Garmin Ltd. (GRMN) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Garmin Ltd. First Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, today's program may be recorded. I'd now like to hand the program over to Teri Seck. Please go ahead.

Good morning. We would like to welcome you to Garmin Ltd.'s First Quarter 2016 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 website. This earnings call includes projections and other forward-looking statements regarding Garmin Ltd. and its business. Any statements regarding our future financial position, revenues, earnings, market shares, product introduction, future demand for our products 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 the 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.

Thanks, Teri, and good morning, everyone. As announced earlier today, Garmin reported first quarter consolidated revenue of $624 million, up 7% year-over-year. Our fitness, outdoor, marine and aviation segments as a group grew 17% year-over-year and contributed 69% of total revenues. Each of these segments have an exciting growth story, which I will cover in a moment, as a result of the strategic investments we have been making in recent years to grow and diversify our business. Gross margin was 54.5%, down year-over-year, driven primarily by product mix. Operating margin declined to 16.6% due to lower gross margin and an expense structure that was up slightly from the prior year. These factors, combined with a higher year-over-year effective tax rate, resulted in GAAP EPS and pro forma EPS in the quarter of $0.46 and $0.49, respectively. We are maintaining the guidance issued earlier in the year as our performance thus far is consistent with our expectations. Next, I'll provide a brief snapshot into the performance of each business segments. Beginning with the fitness segment. Revenue grew 9% on a year-over-year basis, driven by strong growth of products with Garmin Elevate wrist heart rate technology. Running and activity tracker categories experienced robust growth over the prior year, somewhat offset by declines in the multisport category. Growth in operating margins were 51% and 12%, respectively. Gross margin was impacted by product mix shifting towards lower-margin activity trackers, while operating margin was further impacted by ongoing investments in advertising and research and development. As we've mentioned previously, we believe these investments are strategically important in order to maximize the long-term opportunity in the fitness market. While the margin profile of our fitness segment has changed in recent quarters, we believe the performance will stabilize as we complete critical product and market transitions. Our product lineup continues to grow, and I'm pleased to report that the vívoactive HR and the vívofit 3 are now shipping. I'm particularly excited about the vívoactive HR, which adds Garmin Elevate wrist heart rate technology to our multi-activity GPS-enabled smart tracker. The vívofit 3 adds Move IQ automatic activity detection while carrying forward the strength that our vívofit family is already known for, such as industry-leading 1-year battery life and an always-on display. With these additions, we have a strong lineup of products that offer something for every customer. To share this good news with the market, we have launched our spring Beat Yesterday advertising campaign across multiple media outlets. I encourage everyone to look for our Beat Yesterday creative material in train stations, airports, movie theaters and, of course, on television. Looking next at outdoor. Revenue increased 33% year-over-year as we experienced strong demand for outdoor wearables and dog products. The outdoor segment continued to generate strong gross and operating margins of 61% and 29%, respectively. And operating income grew 17% over the year-ago quarter. We've recently launched several golf products, which have brought new excitement to the market. Additionally, we have completed the acquisition of DeLorme and look forward to integrating their technology into a broad range of product categories. Looking next at marine. Revenue was up 29% over the prior year, driven by strong sales of chartplotters and fishfinders. Gross margin declined slightly in the quarter to 53% due to product mix, while operating margin improved to 12% as we've successfully leveraged recent investments in the segment. Operating income grew 125% over the prior year. In recent years, we've made significant investments in our marine segment. As a result, our product line is extremely strong as we enter the 2016 marine season. Our recently launched GPSMap 8400 and 8600 are the largest plotters we've offered and have strong differentiators that stand out in a highly competitive market. Another area of focus has been on improving our cartography offerings. We recently added depth contours to thousands of lights in the U.S. and Canada, which will broaden our appeal in the inland fishing markets. We also added an exciting feature to our chartplotters that we call Quickdraw Contours, which enables users to create their own depth contours for small fishing lakes not covered by our HD maps. Turning next to aviation. Revenue grew 8% over the prior year as we experienced growth in both OEM and aftermarket product lines. Gross and operating margins remained strong at 74% and 29%, respectively, resulting in a 16% increase in operating income. During the quarter, we expanded our reach into organizations that own and operate large fleets. Air ambulance provider, AirEvac, chose Garmin avionics for their fleet of Bell 206 and Bell 407 helicopters. And the United States Forest Service chose our G950 integrated cockpit system for their fleet of Sherpa aircraft that operate in the challenging role of fighting wildfires. In recent years, we have mentioned the ADS-B opportunity, which is the transition to a more efficient, next-generation air traffic management system. This mandated transition, which must be completed by the end of 2019, requires the installation of an ADS-B transponder in every aircraft operating in designated airspace. Garmin has been an early mover in the ADS-B market, and we recently expanded our product offerings with the introduction of the GTX 335 and 345 family for the ADS-B transponders. These transponders feature an integrated dual-link transceiver, offering best available traffic awareness at a value price. We will continue to invest in ADS-B solutions in order to make this transition simple, beneficial and cost-effective for a broad range of aircraft and customers. We continue to support our OEM partners in the development and certification of new aircraft and helicopter platforms. While industry dynamics remain a factor, market share gains and new platforms provide opportunities for future growth. So looking finally at the auto segments. Revenues were down 11% for the quarter, primarily due to ongoing PND market contractions and headwinds caused by additional revenue deferrals associated with auto OEM programs. Gross and operating margins were 44% and 9%, respectively. During the quarter, we began shipping our Drive family of PND devices, bringing driver assistance and awareness features to the aftermarket. Additionally, we experienced strong growth in infotainment systems for the APAC region and also the Middle East. Finally, we delivered production software for the new 2017 Mercedes E-class model. We remain focused on disciplined execution in order to bring desired innovation to the market and to maximize profitability in this segment. So that concludes my remarks for the morning. Next, Doug will walk you through additional details on our financial results. Doug?

