are expected to be between $50 million and $60 million. And depreciation and amortization for the second half of 2021 is forecasted to be between $48 million and $52 million. Based on the mid-October 2021 light vehicle production estimates for 2022, the company estimates that revenue for calendar year 2022 will be approximately 15% to 20% higher than the updated 2021 revenue estimates of $1.68 billion to $1.75 billion. On a positive note, overall vehicle inventory levels are at historic lows. Demand from our customers continues to remain strong and interest from our customers in our core products and new technology areas for future projects is very high. So despite the incredibly turbulent last 18 months and the next few quarters, which we expect to continue to be challenging due to supply chain constraints, our long-term growth prospects have never been higher, and we continue to believe that the next several years will produce above-market growth rates that should provide us the opportunity to achieve excellent shareholder returns. In conclusion, I would like to take just a minute to thank the entire team at Gentex for their incredible effort over the last six months. Our customers will never know the full story of how much work you have done and redesigns, abbreviated developments, early mornings, and late nights trying to find solutions to these supply chain challenges, but I do, and I just want to thank you publicly again for the amazing effort and performance. That completes our prepared comments for today. Thank you for your time, and we can now proceed to questions.
Operator, Operator
Your first question comes from the line of Luke Junk from Baird. Your line is now open.
Luke Junk, Analyst
Good morning and thank you for taking the question. First question I wanted to ask about FDM and appreciate the update on the 10th and 11th OEM customers. I realize there’s a lot of moving parts right now between production, volatility, shifting vehicle mix and whatnot. But do you have a view on how FDM take rates are trending this year on an underlying basis, earlier this month, J.D. Power highlighted some very positive consumer feedback on camera rearview mirrors for the second straight year and we are just hoping you could put that in context of what you are seeing in the business with respect to take rates specifically?
Steve Downing, President and CEO
Yeah. Thanks for the question. What I would say is, on take rates in general, they have definitely been trending higher. Now part of that is because we believe the feature is compelling and consumers, like, you mentioned in the J.D. Power study, obviously, the value of the feature. But the other part especially during the first half of this year with limited production capacity is OEMs were tending to build higher-end vehicles and so that obviously helped our feature content. But what I would say started to change in Q3 was, quite frankly, OEMs were willing to build almost anything, and so I would say that take rates have changed, but not really because of a mix issue or I mean the entire issue... consumer preference, yeah... issue on our side, but because of a mix issue in terms of OEMs were starting to scale back some of the feature content, because they knew it wasn’t possible to get all the electronics they needed to build those vehicles. So it’s really been a tale of kind of two halves of the year. The first half was very rich on the feature mix side. Q3 was turning a little lower and primarily driven by the constraints that exist on the electronics side.
Luke Junk, Analyst
Okay. Thank you for that. And then, I wanted to ask a question about supply chain as well, and specifically, what you are seeing in your supply chain right now both for chips and other electronic components. I know that your teams are very close to this situation, so just would be interested to see what you are seeing real time and if there are any signs of light in the channel right now?
Steve Downing, President and CEO
We are facing a daily challenge with this situation, as our teams are constantly addressing new problems and issues that arise, particularly with different constrained components. As we noted during the call, the situation has worsened; it was already bad in Q2, but Q3 has seen a significant deterioration. At the start of Q4, we still haven't hit the lowest point, and we anticipate that we will be dealing with these types of issues for several more quarters.
Luke Junk, Analyst
Cool. I will go ahead and leave it there. Thanks for taking the questions.
Steve Downing, President and CEO
Thanks, Luke.
Operator, Operator
Your next question comes from the line of David Kelley from Jefferies. Your line is now open.
David Kelley, Analyst
Hi. Good morning, guys, and thanks for taking my questions. Maybe starting with the topline, I was hoping you could talk a bit more about the moving parts into the fourth quarter here, effectively guiding to flat revenues versus Q3. It sounds like based on the prepared remarks, you are below, I guess, in your LVP assumptions. But maybe if you could just walk us through if you are assuming any incremental step up in LVP at all, and also how you are thinking about some of the other drivers, such as mix and outgrowth going into year-end here?
