Garmin Ltd.

Good day and thank you for standing by. Welcome to the Garmin Limited Third Quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone keypad. If you require any further assistance, please press star zero. I would now like to hand the conference over to your first speaker today, Ms. Teri Sec. Ma'am, please go ahead.

Good morning. We would like to welcome you to Garmin Limited Third Quarter 2021 earnings call. Please note that the earnings press release and related slides are available at Garmin's investor relations site at .garmin.com slash doc. 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 position revenues, earnings, gross margins, operating margins, 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 and Form 10-Q file 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 on the company's 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 Pembles, President and Chief Executive Officer, and Doug Bethan, Chief Financial Officer and Treasurer. At this time, I would like to turn the call over to Cliff Pembles.

Thank you, Sherry, and good morning, everyone. As announced earlier today, Garmin reported record revenue of $1.2 billion for the third quarter, increasing 7% over the pandemic fuel levels we achieved in the prior year. Operating income declined year over year to $283 million due to a combination of higher freight costs affecting gross margin and increased expenses as we invest in R&D, information technology, and marketing initiatives. Operating margin was very strong at 23.7%. There are two things to consider when looking at our performance in the back half of the year. First, financial comparisons to the prior year are more challenging due to the pandemic-driven demand and retail disruptions of 2020. Also, we are facing one of the most challenging supply chain environments in history. Our vertically integrated business model and commitment to safety stock was a key factor driving revenue growth for the quarter. But supplies are tight, and we expect freight costs to remain elevated as we rush to fill retail shelves in time for the important holiday selling season. I'm pleased with what we've accomplished in this tough environment, and I'm very proud of our team who've worked tirelessly to maintain continuity of supply from our factories to customers. Last time, I mentioned that we invested in a fourth production facility in Taiwan. I'm pleased to report that this facility is operational and will help us fill more orders during the important holiday selling season. Given our strong performance in the first three quarters of the year, we're updating our full-year guidance. We now anticipate revenue of approximately $4.95 billion, up 18% over the prior year, with double-digit growth expected in each of our five business segments. In a moment, Doug will provide more details on our financial results and updated guidance, but first I'll provide a few highlights for each business segment. Starting with fitness, revenue increased 4% to $342 million, with growth driven primarily by cycling products and advanced wearables. Our Connect IQ development platform is a strong differentiator for us, and we are deploying it across a broader range of Garmin devices. We recently held our fifth annual developer conference where we announced a partnership with Dexcom to deliver real-time glucose information via a Connect IQ app on selected smartwatches and cycling computers, even during activities. Business segment revenue has grown 26% here to date, and we are maintaining our revenue growth estimate of 17% for the year. Moving to outdoor, revenue decreased 3% to $324 million. The decrease in revenue is due to the strong selling activity associated with the launch of our solar adventure watches in the prior year quarter and limited supplies of traditional handheld and dog products in the current quarter. During the quarter, we launched the Approach R10, our first portable golf monitor. The R10 can be used on course or at home to help golfers improve their game with more than a dozen key metrics shown here. The R10 is a product that is shown in real time. Customers are very enthusiastic about the R10, and it's on its way to becoming another Halo product for Garmin. Outdoor segment revenue has grown 26% here to date, and we are maintaining our growth estimate of 17% for the year. Looking next at aviation revenue increased 19% to $180 million with growth in both OEM and aftermarket product categories. During the quarter, we were ranked number one in avionics product support by Aviation International News for the 18th consecutive year. Being consistently recognized for unrivaled support year after year clearly shows our strategic focus on taking care of customers and standing behind our products. We launched Smart Glide, a game-changing safety feature inspired by AutoLand technology that will help pilots manage loss of engine power by automatically flying the optimal glide ratio and navigating to the best available airport. Also in the quarter, we announced the certification of the GFC 600H flight control system on the Bell 505 helicopter. This advanced autopilot includes -the-art safety features such as electronic stability control and a hover assist mode. We're pleased with how the aviation segment has recovered so far this year, and now expect full year revenue guidance to increase approximately 12%. Turning next to the marine segment, revenue increased 25% to $208 million with growth across multiple categories led by chart flotters. We continue to be recognized for innovation and achievements in the marine industry. For the seventh consecutive year, the National Marine Electronics Association named Garmin Manufacture of the Year, and we also received five Product of Excellence awards. During the quarter, we introduced SurroundView, the industry's first intelligent camera system that provides a 360-degree bird's-eye view around the vessel. We also announced our partnership with Malibu Boats. Our seven-inch touchscreen displays will be standard equipment across the Malibu Axis boat line, beginning with the 2022 model year. Given the strong -to-date performance of the marine segment, we are raising our revenue growth estimate to 30% over the year. And looking finally at auto, revenue increased 7% to $138 million with growth primarily driven by OEM programs. During the quarter, we began production shipments of the BMW computing module from our Olathe, Kansas manufacturing facility, and we delivered prototypes of the next-generation BMW system from our new manufacturing facility located in Poland. We also recently announced a refresh lineup of drive navigators for the consumer auto segment. These devices offer larger, higher-resolution displays as well as enhanced connected features. Given the strong -to-date performance of the auto segment, we are raising our revenue growth estimate to 17% for the year. That concludes my remarks. Next, Doug will walk you through additional details on our financial results and updated guidance. Doug.