Thanks, Cliff. Good morning, everyone. I'd like to begin by reviewing our first quarter results, then move to comments on the balance sheet and cash flow statement. We posted revenue of $624 million for the first quarter, representing a 7% increase year-over-year. Gross margin was 54.5%, a 430 basis point decrease from the prior year, driven by product mix. Operating expense grew 2% or $4 million, driven by increased spending in advertising and research and development. Operating income was $104 million. Operating margin was 16.6%, a decrease of 250 basis points from the prior year. This is a result of the decline in the gross margin rate. Pro forma effective tax rate was 18.1% in the current quarter compared to 12.3% in the prior year due to projected income mix by jurisdiction. We still anticipate a full year tax rate of approximately 20.5%. The first quarter tax rate was positively impacted by the release of almost $4 million of tax reserves. Our GAAP EPS was $0.46, and pro forma EPS was $0.49. We'll discuss gross margin and operating expenses in more detail later. Next as we look at first quarter revenue by segment. During the first quarter, we experienced growth in 4 of our 5 segments, led by robust double-digit growth in our outdoor and marine segments and high single-digit growth in our fitness and aviation segments. Collectively, these 4 segments were up 17% compared to the prior year quarter. Looking at the first quarter revenue charts on this page. The auto segment represented 31% of our total first quarter 2016 revenue compared to 38% in the first quarter of 2015. Outdoor grew to 16% of revenue in the current period compared to 12% in the prior year; while marine grew from 11% to 13%, and fitness grew from 22% to 23%. As you can see from the charts illustrate our profitability mix by segment. Outdoor, fitness, marine and aviation collectively delivered 82% for operating income in the first quarter of 2016. Fitness operating income as a percentage of the total operating income decreased from 31% to 16%; while aviation increased from 24% to 29%; outdoor increased from 21% to 27%; and marine increased from 4% to 10%. Drilling down year-over-year gross margin by segment. Aviation posted a gross margin rate increase, while fitness, outdoor, auto and marine posted gross margin declines due to shifts in product mix. Total corporate operating margin decreased from 19.1% in the first quarter of 2015 to 16.6% in the current quarter due to gross margin pressure and increased advertising and R&D investments. These same factors contributed to the decrease in fitness operating margin. Looking next at operating expenses. As previously mentioned, first quarter operating expense increased by $4 million or 2%. However, percentage of sales, operating expense decreased from 39.7% in the first quarter 2015 to 37.8% in the current quarter. Research and development increased $2 million year-over-year, that declined 80 basis points to 17.3% of sales. We continue to invest in innovation and increasing resources focused primarily on aviation, fitness and outdoor. Our advertising expense increased $4 million for the prior year quarter, representing 5.2% of sales, a 40 basis point increase. Additional spending was focused on fitness and investments in media. SG&A was down $3 million compared to prior quarter, decreasing 150 basis points as a percent of sales to 15.3%. The lower SG&A expense were driven primarily by a decrease in year-over-year litigation-related costs. A few highlights on the balance sheet and cash flow statement. We ended the quarter with cash and marketable securities over $2.3 billion. Accounts receivable decreased both sequentially and year-over-year to $408 million. Inventory balance increased year-over-year and sequentially to $518 million [ph] as we grew our product offerings to prepare for a seasonally strong second quarter. During the first quarter of 2016, we generated free cash flow of $115 million compared to $64 million in the first quarter of 2015. Also during the quarter, we paid dividends of $97 million, repurchased about $20 million of company stock, with $140 million remaining for purchase through December 2016. This concludes our formal remarks. Jonathan, could you please open the line for Q&A?

