Garmin's (GRMN) Cliff Pemble on Q1 2015 Results - Earnings Call Transcript

| About: Garmin Ltd. (GRMN)

Garmin Ltd. (NASDAQ:GRMN)

Q1 2016 Earnings Conference Call

April 27, 2016 10:30 AM ET

Executives

Teri Seck – Investor Relations

Cliff Pemble – President and Chief Executive Officer

Doug Boessen – Chief Financial Officer and Treasurer

Analysts

Ben Bollin – Cleveland Research

Rich Valera – Needham & Company

Simona Jankowski – Goldman Sachs

Paul Coster – JPMorgan

Tavis McCourt – Raymond James

Charlie Anderson – Dougherty & Company

Will Power – Robert Baird

Eugene Anderson – Morgan Stanley

Brad Erickson – Pacific Crest Securities

Operator

Good day, ladies and gentlemen, and welcome to the Garmin Ltd First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As reminder, today’s program may be recorded.

I’d now like to hand the program over to Teri Seck. Please go ahead.

Teri Seck

Good morning. We would like to welcome you to Garmin Limited’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 Limited and its business. Any statements regarding our future financial positions, revenues, earnings, market shares, product introductions, 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 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.

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 has 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 in 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’re 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 an activity tracker categories experience robust growth over the prior year somewhat offset by declines in the multisport category.

Gross and 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 in market transitions.

Our product line 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 as Garmin Elevate wrist heart rate technology to our multi-activity GPS enabled smart tracker. The vívofit 3 has Move IQ automatic activity detection while caring forward the strength that our vívofit family is already known for such as industry-leading one-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 our outdoor wearables and dog products. The outdoor segment continued to generate strong growth in operating margins of 61% and 29% respectively and operating income grew 17% over the year ago quarter. We recently launched several golf products, which have brought new excitement to the market and 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 fish finders. Gross margin declined slightly in the quarter to 53% due to product mix while operating margin improved to 12% as we successfully leverage recent investments in the segment. Operating income grew 125% over the prior year. In recent years, we have 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 have offered and have strong differentiators that standout in a highly competitive market.

Another area of focus has been on improving our cartography offerings. We recently added depth contours to thousands of lakes 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 experience growth in both OEM and aftermarket product lines. Gross and operating margins remain 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, Air Evac, chose Garmin avionics for their fleet of Bell 206 the Bell 407 helicopters. And the United States Forest Service chose our G950 integrated cockpit system for their fleet of Sherpa Aircraft that operate in a 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 of ADS-B transponders. These transponders features an integrated dual ring 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 at PND devices bringing driver systems and awareness features to the aftermarket. Additionally, we experienced strong growth in entertainment 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?

Doug Boessen

Thanks, Cliff. Good morning, everyone. I would 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 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 jurisdictions. 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 will 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 four of our five 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 four 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%.

I 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 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, the 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, but declined 80 basis points to 17.3% of sales. We continue to invest in innovation to increasing resources focused primarily on aviation, fitness and outdoor.

Our advertising expense increased $4 million for the prior quarter represented 5.2% of sales, a 40 basis point increase. Additional spending was focused on fitness investments in media.

SG&A was down $3 million compared to the prior quarter decreasing 150 basis points percent of sales to 15.3%. The lower SG&A expense which are primarily by a decrease in year-over-year litigation related costs.

Few highlights on the balance sheet and cash flow statement. We ended the quarter with cash and marketable securities are worth $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, so it grew product offerings to prepare for seasonally strong second quarter.

During the first quarter 2016 we generated free cash flow of $115 million compared to $64 million in the first quarter 2015. Also during the quarter, we paid dividends of $97 million repurchased about $20 million of company stock with $140 million for remaining to purchase through December 2016.

This concludes our full remarks. Jonathan, please open the line for Q&A.

Question-and-Answer Session

Operator

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

Ben Bollin

Thanks for taking the call and the question. 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 that year-on-year revenue declines and then I have a follow-up?

Doug Boessen

Okay, good morning, Ben. In terms of guidance it’s still very early in the year only one quarter behind us and for a long time now we’ve been facing the ongoing challenge of PND market contractions. 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.

Ben Bollin

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? Thanks.

Doug Boessen

Well in terms of Fitness, our first quarter margin was lower based on product mix and its seasonally lower quarter as well so it’s most 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, market structure. So we feel like the margin there is sustainable going forward.

Operator

Thank you. Our next question comes from the line of Rich Valera from Needham & Company. Your question please.

Rich Valera

Thank you. 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. 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.

Doug Boessen

Well, I think year-over-year we’re going to be comping against some 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.

Rich Valera

Got it. And then can you give any color on – 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 for revenue?

Doug Boessen

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

Rich Valera

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

Doug Boessen

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.

Rich Valera

Got it. Okay. Thank you.

Doug Boessen

Thank you.

Operator

Thank you. Our next question comes from the line of Simona Jankowski from Goldman Sachs. Your question please.

Simona Jankowski

Hi. Thank you very much. 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 margins stabilizing for that segment?