Thanks, Cliff. Good morning, everyone. Let me 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 $1,192 million for the third quarter, representing a 7% increase -over-year. Gross margin was 58.4%, 180 basis point decrease period of prior quarter. The decrease was primarily due to higher freight costs. Operating expense percentage of sales was 34.7%, 310 basis point increase for the prior quarter. Operating income was $283 million, 11% decrease. Operating margin was 23.7%, a 490 basis point decrease. Our gap EPS is $1.34, reform EPS is $1.41. Next, we'll look at our third quarter revenue by segment. We have a highly diverse business model providing a rich set of opportunities to reduce our reliance on single markets and product lines. During the third quarter, we achieve growth in four or five segments, double-digit growth in both marine and aviation. Fitness is our largest segment, contributing 29% of the sales the third quarter, followed by outdoor at 27%. Looking at revenue by geography, the Americas and the MEA regions grew 10% and 9% respectively, while the APAC region decreased 2%. The Americas region contributed nearly one half our revenue, the remaining coming from the MEA and APAC regions. Looking next, operating expenses. Third quarter operating expenses increased by $62 million, 18%. Research and development increased by 2%. Our average annual average costs increased $39 million year over year, primarily due to engineering personnel costs. S&A increased $21 million prior to prior quarter, primarily due to increased personnel related expenses, information technology costs. Our average annual expense increased approximately $3 million due to higher media spend. A few highlights on the balance sheet, cash flow statement and taxes. Win of the quarter with cash and market securities were $3.2 billion. Counter seed will decrease sequentially year over year to $639 million. Inventory balance increased both a sequential year over year basis to $1.1 billion, primarily due to raw material requirements preparation for the seasonally strong fourth quarter. Turn third quarter of 2021, generate free cash flow of $204 million, $32 million decrease prior to prior quarter. Capital expenditures for third quarter were $41 million. Expect full year 2021 free cash flow to be approximately $750 million, capital expenditures approximately $325 million. Turn third quarter 2021 for an effective tax rate of 5.9%, compared to .9% the prior year. Decrease was primarily due to impact return provision adjustments associated with filing the US tax return. Turning next to our full year guidance. We estimate revenue of approximately $4.95 billion, increase of 18% for the prior year. Doubled the growth each of our segments. We expect gross margin to be approximately 58.2%, which has lowered our previous guidance .5% due to higher freight costs. We expect an operating margin approximately 24%. Also expect the full year 2021 for form effective tax rate to be approximately 11.5%. To result in pro forma, earnings per share of approximately $5.60. This concludes our form remarks. Rachel, could you please open the line for Q&A?

Thank you. As a reminder, to ask a question, just press star and then the number one on your telephone keypad. And to withdraw your question, just press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Paul Chung from JP Morgan. Please proceed with your question.