[Operator Instructions] Our first question comes from the line of Ben Bollin from Cleveland Research.

Two questions. The first one, good revenue performance on the quarter. No change to guidance. And I'm curious why no adjustment, given the good revenue upside and kind of the expectations that you finished the year, what happens later in the year that would contribute to year-on-year revenue declines? And then I have a follow-up.

Okay, good morning, Ben. In terms of guidance, it's still very early in the year, only 1 quarter behind us. And for a long time now, we've been facing the ongoing challenge of PND market contraction. So we want to try to make sure that we adequately guide in terms of the uncertainties there as well as the other growth opportunities that offset it.

Okay. The other item, when you look at the outdoor and fitness business, you commented you feel like the fitness gross margin maybe starts to stabilize from here. Why is that the case? And kind of what are your thoughts on the ability to stem gross margin pressures in the outdoor business as well?

Well, in terms of fitness, our first quarter margin was lower based on product mix, and it's seasonally a lower quarter as well, so it's more sensitive to those things. We feel like we have a strong product lineup at this moment going forward into the year, so we think that it will stabilize. In terms of outdoor, there's really not any change there in terms of the overall product structure or market structure, so we feel like the margin there is sustainable going forward.

Our next question comes from the line of Rich Valera from Needham & Company.

Just maybe to ask in a different way with respect to the guidance. It would appear that your revenue guidance implies perhaps meaningfully less than seasonal uptick that you've historically seen in Q2. And I'm wondering, is there anything we should be aware of that might cause you to have a less-than-typical seasonal uptick in 2Q, anything that was particularly strong in Q1, for instance, that might be a tough comp? Any color there would be appreciated.

Well, I think year-over-year, we're going to be comping against pretty strong products that we had last year. So that's one factor. But generally, there's not anything material that changes the direction of the business.

Got it. And then can you give any color on -- I mean, I think you had about a month of DeLorme in outdoor. Can you give any sense of how much benefit you got from that in terms of either percentage points of growth or revenue?

DeLorme was really immaterial for the quarter. It closed really late in the quarter, so there was not much impact from DeLorme.

Can you give any sense of how much impact that might have in Q2?

No, we're not breaking that out, but I think that we'll have a full quarter in Q2 and we'll be able to provide more color then.

Our next question comes from the line of Simona Jankowski from Goldman Sachs.

The first one is for Cliff, also following up on the fitness segment. Can you talk about if you still see the growth rate for this year in the vicinity of 10%? And then where do you see gross margin stabilizing for that segment?

Well, in terms of our outlook for the segment, we guided to 10% growth, which is still our outlook there. I think there's various product categories that are up and down for the year, so that's in general where we see things. And could you repeat your second question, please?

Oh, sure. On where do you see gross margin stabilizing in the fitness segment?

Well, I think it's really in the product road map and the products that we have in the market. So the newer products should help us stabilize our gross margin. Our running line now is getting fully populated with wrist-based heart rate, which is helping as well. So we feel like those things will contribute to stabilization.

