Good morning. My name is Julie and I will be your conference operator today. At this time, I'd like to welcome everyone to the Garmin Limited Second Quarter 2018 Earnings Conference Call. And as a reminder, today's call is being recorded on August 1, 2018. Thank you.
Teresa Suck, you may begin.
Good morning. We would like to welcome you to Garmin Limited's 2nd quarter 2018 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/doc and archive of the webcast and related transcripts will also be available on our website. As a reminder, we adopted a new U. S.
GAAP revenue standard 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, growth and operating margins and future dividends market shares, product introduction, 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 Timber, President and Chief Executive Officer and Doug Vessen, Chief Financial Officer and Treasurer. At this time, I would
consolidated revenue of $894,000,000, up 8% over the prior year. Fitness, marine, aviation and outdoor collectively increased 17% year to the prior year due to segment mix. Operating income improved to $218,000,000 up 4% over the prior year. This resulted in GAAP EPS of $1 and pro form a EPS of $0.99 in the quarter. We are pleased with our performance in the first half of twenty eighteen 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 fitness segment, revenue increased 24% driven by growth in Advanced Wearables, and in cycling. Gross and operating margins were 56% 23%, respectively, and operating income grew 40% over the prior year. During the second quarter, we launched the Vivoactive 3 music expanding our music offerings into the advanced wellness category. We also launched new edge cycling computers and the next generation barrier radars targeting the cycling safety market.
The basic activity tracker category continued to decline during the first half of twenty eighteen. However, the impact on our fitness segment was more than offset by growth in other categories. Looking forward, we believe we are well Looking next at marine revenue increased 24% as weather conditions improved and boats were brought out of storage for the season. Approximately half of the growth came from our recent acquisition of Navionics, while the other half was organic across multiple product categories. Gross and operating margins were 59% 21%, respectively, and operating income grew 14% over the prior year.
During the quarter, we introduced Panoptix LiveScope a sonar system that generates real time images underwater. Livescope was quickly recognized by the marine industry as disruptive new technology. At the recent ICAS Sport Fishing trade show, Livescope won the award for Best New Electronics and received the prestigious award for Best of Show. We believe LiveScope is a game changer for the fishing market. Also during the quarter we announced Sportsman Boats selected Garmin as their exclusive marine electronics supplier beginning with their 2019 model year boats.
Sportsman is one of the fastest growing book companies in the U. S. Market and it's an honor to be selected as their exclusive electronics provider. Looking forward we are focused on product innovation and gaining share in the inland fishing category. Turning next to Aviation, revenue increased 23% driven by growth in both OEM and retrofit product categories.
We experienced particularly strong growth in our ADS V offerings and from recently introduced products such as the G5 indicator system, TXI displays and GSE autopilots. Gross and operating margins remained strong at 74% 34%, respectively, resulting in operating income growth of 34% over the prior year. We were recently selected by tactical air support to provide an integrated flight deck to their fleet of supersonic F5 fighter aircraft. We also introduced the G3000 H integrated flight deck for the part 27 turbine helicopter market. As I mentioned earlier, ADS B has been a significant driver of growth in our aviation business.
With just under 18 months to go before the December 31, 2019 deadline, we wanted to provide an update on the market development and how we see things playing out as the deadline approaches. According to the FAA, as of July Approximately 59,000 aircraft have been equipped. The FAA has estimated that approximately 100,000 to 160,000 aircraft will eventually be equipped with ADS B. Based on the more conservative estimate, the market is just past the halfway point in the ADS B cycle. There are a few key observations that we would like to share.
1st, significant opportunity remains in the ADS B cycle. According to FAA estimates, anywhere from 40,000 to 100,000 aircraft remain to be equipped. Interest in ADS B is increasing. And many customers are 2nd, shop capacity appears to be a limiting factor in ADS B adoption. With a modest increase in shop capacity, it is possible to reach the low end of the FAA estimates by the December 31, 2019 deadline.
If shop capacity does not increase, or if the final equipage level increases above the more conservative estimate, the opportunity would continue past the deadline. Finally, ADS B is a significant opportunity, but it is only one of many that we are pursuing. To prepare for the future beyond the ADS B cycle, we are investing in long term opportunities such as gaining share in the OEM market, establishing a position in government and defense markets, and developing new product categories. In summary, we are pleased with the performance of our aviation business and we are optimistic about its future. Turning next to Outdoor, revenue increased 4% on a year over year basis.