Steve Downing, President and CEO
If you examine the IHS data, it indicates a 2.5 million unit increase from Q3 to Q4. We anticipate that Q4 will resemble Q3 production levels closely. Therefore, we are quite cautious, mainly because we do not believe the supply side can accommodate that extra volume in such a short timeframe. Following this line of reasoning, we have outperformed by 700 basis points compared to the decrease in light vehicle production. We expect that trend to continue. Over the past 18 months, our performance has consistently outpaced the market by that margin, which places us at the upper end of mid-single digits for our outperformance.
David Kelley, Analyst
Okay. Got it. Thank you. That’s helpful. And then maybe shifting gears to gross margin trajectory, can you give us a sense of how you are thinking about some of the opportunities to recover this raw material cost or pass on some of the elevated electronic component cost? And as we think about the revenue growth guidance for the out year for 2022, obviously, you are not guiding to next year yet, but maybe if you could walk us through how you are thinking about leveragability of the gross margin line into next year?
Steve Downing, President and CEO
Yeah. I would say, first on the ability to get compensated from our customers on the increased cost structure. We know this is a trend in the industry, and it’s not going away soon. So there’s going to be a lot of suppliers having this conversation with OEMs. I think OEMs are going to have to address this to some degree with the supply base. Our goal here is to try to make sure we understand that before we go in and ask for relief because the cost increases aren’t done yet, it’s really just the beginning of that cycle. So before we go in and try to renegotiate anything, we are going to be trying to make sure we understand the full picture first. Certain other Tier 1s probably won’t have that luxury or are going to move sooner, and that will obviously help establish the playing field for what’s going to be acceptable at an OEM level. In terms of future guidance, if you remember, our original guide for this year was, I think, 38.5% to 39.5%. Our initial take on 2022 would be that it is probably going to be slightly lower than that given the material cost pressures that we are seeing, and without having a line of sight yet in terms of any ability to get compensated back from our customer. So we would say it’s probably trend end up 50 basis points to 100 basis points lighter than that assuming there’s not help from the customer.
David Kelley, Analyst
Okay. Thank you. That’s really helpful. Maybe one more if I could squeeze it in just a follow-up to that point. The electronic component cost, you noted the ongoing shortages and deterioration as far as volumes go. But are you continuing to see cost rising from your electronic suppliers or any plateauing there and how should we think about some of the further pressures, if any into next year?
Steve Downing, President and CEO
We mentioned earlier that this situation isn’t going to change anytime soon. As long as there are constraints, the power in the relationship shifts towards the supply due to limited components. Therefore, you can expect to see pricing pressure until there’s more capacity, or if demand were to decrease. However, we don’t foresee any changes in that dynamic over the next 18 months, so we will continue to experience some pressure from the supply side.
David Kelley, Analyst
Okay. Got it. Thanks, guys.
Steve Downing, President and CEO
Thank you.
Kevin Nash, CFO
Thank you, David.
Operator, Operator
Your next question comes from the line of John Murphy from Bank of America. Your line is now open.
John Murphy, Analyst
Good morning, guys. I have got a few questions in this very uncertain time, so, I mean, answer as best you can or whatever you can. But when you talk about the fourth quarter, you are talking about units getting about 2.5 million units better. I am just curious why you think you are going to have that visibility in the fourth quarter and you seemed to be saying it’s not getting much better, but it is getting better. So I am a little bit confused as to what the message is in the near-term?
Steve Downing, President and CEO
No. We were referencing IHS forecasting per vehicle production to get 2.5 million units better. We actually think that our revenue is going to be very similar to Q3 and we think the overall vehicle production will be much more similar to Q3 than what IHS was forecasting. So we don’t see the industry... being able to support that additional volume.
John Murphy, Analyst
Got it. As we look towards early next year, I understand it’s challenging to predict, but what are your thoughts on the situation? If revenue is projected to increase by 15% to 20% year-over-year, your teams must have some perspective on where the changes might occur during the year. What gives you confidence, and what are your insights on this matter?