At the current levels, is that what you're implying?

Well, we think that the margin levels in fitness should be somewhere in the low to mid-50s, so that's about where we're targeting.

Okay. And then a couple of questions for Doug as well. First of all, what was the impact of FX in the quarter? And since the FX headwinds are now diminishing, if rates were to stay where they are, what would be the embedded FX impact for the full year?

Yes. So actually, there was a little impact of FX on a quarter-over-quarter basis when you look at the euro of the last quarter 2015 versus Q1 '16. And then also, you had the Taiwan dollar impacting a little bit the gross margin. So as it relates for the full year, basically, if we stay somewhere where we're at, we're probably anticipating little impact for the full year.

And then -- Doug, and then a quick follow-up in terms of the recent treasury rules on inversions. Any impact for Garmin from a tax perspective?

No, we don't anticipate any impact to relate into those regulations on our tax rate.

Our next question comes from the line of Paul Coster from JPMorgan.

A couple. First off, the marine segment was very strong relative to our expectations anyway. I'm just wondering from a year-over-year perspective, was there something that may -- that contributed to this strength in terms of product cycle or inventory levels or whatever?

Yes, I think year-over-year, Paul, as I mentioned, our product line is extremely strong this year. We had products early in Q1. Our comparable last year of Q1 of 2015, was quite a bit easier than what it will be in Q2. So all of those factors led to some early growth in marine for this year.

Okay. So you've noted that the gross margins were down in all segments except aviation and attributed it to product mix. Is there some broader message, though? Is it just kind of flukish that it happened in all segments this quarter? Or is it possible that you're seeing a change in competitive landscape or consumer tastes or you're going after new markets and market segments that explain this shift?

No, we don't think so. In marine, I mentioned there's a product mix factor there, so that's very understandable. I think outdoor fluctuates up and down, so really no change there. Aviation is pretty steady, and automotive has been pretty steady as well.

Our next question comes from the line of Tavis McCourt from Raymond James.

I've got a couple of them. First, in the auto segment. I guess if you can give us kind of the logic behind -- I don't know if it's a rebranding or new products between nüvi and Drive. And does this signal kind of maybe a bigger emphasis on some of the safety and camera features associated with the -- with your new PNDs? And then in the prepared remarks and in the press release, you mentioned the infotainment business in APAC and emerging markets. Are these system sales? Or is this still turn-by-turn driving software sales? And then I had a question on the fitness business. I think you indicated the activity tracker business for you was relatively strong in the quarter, which is a bit surprising to me because I think you were kind of towards the end of a product cycle and launching a new one here in Q2. So did any of the vívofit 3 ship into the March quarter? Or is that all a June impact?

Okay, thanks, Tavis. So kind of hitting from the top there in terms of our rebranding of the PND products. Yes, indeed, we are rebranding intentionally, and we felt like nüvi has served us well over the years, but also probably doesn't recognize some of the great new features that have been brought into the product line over the years. And particularly, you mentioned that the safety features, we have lane departure warnings, we have camera features in the product with collision warnings. So we felt like it was time to kind of recast the nüvi line into something else. In terms of infotainment, those sales that we referred to were system sales that are done on a port-install basis with automotive carmakers in APAC and also the Middle East. And then finally, on fitness, vívofit 3 has really started shipping now, so it's a Q2 impact, not a Q1 impact.

Got you. And then a follow-up. I assume if there was any impact from the earthquake in Taiwan, we probably would have seen it in March, but just want to make sure of that.

Yes, at this point, it's limited. This is one of the reasons why we keep healthy levels of safety stock. And at this point, we're working through that. But at this moment, we don't have any material impact.

Our next question comes from the line of Charlie Anderson from Dougherty & Company.

I wanted to ask about Garmin Elevate. I think I heard you, Cliff, say that, that was helpful to margins. If I think about that on a year-over-year basis with products that sold with a chest strap, how does that compare? And as you go through bringing that to more products, how is that going to influence gross margins on both maybe outdoor and fitness?

