Garmin Ltd.

Good day, ladies and gentlemen, and welcome to the Garmin Limited Second Quarter 2019 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 follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Terry Seck, Investor Relations Manager. You may begin. Thank you.

Good morning. We would like to welcome you to Garmin Limited's second 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. An archive of the webcast and related transcripts 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 position, revenues, earnings, gross and operating margins, and future dividends, market shares, 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. Presenting on behalf of Garmin Limited this morning are Cliff Pimble, President and Chief Executive Officer, and Doug Besson, Chief Financial Officer and Treasurer. At this time, I would like to turn the call over to Cliff Pimble.

Thank you, Terri, and good morning, everyone. As announced earlier today, Garmin reported strong results, including record revenue and operating income for the second quarter. Consolidated revenue for the quarter came in at $955 million, up 7% over the prior year. Aviation, marine, fitness, and outdoor collectively increased 12% year over year. Gross margin improved to 60.3%. Operating margin expanded to 26.8%. Operating income increased 18% to $256 million. This resulted in GAAP EPS of $1.17 and pro forma EPS of $1.16 in the quarter, up 17% over the prior year. We are pleased with our performance for the first half of 2019, and these strong results give us confidence to raise our full year guidance. Doug will discuss our financial results in greater detail in a few minutes, but first I'd like to provide a few brief remarks on the performance of our business segments. Starting with the aviation segment, revenue increased 20%, driven by growth in both aftermarket and OEM product categories. We experienced strong growth in our ADS-B product offerings. Gross and operating margins remained strong at 75% and 36%, respectively, resulting in operating income growth of 27% over the prior year. During the quarter, we achieved certification of the G5000 integrated flight deck for the Citation XL and XLS, bringing a state-of-the-art cockpit system to this popular family of aircraft. We also announced the availability of the NXI upgrade for Cessna and Beechcraft models equipped with the original G1000 system. We continue to see strong customer demand and appreciation for this upgrade program. As I mentioned earlier, ADS-B has been a significant driver of growth in our aviation business. According to the FAA, as of July 1, 2019, approximately 91,000 total aircraft have been equipped, of which approximately 7,000 are commercial aircraft. Of the remaining 84,000, Garmin has captured roughly 80% market share. Based on everything we see, it is likely that the ADS-B opportunities will continue into 2020. While ADS-V has been a significant opportunity, it's not the only opportunity for the aviation segment. New OEM platforms, retrofit cockpit systems, NXI upgrades, and the growing demand for trainer aircraft represent opportunities for growth beyond the ADS-V cycle. We are optimistic about the future of our aviation business. Looking next at marine, revenue increased 13%. as we experienced strong demand for our chartplotters and Panoptix LiveScope sonars. Growth and operating margins were 61% and 28%, respectively, resulting in strong operating income growth. Last quarter, we mentioned that the Independent Boat Builders Incorporated named Garmin its Supplier of the Year. I'm pleased to report that our relationship with IVVI has expanded and now includes audio equipment. Our fusion brand of marine electronic systems was selected by IBBI as a preferred choice for its members. New markets and new product categories are an area of strategic growth because they represent significant growth opportunities. In keeping with this strategy, at the recent ICAST fishing show, we introduced FORCE, our first entry into the freshwater trolling motor market. FORCE was named Best New Boating Accessory and won the coveted Best of Show Award for 2019 making Garmin a back-to-back best-of-show winner at ICAST. We are very proud of the accomplishments of our marine team, and we're excited about the new opportunity that force represents in the segment. Looking next at the fitness segment, revenue increased 12%, driven by growth in running products as well as contributions from our recent acquisition of tax. Growth and operating margins were 54% and 20%, respectively. During the quarter, we began shipping our refreshed line of forerunners, providing both smartwatch features and enhanced running dynamics for all capabilities of runners. We also completed the acquisition of tax and are now in the process of expanding the distribution of tax products through Garmin retailers. Turning next to the outdoor segment, revenue increased 4% on a year-over-year basis, driven by growth in our golf and in-reach products. We believe this is a remarkable accomplishment, considering the significant impact of the Fenix 5 Plus launch during the first half of 2018. Growth and operating margins were 64% and 34%, respectively. During the quarter, we began shipping the Mark Luxury Watch. In addition, we experienced strong demand for golf wearables and the Instinct Adventure Watch. We also introduced a refreshed line of handheld navigators adding in-reach satellite communication technology to our flagship handheld devices. Looking finally at the auto segment, revenue decreased 13% due to the ongoing decline of the P&D market. Gross and operating margins improved year over year to 48% and 16% respectively. Our global market share position in the P&D category remains very strong. We launched the DriveSmart 65 with integrated Alexa Personal Assistant, bringing enhanced voice control functionality to drivers. We also announced the Garmin Overlander, an all-terrain GPS navigator specifically designed to fit the needs of the growing overlanding community. This is a unique product offering for those looking to explore off the grid. In summary, we are very pleased with our results in the first half of 2019. Given this strong performance, we are raising our projected revenue to approximately $3.6 billion for the year, representing an 8% increase over the prior year. Gross margin is projected to be 59.5% for the year. Operating margin is projected to be 23.2%. Assuming a pro forma effective tax rate of 16.5%, Performa earnings per share is expected to be approximately $3.90. Looking at our annual revenue outlook by segment, we have increased our growth expectations for the aviation segment to 17%, the marine segment to 12%, and the auto segment to down 15%. Fitness and outdoor are unchanged. That concludes my remarks. Next, Doug will walk you through additional details on our financial results. Doug?

