Thank you for standing by and welcome to the Garmin Limited Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, today's program may be recorded. And now, I'd like to introduce your host for today's program Teri Seck, Director of Investor Relations. Please go ahead.

Good morning. We would like to welcome you to Garmin Limited's third quarter 2022 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 Limited and its business. Any statements regarding our financial -- our future financial position, revenues, earnings, gross margins, operating margins, future dividends, or share repurchases, market share product introductions, future demand for our products 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 the Securities and Exchange Commission. In particular there is significant uncertainty about the duration and impact of the COVID-19 pandemic. This means that results could change at any time and any statement about the impact of COVID-19 business results and outlook is the best estimate based on the information available as of today's date. Presenting on behalf of Garmin Limited 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 reported earlier today, consolidated third quarter revenue came in at $1.14 billion down 4% from the prior year. Revenue was negatively impacted by approximately $70 million due to the strengthening of the U.S. dollar relative to other currencies. Excluding this impact, revenue would have increased about 2% over the prior year. While the stronger dollar and negatively impacted revenue, cost of goods benefited due to the weakening of the Taiwan dollar. In addition, cost of freight came down as more products are being shipped by ocean and as rates decline due to excess capacity in the shipping industry. These combined with favorable segment mix resulted in gross margin at 58.8%, an increase of 40 basis points over the prior year. Expenses increased 4%, as growth in R&D and SG&A was partially offset by advertising efficiency. This resulted in operating income of $239 million, which was down 15% from the prior year. Operating margin was solid at 21%. Considering our year-to-date performance, we are adjusting expectations for the remainder of the year. We now anticipate full year revenue of approximately $4.85 billion, a year-over-year decline of 3%. We are raising our full year EPS guidance to $4.95 on improving gross margins, increased efficiency in our expense structure, and the lower full year effective tax rates. Doug will provide more details on our financial results and updated guidance in a moment, but first, I'll provide highlights on the performance and outlook of each business segment. Starting with fitness, revenue decreased 18% to $280 million, primarily due to lower sales of the advanced wellness wearables and indoor cycling products. Gross and operating margins were 53% and 15% respectively, resulting in operating income of $41 million. During the quarter, we launched the Index BPM smart blood…

Thanks, Cliff. Good morning, everyone. I begin by reviewing our third quarter financial results, provide comments on the balance sheet, cash flow statement, taxes or updated guidance. We posted revenue of $1.140 billion for the third quarter, representing a 4% decrease year-over-year. Gross margin was 58.8%, a 40 basis point increase compared to prior year quarter. The increase was primarily due to favorable segment mix in lower freight, partially offset by the net unfavorable impact of foreign exchange rates. Operating expense as a percentage of sales was 37.8%, a 310 basis point increase from the prior quarter. Operating income was $239 million, a 15% decrease. Operating margin was 21%, 270 basis point decrease. Our GAAP EPS was $1.09, pro forma EPS was $1.24. Next, look at our third quarter revenue by segment and geography. During the third quarter, growth in the Outdoor and Aviation segments were more than offset by declines in the Fitness, Marine and Auto segments. Our geography, the Americas region was down 2%. The EMEA region was negatively impacted by foreign exchange rates, excluding the impact of foreign exchange rates, EMEA sales performance put in more in line to America's sales performance. APAC region was up 10% with the prior year. Excluding the approximate $16 million impact of foreign exchange rates, APAC region would have been up 19% with the prior year. Looking next, operating expenses. Third quarter operating expenses increased by $18 million or 4%. Research and development increased $10 million year-over-year primarily due to engineering personnel costs. SG&A increased $12 million from prior year quarter primarily due to increases in personnel-related expenses, information technology costs. Advertising expense decreased approximately $4 million due to lower co-op advertising. A few highlights on the balance sheet, cash flow statement and taxes. Ended the quarter with cash and marketable…

Certainly. [Operator Instructions] And our first question comes from the line of Paul Chung from JPMorgan. Your question please?