Cliff Pemble

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?

Simona Jankowski

Well sure, where do you see gross margin stabilizing in the fitness segment?

Cliff Pemble

Well, I think it’s really in product roadmap 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.

Simona Jankowski

At the current level? Is that what you are implying?

Cliff Pemble

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.

Simona Jankowski

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, therefore rates were to stay where they are, what would be the embedded FX impact for the full year?

Doug Boessen

Yes, so actually there was little impact of FX on a quarter-over-quarter basis when you look at the euro of last quarter 2015 versus Q1 2016 and that also you had Taiwan dollar impacting that a little bit on the gross margin. So as it relates for the full year, we’re basically if we stay somewhere at that were probably just fitting little impact, [indiscernible].

Simona Jankowski

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

Doug Boessen

No. We don’t anticipate any impact relating to those regulations on our tax rate.

Simona Jankowski

Thank you. Appreciate it.

Operator

Thank you. Our next question comes from the line of Paul Coster from JPMorgan. Your question please.

Paul Coster

Thank you for taking my questions. Couple, first of the Marine segment was very strong relative to our expectations anyway. I am just wondering from a year-over-year perspective, was there something that may contributed to the strength in terms of product cycle or inventory levels or whatever?

Cliff Pemble

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 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.

Paul Coster

Okay. So you’ve noted 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 seeing a change in competitive landscape or consumer taste or you’re going after new markets and market segments that explain this shift?

Cliff Pemble

No. We don’t think so. In Marine, I mentioned there is 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.

Paul Coster

Okay, thank you.

Cliff Pemble

Thank you.

Operator

Thank you. Our next question comes from the line of Tavis McCourt from Raymond James. Your question please.

Tavis McCourt

Hey, thanks for taking my question. I’ve got a couple of them. First, in the Auto segment, I guess if you could give us kind of the logic behind it, I don’t know if it’s a rebranding or new products between new V 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 then freshly 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 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 June impact? Thanks.

Cliff Pemble

Okay. Thanks, Tavis. That kind of the 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 as 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, 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 refer 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 shifting now, so I’d say Q2 impact, not a Q1 impact.

Tavis McCourt

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

Cliff Pemble

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. At this moment we don’t have any material impact.

Tavis McCourt

Great. Thanks, Cliff. Nice start to the year.

Cliff Pemble

Thank you.

Operator

Thank you. Our next question comes from the line of Charlie Anderson from Dougherty & Company. Your question please.

Charlie Anderson

Yes. Thanks for taking my question and congrats on the results. I wanted to ask about Garmin Elevate. I think I heard you Cliff say that that was helpful to margin. 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 in both maybe Outdoor and Fitness?

Cliff Pemble

Yes. So maybe to clarify on that, we went through kind of two-step process in getting to wrist heart rate. The first step was with a third-party solution with our Forerunner 225 and then we transitioned to our Garmin solution after that on our Forerunner 235 and Fenix3 HR.

In terms of margin structure, certainly the wrist-based heart rate products are lowest margin structure than our chest base. But at the same time, our Elevate technology is 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 chest-based solutions of the past.

Charlie Anderson

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

Cliff Pemble

I think those markets are fairly niched 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 the some of the Marine products and it’s been doing very well in channels like VesPRO and Cabela’s.

Charlie Anderson

Thanks so much.

Cliff Pemble

All right. Thank you, Charlie.

Operator

Thank you. Our next question comes from the line of Will Power from Robert Baird. Your question please.

Will Power

Great, thanks. Yes, just I’m curious on 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?

Cliff Pemble

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 uptick of wearables in APAC including both Fitness based wearables as well as Outdoor based wearables.

Will Power

Okay. And did the U.S. still grow year-over-year within Fitness any color there?

Cliff Pemble

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

Will Power

Okay. And then just on 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 driving an outsize benefit?

Cliff Pemble

Well, I think two things in Outdoor that really drove the growth was Fenix line and also dog products. Those are the two major drivers. There was some incremental contribution by Golf but the other two 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, Q3 and Q4 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.

Will Power

Great. Okay. Thank you.

Cliff Pemble

All right. Thank you.

Operator

Thank you. Our next question comes from the line of James Faucette from Morgan Stanley. Your question please.

Eugene Anderson

Hi. This is Eugene 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 and 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.

Cliff Pemble

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.

Operator

Does that answer your question?

Eugene Anderson

Yes. Thanks so much.

Operator

Thank you. Our next question comes from the line of Brad Erickson from Pacific Crest Securities. Your question please.

Brad Erickson

Great. Thanks for taking my questions. 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 two products that’s within Fitness.

Doug Boessen

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

Brad Erickson

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

Doug Boessen

That’s been what we have been experiencing, yes.

Brad Erickson

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

Cliff Pemble

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 maybe not yet the kind of lifestyle or health focus that what you have in the U.S. and in 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.

Brad Erickson

Got it. That’s helpful. Thank you.

Cliff Pemble

Thank you.

Operator

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

Teri Seck

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

Operator

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

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