Steve Downing, President and CEO
Well, I think, when you look at what happened this year, there were definitely some real troughs in terms of vehicle production that if you take those out and you run at a more consistent run rate, it provides, I mean, I think, right now IHS is forecasting 9% vehicle production growth from 2021 to 2022. And so we are looking at that TAM, yes, and the demand that we saw from our customers is actually better. So that would put us that guidance range would be about 7% or at midpoint would be 7.5% outgrowth versus the market, which is what we have been running at. And so we think there’s going to be some improvement in the supply base at some point next year. It may take until midyear before some of the constraints start to alleviate and start to improve. But we don’t see any reason why the first half couldn’t be slightly better than the first half of this year as well.
John Murphy, Analyst
Got it. Okay. You're expecting the second half to be the real turning point where things hopefully normalize and start flowing better. If we consider a 15% to 20% increase in revenue year-over-year, all else equal, it would suggest significant operating leverage and improved margins. However, what we've observed recently, especially this quarter, is that SG&A has increased while sales have declined, and raw material costs are rising. There seems to be cost inflation affecting almost every aspect of the business. How do you view the balance between operating leverage and positive mix versus rising costs next year? I'm not asking for a specific margin target right now, but could you share your thoughts on the benefits of volume mix in relation to cost inflation, whether it's related to raw materials, input costs, or labor? How should we consider these major factors?
Steve Downing, President and CEO
That's a good question. With the sales decline this quarter, we've observed that fixed costs are becoming a larger part of our overall expenses. When growth is in the 15% to 20% range, we can manage those costs more effectively. However, changes in production and OEM schedules have led to some inefficiencies. This has resulted in hectic labor schedules, as we have to adjust staffing based on fluctuating production plans throughout the week. As we work toward a more stable growth pattern and improve our ability to predict OEM behavior, our staffing will improve. There are certainly ongoing cost inflation issues to consider, but we've also seen strong product growth, particularly with FDM and OEC, which are expected to continue driving growth into next year. These factors can help mitigate some of the rising costs, many of which are temporary, and potentially offset some of the price increases we're facing.
Neil Boehm, Vice President of Engineering and CTO
The one thing I will just add...
John Murphy, Analyst
Okay.
Neil Boehm, Vice President of Engineering and CTO
One thing I will add to that too just quickly John is, the R&D expense is, I believe, a bullish, because that’s reflective of the work we are doing to drive revenue three years out. And so that’s in our estimate at least and what we really want to drive home is those are not tied to the current issues that we are experiencing. Those are some of the same resourcing has been working so hard and it’s not dropping the ball on those new product awards and those new OEM launches and the real R&D that’s going on behind the scenes on some of the future growth.
John Murphy, Analyst
Got it. And then, just lastly, real quick on the inventory number, I think you guys say $269.2 million at the end of the quarter versus $226 million at the end of last year, about 19% increase. It’s a big number as sales are grinding down and things are getting tighter. You mentioned raws were part of that inflation. I mean, what’s going on there? Is there some pre-built that maybe you are doing in addition to some of that raw inflation?
Kevin Nash, CFO
Yeah. If you read between the lines, right, Steve talked about $120 million, $125 million of sales falling out of the forecast, a lot of that is in high electronic content stuff. So, I mean, we are buying displays, electronic content, like, the things that we can get and we are anticipating orders from customers, because these orders were real from customers at the beginning of the quarter and throughout the quarter. So we have a buildup in electronic displays for FDM and a lot of our higher electronic feature sets. So it’s really just a driver. It’s that pent-up raw material from things that didn’t come to fruition. So we would expect that to bleed off as things grow. But these are components that are fairly new and have very low risk of obsolescence. So it’s nothing that’s a risk to us.
John Murphy, Analyst
I apologize, but could you provide us with a breakdown of finished versus unfinished inventory? This would help clarify that we are incurring not only the purchase costs but also labor, production, and assembly costs without yet receiving the revenue. Looking ahead to the second and third quarters, as these issues begin to resolve and we start to see a flow of product, we need to understand the implications of having absorbed these costs in earlier quarters. What can we expect to happen next?
