Garmin Ltd. (GRMN) Q1 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Garmin Limited's First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later there will be a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder this conference call is being recorded. I would now like to turn the conference over to Teri Seck, Manager of Investor Relations. Ma'am, you may begin.

Good morning. We'd like to welcome you to Garmin Limited's first quarter 2019 earnings call. Please note that the earnings press release and related slides are available at Garmin's Investor Relations site on the Internet at www.garmin.com/stock. An archive of the webcast and related transcript will also be available on our Web site. In the first quarter of fiscal 2019, we refined the methodology used to allocate certain, selling, general and administrative expenses to this segment. The composition of segments do not change. Prior year amounts are presented as they were originally reported as it is not practical to accurately restate prior period activity in accordance with the refined allocation methodology. For comparative purposes we have included in the appendix of this webcast an estimate of the segment operating income impact if the refined allocation methodology would have been used in 2018 for both the 13 weeks ended March 31, 2018, and the 52 weeks ended December 29, 2018. There was no change to either the consolidated SG&A expenses, nor the consolidated operating income. This earnings call includes projections and other forward-looking statements regarding Garmin Limited and its business. Any statements regarding our future financial position, revenues, earnings, gross and operating margins, and future dividends, market shares, product introduction, future demand for our product and plans and objectives, are forward-looking statements. The forward-looking events and circumstances discussed in this earnings call may not occur and actual results could differ materially, as a result of risk factors affecting Garmin. Information concerning these risk factors is contained in our Form 10-K filed with Securities and Exchange Commission. Presenting on behalf of Garmin Ltd. this morning are Cliff Pemble, President and Chief Executive Officer; and Doug Boessen, Chief Financial Officer and Treasurer. At this time, I would like to turn the call over to Cliff Pemble.

Thank you, Teri, and good morning everyone. As announced earlier today, Garmin reported record revenue for the first quarter of 2019 with growth and operating income and EPS. Consolidated revenue came in at $766 million, up 8% over the prior year. Revenue from marine, aviation, fitness, and outdoor collectively increased 12% year-over-year. Gross margin was 59% compared to 60% in the prior year. Operating margin was 19.8%, and operating income grew 6% over the prior year. This resulted in GAAP EPS of $0.74. Pro forma EPS was $0.73, up 7% over the prior year. We are encouraged by our first quarter results. Since Q1 represents the lowest seasonal quarter of our financial year and much of the year remains ahead of us, we are maintaining the guidance issued in February. Before moving on to segment highlights, I want to mention the recognition we received recently from Forbes, who ranked Garmin as one of the top five best employers in America. Speaking on behalf of all Garmin employees, we are truly honored to receive this recognition. Garmin employees are passionate about what we do, and we share a deep commitment to serving our customers and each other. Of the many qualities that make Garmin a great place to work is the commitment of our employees that sets us apart. Moving next to our segment highlights, revenue in the Marine segment increased 18% on strong demand for chartplotters and Panoptix LiveScope sonars. Gross margin was 58% and operating margin improved to 19%. During the quarter, we announced the ECHOMAP Ultra series, combining built-in Panoptix LiveScope compatibility with new mapping content. Also in our first year as their exclusive electronic supplier, we were named the 2018 Supplier of The Year by Independent Boat Builders Incorporated, the boating industry's largest purchasing cooperatives. It's an honor to be recognized by the IBBI, and I want to thank our marine team for delivering superior products, service, and support to our customers. Looking next to the Aviation, revenue increased 17%, driven by growth in both aftermarket and OEM product categories. Gross and operating margin remained strong at 75% and 34% respectively. During the quarter, we delivered the new G1000 NXi upgrade for the Citation Mustang, which is the first business jet to adopt our G1000 system. We announced compelling new products, such as the GPS-175, GNX-375, and the G3X Touch, which expand the addressable market for our retrofit systems. Our aviation team was also recognized as an outstanding supplier to the industry. At the recent Embraer Supplier Conference we were named Supplier of The Year for electrical systems. This is the 10th supplier award we received from Embraer, and again, reflects the strength of our products, service, and support. I want to thank our aviation team for their deep commitment to being the very best. Looking next to Fitness, revenue increased 9% driven primarily by strong growth in our wearable category. Gross margin was 50% and operating margin was 10% in the quarter. Margins decreased due to a combination of factors, including lower selling prices, and a shift in mix as certain products in our consumer wellness categories experienced significant year-over-year growth. In early April, we completed the acquisition of Tacx, expanding our reach into the indoor cycling and training market. Yesterday we announced a fully refresh line of running watches with the Forerunner 45 in two sizes, the Forerunner 245 with optional music storage, and are Forerunner 945 which has it all. These new smartwatches offer features that will appeal to a broader range of running enthusiasts. Also we announced the availability of our menstrual cycle tracking feature. This new feature was developed by Garmin Women focusing on the special needs of those who are highly active. This feature will help women make connection between their current cycle phase, physical and emotional symptoms, and their overall wellbeing. We also announced that we are cooperating with the University of Kansas on research to better understand how wearables and the biometric data they produce can help women manage and improve their health. Moving to Outdoor, revenue increased 7% on strength across multiple product categories. The Outdoor segment generated strong growth and operating margins of 63% and 27% respectively. During the quarter we introduced MARQ a collection of five premium smart tool watches, these watches were created from our active lifestyle DNA to inspire adventures and flying, racing, sailing, exploring and sports performance. Also we recently announced the Approach S40 a stylish golf watch featuring a color touch screen display and smartwatch capabilities. Looking finally at the Auto segment, revenue decreased 10% for the quarter due to the ongoing decline in the PND market, partially offset by growth and certain specialty product lines, our global PND market share remains very strong, gross margin was 45% and operating margin improved to 6% during the quarter we launched the BC40 a new wireless backup camera that's easy to install and provide drivers with a wide clear view behind your vehicle also during the quarter we announced that BMW selected us as their lead design and production partner of infotainment modules for the BMW Group validating us as a tier one supplier to the world's most respected brands. I congratulate our automotive team and thank them for their hard work and dedication in securing this win. That concludes my remarks. Next, Doug will walk you through additional details on our financial results, Doug.