Hi, thanks for taking my question. So just on aviation, you know, 4Q implied guy kind of suggests, you know, sequential down tick. You typically see an uptick in 4Q. So what's going on there? Is that an impact from, you know, supply chain headwinds and then on up margins, you know, it's stabilized in 3Q, but you still remain well below that low 30s range you've seen historically. So is this the right level to think about moving forward or is there also some, you know, transitory hits in the near term?

Yeah, thanks Paul. I think certainly there's some noise associated with aviation in the prior year versus this year as well. So part of it is timing of shipments that occurred from year to year, but also lead times on equipment in aviation is getting longer. So we're accounting for that and wanting to make sure that we're taking into account all of those factors that might affect Q4 revenue.

Thanks. And then as we think about next year in the context of, you know, pretty strong business jet demand, do you see this business growing along with the industry or at a faster pace given kind of, you know, the new certifications, Autoland and SmartLag that you've introduced?

I think we have the most innovative product line for sure. So across aftermarket and OEM, we're well positioned with our products and on the platforms that are the most popular. The most significant interest in business jet demand right now is in the sweet spot of where our products are installed. So I would expect that we would continue to perform well as the industry performs.

Okay, great. And then lastly, you know, inventory balances have increased as you signaled, you know, how comfortable are you heading into the holiday season with supply components, logistics, and then, you know, separately, as we head into fiscal year 22, you know, how should we think about working cap, particularly in inventory, you're gonna have a bigger harvest and then the pace of cap backs in 22 would be helpful as well. Thank you.

Yeah, I'll just make a comment on the general inventory and then ask Doug to finish the other parts of your question. But in this environment, I think inventory is definitely a positive thing. And we've been able to secure the kind of inventory that we feel we need to make for a successful year. I think nobody would ever say they have too much in this environment and with shipping delays that are taking place that we hear of every day in the news, definitely a higher level of inventory is required. So Doug. Yeah,

first regarding free cash flow and inventory levels, as Cliff mentioned, you know, we'll be continuing to, you know, keep our inventory levels at the appropriate level to meet our demands. So there will be, you know, increased levels at year end with that as relates to a cap backs, you know, our forecast for the current year is $325 million. There's a number of projects that we do have in place, you know, for that. So we do expect some elevated capex, you know, going into 2022. So those things will need to be factored into free cash flow when we come up to 2022 relating to the inventory levels as well as capex.

Thank you.

Thank you.

Thank you, your next question comes from the line of Ben Bolin from Cleveland Research. Your line is open.

Good morning. Thanks for taking the question. Cliff, I was hoping we could talk a little bit about how you think about the advanced wearables business, near term, longer term, within fitness and outdoor in particular. Any thoughts you have on, you know, maybe you saw some pull forward during COVID, you know, how significant do you think that might have been versus, you know, kind of broader secular category growth? Also interested in any thoughts you have on, you know, sell in inventory stocking versus like sell through performance and where channel inventory you feel is today versus maybe history?

Yeah, so I would say in terms of the general performance of those categories over the past nearly two years now, certainly there was a lot of pandemic related interests in those products in the early part of the pandemic cycle. That interest of course, still remains very strong and we believe as the industry has reported that there's still a lot of growth potential in the wearables market. I think we're positioned really well in that market because we are differentiating ourselves around the active lifestyles theme. So everything we do with our products has a purpose and is built for purpose. In terms of sell in versus sell through, I think we can definitely see those trends with our product registrations and we feel like the sell in and sell through has matched very well at this point and the inventory levels in the channel are better than they have been although again, depending on product lines, there can be pockets of imbalances here and there.

And then the other question I have is just in regards to calendar 4Q this year versus prior years, have you seen any notable changes either in timing around retailer commitments, if they prepare for the holidays, any thoughts around the promotional environment versus prior years and anything along the lines with consumer behavior, do you think they're shopping earlier versus prior and that's it, thank you.