Kevin Nash, CFO
Yeah. If you look at our inventory, it’s probably 80% raw material. I mean, we don’t carry... even more than a couple of weeks, a few weeks of sub-finished goods on hand we turn those pretty quick.
John Murphy, Analyst
Got it.
Kevin Nash, CFO
We tend to carry more inventory as we have talked about for several years in order to avoid things like shutting down customers. So I mean that... that’s a strategic play for us.
John Murphy, Analyst
Okay.
Steve Downing, President and CEO
Thank you.
Kevin Nash, CFO
Thanks, John.
Operator, Operator
Your next question comes from the line of Ryan Brinkman from JPMorgan. Your line is now open.
Ryan Brinkman, Analyst
Hi. Thank you for taking my question, which is focused on vehicle mix. It appears that the projected sales for the fourth quarter, at the midpoint of your guidance, is $405 million, indicating a 24% decline compared to the previous year. This is in contrast to IHS, which predicts a 20% reduction in global light vehicle production and a 20% decrease in North America, Europe, Japan, and Korea production, which seems more relevant for comparison. I would like to understand the reasons behind this anticipated underperformance in the fourth quarter, especially considering your recent strong performance. In your press release, you mentioned that products with high-end features may have been more significantly affected by production cuts. However, during previous calls, we discussed how automakers were prioritizing scarce semiconductors for their higher-end vehicles that are more likely to include your advanced features. Could you clarify what is driving the difference in trend and growth compared to the market? Looking ahead to next year, you expect 15% to 20% growth, which is significantly higher than IHS’ forecast of 10.6% growth in light vehicle production. This represents a notable reversal from the fourth quarter trends. Could you share what gives you confidence in this expected outperformance next year, particularly regarding the vehicle mix and the impact of backlog? Thank you.
Steve Downing, President and CEO
That's a very good question. If you refer to our Q4 guidance, the IHS data currently indicates a 20% decline. However, we believe there are a couple million units of uncertainty in the IHS production forecast. By adjusting for these units, we maintain that the level of outperformance remains similar, with a potential further decline of 10% or 12% on top of the 20%. Therefore, if Q3 performance repeats, we might see a year-over-year drop closer to 30%, but our guidance would still reflect the same level of outperformance. Fundamentally, we assert that the market, as projected by IHS Markit, is expected to improve sequentially. We are, however, a bit more cautious regarding the industry’s capacity to uphold that production level. Looking ahead to 2022, the outperformance relative to the market reflects a consistent trend we have maintained. We prefer not to view short-term fluctuations in Q3 or Q4 as indicative of the market's overall direction. For 2022, we anticipate a response from the industry, with the supply chain beginning to ramp up to support higher volumes, in which we expect to perform strongly. Regarding your second question about the mix, your observation is spot on. In the first half of the year, manufacturers focused on producing their highest-end vehicle models due to limitations on production capacity. However, in Q3, given various constraints, manufacturers became more willing to produce a broader range of vehicles, which led to fluctuations affecting us not only in terms of our production capability but also influenced by the overall industry’s production capacity. If they couldn’t manufacture the top-tier versions, they shifted to mid-grade options, which sometimes affected the demand for our products.
Ryan Brinkman, Analyst
Okay. That’s really helpful color. Thanks. And then just last question here is on capital allocation, you bought back $91 million of stock in the quarter, which is pretty in line with the average that you have repurchased over the past three quarters. You have certainly differentiated yourselves relative to other suppliers in continuing to allocate capital toward repurchases throughout the isolated macro environment. Just wanted to check in on the appetite for continuing to buy back stock in the uncertain environment with the Gentex of all, eight years, nine years, 10 years ago, would stop its repurchases at the drop of a hat with any sort of macro fluctuation? I don’t know if there’s something you are trying to communicate in terms of you are going to just continue to chip away at this or what your thought process is in this uncertain environment?
