Good day, ladies and gentlemen, and welcome to the Garmin Ltd. 3rd Quarter 2018 Earnings Conference Call. At this time, all participants on the listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time. As a reminder, this conference call is being recorded.
I would now like to introduce your host for today's call, Ms. Mary Sac, Manager of Investor Relations. Ma'am, you may begin.
Good morning. We would like to welcome you to Garmin Limited's third quarter 2018 earnings call. Please note that the earnings press release and related slides are available at Garmin's a relation site on the internet at www.garmin.com/doc. An archive of the webcast related transcripts will also be available on our website. As a reminder, we adopted the new U.
S. GAAP revenue standards in the first quarter of 2018. The prior periods presented here have been restated to reflect adoption of this new standard. 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 Pemble, 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 Pemble,
Thank you, Terry, and good morning, everyone. I'd like to begin by mentioning a couple of important milestones we recently celebrated. During the third quarter, we shipped our $200,000,000 product, which is a testament to our ability to design, manufacture and sell unique applications of technology for active lifestyles. Equally is exciting. We started production in our new aviation manufacturing facility, located in Olathe, Kansas.
This new facility more than doubles our production capacity, allowing us to serve our growing aviation business for many years to come. Moving now to the quarterly results earlier today, Garmin reported strong 3rd quarter consolidated revenue of $810,000,000, up 8% over the prior year. Marine Aviation Fitness and Outdoor collectively increased 16% year over year and contributed 80 percent of total revenues. Gross margin improved to 59.4% compared to the prior year. Operating income This resulted in GAAP EPS of $0.97 We are pleased with our performance in the 1st 3 quarters of 2018, and these strong results give us confidence to raise our full year EPS 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 Marine segment, revenue increased season. Approximately half of the growth was organic, while the other half came from acquisitions. Gross and operating margins were 59% and 14% respectively. We recently announced our GPSMAP 8600 series of chartplotters.
This is the first product We've been very intentional about investing in our Marine segment and the industry is taking notice. For the 4th consecutive year, we were recognized by the National Marine Electronics Association as manufacturer of the Year and Panoptix LiveScope won their prestigious Technology Award. We were also recognized as one of the top 10 most innovative marine companies in 2018 by soundings trade only which is a B2B news and information provider for the recreational boating industry. It's an honor to be recognized by the marine industry, and we will continue to invest in this segment to maximize its potential. Turning next to Aviation, revenue increased 17% driven by broad based growth within the segment.
Gross and operating margins increased to 76% and 35% respectively, resulting in operating income growth of 49% over the prior year. During the quarter, we completed the acquisition of fliteplan.com and have begun integrating these new services into Garmin's existing apps. Also, we recently announced that our ADS B solution was selected by Gulfstream for the G280 aircraft. Finally, we announced a teaming agreement with Bell to supply Avionics for on demand mobility vehicles. While this project is in its early stages, It's an important first step towards creating a viable urban air transport system.
Turning next to the fitness segment, revenue increased 14%, primarily driven by growth of our wearable products. Gross and operating margins were 54% 20%, respectively, and operating income grew 12% over the prior year. During the third quarter, we launched the Vivo Smart 4, a slim smart activity tracker that includes a pulse ox sensor, In addition to providing blood oxygen saturation levels, this device also provides users with advanced sleep monitoring, and the new body battery feature that helps individuals understand and manage their energy levels throughout the day. We also added Disney Princess and Marvel Spiderman bands to our popular VivoFit junior product line, along with new mobile app adventures. Turning next to the Outdoor segment, revenue increased 13% on a year over year basis.
Driven primarily by growth in wearables. Gross and operating margins improved year over year to 65% and 38% respectively, resulting in operating income growth of 16%. We recently announced the integration of Spotify for the Phoenix 5 plus series and just this morning, the 46400 and 645 music was added to the list of Spotify compatible wearables. This gives our customers the ability to download Spotify playlists through the watch via the Spotify app, which is available from the connect IQ store. The app is already proving to be very popular with customers.
During its first full day of availability, Spotify set a record for the most downloads of a new app from our connect IQ store. Finally, we recently announced Instinct, a rugged and reliable GPS smartwatch designed to expand the market for outdoor wearables. Looking finally at the auto segment, revenues decreased 16% due to the ongoing decline of the P and B market. Gross and operating margins declined year over year to 43% and 9%, respectively. Our global market share position in the PND category remains very strong.