Yeah, so in terms of our Q4 versus prior years, last year, I think the market was still very distorted with many retailers starting to reopen or figure out how to open in light of the pandemic and their inventories and online warehouses were very much depleted. So we're still seeing that pandemic driven spike on a year over year comparison basis. In terms of promotional environment this year, I would say that things feel like they're getting a little bit back to normal, although it remains to be seen. I would say that there is not a rush as far as we can see that everyone's trying to shop early, there's obviously reports of that in light of the general inventory situation you see with products on the market, but in general, I would say that it's looking more normal in the seasonality of the business.

Thank

you. Your next question comes from the line of Will Power from Beard, please proceed with your question.

Okay, great, yeah, I guess a couple of questions. First, I was hoping to come back just to some of the supply chain commentary, and I guess just trying to better understand it if possible where you're seeing the primary impacts, what segments I guess in particular, and how you're thinking about the overall impact in Q4 versus what you saw in Q3. Do you expect it to get worse, is it stabilizing? Just some broader views on that front would be great.

Okay, yeah, I would say that the supply chain environment as I mentioned earlier in my remarks is really tough. We're handling thousands of components on a -to-day basis and managing the inflow and the use of those components, and in some case, allocating how they're allocated to product manufacturing. In terms of our Q3, I would say that definitely we saw an impact in the outdoor segment with regard to those products I mentioned, the dog products and the traditional handhelds, but for the most part, across the business, we're doing okay and managing it again on a -to-day basis. So that's generally what we see.

Okay, thanks. And that question on auto, I guess maybe two part. As you think about the OEM segment, what's the current thought process on margin outlook there? I know there've been investments as programs, ramp up, but any thoughts as to how to think about the cadence of margins from here? And then I guess on the consumer side, margins down a bit -over-year, operating margins down a bit -over-year. I assume that's just something tied to mix, but any color there would be helpful too, thanks.

Yeah, so auto OEM in the margin outlook as our business transitions to the tier one manufacturing opportunities that we've been talking about, of course, those have a thinner margin on the gross margin line, so that will definitely impact our gross margin. As we develop the scale and get these programs into production, then of course, what we're working towards is profitable bottom line, but again, you should think of those in terms of traditional auto OEM margin structures. On the consumer side, definitely we saw some impact on margin there, part of that is freight, but we also had some component costs in the consumer auto side that impacted the gross margin.

Okay, thank you.

Thank you, your next question comes from the line of Ivan Fineseth from Tigris Financial Partners. Please proceed with your question.

I thank you for taking my call, and congratulations on good performance in a difficult time.

Thank you.

Some of the headwinds you spoke about, freight, things like that, are you starting to see them abate, or what is your near term outlook on some of these?

In near term, we would say it's an ongoing thing. We probably don't see anything in the near to intermediate term that really changes what's happening right now until there's really more capacity brought into the system, and some of these bottlenecks get solved.

Maybe you have a slight increase in cost, but it's not really disrupting your manufacturing process,

right? I've mentioned we've managed the situation very well, probably as well as anyone could ever imagine, and I would say in this environment, of course we're very sensitive to the profitability, so we're using this situation to reevaluate pricing of both existing products as well as new product introductions and promotions that we do in order to adjust.

In your TAPEX spending, you said you're gonna increase spending on R&D, IT, and marketing. In what kind of R&D areas can you give some idea of what you're working on or see new opportunities also in your IT? What areas are you looking to invest in and improve, and what type of marketing initiatives could we expect to see going forward?

Well, in terms of R&D, one of the bigger pieces of the increase in Q3 was the investment in the auto OEM programs to bring the next generation BMW system to market, which will launch later next year. And then across the business, we've had higher personnel costs as we work to retain our people. And also general growth as we invest in new product categories and new markets across our segments. IT, our business is very much driven around the cloud and the online component of our products and the things that we offer, and so we're investing in the IT infrastructure that we need to support all of that business. Marketing-wise, again, we've got exciting product roadmaps and so we're working on all of those and getting ready to launch new products.

I really like the VEXCOM partnership, the integration into your app and wearables there. What other kind of areas can you give some idea of stuff that you're looking at?