Hi. Good morning. And thanks for taking my questions. So Aviation is on track to kind of hit record annual revenues even ahead of '19 levels. If you could expand on kind of the product portfolio, where you're gaining share, where you have pricing power and what new products you're excited about? And then on the margin front, can you see operating leverage with kind of record revenues maybe heading into '23 as inflation effects and some supply chain dissipated. I know the ADS-B cycle in '19 drove those mid-30% operating profit margin. But can you get to that low 30s soon? And then I have a follow-up.

Yeah, good morning, Paul. I think in Aviation, we've been able to build the revenue that was vacated by the ADS-B mandate through a couple of things. We have new product lines such as our Autopilot systems, which as we certify each new aircraft, we are able to offer a totally new product category to that particular group of aircraft that are out there. So we're definitely gaining share as a new product category in autopilots. And then indicators, the stand-alone indicators, our GI 275 as well as our G5 and our standalone GPS NAVCOM products, the GTN series have been very strong in this environment where people are retrofitting their planes. As far as the forward look, we're not really ready to talk about 2023, but aviation, of course, will be a market where the operating profit is driven by the investments we have to make. And so as new programs come along, which tend to be long life cycle, we sometimes have to invest in advance. So that's one variable that we'll look at as we think about our 2023 guidance and then also the sales volume will drive leverage. And so again, we're not quite there yet in terms of talking about 2023, but those are factors we'll consider.

Great. And then a follow-up on Fitness. You're seeing a recovery here in margins. You mentioned earlier this year component inflation as some of the primary drivers for kind of the underperformance in the first half. So how are those two shocks evolving? And can we get back to the 20% here shortly as we head into the holiday season. And then separately on competition, you have Apple with Ultra and Google Pixel here ramping? What is the data showing you on market share? And how are you kind of protecting your niche categories? And are you adjusting prices somewhat, increasing promotions, increasing marketing? Anything you can comment there? Thank you.

Yeah. So in terms of Fitness, FX definitely did impact us. I think in terms of the improvement we saw, it would be primarily due to product mix as we had new products in the segment. Our running categories, in particular, have been very strong with the release of the 255 and 955 series. In terms of a particular target, I think where we landed in Q3 was actually where historically, we've kind of targeted in terms of mindset around what is the performance of this segment. Fitness is a more competitive segment due to the advanced wellness wearables, so that mid-teens kind of range for operating margin is actually a very good result and that will fluctuate up and down depending on promotions and on product cycles. In terms of competition, we're always mindful of that. We still believe, even with the release of the Apple Ultra and the Google Pixel that we have unique differentiators, not the least of which is some of our products are able to have 25 times the battery life of of those devices. So that's a significant advantage, and we're more oriented to the unique needs of our users around activity and adventure. So we continue to believe that we can carve out unique spaces for ourselves there, and we don't believe that we're losing market share in light of that.

Okay, great. Thank you.

Thank you. Our next question comes from the line of David MacGregor from Longbow Research. Your question please.

Good morning. Thanks for taking the questions. I guess, I wanted to just start off by -- I think I heard you say the free cash flow guide for the year was $450. I was just wondering what the -- how you're thinking about inventory within that context and what your year-end targets would look like?

Yes, great question. Yes, our full year free cash flow estimate is $450 million. And inventory is a big driver of that. As you've noticed, our inventory has been increasing year-over-year and did increase here in Q3. As we look at year-end, we would expect that our full -- our end of year inventory will be lower on a sequential basis compared to Q3, maybe by around 10% or so and that would mean that our year-end inventory would probably be up over the comparable period in 2021 by mid-teens or so. So there will be -- and last year, comparing that to it, you saw in 2021, actually inventory increase from Q3 to Q4 about 10%.

Okay. And then I realize it varies rather dramatically across the different segments. But can you talk a little bit about just field inventory in the field?

