Garmin Ltd.

Thank you for standing by and welcome to Garmin Limited Third Quarter 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. However, at any point in time, if you'd like to ask a question, simply press star 1-1 on your telephone. As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Terri Seck, Director of Investor Relations. Please go ahead.

Good morning. We would like to welcome you to Garmin Limited Third Quarter 2022. 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. An archive of the webcast and related transcripts will also be available on our website. This earning 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 or share repurchases, 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. In particular, there is significant uncertainty about the duration and the 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 a best estimate based on the information available as of today's date. 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, 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 U.S. dollar relative to other currencies. Excluding this impact, revenue would have increased about 2% over the prior year. While the stronger dollar 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 of 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 a lower full-year effective tax rate. 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 advanced wellness wearables and indoor cycling products. Growth 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 Pressure Monitor, which measures systolic and diastolic blood pressure at home or on the go. When paired with our Garmin Connect app, users can see their measurement history and trends alongside other health stats. We also launched the Venu SQ2, featuring a bright AMOLED display and up to 11 days of battery life, which is nearly double that of its predecessor. Considering year-to-date performance in the fitness segment, we are maintaining our expectation that revenue will decline 25% for the year. Moving to outdoor, revenue increased 5% to $340 million, driven by growth in adventure watches and in-reach devices and services, but partially offset by declines in other product lines. Gross and operating margins were strong at 65% and 36%, respectively, resulting in operating income of $121 million. inReach remote communication devices and response coordination services have been a strong product category and unique differentiator for the outdoor segment. During the quarter, we launched the inReach Messenger, a versatile communication-focused device with global two-way texting, location sharing, and SOS capabilities. Whenever a customer presses the SOS button, their communication is sent to our Garmin Response Center, which oversees and coordinates a unique response based on the situation. Since launching inReach services in 2011, the Garmin Response Center has coordinated over 10,000 inReach SOS responses in more than 150 countries and on all seven continents for activities ranging from hiking and backpacking to roadside assistance in areas of poor cell phone coverage. Many customers claim that inReach products and services were instrumental in returning safely to family and friends. Considering year-to-date performance in the outdoor segment and current trends, we now expect revenue to grow 17% this year. Looking next at aviation, revenue increased 4% to $188 million, primarily driven by growth in aftermarket product lines. Demand for aviation products remains strong, and we continue to experience higher than normal backlogs for our products. Supply chain constraints have improved, but continue to affect our ability to completely clear the backlog. Growth and operating margins were strong at 73% and 26%, respectively, resulting in operating income of $48 million. During the quarter, we announced that our G3000 integrated flight deck was selected by Tactical Air to modernize F-5 fighter aircraft operated by the US Navy and Marine Corps. Our expanding role on the F-5 demonstrates the capability and versatility of our integrated cockpit systems for use in demanding military applications. Additionally, a recent survey by Aviation International News ranked Garmin number one in avionics product support for the 19th consecutive year. This long period of recognition demonstrates an unwavering commitment to meet the needs of highly demanding markets from owner-flown aircraft to large Part 135 commercial operators. I congratulate our team for once again earning this award, which is a testament to the quality of Garmin equipment and the amazing way our associates care for our customers. The aviation segment has delivered solid performance so far, but supply chain constraints are affecting our ability to achieve our original plan by the end of the year. With this in mind, we are adjusting our revenue growth estimate to 7% for the year. Turning to the marine segment, revenue decreased 5% to $197 million. The marine business is highly seasonal and Q3 typically represents the lowest quarter of the year. For the past two years, these seasonal trends have been difficult to predict due to the influence of the pandemic. we believe the market is returning to more typical seasonal trends. Growth and operating margins were 56% and 23% respectively, resulting in operating income of $45 million. During the quarter, we began shipping the LiveScope XR system, which operates at greater depths and expands the addressable market for live action sonar to coastal and deep lake fishing applications. We also launched the LiveScope Plus ice fishing bundle with high resolution real-time imaging, which creates the ultimate portable solution for winter fishing. And finally, we continue to be recognized for innovation and achievements in the marine industry. For the eighth consecutive year, the National Marine Electronics Association named Garmin Manufacturer of the Year, and we also received five Product of Excellence awards. I'm very proud of our accomplishments in the marine market and I congratulate our team on these achievements. Considering year-to-date performance in the marine segment and the return of typical seasonality patterns, we are lowering our revenue growth estimate to 3% for the year. Looking finally at Otto, revenue decreased 2% to $136 million. as declines in consumer product lines more than offset growth in OEM programs. Gross margin was 40%, and the operating loss, driven by investments in auto OEM programs, narrowed significantly from the prior year to $16 million. During the quarter, we announced that our tread navigators had been selected by Articat as standard equipment on select side-by-side off-road vehicles beginning in model year 2023. Considering year-to-date performance in the automotive segment and current trends, we now expect revenue to decline 7% for the year. So 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 third quarter financial results. Write comments on the balance sheet, cash flow statement, taxes, or updated guidance. We post a revenue of $1 billion $140 million 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 and lower freight partially offset by the net unfavorable impact of foreign exchange rates. Operating expense and sales was 37.8%, a 310 basis point increase for the prior year quarter. Operating income was $239 million, a 15% decrease. Operating margin was 21%, a 270 basis point decrease. Our gap EPS was $1.09. Performing 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 more than offset by declines in the fitness, marine, and auto segments. By geography, America's region was down 2%. The EMEA region was negatively impacted by foreign exchange rates, excluding the impact foreign exchange rates, EMEA sales performance would have been more in line with America's sales performance. APAC region was up 10% for the prior year, excluding the approximate $16 million impact foreign exchange rates, APAC region would have been up 19% for the prior year. Looking next, operating expenses. Third quarter operating expenses increased by $18 million for 4%. Research and development increased $10 million year-over-year, primarily due to engineering personnel costs. SG&A increased $12 million for the prior year quarter, primarily due to increases in personnel-related expenses, information technology costs. Advertising expense decreased approximately $4 million to lower co-op advertising. A few highlights on the balance sheet, cash flow statement, and taxes. End of the quarter with cash and marketable securities approximately $2.7 billion. Account receivable was relatively flat year-over-year and decreased sequentially to $641 million. Inventory balance increased year-over-year to approximately $1.5 billion. This increase was in line with our expectations we've been executing our strategy to reduce freight costs through a higher mix of ocean versus air shipments. During third quarter 2022, we generated free cash flow of $104 million, $100 million decrease in the prior quarter, primarily due to lower operating income, increased working capital needs. Capital expenditures for the third quarter were $50 million. We expect full year 2022 free cash flow to be approximately $450 million, Capital expenditure is approximately $250 million. Also during the quarter, we paid dividends of $141 million and purchased $83 million of the company's shares, leaving $186 million remaining at the end of the quarter. Share of purchase program is authorized through December 2023. During the third quarter of 2022, we reported an effective tax rate of 4.3% compared to 5.9% the prior quarter. Decrease in effective tax rate is primarily due to income mix by tax jurisdiction and increase in U.S. tax deductions and credits. Turning next to our full-year guidance, we estimate revenue approximately $4.85 billion compared to our previous guidance of $5 billion. We expect gross margin to be approximately 57.5%, which is higher than our previous guidance, 56.7%, primarily due to year-to-date performance including favorable segment mix and lower costs. We expect an operating margin of approximately 20.7%. Also, we now expect the full-year 2022 pro forma effective tax rate to be approximately 8%, which is lower than our previous guidance of 8.5% to projected full-year income mix by tax jurisdiction. This results in pro forma earnings per share approximately $4.95. We conclude our formal remarks. Jonathan, could you please open the line for Q&A?