Beginning in model year 2020. This award demonstrates the progress we are making as a Tier 1 auto supplier. In summary, we are pleased with our results in the 1st 3 quarters of 2018. Light of the strong 3rd quarter results, we are making some adjustments to our guidance. We anticipate our 4th quarter revenue to be relatively flat on a year over year basis with full year revenue of approximately $3,300,000,000 and a gross margin of 58.5 percent We are raising our full year operating margin to approximately 22% and lowering our full year pro form a effective tax rate to approximately 16%, resulting in pro form a earnings per share of approximately $3.45.
That concludes my remarks. Next, Doug will walk you through additional details on our financial results. Doug?
Thanks, Cliff. Good morning, everyone. I'd like to begin by reviewing our third quarter financial results. Let me do comments on the balance sheet, cash flow statement and taxes. Post a revenue of $810,000,000 for the 3rd quarter, representing 8% increase year over year.
Gross margin was 59.4% 120 basis point increase from the prior year. Operating expense as a percentage of sales was 35.2% consistent with the prior year. Operating income was $196,000,000, a 13% increase year over year. Operating margin was 24.2% 1 or 10 basis point increase from the prior year. Our GAAP EPS was $0.97, pro form a EPS was $1, 30% increase from the prior year.
Next, look at our 3rd quarter revenue by segment. During the quarter, we achieved 8% consolidated growth led by double digit growth in 4 of our five segments. This growth was partially offset by a decline in our auto segment as a result of continued decline in our auto P and D business. Combined basis, marine, aviation, fitness and outdoor were up 16% compared to prior year quarter. Looking next at 3rd quarter revenue and operating income.
On a combined basis, marine, aviation, fitness and outdoor segments contributed 80% total revenue third quarter 2018 compared to 74% in the prior year quarter. All declined from 26% to 20% while every other segment grew. Marine grew from 10% to 12% and fitness grew from 22% to 24%. You can see from the charts illustrate our profit mix by segment combined basis, the marine, aviation, fitness and outdoor segments delivered 92% operating income in third quarter 2018, compared to 89% third quarter of 2017. The Aviation Outdoor segment's year over year increase in both operating income dollars and operating margin.
Looking next to operating expenses. Our 3rd quarter operating expenses increased by $21,000,000 or 8%. Research and development increased $9,000,000 year over year due to investments in engineering resources and recent acquisitions. Our advertising expense was down $1,000,000 for the prior year quarter. SG and A was up $13,000,000 compared to the prior year quarter increased 60 basis points as a percent of sales.
Increase was primarily due to personnel related expenses, incremental costs associated with recent acquisitions. A few highlights on the balance sheet and cash flow statement. End of the quarter with cash and marketable securities are approximately $2,500,000,000. Account receivable decreased sequentially due to seasonal trends and increased year over year on stronger sales. Inventory balance increased on a sequential basis to $557,000,000 compared for the seasonally strong 4th quarter.
In the third quarter 2018, we generated free cash flow of $234,000,000, $81,000,000 increase for the prior quarter. Also during the quarter, we paid dividends of $100,000,000. During the third quarter of 2018, we reported an effective tax rate of 8.5% compared to the effective tax rate of 20.5% in the prior quarter. The decrease in effective tax rate is primarily due to benefits from U. S.
Tax reform and increased benefit from U. S. R and D tax credits. We expect our full year 2018 pro form a effective tax rate to be approximately 60%. This concludes our formal remarks.
Miranda.
First question is from Charlie Anderson from Dougherty. Your line is open.
Yes, thanks for taking my questions. It looks like on the guidance, you guys have kept pretty much everything with the exception of the operating margin a little bit higher. So maybe if you could just add a little color on why you're seeing the better operating margin despite it looks like mix is going to fairly similar. And then as a follow on question, Cliff, I just would be curious in your thoughts on the geopolitical situation in terms of its impact on your business. Are you Are you seeing anything changing in terms of consumer behavior in Asia?
And then I don't think you want to be a contract manufacturer, but what people scrambling to to move outside of China. Are there any opportunities for you guys? Thanks.
Yes. So in terms of guidance, basically each segment that comprises our guidance has a different set of circumstance that we're looking at there. So we took each one of those into consideration when we constructed our guidance and the result came up to essentially relatively flat with last year. With the product mix and the overall trends we're seeing, we felt confidence to upgrade our operating income estimate as well. In terms of geopolitical issues right now, we don't really see anything that's moving the needle in terms of concerns.
The Asia demand still appears to be very strong. I think there's increasing competition in some of the product lines there, particularly in wearables, but but we are very competitive with our product line. I would say we probably don't have a vision to become a contract manufacturer given the situation around tariffs. We actually feel like our capacity is is really quite constrained with our own demand right now. So we probably don't have the ability to look for other opportunities like that.