Driven by growth across all product categories. While this growth rate is below recent trends we feel it is a remarkable accomplishment considering the strong growth we experienced in Q2 of 2017, driven by the initial channel fill of the Phoenix 5 Series. Gross and operating margins were 64% 36% respectively. Late in the quarter, we launched the PENIX 5 plus series adding music color maps and mobile payments to all three watch sizes. In addition, we expanded our sensor technology with the addition of pulse ox to the Phoenix 5X Plus, providing blood oxygen saturation awareness for athletes and outdoor enthusiasts.
We also launched the Inreach Mini, a compact versatile satellite communicator that can be used with other garment products paired with a smartphone, or used as a standalone device. Looking forward, we are focused on opportunities in wearables and other product categories within the outdoor market. Looking finally at the auto segment, revenues decreased 19% due to the ongoing decline of the PND market. Gross and operating margins declined year over year to 42% and 7%, respectively. Our global market share position in the P and D category remains very strong.
Looking forward, we are focused on disciplined execution to bring the desired level of innovation to the market and to maximize profitability 18. In light of the strong performance, we are raising our projected revenue to $3,300,000,000 for the year. Up about 6% over 2017. Gross margin is projected to which is unchanged from the previous estimate. Operating margin is projected to be 21.5% which is a slight improvement over our previous pro form a earnings per share is expected to be approximately $3.30.
Looking at our annual revenue outlook by segment we have increased our growth expectations for the fitness segment to 10% and the aviation segment to 18%. Outdoor and auto are unchanged while the outlook for marine has been relies down slightly to 15%. 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 second quarter financial results and maybe comments on the balance sheet, cash flow statement, and taxes. We posted revenue of $894,000,000 for the 2nd quarter, representing an 8% increase year over year. Gross margin was 58.5 percent, a 30 basis point increase from the prior year.
Operating expense, as a percentage of sales, was 34.2% 120 basis point increase in the prior year. Operating income was $218,000,000, a 4% increase year over year. Operating margin was 24.3 percent, 90 basis point decrease from the prior year. Our GAAP EPS was $1 our pro form a EPS was $0.99, a 9% increase from the prior year. Next, like look at our 2nd quarter revenue by segment.
During the quarter, we achieved 8% consolidated growth led by robust double digit growth in our fitness, marine and aviation segments. This growth was partially offset by a decline in our auto segment which resulted in continued decline in the auto P And D business. On a combined basis, fitness, marine, aviation and outdoor were up 17% compared to the prior year quarter. Looking next at 2nd quarterrevenueandoperatingincome. On a combined basis, fitness, marine, aviation and outdoor segments contributed 80% of total revenue second quarter of 2018 compared to 73% in the prior year quarter.
Fitness grew from 22% to 25% Aviation grew from 15% to 17% and marine grew from 13% to 15%. You can see from the charts illustrate our profit mix by segment. On a combined basis, the fitness, marine, aviation and outdoor segments delivered 94% operating income in the second quarter of 2018 compared to 84% second quarter 2017. The fitness and aviation segments a year over year increase in both operating income dollars and operating margin. Looking next on operating expenses.
2nd quarter operating expenses increased by $31,000,000 or 11 percent. Research and development increased $15,000,000 year over year due to investments in engineering resources and recent acquisitions. Our advertising expense was up $2,000,000 for the prior year quarter was relatively flat as a percent of sales. SG and A was up $16,000,000 compared to prior quarter, relatively flat as a percentage of sales. The increase was primarily due to personnel related expenses incremental costs associated with recent acquisitions.
Fee highlights on the balance sheet and cash flow statement. We ended the quarter with cash and marketable securities of approximately $2,400,000,000. Accounts receivable increased sequentially in year over year to $533,000,000. Inventory balance decreased sequentially in year over year to $501,000,000 we exit the seasonally strong second quarter. During second quarter of 2018, we generated free cash flow $157,000,000 a $28,000,000 increase in the prior year quarter.
Also during the quarter, we paid dividends $100,000,000. In the second quarter of 2018, we reported an effective tax rate of 19.4% compared to the pro form a effective tax rate of 21.4% in the prior quarter. The decrease effective tax rate is primarily due to the benefits from U. S. Tax reform.