Kevin Nash, CFO
No. I think Q3 is hopefully a positive indicator of our belief in the long-term growth rate of the business. Whenever we encounter favorable prices, we will take advantage of that. We also want to ensure that our balance sheet remains strong. We believe there may be acquisition opportunities in the next couple of years, and we hope valuations will align favorably. If we reduce our repurchases, it will be because we are considering or preparing for potential acquisitions or fair value opportunities. We have always been open about the fact that we haven't found the right multiples for us in the past few years, as we felt they were too high. However, given the current constraints and developments in the industry, some of those valuations may now be more in our favor, so we want to be prepared to act.
Ryan Brinkman, Analyst
Okay. Maybe just final question, as we look forward to CES here, what you guys might be looking forward to showcase, obviously, not going to make huge announcements in advance. But is there any sort of theme in terms of, a couple of years ago we are looking at medical, making a lot of waves, this year with your sort of, what it’s called, wafer signs or whatnot, some of the other things. What are the technological trends that maybe we should keep an eye out for, etc.
Steve Downing, President and CEO
Well, I think, first and foremost, what we are excited about is, I mean, we basically missed the entire year and that’s a great marketing platform for us. So we are first and foremost just excited to hit back and be there and try to engage with customers face-to-face. That’s pretty exciting. I think the team’s pretty amped up and ready to go for that one. If you can’t hold off until January, we are going to be at CMOS, so stop by if you are bored or have nothing better to do. But the goal there on the team side has been to continue to expand on, especially on the sensing platform side, large area devices, so our core electrochromics but in larger format, so not only in aerospace but also in automotive. So you are going to see a lot of that right, which is, how can core electrochromics play a role not only in the car today but in the ride sharing or autonomous vehicle in the future. But then more importantly, what are the sensing skills that we have and how do you deploy those skills in a new feature content. So that’s really been the theme for the last couple of years. We are going to continue to drive that home this year at CES.
Ryan Brinkman, Analyst
Okay. Great. Thank you.
Steve Downing, President and CEO
Thank you.
Operator, Operator
Your next question comes from the line of Josh Nichols from B. Riley. Your line is now open.
Josh Nichols, Analyst
Yeah. Thanks for taking my question. Well, one point I kind of wanted to hit on, well, clearly there’s a lot going on in the automotive supply chain and that’s probably going to last in the next few quarters. But it seems like the gap is actually kind of widening and I am just thinking about this as the fact that, well, production capacity is limited, but you have an exceptionally strong consumer and a record low inventories? I am just kind of curious, like, what are your thoughts and how long it takes to actually rectify, right, the supply and the inventory situation? I would think that, well, there’s some near-term headwinds that provide you with a lot better longer-term visibility then you probably would have as long as the consumer stays strong?
Steve Downing, President and CEO
No. You are exactly right. The hard part right now is getting through the short period of time, trying to make sure you are taking care of customers and delivering, making sure you have to predict where they are going to be and what they are going to need and make sure you can secure the components obviously. But the hard part is getting through this period. The upside of what’s happening on the macro side of the industry should be phenomenal for us over the long period, because it’s going to take a while to rebuild, not only get back to production levels and sales that makes sense based on demand, but also to rebuild the inventory levels at their dealerships. So we believe really for the first time in a while, not only is our product portfolio strong and there is a lot of demand for our products, but there’s going to be some tailwinds from the overall industry over the next couple of years. And I really believe it’s going to take at least a year maybe two years to kind of get back to the level of inventories that OEMs are looking for. And that’s all assuming to your point that overall demand from the consumer doesn’t change, which we don’t see any reason why that won’t continue for at least the next couple of years.
Josh Nichols, Analyst
Thanks. You've been quite accurate in your skepticism regarding some of the IHS numbers, as you mentioned similar concerns last quarter, believing they were a bit too optimistic. You clearly feel that the fourth-quarter numbers are inflated. It's challenging to project a year ahead considering the current situation. However, looking at the estimated SAAR for next year in North America, it stands at about $15 million, with $70 million globally. What are your views on these figures? Do you think they are realistic, and what factors would influence their risks?