Great. Thanks so much.
Thanks, Charlie.
Our next question comes from Robert Sengar from Credit Suisse. Your line is open.
Good morning. Just Cliff on that last thing on the op margin guide, you talked about it overall kind of flattish with last year's hot, almost 22. Automotive is clearly coming down a bit this year. So what do you see the strength that's offsetting that?
Should we just follow the trends
that we've seen for the 1st 9 months? Is there anything different about the fourth quarter?
Well, I think segment mix as auto comes down, we get improvements from some of the other segments, which are typically higher than than auto. And there's variables within each segment as well in terms of product mix, but for the most part, it's segment mix.
Okay. I was just thinking, yeah, autos down from last year. So is there one particular segment where you see more momentum in the margin strength out of the other non auto segments?
Well, we're doing well. As we said in outdoor, I think our our Phoenix line continues to be an increasing part of the overall outdoor segment mix. And the new Phoenix 5 plus series has a strong margin profile. And also in Aviation, obviously, we're doing well there. A large part of benefit there with product warranty, which has been very good and our products are very reliable in aviation.
So we're getting some benefit on the margin side of the pad.
Okay. And then just lastly on marine. Your organic growth is, I guess, solidly in the mid teens now. And I wanted to ask how that compares with the overall marine market. You've obviously you're quite innovative across the product line.
How would you say your share movement, your market share movement has been? Is there a way to quantify?
Yes, I think it's harder to quantify in Marine. It's a fairly small industry in the recreational boating category, but by our estimates. And I think based on financial estimates that we see from other players that have to be reported publicly. We are taking share and the overall market's probably growing in the 4 end range while we're growing, as you said, kind of in the low to mid teens organically.
Yes. Okay. Well, thank you very much.
All right. Thanks, Robert.
Our next question comes from Joe Pantin from Longbow Research. Your line is open.
Thank you. Good morning. First off in automotive, can you help us understand the scope of the Geely agreement? Are you going to be included in in every Geely car in China or is it kind of an option? And if you could address timing of both that agreement as well as,
Yes. So, the camera solutions that we're providing to Geely are across most of their models. In China, there is regulation around having camera in vehicles. So it is equipment that is required in the vehicle. Timing will be the model year 2020.
When the first model start rolling out. So, we'll start ramping up in later 2019 and that happens to also coincide with the BMW China supply agreement as well.
So, Cliff, do you anticipate those rolling on are enough that people like us will notice a change in the trajectory of the segment, which has been pretty constant over the last couple of years.
Yes, I think definitely that will change the trajectory around auto OEM for short. And we also have additional wins in there that will come online in the 2020 timeframe as well. So we anticipate that that will be a strong building year for us.
Okay. And then second, in aviation, in the aftermarket portion, and I know there's good things happening on the OEM side, but, can you update us on what you're seeing in terms of incremental see additions. It's been 90 days or so since we last surveyed that channel. So curious what you're seeing in hearing. And obviously, I'm just trying to modulate whether we should be expecting much growth in 2019 off of 2018 given those potential capacity constraints?
I don't think we really see anything different in terms of the trends of capacity. We're selectively adding some shops to our list as we see qualified shops out there that can bring on garment equipment. But in general, it's still, fairly linear right now, which is one of the constraints face, I think, going forward in aviation, it's really not demand limited. It's capacity limited.
So it's fair to say that we're capacity is a problem in 2019. Therefore, some of this demand on the regulation side will spill into 2020 is still your base case?
That's our belief. I think we could reach the low end of the equipage estimates based on today's capacity rates, but nobody probably believes at this point that the low end is the most likely case. We think that there's upside potential on the 2020 deadline.
Next question comes from U. G. Anderson from Morgan Stanley.
Thanks very much. This is James Foster sitting in for for Yuji. I just wanted to dig in a little bit on the December quarter and how you're looking that on a year over year. And wondering on the fitness specifically, how much of the year over year growth in Q3 was attributable to new launch timing versus what was really existing Vivo active and for runner growth? Just trying to look and see if how much timing of launches may have had an impact on Q3 and Q4?
Well, I think timing definitely had an impact on Q3. If you look back where we were last year, We had not yet delivered our new product lines into the market. So it was a very easy comp versus Q3 of last year. In terms of what we're looking at for Q4, there's really 2 dynamics that we see. One is year over year comp with particularly the vivoactive 3, which is a very popular line last year as well as this year.