We expect our full year 2018 pro form a effective tax rate to approximately 17.5%. To conclude our formal remarks, Julie, could you please open the line for Q And A?
Your first question comes from the line of Joe Wittim from Longbow Research. Joe, your line is open.
Hey, good morning. Congrats on the results. In Aviation, I appreciate the color, Cliff, and we've heard of the tight capacity too. Can you just take it a step further and help understand how this may play out in your reported results in 'nineteen and 'twenty? Like, let's say the FAA's conservative scenario plays out.
So 100,000 total tails and you do get that modest increase in shop capacity to, let's say, allow the industry to meet 100,000 by the end of 2019. So the question is would you still see healthy growth in 2019 versus 2018? And then if it were to drop off there and be complete at January 1, 2020, would that be enough of a drop off to potentially drive, Garmin AVA down in 2020. Just a little more help taking into the model would be great. Thanks.
Well, I think just to shed some light on that specific category of ADS B. It's only one category within our broader aviation segment. So, if we just speak generally about that. I would say that with some additional shop capacity, of course, that would drive additional sales in that category. As I mentioned in my remarks, there is a follow through trend with customers adding additional equipment to their aircraft when they're bringing the aircraft in for work.
A lot of times it makes sense to add other things that they want to have in the aircraft. So we're seeing compounding effect from that and we would expect that to continue as the mandate approaches. In terms of specific numbers around aviation for 2019 2020, we can't really provide specific color on that. As I said in my remarks, we're working on more than one opportunity. So we believe that we have growth paths beyond the ADSV cycle.
And given what we see playing out with ADSV, we do anticipate more of a soft landing than a hard cliff of revenues in terms of that category.
Perfect. Thanks. And I wanted to move to fitness where the numbers were, very impressive. I think the products as obviously your friend today. Looking to the second half, should we anticipate, I don't want to say a pause, but simply an easing in the timing of new product introductions especially in advanced wearables?
Or do you have these things spaced out to the point where you'd have us expect a typical slate of new product announcements into the holidays?
We do have some additional announcements that will come in the back half of the year, but for the most part, our product lineup is is set. We do have a very refresh product line at this year. So we feel good about our positioning and of course, last year, we We did have the introductions of some of our advanced wearables and new categories and wellness in the back half of the year. So we're comping against that. The fitness market has shown that it's been a little more dynamic.
So we are taking a more cautious view on the back half, but we believe there's there's a strong reason that our products and our business should perform well.
Thanks. And then last
one for me. Doug, can you help us on ad spend at all, especially modeling the second half here on a year over year basis? Your ad dollars were kind of flattish a little bit up second quarter that you're still down for the first half in total. So how will the second half look year over year, especially considering, I think you pulled back some in last year's fourth quarter?
Yeah. So as it relates to advertising, give you a full year perspective on it. Yeah. We expect full year advertising dollars to be relatively flat year over year as well as a percentage of sales. So second half will even out so that we're basically a situation that will be flat hopefully for year over year.
Your next question comes from the line of UGI Anderson from Morgan Stanley. UGI, your line is open.
Great. Thanks so much and good morning. My question is on the autos guidance, it seems to imply some decelerate declines at the end of the year. So hoping to get a little bit color on that? And similarly on that point, how should we think about the mix between PND and the other categories exiting year?
Yes. So in terms of auto, as we've has been our practice really for years is we do take a fairly conservative view of that given the situation of the market. We do see the ongoing decline of PND during the quarter. We did experience strength in both truck and camera products. So we're offsetting some of those declines with new categories.
And in terms of OEM, We are seeing some programs roll off like Chrysler and other new programs which have not contributed yet such as BMW. So we'll we'll see some ups and downs in the OEM portion of the contributions. But that's our outlook for the remainder of the year. And then of course, as we move into into future years, we'll be able to update that as we see new programs coming on and as the categories change.
Got it. And then just a quick clarification on the prepared remarks for the outdoor segment there. With the guidance and it looks like should be some acceleration off of Q2. Is that building in some additional product launches there?
So in outdoor, we do have additional launches in the back half of the year, but for the most part, our major categories are are set. And I think we're right where we expected to be in the segment. And so that's why we left our guidance unchanged. Okay. Thank you.
I guess move on to the next question.
All right. Your next question comes from the line of Brad Erickson from KeyBanc Capital Market. Brad, your line is open. Thanks. Just a few follow ups here.