Thanks, Cliff. Good morning, everyone. I begin by reviewing our second quarter financial results through the comments on the balance sheet, cash flow statement, and taxes. We posted a revenue of $955 million for the second quarter, representing a 7% increase year-over-year. Close margin was 60.3%, 180 basis point increase from the prior year. Operating expense percentage of sales was 33.4%, 80 basis point decrease from the prior year. Operating income was $256 million, 18% increase year-over-year. Operating margin was 26.8%, 250 basis point increase in the prior year. Our GAAP EPS was $1.17, our GAAP EPS for year. Next, we look at our second quarter revenue by segment. We achieved record second quarter revenue of $955 million. Consolidated revenue grew 7%, led by double-digit growth in our aviation, marine, and fitness segments. Also, the outdoor segment had solid growth during the quarter. On a combined basis, aviation, marine, fitness, and outdoor were up 12% compared to prior year quarter. Looking next at second quarter revenue and operating income. On a combined basis, aviation, marine, fitness, and outdoor segments contributed 83% of total revenue in the second quarter of 2019, compared to 80% in the prior year quarter. Aviation grew from 17% to 19%. Marine grew from 15% to 16%. And fitness grew from 25% to 26%. You can see from the charts that illustrate our profit mix by segment. On a combined basis, aviation, marine, fitness, and outdoor segments delivered 90% of operating income in the second quarter of 2019, compared to 94% second quarter of 2018. The aviation, marine, and auto segments had strong year-over-year increases in operating income dollars and improved operating margins. Looking next, operating expenses. Second quarter operating expenses increased by $13 million, or 4%. The percentage of sales operating expenses were 33.4% in the second quarter of 2019, 80 basis point decrease in the comparable quarter last year. Research and development increased $7 million year-over-year to investments and engineering resources. The advertising expense was down $2 million for the prior quarter to the lower expenses and auto segment. The SG&A was up $8 million compared to the prior quarter to relatively flat expenditure sales. The increase was primarily due to personnel-related expenses and incremental costs associated with recent acquisitions. A few highlights on the balance sheet and cash flow statements. We ended the quarter with cash and marketable securities approximately $2.4 billion. Account receivables increased sequentially year-over-year to $584 million due to strong second quarter sales. The inventory balance increased sequentially year-over-year to $648 million due to timing of new products, raw material requirements, acquisition of tax. During the second quarter of 2019, we generated a free cash flow of $80 million, a $77 million decrease in the prior quarter. Also during the quarter, we paid dividends of $108 million. During the second quarter of 2019, we reported an effective tax rate of 18.9% compared to an effective tax rate of 19.4% prior to the quarter. We continue to expect our full year 2019 to perform an effective tax rate of approximately 16.5%. This concludes our formal remarks. Gigi, could you please open the line for Q&A?

Ladies and gentlemen, at this time, if you have a question, please press the star, then the number one key, on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. And our first question is from Charlie Anderson from Dougherty and Company. Your line is now open.

Yeah, thanks for taking my questions, and congrats on the strong results and the upside guidance. Thanks, Charlie. Yeah, so I want to start just within the guidance. You know, I think outdoor, you had sort of single-digit growth in the first half, but you're still calling for 10% for the year. So I wonder if you could just kind of speak to what you anticipate happening in the second half to sort of reaccelerate the growth rate there. And then on tax, I guess I'm just kind of curious sort of where things stand now. You know, you're integrated to some degree, but how much headroom is there to improve gross margin and then also some of the sales distribution there? And then I've got follow-up.