Thanks, Cliff. Good morning, everyone. I will begin by reviewing our first quarter financial results then move to comments on the balance sheet, cash flow statement and taxes, we posted a revenue of $766 million for the first quarter represent 8% increase year-over-year, gross margin was 59%, 100 basis points decrease from the prior year. Operating expense as a percentage of sales was 39.2%, 80 basis points decrease from the prior year. Operating income was $151 million a 6% increase year-over-year, operating margin was 19.8% relatively consistent as prior year, our GAAP EPS was $0.74, our pro forma EPS was $0.73, next we will look at the first quarter revenue by segment, we achieved record first quarter revenue of $766 million, consolidated revenue grew 8% where by double-digit growth in both marine and aviation. Also both the fitness and outdoor segments achieved solid growth during the quarter. Combined basis marine, aviation, fitness and outdoor were up 12% compared to prior year quarter. Looking next, the first quarter revenue and operating income charts, collectively marine, aviation, fitness and outdoor contributed 83% of total revenue first quarter 2019 compared to 80% in the prior year quarter, the marine grew from 16% to 17%, and aviation grew from 21% to 22%. The fitness grew from 23% to 24%. You can see from the charts it illustrate our profit mix by segment. Marine, aviation, fitness and outdoor segments collectively delivered 95% operating income in the first quarter 2019 compared to 98% in the first quarter of 2018. Looking next at operating expenses, our first quarter operating expense increased by $16 million or 6%, research and development increased $4 million year-over-year due to investments in engineering resources. Our advertising expense increased $3 million year-over-year represented 3.6% of sales consistent with the prior year quarter. SG&A was up $10 million or 16.5% of sales consistent with prior year quarter. The increase was primarily due to legal related costs and personnel related expenses, few highlights from the balance sheet, cash flow statement and taxes. We ended the quarter with cash and marketable securities for approximately $2.7 billion, cash receivable decreased sequentially to $453 million following seasonally strong fourth quarter, inventory balance increased on a sequential and basis compared with the seasonally strong second quarter upcoming product launches. During the first quarter of 2019, we generated free cash flow of $134 million; $53 million decrease from the prior year quarter, also during the quarter we paid dividend of $201 million which includes both the December 2018, the March 2019 payments. During the first quarter of 2019, we reported effective tax rate of 15.7% or 16% prior quarter. This concludes our formal remarks, Shannon can you please open the line for Q&A.

[Operator Instructions] Our first question comes from Ben Bollin with Cleveland Research. Your line is open.

Hi, good morning, everyone. Thanks for taking my question. Wanted to start in the fitness business, could you talk a little bit about the mix overall, what drove the higher mix of kind of wellness devices in the quarter? What were the incremental legal expenses within that business in the quarter, and does that persist? And then any thoughts on margin trajectory through the year with new product launching, and then I have a follow-up?