Certainly. Once again, as a reminder, if you have a question at this time, please press star one one on your telephone. And our first question comes from the line of Paul Chung from J.P. Morgan. Your question, please.

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

Yeah, thanks, and 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 standalone indicators, our GI-275 as well as our G-5, 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 lifecycle, 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 follow up on fitness, you know, you're seeing a recovery here in margins. You mentioned earlier this year, you know, FX and 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, you know, can we get back to the 20% here shortly as we head into the holiday season? And then separately on competition, you know, you have Apple with Ultra and Google Pixel here ramping. You know, what is the data showing you on market share and how are you kind of protecting your niche categories? And, you know, are you adjusting prices somewhat, increasing promotions, increasing marketing, anything you can comment there? Thank you.

Yeah, so in terms of fitness, you know, FX definitely did impact us. I think in terms of the improvement we saw, It would be primarily due to product mixes. 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 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.

Thank you. One moment for our next question. And our next question comes from the line of David McGregor from Longbow Research. Your question, please.

Yes, 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 million. I'm just wondering how you're thinking about inventory within that context and what your year-end targets would look like.

Yeah, 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 Q4, our year end, we would expect that our end of year inventory will be lower on a sequential basis compared to a 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, you know, 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 inventories, 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 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, 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, you know, 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 the 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, you know, 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 head counts. Thank you very much.

Thank you. One moment for our next question. And our next question comes to the line of Ben Bolin 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 and 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 online, and then we get a new customer through a used 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're 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.

Yes, the 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. One moment for our next question. And our next question comes to the line of Ivan Pintas 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 monitor, 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. You know, 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 products in wearables, can you give some indication of percentage of people who already own a garment? product and are adding another one because you can tell by the activation and the connection to your app or what percentage are new and let's say how many people let's say continue to use two devices or let's say give it to a family member or add 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 steps in front of me.

Okay, thank you. Congratulations again. Thanks, Ivan.

Thank you. One moment for our next question. And our next question comes from the line of Eric Woodring from Morgan Stanley. Your question, please.

Hey, guys. Good morning. Thanks for taking the question. I guess maybe, Cliff, I'll start with you. Maybe just a high-level question, and that is, you know, 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 somewhat out of line? And then I have a backup. Thank you.

Yeah. Good morning, Eric. 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, 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. Um, we, uh, several years ago, um, created a factory in China. So we, we have that diversity and we're able to quickly stand up capacity where we need it. Um, so we, we just constantly look at that and, um, and, uh, evaluate what our needs are.

Okay. That's helpful. And then, 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? You know, how we should think about, you know, 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, you know, 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 lifecycle that we can promote. The older ones, for example, 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, you know, 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 is just maybe helping us understand what percentage of COGS is in Taiwan dollars versus US dollars. And that's it for me. Thanks.

Yeah. So, uh, yeah, gross margin. So as you mentioned, there's a lot of different, um, moving pieces in, uh, that, um, gross margin number. So, you know, some of our headwinds are probably in the top when we have Lena, that one is just the FX impact we had on revenue. Now we do have, as Cliff mentioned, Now, the side of that, with the strengthening of the US dollar against the Taiwan dollar, there's a lower cost relating to that piece of it, 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 one is that we are shipping a larger percentage of our shipments on ocean versus air, so that's giving us some benefit that we have from a different standpoint. Those are big drivers. You always have some other things in there relating to a segment mix. From a consolidated standpoint, if 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. It also got product mix in there as it relates to new products that we're launching in their period of time. proportional times of the year also we had. So a lot of different mixes through that.

Great. Thanks for the call, Doug.

Yeah, appreciate it.

Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Terri Sack 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 today.

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