Yes, so outdoor, we do anticipate in the back half that we'll be refreshing product lines, so that's built into our assumptions on the outdoor segment. As far as tax goes, it's early days, but we are in the process of integrating them into our business infrastructure, including our supply chain, and they are also working on updating their factory facilities in order to build trainers there. In terms of gross margin, again, early days, but there's probably opportunity to improve over time, but that would take some amount of time to be able to realize those savings as we go along.

Perfect. And then, Doug, just real quick on inventory, it seemed like it was up a decent amount year over year. I wonder if you could just expand on what was going on there.

Sure. Yeah, inventory is up year over year. It's due to a number of factors, one of which is just timing of product launches, just anticipation of product launches in the back half. Also, some raw material requirements, just making sure we have appropriate levels of safety stock. And also, we acquired tax, so that basically was an incremental increase year over year. Also, looking at the prior number, probably a little bit lighter last year on inventory than we'd like to have been. Kind of looking at inventory on the go forward for the rest of the year, I probably would expect the year-end inventory balance to be pretty similar to what I saw in Q2. It will probably go up some in Q3, probably similar type of year-over-year change I saw in Q2, but it will come down some in year-end. We just want to make sure we have appropriate levels of inventory to meet our continuing demands.

Perfect. Okay. Thanks so much. Thank you.

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

Thank you. Good morning. So strong performance in aviation, and you attributed that to ADS-B, and I guess I just wanted to follow up if you thought that or why you thought that the ADS-B activity would continue into 2021 or, sorry, 2020, just what your thoughts are there.

Yeah, so ADS-B was definitely a growth factor for the segment, but it's not the only factor. As I mentioned, there's really broad-based growth across many product categories and also the segments of the market, OEM and aftermarket. In terms of our views of the activity after the mandate, we're basing that on feedback from our installing partners who are telling us that they are booked out, some now into 2020, and And just looking at the total number of aircraft that remain to be equipped and the rates at which they're currently being equipped, we feel like there's a good chance that those will continue into 2020.

Got it. That's helpful. And then just on the tax acquisition, can you say how much of the year of your growth in 2Q was from tax and then You made reference to the margins there. Can you just give us a sense of what their gross margins are, either in absolute terms or relative to historical fitness gross margins?

Yeah. So as it relates to the amount of tax for Q2, it was a little bit under half. We do expect tax for the full year to be about a half of the year-over-year growth in the fitness business. Then it relates to the gross margins. We don't give a specific gross margin by each one of our product lines, but like Cliff mentioned, we're looking to improve those over time. Okay. Thank you. Thank you.

Thank you. Our next question is from Ben Bolin from Cleveland Research. Your line is now open.

Good morning, everyone. Thanks for taking my question. Cliff, could you talk a little bit more on aviation? Any thoughts on the mix of OEM versus retrofit? And then you talked about ADS-B continuing into next year. Do you have any thoughts about the potential? Have you seen any pull forward of other retrofit activity, you know, last year, this year, as those aircraft go out of service? And how do you think about that implication on a look-forward basis out, you know, late 2020 and beyond? And then I have a follow-up.

Okay, so Ben, the mix in terms of OEM and retrofit, we don't break it down in detail, but we've said directionally in the past that it's roughly split between the two evenly, and that remains to be true. And we saw pretty much identical growth rates between those two categories of product for the quarter. So there's strength across both categories of the markets that we serve. In terms of pull-forward impact on ADS-B, for sure, those people that have equipped with ADS-B and have taken the time to fully upgrade their panels with new technology, they obviously are not going to be upgrading in 2020 again, per se, but there's many, many more aircraft out there that are needing new technology. Some of them are flying with equipment that's decades old, and we believe this is an opportunity for people to reassess the electronics in their aircraft and upgrade to new technology that's available now.

Okay. And then within the auto mobile business, could you talk maybe a little bit about how the revised guidance, is that all inclusive of first half? Is it inclusive of contribution from BMW China later this year? And then any longer term thoughts or color you can provide on the lead design opportunity with BMW? Where are you in the facility, and when does that become more material over time? Thank you.

Okay, so our automobile guidance takes into account everything we've experienced so far. We're rolling forward the benefits that we've had into the guidance and not making bold assumptions about where the market will go, although we're pleased with how the performance of certain product categories in the segment have performed. particularly the higher-end T&D lines, have been stronger than what they've been in the past. So that's all good news. In terms of BMW, the first set of our programs is scheduled to be a 2020 program, and that's progressing. As we have said before, there will be minimal impact in 2019. That's been built into our guidance, obviously. And the newer sets of business that we've won with BMW is an ongoing effort that we'll take some number of years now to develop, but we're in the process of investing in the capital infrastructure that we need to be able to support that program, including upgrading some of our existing factories and establishing a new facility in Europe. Thank you. Thank you.