Yes. So in terms of mix, Ben, we saw strong sales of our Vivomore HR line as well as our Vivoactive 3. So, those were drivers of mix towards the consumer wellness categories. In terms of legal, we wouldn't comment on specific other than to say we wouldn't expect a repeat of some of these, but again, the environment is unpredictable, so we don't really know in the future what additional things we might face, but we view it as somewhat of a one-time thing. And in terms of margin trajectory depending on how the mix goes, we would probably still anticipate some downward pressure on overall fitness margins probably in the low to mid 50s range, but that will depend on again the overall product mix and the sales trajectory on some of those product lines.

Okay. And within outdoor, any thoughts you have on the initial interest for MARQ, or how you feel about the current line-up and what MARQ does to the overall TAM [ph] as you move into these higher price point products?

Well, we feel like the initial interest in MARQ has been very encouraging. So we are now starting to deliver those devices into the field. So we will start to see some impact from that. In terms of what it does to our overall product line-up, I think it expands our reach towards the upper end of the watch market. In terms of where we are today, obviously not the upper end of where watches are in total, but for us it does expands our reach and we feel very good about it, we see high MARQs in terms of the design of the product and the materials we have selected. So we feel very good about it.

Thank you.

Thank you.

Thank you. Our next question comes from Rich Valera with Needham & Company. Your line is open.

Thank you, I was wondering if you could comment on the BMW deal and sort of how you get paid on that and what you will actually get paid on. Thank you.

Well, I think maybe you are referring to some capitalized costs, so that basically an agreement that we have to be able to recover some of our R&D cost that go into that project, and those will be capitalized as we go along. But in terms of once we reach the production point, then it's like any other arrangement, where we sell a product and [indiscernible].

Yes, I guess the question was what exactly will you be selling them; software, hardware if you kind of just give us a sense of the magnitude of what will be going into each vehicle?

Well, it's the main media computing modules that go into every vehicle, and it drives the instrument cluster as well as the center stack and then some configurations that will also drive entertainment in the back seat.

Got it. And then just on aviation, can you kind of give us an update on your thoughts on the ADS-B, one that sort of contribution this year, and then how you think about that going into next year post the mandate?

But we don't break it out by categories but it is generating growth. It's not the only growth driver though in the overall Aviation segment because we're also seeing strong demand for retrofit systems, integrated cockpit systems as well as display systems and GPS systems that go in the cockpit. We think the trajectory is still strong for this year although towards the back half of the year there could be some tailing off of the growth rate. We do see that in 2020 that the market will probably continue somewhat because we don't think that every airplane that wants to be equipped will be. But we'll have to see how that goes as we reach that point.

Okay. Thank you.

Thank you.

Thank you. Our next question comes from Charlie Anderson with Dougherty & Company. Your line is open.

Yes, thanks for taking my questions. Just going back to the wearables and some of the gross margins you're seeing there. I know Cliff you've had sort of a multi-year trend of people going maybe more up-market on wearables as opposed to down market. I wonder if we're seeing a reversal of that trend at all or this is just a function of where we are point in time on the product cycle and then I've got a follow-up.

Well actually in the tracker category, it is people going upmarket because they're moving towards the higher end even when they charge as opposed to basic tracker band. It so happens that the margins on those products are lower than the headline of fitness. So depending on mix of course that impacts the overall segment margin.

Okay, great. And then just a housekeeping question for Doug. I noticed in the Q that we did see that reclassification of SG&A a little bit more to aviation, a little bit less to Marine. I wonder if you could just walk us through the basis behind that change? Thanks.

Sure. Actually it's refinement of our methodology for the general and administration expenses and now as time goes by, there's evolution of our different segments, different dynamics with it some of which relating to the late facility expansion here some of which is Aviation becoming a bigger piece of our business, international. So looking at all those different dynamics, we took a look at by allocating our administrative expenses where we thought to be each one of our segments. So yes, there are incremental additional expenses being allocated to aviation.

Okay, great. Thanks so much.

Thank you.

Thank you. Our next question comes from Paul Coster with JPMorgan. Your line is open.

Hi, thanks. This is Paul Chung on for Coster. Thanks for taking my question. So I have a couple on marine, where you kind of seeing pockets of growth whether it's region, product, subsets of the boating market and then given the strong start for both marine and aviation for the years, how is your outlook for 10% growth for both segments changed at all?

Yes. So in terms of marine growth, I'm trying to add a little more color to that, I would say it's strong globally particularly it's strong here in the U.S. market. A large majority of our revenue is generated in the Americas market and so products like Panoptix LiveScope and our chartplotters are driving some significant growth there. In terms of our outlook for both marine and aviation, as we mentioned we're not ready to think about guidance yet because it's still early in the year but we're encouraged by the results we've seen in both of those segments. I would say as I mentioned earlier in aviation that towards the back half of the year, we would naturally expect that the growth rates of ADS-B might come down a bit as the rush of people that are trying to get into the installed tapers off a bit but that's what we're anticipating and that's why we're just holding back a little bit.