Steve Downing, President and CEO
Yeah. Well, thanks for noticing that we were probably, I mean, last couple of quarters has been odd. We have been probably one of the few companies that’s been talking about the issues around the industry. So occasionally you think, well, maybe we are being overly paranoid, but obviously this quarter kind of showed that we weren’t wrong in our assumption that the industry was pretty constrained and there were going to be challenges. When you look out over the numbers for next year, they are not way out over the ski tips in terms of can the industry support those level of volumes? There might be a little bit of risk in terms of the supply chain side of hitting those. We don’t believe there’s demand challenge at those levels of production. So we think there’s plenty of pent-up demand to support those production levels. The question is, can the industry keep up? If you look at the year-over-year change from an IHS standpoint, we don’t believe that those are so far reaching that the industry can’t get there. Maybe the first half of next year might be a little bit of a challenge, but the back half, for sure, there should be some capacity increases on the supply side that should help get to those numbers.
Josh Nichols, Analyst
Thank you. That’s all from me.
Steve Downing, President and CEO
Thank you.
Kevin Nash, CFO
Thanks, Josh.
Operator, Operator
Your next question comes from the line of David Whiston from Morningstar. Your line is now open.
David Whiston, Analyst
Thanks. Good morning.
Steve Downing, President and CEO
Good morning, David.
David Whiston, Analyst
Steve, you talked earlier about Gentex kind of waits to unlike other suppliers that ask for some input recoveries from OEMs and is that just fortuitous luck on timing or is there another reason?
Steve Downing, President and CEO
Well, I think, if you look at our profitability, we are able to wait a little longer than some because of that. And then, more importantly, we think it’s prudent because the game is changing daily. And so going in and negotiating early isn’t always to your best advantage because you don’t know how much higher pricing can go and what is really going on. If demand hits what we are predicting, then we think it’s going to be a constrained environment for a long time, in which case the supply base will have a lot more leverage. And so, you are going in now and talking to an OEM about cost increases, which you may only see 20% or 30% off right now is probably not prudent, because you are going to want to see that full picture before you go in and have the conversation. Our preference has always been to walk in with a full story and a complete picture, not try to do it five times over the next few years or so. And quite honestly, it allows the industry to understand what’s happening for OEMs and our customers to get their legs under them and understand truly what’s happening in the industry on the cost side and then to find out what is their position with their consumer. So ultimately, you have to understand all that and the full consequence before you go in and have a partial conversation. So, fortunately for us, our profitability does allow us to wait a little longer than certain suppliers.
David Whiston, Analyst
And the OEMs probably understand that dynamic too, but I assume it’s totally up to the supplier to initiate these talks or will the OEM come to you early?
Steve Downing, President and CEO
No. They rarely answer their phone ... will you want to have a conversation like this. So, no, we are not expecting a warm reception, when we going to have these. Typically for us, what also helps us, usually we have contracts reestablishing pricing for a couple of years. One of the things that you are able to do on this is talk about renegotiating those price downs or talking about. It’s not always just about price escalation, sometimes it can be about netting against price reductions that you are pretty committed to. There’s also future awards and business growth opportunities. So it’s a many-faceted question and so we try to walk in with that big picture in place and not get into a dime conversation about, this one part has got to go up by a nickel right now or else, it’s more about, hey, let’s look at the whole book of business and let’s talk about where we are going as partners.
Neil Boehm, Vice President of Engineering and CTO
And you mentioned earlier the OEMs? Oh, sorry, go ahead?
David Whiston, Analyst
Neil, you mentioned earlier that there is some technology in China gaining traction. Could you please clarify which specific technology you are referring to?
Neil Boehm, Vice President of Engineering and CTO
Yeah. No problem. Actually, with the increases in base mirror launches continue to go up in the Chinese domestic market.
David Whiston, Analyst
Okay. So I was...
Neil Boehm, Vice President of Engineering and CTO
So, yeah, core auto-dimming...
David Whiston, Analyst
Okay.
Neil Boehm, Vice President of Engineering and CTO
No problem. Just our core auto-dimming continues to grow and continues to expand into additional local platforms.
Steve Downing, President and CEO
And so, I guess, in China, did it kind of start backwards and something you started with the more advanced content first on the likes of the Germans or is there still a lot of room to go advanced in China from here?