I think Connect IQ is a very versatile platform that allows people to tap into, by far, the best hardware-based platform for wearables and purpose-driven devices that we have in cycling and outdoor, traditional, those kinds of products. So it's a great asset for us and we're constantly working on new opportunities to showcase Connect IQ apps with our devices.

Okay, thank you. Thank

you.

Thank you. Once again, ladies and gentlemen, if you have a question, please press star and then the number one on your telephone keypad. Your next question comes from the line of Nick Tador from Longbow Research. Please go ahead.

Yeah, thanks and good morning, everyone. Question on Marine. I think you guys continue to perform exceptionally well there and even versus tougher comps, especially if you compare it to some of the other segments that benefited last year from COVID, like fitness and outdoor. So can you give us a little bit more details what's driving the ability to address upside in Marine? Is it ability to have better supply than competitors in gaining share or what's the kind of some of the drivers there?

Well, there's a lot of moving pieces and all of that for sure. I would say that our product line is superior and we're gaining market share with particularly some of the halo technologies that we have, such as LiveScope. The supply chain issue is, again, across the business, but in Marine, we were able to benefit there by being able to continue to deliver products and take advantage of opportunities. And then on the OEM side of Marine, they're of course ramping up their production lines to meet the boat demand that is still very persistent and extends even now we're hearing into 2023 in terms of their backlog. So we're working to support those customers, those OEM customers and support the general growth of the market that's taking place right now.

Okay, thanks for that. And then a question on the model, Doug, maybe, sorry if I missed this, but you took gross margin down for the year, but then the operating margin up. So can you share what is the offsetting factor there?

Yeah, it's really leveraging operating expenses. So looking at operating expenses really gave that difference between the operating margin as well as the gross margin decline there.

Okay, okay, got it. Thanks, that's all the questions for me. Good luck,

guys.

Thanks, Nick. Thank you, and once again, ladies and gentlemen, if you have a question at this time, please press the star and then the number one key on your touchstone telephone. Again, just press star and then the number one on your telephone keypad. Our next question comes from the line of Eric Woodring from Morgan Stanley. Your line is open.

Thank you, and good morning, everyone. Cliff, I guess this one's just for you. I just wanna be clear. Would you say as you sit here today, obviously we know about the supply chain challenges, but do you feel confident right now in Garmin's ability to have products on the shelf for the holiday season? I just wanna start with that one, then I would follow.

Yes.

Easy enough. APAC was noticeably.

I'm not sure. I'm not sure you heard me correctly. You said, are you confident, and I said yes.

Yep, no, that's perfect. Second question was just, if we look by geographies, APAC was noticeably weaker than North America or Andamia. Just curious if you could share some color there, why that would be, thanks.

Yeah, in APAC, there's really two factors. One was the rolling progress of the pandemic as Delta swept through various countries across the region, and so we had some impact in the markets generally as there were more stringent lockdowns and measures taken to control the Delta spread. And then the other major factor was the timing of product introductions, particularly in outdoor. The APAC market is definitely reliant on those product introductions, and so they're comping against the very strong introduction of our solar products that we did last year in Q3. Got it, thanks. If I could just

sneak one last one in there. You made those comments about the boating market, specifically the OEM market. I guess with that, the fact that backlog is potentially extending out to 2023, is it accurate to say that there might not be as weak of a off-season this year similar to last year? Is that a fair thing to say?

Well, I think the OEM part of the business is a smaller percentage compared to aftermarket. So even if it swings to a greater degree, it's less influential on the overall business just because of the mix of that. But that said, I would say that the seasonality of marine is a little bit more normal in the current year versus where we saw last year. So we would expect as economies and business activity tends to normalize around the pandemic and endemic behaviors of this virus, that the marine industry would also return to its normal seasonality, and we've seen some of that in Q3 and Q4.

Okay, perfect. Thank you,

guys. Yep, thank you.

Thank you. Once again, ladies and gentlemen, if you have a question, just press star and then the number one on your telephone keypad. I'm showing no further questions at this time. I would now like to turn the conference back to Terry. Please go ahead.

Thanks, everyone, for your time today. Have a great day. Bye.

This concludes today's conference call. Thank you for participating. You may now disconnect.