Got it. And then my follow-up is on tax. What's your go to market strategy there. Can you give some more details on margins, revenues. I think you mentioned maybe six points of growth for fitness but has that view now changed that you closed the acquisition? Thank you.

There's really no changes in terms of the go to market. They are the market leader particularly in the European region. And so we expect to continue to capitalize on that strength. And we see opportunities for growth in the Americas and Asia where they're less represented. So we're working hard to implement those sales strategies right now. In terms of margins, it's fairly consistent with the overall headline margins of fitness. So we don't anticipate really any impact there. There will be allocation of the purchase price to fitness. So that will impact some of the operating margins. But on a pre-amortized basis, it's very positive to our fitness segment on a cash flow basis.

Thank you.

Thank you.

Thank you. Our next question comes from Nick Todorov with Longbow Research. Your line is open.

Hey, guys, good morning. First [indiscernible], just on aviation, my sense is that results came a little better than expected maybe can you talk some aftermarket OEM, what surprises you saw in this quarter? And then secondly, some of your competitors have talked about the pricing environment given and saw supply constraints. Maybe you could comment on that. I was wondering if you see anything different.

So Nick I'm sorry to say but your call quality was kind of challenging. So I'm not sure that we've really tracked your question. I don't know if you could maybe try to restate it or help us out a little bit there.

Sorry about it. Can you hear me?

It's incrementally better.

Sorry, can you hear me better now?

It's better now, thank you.

Okay, sorry about it. So in aviation, the sense is that results came a little bit better than expected. Maybe can you talk about whether you saw some surprises either on the OEM or on the aftermarket side? And secondly, can you comment that if you see any changes in the pricing environment and the aftermarket side, some of your competitors have talked about some changes given the supply constraints. I was wondering if you see anything different.

Yes, so in terms of aviation in our view there and what we saw, I would say that aftermarket was very strong and that reflects true demand and sell through to customers that are out there. In terms of OEM, there is some timing related things that helped us in Q1. But in general we still feel very positive about the OEM environment. In terms of pricing and aviation, I would say that pricing has been firm, we did go through some pricing increases at the first part of the year which didn't seem to have any impact in terms of our demand that we're seeing in the segment.

Okay. So you said you went through some price increases in the first -- in the first quarter this year or that was last year, I'm sorry.

It was basically in January.

Okay, okay, got it. And Doug can you comment on what are some of the changes in OpEx allocation changes your outlook? I believe last quarter you were talking about expecting about 100 basis points increase, OpEx as a percent of sales. Had that outlook changed?

No, we are consistent with that outlook for the full-year, so we have about 100 basis points increase for total operating expenses, we expect advertising as a percentage of sales to be relatively consistent year-over-year and probably about 50 basis point increase in R&D on a full-year basis and then a 50 basis point increase in SG&A on a full-year basis. I should also mention the tax acquisition about 25% of that year-over-year increase in operating expenses will be attributed to the tax acquisition which we closed on here in the second quarter.

Okay. And lastly from me, Automotives gross margin came a little bit stronger than the trend over the last couple of years. Is there anything worth calling out or was it anything maybe tied to the specialty products that offset some of the PND declines, or that's something else?

Yes, one thing we did see in PND is that we had a new drive line of PND that was launched here in first quarter, so with that new launch we did see some improvement relating to our gross margins.

Okay guys, thanks. Good luck.

Thank you.

Thank you. Our next question comes from Ivan Feinseth with Tigress Financial Partners. Your line is open.

Thank you. Thank you for taking my call and congratulations on another great quarter and being named one of the top five places to work.

Thanks Ivan.

I have a few product questions and platform questions, first at this year's Connect IQ Developer Conference like year-over-year how is attendance growing and what have been some of the topics covered? And I really do like also the new Connect IQ App that organizes the applications.

Yes, so our Connect IQ Summit was actually very, very good. We had strong attendance same as the previous year, so we're not seeing any decrease in the level of interest. We announced new features for Connect IQ that allows App developers to further leverage the platform, so they can have better access, through access to the wireless capabilities of devices. There's great new animation tools that they can use to create more lively apps, so, a lot of enthusiasm around the things that we've been doing.

Is there any plans to create like a marketplace, so that those who want to offer apps that they could charge would be able to do that because I know there are, most of the apps are free, some of the developers say if you'd like to send the money let's say through PayPal you can do it but is there eventually going to be a flick of formalized e-commerce process on the platform?