And then the rotation of product mix within fitness from basic trackers to advanced trackers is another dynamic that's shifting things around within the segment. So So all that coming together, we feel like our implied guide is basically what it is fairly fairly flat to slightly down, but we feel very good about the product positioning within the segment and where we're at this year. And I think looking forward into the coming year, we'll have a strong product portfolio that we can build on.
Maybe a question for Doug. I just wondering on costs associated with, the new facility, are the fix costs now fully built into the implied Q4 guidance? Or will there continue to be incremental fixed costs that still need to be layered in before we get the sustained run rate there?
Yes. So basically, we're only partial way through our facility build. So the current situation is that we have opened. We're running our aviation manufacturing piece. In 2019, we'll be moving over our distribution center, then after that's complete, we'll be renovating our existing facilities into office space.
So there will be continued CapEx spend as well as costs in there. But we're factored those into the guidance we gave you, what the depreciation for Q4. And then when we get to a next year refactoring that depreciation expense at that point in time.
That's great. And just from a timing perspective, how long until you get to fully installed and you'll be done building out that new space and facility?
Yes. It'll probably be when it's all said and done. Like I said, the distribution center will have that moved in 2019 and probably be a couple of years after that by the time we fully built out on the renovation of new facility. We're doing it over a period of time depending on what our needs are.
Okay, great. Thank you very much, gentlemen.
Thanks, James.
Our next question comes from Ben Boll from Cleveland Research. Your line is open.
Good morning, everyone. Thanks for taking my question.
Cliff, could you talk a
little bit about the wearables market overall what do you think about the organic growth in high end wearables? How much of your growth would you characterize as expansion of the base versus refresh trade up? And any thoughts you have on kind of the competitive environment overall? And then a follow-up Thank you.
Yes. So in terms of organic growth, we still see the Smartwatch market as being a growth market, especially as people who have been in basic trackers over the years, start to look to trade up and do more. I think there's a lot of awareness around the space right now. So that's helping as well. So we're getting some benefits from organic growth, but also as we expand our product line like we've done with the instinct that helps expand our reach to other customers who otherwise may not may not be ready to go or make that kind of commitment to like a Phoenix Watch for example.
In terms of competition, it's definitely getting us stronger. There's a lot of competitors out there and some coming into the space from China. So that is a dynamic especially in the Asia market, but also even other areas as they start to play the market like what is typically done from those players they play typically on price. So that's the way we see things right now.
And then within the aviation business, What are your thoughts when you look through the ADS B cycle? Even the spillover of demand, Do you have any high level thoughts? Is this where maybe you start to segue into more targeted commercial aviation opportunities? Any concerns on pull forward of demand potentially staffing consumption in future years? What are your high level thoughts on what the cycle means once you kind of get through it?
Thanks.
I think definitely there'll be some slack to take up once the cycle is complete. I think if there's any good news in the capacity issues that we believe it will be more of a soft landing than what passed mandates have been. In terms of segwaying to other areas, we definitely have new categories and new opportunities that we're pursuing and the activity in aviation really is very strong right now in terms of the overall market. So we anticipate that there are other opportunities that we can leverage. Pull forward is certainly a concern in a situation like this, particularly as we see a lot of people updating their cockpits along with ADS B, but we do believe we have a strong product line that that should be able to now coming forward to maybe complete a panel upgrade after they did some basic work with ADS B earlier.
Thank you.
Thank you.
Our next question comes from Ron Epstein from Bank of America. Your line is open.
Hey, yes. Good morning guys. What do you
see in Cliff in terms of how can I say the sell into the aviation channel OE next year, right? Are you starting to see, I mean, I would imagine you would the pickup in OE demand, particularly sort of in the business jet segment?
Well, I think, it's a little early to give specifics, but I would say that some of the platforms we're on that have been very strong. Like Latitude, we continue to feel very positive of that going forward. With the longitude coming on for Garmin, that will be a represent an incremental market share gain for us. So that should be a growth driver in 2019. And in general, the industry, as you know, has had a lot of activity.
So barring some kind of an economic shock that might change the calculus of everything, I would say that our view is optimistic for the future.
Okay, great. And then just maybe a couple other point shifting gears here. When you think about the sell into the channel into the holiday season, how's that going? Particularly when we think about Black Friday, Cyber Monday and all that. Do you guys have any promotions going on?
And I mean, what's your thoughts going into the holiday season?
Well, I think it's just like past years, definitely we have a lot of promotional activity that we're planning in terms of both cooperation with our retailers on sales as well as advertising in terms of just overall activity, I would say it's about where we expect it to be. I think there's really no surprises. And if anything, we're chasing demand and keeping our factories busy. So I think right now we feel optimistic about the quarter.