Yes. So maybe to clarify on that. We went through kind of a two-step process in getting the wrist heart rate. The first step was with a third-party solution with our Forerunner 225 and then we transitioned to a Garmin solution after that on our Forerunner 235 and fenix 3 HR. In terms of margin structure, certainly, the wrist-based heart rate products are lower margin structure than our chest-based. But at the same time, our Elevate technology has much higher margin structure than when we were using a third party. So it is improving from where we were in that interim step, but not necessarily compared to the wrist -- or the chest-based solutions of the past.

And then just a quick follow-up. I wonder if you guys saw any sell-through data from anyone on marine and then outdoor, and how that matched up with the sell-through rates you reported in Q1?

Yes. I think those markets are fairly niche, and retailers don't carry a lot of inventory, so the sell-through has been fairly robust. There's been a lot of spring promotions around some of the marine products, and it's been doing very well in channels like Bass Pro and Cabela's.

Our next question comes from the line of Will Power from Robert Baird.

Just curious back on the fitness side. As you look at the year-over-year growth and key drivers, qualitatively, any color around U.S. growth versus what you're seeing internationally and perhaps product mix across geographies there?

I think we're actually seeing very good results in the European region. In terms of the market development there, Europe is probably behind that of the U.S. So there's a growing market there and players are establishing themselves, including Garmin. We've also seen strong uptake of wearables in APAC, including both fitness-based wearables as well as outdoor-based wearables.

Okay. And then the U.S. still grow year-over-year within fitness? Any color there?

Yes, definitely, the U.S. is still growing, no question about that, but it's a more mature market than those other regions.

Okay. And then just the outdoor segment. You referenced both fenix and golf, I guess, improving. I guess, just, how would you characterize, I guess, the key pieces or key drivers of the growth there? I mean, is it evenly balanced? Or is there something there that's driving an outsize benefit?

Well, I think 2 things in outdoor that really drove the growth was the fenix line and also dog products. Those are the 2 major drivers. There was some incremental contribution by golf, but the other 2 were really the major contributors. Fenix has been strong in recent quarters. And over 2015, we're going to now start to comp against those strong results in Q2, 3 and 4 with fenix. So we're going to have to navigate that in terms of comparables. But so far, the product has been very strong, especially since we've added wrist-based heart rate to it.

Our next question comes from the line of James Faucette from Morgan Stanley.

This is Yuuji Anderson on for James. I think most of my questions were answered. But I was hoping on aviation, perhaps if you could give a little bit more color on the different geographies, I mean, what are you seeing in terms of OEM versus retrofit as you go region to region? And I guess, it will be helpful to just get your perspective on the strength of order activity generally versus everything that we're hearing in the macro environment.

Yes. I think we still see challenges in aviation like we noted in the remarks. Some of the underlying factors that have slowed the market recently are still there. But for us, new platforms have been a big driver of the success, and we're seeing some incremental increase in revenues in the retrofit side, too, especially in ADS-B products.

Does that answer your questions?

Yes.

Our next question comes from the line of Brad Erickson from Pacific Crest Securities.

First, just on the fitness segment. When you split between the activity trackers versus the running watches, where are you looking for stronger growth this year between those 2 products that's within fitness?

I think we're looking for strong growth really in both of those categories, and that's what we experienced in Q1.

So fair to say roughly equal from a growth rate perspective?

That's been what we've been experiencing, yes.

Okay, that's helpful. And then ultimately, how do you think about the size of these new -- the emerging geographies you talked about for fitness where you're seeing sort of higher growth? How do you think about the ultimate size of those markets relative to what you found in terms of the TAM here in the U.S. for fitness?

I think theoretically, the size of those markets is really driven by population and especially population that's interested in health and fitness. I would say, generally, Europe should match that profile pretty well. I think in APAC, of course, there's a lot of population that may be not yet the kind of lifestyle or health-focused like what you have in the U.S. and Europe markets. So nevertheless, I think there's still good uptick of fitness products in APAC. I think they're very interested in running products as well as fitness and multisport products.

[Operator Instructions] And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Teri Seck for any further remarks.

Thanks, everyone. Doug and I will be available for any follow-up calls later today. Thanks. Have a good day. Bye.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.