Neil Boehm, Vice President of Engineering and CTO
I think there’s still a lot of room to grow from an advanced technology side. Obviously, electrochromics came in with JV partners being, a lot of the Europeans came into the China market. Now what we have been seeing is continued expansion of that base technology to local domestic manufacturers as well and it continues to grow and grow at a decent rate.
David Whiston, Analyst
Okay. Thanks, guys.
Neil Boehm, Vice President of Engineering and CTO
You are welcome.
Steve Downing, President and CEO
Thanks, David.
Operator, Operator
Your next question comes from the line of Charlie Sloan from Oak Family Advisors. Your line is now open.
Charlie Sloan, Analyst
Good morning and thanks for taking the questions. Great quarter, by the way, and I can only imagine the employee base how hard they are working to get all this stuff done for the OEM, so that you are not the one sitting there not allowing production to occur and so it’s really amazing. I mean, you guys are pretty small, right, but you guys have a pretty wide berth of commitments you have to fulfill. So that’s awesome.
Steve Downing, President and CEO
Thank you for that. That’s very well said.
Charlie Sloan, Analyst
It's impressive. Regarding your R&D, Steve, you mentioned how noticeable it is. When considering the components of your R&D, is it primarily focused on the core auto market, or are you diversifying your R&D efforts into other areas that might attract investors' attention?
Steve Downing, President and CEO
I would say that about 85% of our R&D budget is centered on automotive, while the remaining 15% is directed towards projects in aerospace and fire protection, as well as innovative projects that could potentially apply to automotive technologies, but are not exclusively focused on that sector. Essentially, the fundamental competencies we aim to develop are at the core of our efforts.
Charlie Sloan, Analyst
Okay. So things, but not necessarily hard glass for Josh O'Berski's cell phone?
Steve Downing, President and CEO
Yeah.
Josh O'Berski, Director of Investor Relations
Yeah. Thank you for that anyway.
Charlie Sloan, Analyst
Yeah. You bet. My pleasure.
Steve Downing, President and CEO
Yes, some of these technologies can influence our approach to electrochromic applications. For example, when we discuss large area devices, we are referring to the process of scaling up electrochromic technology to create bigger devices. This involves significant core technology considerations, including the capability to manipulate larger pieces of glass and utilizing various substrates where electrochromic technology can be applied. There are multiple methods for achieving darkening effects, and while these innovations have a potential connection to the automotive sector, they could also benefit various other industries.
Charlie Sloan, Analyst
Sure. We are very pleased with the share buyback commitment demonstrated this quarter, which reflects the forward-thinking vision you have for the future. Additionally, regarding the OEMs, when does the annual price reduction take effect? Is it midyear or at the beginning of each year?
Steve Downing, President and CEO
About 85% of our customers on January 1.
Charlie Sloan, Analyst
Okay.
Steve Downing, President and CEO
So we still have a few customers who are especially in Asia, who are on Asian fiscal year. So there are some on April 1, and we do have a few other projects here and there that are randomly paced throughout the year. Certain contracts are based on one year after SOP of a vehicle, for instance, so some of those just happen at random times throughout the year. But I’d say about 85% of our price downs happen on January 1.
Charlie Sloan, Analyst
Okay. And so you still expect those, but those are always open to discussions privately?
Steve Downing, President and CEO
Correct.
Charlie Sloan, Analyst
Yeah. Okay. Well, good luck.
Steve Downing, President and CEO
Appreciate it. Thank you very much.
Charlie Sloan, Analyst
Okay. Thanks, guys.
Steve Downing, President and CEO
Yeah.
Kevin Nash, CFO
Thanks.
Operator, Operator
There are no further questions at this time. I will now turn the call back to Josh O'Berski. Please go ahead, sir.
Josh O'Berski, Director of Investor Relations
Thank you everyone for your time and questions today. As Steve noted, we will be at SEMA and CES in the coming months and would welcome investors at our booth during those shows. So please reach out to your analysts or to myself and we can confirm the details. Thanks again and have a great weekend.
Operator, Operator
This concludes today’s conference call. Thank you everyone for participating. You may now disconnect.