Yeah. Right now, I would say that we feel like channel inventory is mostly at reasonable levels. The one exception to that has been the indoor cycling trainers, which the channel is full of trainers from all manufacturers, not just a garment specific thing because of the shift from indoor cycling training during the pandemic to more outdoor cycling training. So that's the one area that the market is continuing to work through. But in general, we feel like the levels are mostly good. The one thing that is a factor out there, as we look forward and really kind of difficult to predict how it will go. But retailers generally have inventory of lots of different things right now. So as they move into Q4, many have signaled that they're promoting. And so as we look at Q4 we'll be looking for signals around open-to-buy dollars and promotions that they're willing to do given their overall inventory picture.

Good. And then last question for me is just as you think forward to 2023, and I realize you're probably going to have a lot more to say with 2023 once we come to January. But just thinking at a high level, if 2023 ends up being sort of the more negative type of macro scenario and things really are down rather significantly. Can you just talk about your ability to flex OpEx and just how much flexibility you have there?

I think we do have some flexibility around OpEx, particularly in the areas of advertising and some of the discretionary areas I think that slowing some of the other things in terms of R&D commitments are more difficult or take more time to really see the result. We do have a list of priorities that we've vetted and we're committed to, regardless of the environment so that we can grow for the future. But right now, I would say that we're taking a generally cautious wait-and-see view about how things go, and we're being very careful with how we spend and grow our headcounts.

Great. Thanks so much.

Thank you. And our next question comes from the line of Ben Bollin from Cleveland Research. Your question please.

Good morning, everyone. Thanks for taking the question. Cliff, I was hoping you could speak a little bit about how you think about device refresh. Any thoughts around the composition of mix, in particular, in wearables that you think refresh represents today? And how that's evolved throughout COVID, what you saw in the last couple of years? And then I have a follow-up.

Yeah. I think we are typically seeing still the majority of customers coming into our platforms as new to Garmin customers. So there's certainly an element that is people that buy a second device or a new device of some kind. And there's some secondary market for our devices as well. So they might sell them on online, and then we give a new customer to reduce device. But in general, it's still slightly over a majority of those customers are new to Garmin.

Okay. The last question is, if I recall, last year, I believe Garmin had slightly better inventory availability versus a lot of other categories. And I was left the impression that might have benefited some of the retailer commitments into the holidays last year. Please correct me if I'm wrong, but I'm curious if that's playing into anything you're seeing this year? And then I'm also curious what you're seeing from your partners in terms of how they are thinking about working capital commitments into the holidays and beyond? Have you seen any change in how much inventory they're willing to sit on? Or how far in advance they're ordering product? That's it. Thanks.

Yeah. So last year, we did feel like we had availability when many others did not due to supply chain issues even so, I think we were still limited on some of the things that we could supply and some of our deliveries came very late in the quarter, which might have missed the overall holiday season. So there was a lot of dynamics last year that we won't comp this year because things are more normal. And of course, we'll have to wait and see how the customer responds in Q4 to the holiday buying season. In terms of our partners, like I mentioned earlier, I think what they call open-to-buy dollars in the retail channel is something that's really important retailers do have a lot of inventory of many different things. And so they're balancing what to bring in based on what they think will sell well. and they can maximize their results as well. So it's a little bit different environment this year because last year was all about getting anything they could and this year is all about selling the right things.

Thank you.

Thank you. And our next question comes from the line of Ivan Feinseth from Tigers Financial Partners. Please go ahead.

Thank you for taking my question. And congratulations on the great cadence of new product introductions. So on the blood pressure mine, this is the second item in your index line? Or are you envisioning expanding the index as a product line now that you have the blood pressure monitor going along with the scale? And what other types of products in that segment are you thinking about?

Yeah, good morning, Ivan, I would say, generally, we're always looking at new category opportunities. So index has been a great category for us as a wellness device on the scale first, and the blood pressure monitor has been a delightful surprise in terms of the interest that we've had in that and we quickly sold out what we had on hand and looking for more deliveries. So we're excited about that, and we're constantly looking at new categories to grow our business.