Thank you. Our next question is from Paul Chung from J.P. Morgan. Your line is now open.

Hi, thanks, guys. Thanks for taking my questions. So just a follow-up on aviation. So your guidance kind of suggests, you know, a slowdown in second half relative to the first half. Is that just some conservatism there? Or, you know, do you think ADS-B upgrades have kind of peaked in 2Q?

Yeah, I think we definitely see, you know, some reason to be a little more cautious in the second half. We're comping against really strong growth numbers last year And the installation capacity in the field is pretty much established and fixed, so it's harder to grow on big numbers like we did in the past. So we believe that's a solid guide for the segment. And inevitably, as we approach the deadline, there will certainly be a wind down of the activity as we go forward. So we're looking forward to that as well.

Okay, thanks for that. And then a follow-up on outdoor margins, you know, with the kind of refresh of Phoenix probably coming in the second half, how should we kind of think about operating margins there as, you know, we're kind of hitting some tough comps there as well. Is there some possible up-list maybe to ASPs on the refresh?

Yeah, I can't comment on specific plans for the line, but I would say that like every other product launch that we do, there's opportunities for improved margin, both gross and operating margins as new products come into the mix and we promote the older products that are being phased out.

Okay, and then last question on fitness. Thanks for the kind of reiterated six points of growth from tax this year. Is that mainly from the kind of existing base European business and does not include any Americas or Asia expansion potential? And then what's your initial read on possible demand in those regions?

I think it's based on what we see from the tax business historically, and rolling out the product into new markets does take some time, so there's some incremental benefit from that, but that's already figured into our outlook.

Thank you.

Thank you.

Thank you. Our next question is from Yvonne Francis from Tigris Financial. Your line is now open.

Thank you for taking my question, and congratulations on another great quarter.

Thanks, Ivan.

I have two questions. First, there's a coming European ADS-B mandate that looks like it starts in June of 2020. What type of opportunity do you see there?

Yeah, that's an opportunity we're obviously watching and preparing for. It's certainly going to be a much smaller opportunity than what we've seen in the Americas because the majority of ADS-B potential aircraft are in the American market. But still, it remains an opportunity for us to be able to serve that mandate as well.

Very good. And now on the tax product line. What type of opportunity or like new product introduction do you see in their fitness equipment in addition to, I guess, what they call the fitness trainers is where it attaches to a bicycle, but they have a really nice treadmill and exercise bike, which I think that could be a big opportunity. What is your outlook or vision for bringing new products in those lines to market and their marketing plans?

Well, we won't comment on specific plans, but I would say that we do have a solid roadmap in the tax division for their products, and we're investing more in R&D to be able to bring those to market.

Okay.

Very good.

Thank you.

Thanks, Ivan.

Thank you. Our next question is from Will Power from Baird. Your line is now open.

Great, thanks. Maybe first question on fitness. I know you introduced some new forerunners. I guess any early color on what sell-through is looking like versus initial sell-in on those products?

Yeah, we think the sell-through is very strong. The products have been received very well by the market, and we're excited about the new products.

Okay, and then... On the outdoor front, I guess it's probably early, but as you look at some of the new products introduced, I guess the Mark Instinct, any initial thoughts on demand there? I guess this is the first time in a while we haven't heard Phoenix called out. I'm guessing that's a function of timing and refresh, and do we expect that to get refreshed in the second half?

Yeah, so Mark, we're very pleased with how things have gone out of the gate. The The sell-in was delightful for us, and the sell-through has been something that we think is very strong. The Instinct has been a very strong product for us. It's expanded the base of users in the Adventure Watch market, so it's got a strong following, a strong sell-through. The Fenix, obviously, it's been a little over a year now since we introduced the Fenix 5 Plus, and we expect to have additional new product announcements coming shortly.

Okay, thank you.

Thank you.

Thank you. Our next question is from Eric Woodring from Morgan Stanley. Your line is now open.

Hey, good morning, guys. Congrats on the quarter. I guess I just want to start out on aviation again since you brought up the new data points from the SAA. So I just want to confirm if we're 91,000 or through 91,000 planes. Does that imply basically that there's something like 10,000 to 70,000 more upgrades to go before year-end, and then I have a follow-up.