Yes, so we're evolving the platform to be able to support monetization and as we say right now, it's not as strongly linked in terms of helping our App developers that we're working on a roadmap that gets us there and I think in the coming year, we should have improvements.

Very good. I love the new product cadence and the number of new cycling computers. My one question is on like the Zumo line for example it connects to the tire monitors, so are you going to be offering the ability to have tire pressure monitors on a bicycle that connects to the cycling computers. I think that's a pretty cool feature.

Yes, it's definitely a technology we can leverage in cycling. And so I wouldn't rule it in or out at this point because we're evaluating our roadmaps but it is something that we can leverage across multiple product categories.

And as far as product line. Are you looking to want a refresh to Zumo or what is your thoughts on the Zumo line?

Well the Zumo line is an integral part of our overall PND lineup and so we have a strong roadmap there as we do in the other areas as well.

And then like the Garmin Connect is pretty cool. And have you thought about some kind of other onboard diagnostic port connection to any of your other GPS devices that could incorporate that data into the screen of the GPS?

We've invested some effort in understanding OBD connection to the vehicle and of course on our OEM side, we have a lot of access to the vehicle in terms of the can buses and things. But in terms of aftermarket diagnostics, it's somewhat of a crowded market and so we've struggled to find a place where we can really carve out our own unique niche there. So it's not something that we've been actively pursuing recently.

Okay, understood. And then I love the Newmark watches. They are beautiful. Can you give some thoughts on unit volume?

Well, we don't break out by volume but I would say as we mentioned in the remarks that the reception has been good and we're pleased with that and so we're just at the front end now of delivering those products to market. And we'll have an updated view in the future.

Thank you. And also on tax, can you give us some thoughts as far as product branding. Are you going to maintain the tax name or somehow incorporate the Garmin name with it, also do you see any focus on specific products and expanding the product availability into the U.S. and the marketing strategy behind it?

Yes, so the tax name is very strong. So we want to maintain that. And so the branding will be definitely taxes. The headline on those products and for the Web site and things we're calling it a Garmin company. In terms of our specific product focus, our emphasis at taxes emphasis before acquired them, it was that smart trainers and advanced trainers is their specialty and so we're going to continue investing in that. And then in terms of bringing the product to other markets where we're working very hard to bring it into U.S. distribution now in a more complete way and so that's ongoing and should be more evident as we as we move into the back half of the year.

Thank you very much. Congratulations again.

Thanks Ivan.

Thank you. Our next question comes from Erik Woodring with Morgan Stanley. Your line is open.

Hey, guys, congrats on the quarter. Good morning. I just want to get at first quarter revenue growth of 8% was strong but in the past you've talked about how the ramping of product launches and new product launches flew essentially help accelerate that growth in the back half of the year versus the first half. And so with guidance unchanged, I just kind of wanted to reconcile those data points given the outperformance in the first quarter?

Yes, so we mentioned in the last call that our product releases were back half loaded. And I think that's certainly playing out as we're just now getting our new fitness products to market and we'll have more releases as we go through the year. So we'll have to wait and see. We've mentioned before that this quarter is literally the smallest contribution to our overall yearly revenues. So we don't want to get too excited or disappointed on first quarter because there's a lot that lies ahead of us in terms of the overall sales environment and the competitive environment.

Okay, thanks. And then just as my follow-up, auto results revenue down 10% was essentially the best performance you've had for that segment since the first quarter of 2016. So just curious is that just the new drive on PND that was launched or was there something else that contributed, any puts and takes there and understanding any puts and takes would be helpful there? Thank you.

Drives certainly help, that was a selling event although we've heard good remarks from our retailers on the sell through of that product. So that's one dynamic but we also saw strong demand for our specialty PNDs particularly in the truck RV and motorcycle areas and that helps a lot. And so that represents really true demand in the market. So we were pleased with the result and we'll have to wait and see how things go throughout the remainder of the year.

And I'm just curious is that a trend do you think that could continue or is it would you call that or think of that more as a one-time, a one-time benefit to the quarter?

Well, it's hard to say again we're waiting to see more data as we experience the sell through of the new products especially and as the driving season comes upon us here, so we'll have to wait and see.

Okay. Great, thank you for taking this time.

Yes, thanks Erik.

Thank you. And I'm showing no further questions. At this time, I'd like to turn the call back over to Teri Seck for closing remarks.

Thanks everyone. Doug and I are available for callbacks throughout the day. Have a good one. Bye.

Ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day.