And on your new -- let's say, in wearables, can you give some indication of percentage of people who already own a Garmin product and are adding another 1 because you can tell by the activation and the connection to the your app or what percentage are new and let's say, how many people, let's say, continue to use 2 devices or, let's say, give it to a family member or had other people?

Yeah. I don't have specific stats in front of me on that. We do see that and track it. It's at a level less than what I mentioned earlier in terms of just people that are buying another Garmin device, but I don't have those specific stats in front of me.

Thank you. Congratulations again.

Thank you. And our next question comes from the line of Erik Woodring from Morgan Stanley. Your question please.

Yeah, good morning. Thanks for taking my question. I guess maybe, Cliff, I'll start with you, maybe just a high-level question. And that is, how do you discount or consider geopolitical risk and how that influences your manufacturing footprint? And are there any regions that you'd target as a potential source of new capacity? Or is the premise of that question, some of that a lot. And then I have a backup. Thanks.

Yeah. Good morning, Erik. So geopolitical risks have been something we've dealt with since the beginning of the company. They're really not new. They tend to be shifting around the globe as things evolve. In terms of looking at new capacity, I mean, we've demonstrated recently that we have the ability and the expertise to stand up new factories in new regions such as our automotive OEM factory in Poland. We, several years ago, created a factory in China. So we have that diversity, and we're able to quickly stand up capacity where we need it. So we just constantly look at that and evaluate what our needs are.

Okay. That's helpful. And then maybe just digging into the consumer-facing businesses that you have -- is there any way you can help us kind of understand here in the back half of the year, how we should think about volume versus pricing and which one is a more significant driver of growth or limiting declines versus the other? And then one more. Thanks.

Yeah. I think this question of volume versus pricing, that's always the big question as you think about pricing your products and running promotions. And the name of the game is maximizing. For us, we always want to maximize the profit dollars for Garmin that allows us to be successful. So it's a big question, and I don't think anyone has a magic way to do it, but we try to balance all of those factors and also take into account the availability of products in various stages of life cycle that we can promote the older ones, for example, and allows us to keep the pricing on the newer products higher.

Okay. That's helpful. And then last question for me, maybe this is for Doug. It's just really nice performance on the margin side, both gross and operating. Maybe if we just stick on the gross side. Can you maybe list from most to least impactful kind of the upside versus downside headwind versus tailwind drivers for the nice margin performance this quarter? And then just kind of second to that, it's just maybe helping us understand what percentage of COGS is in Taiwan dollars versus U.S. dollars. And that's it from me.

Yeah. So yes, gross margin. So as you mentioned, there's a lot of different moving pieces in that gross margin number. So some of our headwinds probably in the top we have lean that one is just the FX impact we had on revenue. Now we do have, as Cliff mentioned, the other side of that with the strengthening of the U.S. dollar against the Taiwan dollar, there's a lower cost relating to that piece of -- but it's not able to offset all of that headwinds relating to the FX on the revenue side. Then kind of taking you back a little bit, one of our biggest headwinds we had previously related to our freight. Freight had been increasing quite a bit year-over-year. So now we're seeing some of those freight costs decline. And it's actually declining for two reasons, one of which relating to lower freight rates. And the other 1 is that we are shipping a larger percentage of our shipments on ocean versus air, so that's given us some benefit that we have from standpoint. So those are big drivers. And you always have some other things in there relating to a segment mix from a consolidated standpoint, one segment has a higher percentage of the total, like, for instance, of Aviation or Outdoor increases more than other ones, that gives a benefit from that standpoint. So -- and then also you got product mix in there. as it relates to new products that we're launching in the period of time and proposal times of the year also we had. So a lot of different mixes.

Great. Thanks for the color, Doug.

Yeah. Appreciate it.

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, for your time today. Doug and I are available for callbacks this afternoon. Thank you. Bye.

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