Yeah, I think there's admittedly some amount of shifting definitions of those numbers provided by the FAA, and we interpret the 90,000 obviously as including everything, like I highlighted, including commercial as well as experimental aircraft. The 100,000 to 160,000 aircraft probably only includes just those GA aircraft, and people aren't really thinking about the high-end experimentals that also want to have that equipment. So we see a pretty significant runway, even if you ignore those nuances and just look at it for what it is. We think that the 100 number is certainly too low, and if you look at the higher number, the 160, it would appear that we have nearly the same amount of market left to go in the cycle. So that represents a significant opportunity.

Awesome. Thank you for that color. And then I guess if we could just talk about marine quickly. So you raised guidance. I'm just wondering if that's a result of general market growth in the marine business, a result of macro factors, or is it more a function of you guys getting more share than you originally expected?

I think there's a combination of those factors. Certainly the market has been strong, especially in the higher-end votes, and that's where our equipment and our content is very strong. But we also see market share gains as we've introduced these disruptive new technologies like Panoptix LiveScope that's caused people to rethink their choices and purchase new equipment that's compatible with our system so that they can take advantage of the new technology.

Awesome. Thank you again.

Thank you.

Thank you. Our next question is from Nick Totoro from Longbow Research. Your line is now open.

Hi, guys. Thanks for squeezing me in. Cliff, on ADS-B, we've been talking about tight capacity for a while now, and we saw some inflection in ADS-B installations this quarter. So in your view, where did the capacity come from in order to accommodate those installations? And you're obviously guided to upside in aviation relative to prior expectations. So there seems to be some incremental demand that's coming up. Where do you see that capacity, I guess, coming from?

Yes, so a few factors. One is that the market is certainly gravitating towards quicker solutions as we get closer to the mandate. People are realizing that they need to be compatible with with the mandate, and so they're selecting some solutions right now that will get them by. We expect some of those will come back in the future to do more. We've also been working proactively to expand our install base, so that's helped improve the throughput, certainly of our equipment. So that's yet another factor that's out there. And then finally, I think shops have figured out how to be more efficient, and so they've obviously been hiring people. The rates, the labor rates have been improving, which of course attracts employees into the field. So there's many different combinations of things that are going on that have improved the throughput in recent months.

Okay. And just as a follow-up on ADS-B, so there's some indication that suggests that a lot of the remaining planes that are yet to be equipped with ADS-B are older airframe machines that the owners may hesitate whether to upgrade or to scrap the airplane. I mean, what are you hearing from your partners and and dealers in terms of the mix of remaining aircraft that need to get equipped with ADS-B in terms of what's the likelihood that we're going to get to that 160 high end of estimates?

Well, certainly, you know, hitting the high end is more of a challenge than hitting the lower numbers, but we do think it's possible to do. For the airframes that are out there where people might be contemplating the upgrade versus scrap, I think those airplanes probably aren't candidates anyway, so they've already been factored into the projected numbers.

Okay, got it. And, Doug, on OPEX, we've talked about this in the last couple of quarters, but have your expectations changed? I'm just asking because the first half, growth in OPEX trailed growth in sales, and the guidance kind of implies that. a pretty steep growth, maybe a little bit abnormal in OPEX in the second half. I know tax is playing a factor, but I guess, can you please refresh your expectations there?

Yeah, sure. You're exactly right. Tax and acquisitions will play a bigger factor in the back half, so that will cause our OPEX to grow at a faster rate in the back half. So, give kind of a rundown between the different OPEX. So, overall, Operating expenses consolidated, we'd expect as a percentage of sales probably about a 50 basis point increase year-over-year. Looking at advertising, I still think as a percentage of sales, that would probably be a relatively flat year-over-year. So probably have some year-over-year increases in advertising just as we have new product launches come out in the back half and they're a little bit higher year-over-year increase than we saw in the first half. Then as it relates to R&D, I would expect that to be relatively, as a percentage of sales, a consistent year-over-year. Then in SG&A, that will probably be up about 50 basis points, and that's primarily due to, you know, the acquisitions impact on the back half of the year for a full period of time.

Okay. So it seems like relative to original expectations, you know, R&D is not expected to be flattish versus previously I think you were expecting plus 50 basis points. So you get some efficiency there.

Yeah. And that's really because of leveraging the sales. You know, we took our sales up from that standpoint. So, you know, in the R&D area, we're continuing to add headcount there for our product lines, but continue to optimize that as we go along. But, yeah, it's really just due to leveraging, you know, basically increased sales.

Okay, that's helpful. Thanks, guys. Good luck.

Yep, thank you.

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

Great. Thank you, everyone, for calling in. Doug and I are available for callbacks throughout the day. Have a wonderful one.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.