Okay. Then maybe just one last financial question. When you think about your balance sheet, Do
you think you're
effectively capitalized? I mean, are you using the balance sheet the best you can? And then finally, what are you going to do with all the cash?
Yeah. So, yeah, Linda Cash, no, looking at that, our primary uses for our cash one of which is paying reliable dividends. That's very important for us. We did increase our dividend this last year. The second of which is investments back into our business.
An example of that is the facility expansion that we did here relate to aviation Manufacturing, our distribution center as well as building out some existing space for office there. But then also acquisitions acquisitions we've done in the past to lower them, the avionics and such. So look at those are really the priorities for our cash on a go forward basis.
Great. Thank you very much.
Our next question comes from Paul Coster from JPMorgan. Your line is open. Hi,
thanks. This is Paul Chung on for Koster. Thanks for taking my questions. So just on your operating margins, they're usually seasonally weaker in 3Q, but it came in pretty strong. Know aviation was a big contributor, but anything else you want to point out?
Well, as you said, segment mix is a big factor. So I think it's difficult to look year over year just at the number and draw conclusion. You really have to look at how the pieces are moving within the segments.
Okay. So then that would mean that your view on kind of seasonality in fiscal year 2019 is unknown at the moment based on product mix?
Well, I think seasonality is yet a different consideration. Each segment has their own seasonality. And I think as segments are growing and moving around each other. That will impact obviously the overall combined margin of the business.
Okay. And then next question is on auto. So how should we think about longer term sustainable operating margins? Have we kind of hit trough levels? Or is there some kind of opportunity to cut OpEx in this segment?
I mean, judging by your new win in China, it looks like you're investing a bit?
I think we're investing in the tier 1 side of auto OEM and we're also investing in in keeping our consumer products fresh. We're investing in a third area, which creating niche applications of PND technology for other types of vehicles and navigation out there. So there's targeted things that we're doing. Some ability to scale our expenses, but I think as the business transitions especially if we get the larger revenue contributions from OEM, the margin profile will obviously follow the mix the segment and will tend to be in the kind of range that we're seeing now.
Okay. And then quick modeling question. What should we model for tax rate for 2019? Thank you.
Yes. So it relates to 2019. We'll give that to guidance in February when we give all of 2019 guidance. But I should mention that in 2018, we did see some favorable benefit that probably will not recur into 2019, one of which was the R and D tax credit. So when we were doing tax term in 2017, we identified some additional benefits.
So we rolled through some of those impacted from a catch up basically in 2017, 2018. So, I'll give you a little bit of color on that, but we'll give you a better idea on 2019 effective tax rate when we give all the guidance in, February.
I appreciate it. Thank you very much.
Thank you. Our next question comes from Will Power from Baird. Your line is open.
Okay, great. Thanks. Yeah, just a couple of additional questions. Continued strong growth in APAC, I guess that's been kind of a running theme. I know Phoenix is a specific driver of that.
Is that still the principal driver of the growth there? Are you seeing uptake of new products that are potentially helping that. And given Cliff some of the commentary on increasing competition out of China, do you think you continue to grow that that region double digits?
Yes. So in terms of driving growth in APAC, definitely Phoenix is one part of that. Each country and each market is probably different, but we've also been able to grow with some of our other categories such as GOL and dive watches as an example. In terms of China, that's definitely a new factor that's going to put some dynamics into the market, but we believe that we have a strong product lineup and plans around our product line that will help us be competitive there. So at this moment, again, it's probably the normal course of competitiveness that we see.
Okay. All right. And then just coming back to fitness, I know you called out wearables as I think the key driver. Is there any way to get any further granularity with respect to trackers versus smartwatches, forerunner, what the kind of the key pieces of the growth were in the quarter?
Yes, I think a lot of the growth was driven around the Advanced Wearable category, which is really our GPS enabled vivo line of products. We also saw growth in what we call the basic tracker category, which which we have a more unique product lineup there compared to the rest of the market, but our unique product offerings have helped to to grow that category as well. In terms of what we call the pure running market, kind of at the end of a product lifecycle there. And so, I think going forward as we introduce new products, we'll see we'll see upticks, but we were relatively flat in terms of the quarter on running.
I'm showing no further questions at this time. I would now like to turn the call back over to Terry Sachs for closing remarks.
Thanks, everyone, and have a great day. Doug and I will be available for, for calls the rest of the day. Thank you. Bye.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may disconnect and have a wonderful day.