First on the fitness business, I guess, it's kind of interesting.
If you look at that business, it's like, I don't know, $60,000,000 or so higher than it was 3 years ago or so. Margins seemed to be tracking kind of in line though or below where worth those levels. Talk about just overall fixed cost leverage you start to get particularly as you get some of these nice channel fill quarters. Seems like you've returned to a little bit of margin expansion, just what should be the expectation around fitness margins there?
Well, I think we've been targeting our margins around the mid to upper 50s and our operating margins in the low to mid 20s in the segment. And as we see lumpiness around the seasonality as well as product launches that can be up and down, but that's generally the long term targets that we're shooting for.
Got it. And then just on the aviation, do
you have any sense, can you give us
a sense, rather, of what the attach rate your resellers are seeing for when they're selling ADS B with say other avionics products?
I would say it's very high, probably close to all of them.
Got it. And then lastly, just around FX, it seemed like that should have been maybe a bit of a tailwind start the year probably neutralize as it becomes a headwind. What's the any clarity you can give us on the net benefit you're or or headwind you're contemplating owed to FX for the year in the updated guidance? Thanks.
Yes. So for Q2, you're correct. There was a tailwind on revenue about the $20,000,000. Looking at the back half of the year, we expect very little probably immaterial impact the euro right now is pretty well consistent at what I'll say the average was sort of back half. So probably everything stays the same as it is right now.
A very little impact on the back half.
Your next question comes from the line of Charlie Anderson from Dougherty and Company. Charlie your line is open.
Yes, thanks for taking my questions and congrats on the strong start to the year. I wanted to ask about geographic again, I know I asked this last quarter, but Asia was very strong. Again, I wonder if there were any particular geos you could call out there that are doing well. And is that Is it a sense where you're building there and you're in sort of an expansion phase or just kind of roughly what's going on there? And then also on Europe, it seems like there was one flowed out.
It was Europe a little bit. So I wondered if you could maybe unpack what's going on there? And then I've got a follow-up.
Yes. So in Asia, there are some larger countries that driving some growth there, particularly China and Japan have been superstars in terms of the overall APAC market that there are other markets as well that are doing very well. In terms of the Europe dynamic, I think our year to date performance there can be completely attributed to the Phoenix effect from last year. They were super strong in their launch of Phoenix from last year and they had almost really really at the whole quarter of Q2 to be able to launch Phoenix 5. This year, we announced the Phoenix 5 with less than 2 weeks ago in the quarter.
So consequently, they had very little opportunity in terms of their channel fill as compared to other markets. So I think the dynamics there can be completely attributed to Phoenix.
Got it. And then on fitness, going to be up 10% on the year. I wonder to what degree do we attribute that to ASP relative to units? And I wonder as you move to these higher end wearables, does it feel like that's a multiyear trend or, just kind of roughly how do you look at that going forward in terms of consumers willing to sort of pay up for more features? Thanks.
Yes, definitely the dynamic of the market is that customers stepping up for more capability and for unique offerings like what we have. And so there's definitely an increase in the ASP that we see there. But we also see growth in units as well as we had super strong performance in our Advanced Wearables category.
Okay.
Pardon me. Our next question comes from the line of Ben Bollin from Cleveland Research.
Could you talk a little bit going back to fitness, were there any unique items in the quarter that you continue to see some sell in benefit for forerunner 645, are you seeing any further box expansion or linear square foot expansion in your existing partners?
We did announce the Vivo active 3 music and that product seemed to have been received well in in terms of its unique design and capabilities adding to the Vivoactive line of music. So that was one dynamic. In terms of overall distribution. I think for the most part, our distribution is pretty well set, although we see some some countries in some areas, some markets improving incrementally, but for the most part, it's, what it's been for a while.
Great. And then within fitness in the press release, she talked about the potential for more high end wearables or more high end features in that product category. What is your assessment of what those characteristic or features are what makes it a high end wearable? And then last item would be, have you seen any benefits from TomTom exiting the market in the first half? And have you think that opportunity could play out in the back half?
Thank you.
So in terms of customer preferences, they do seem to be moving toward products with more features. It seems like smart features are table stakes, if you will. Customers like the sensor technology and especially the additional features that we bring to the table such as stress monitoring and sleep tracking. And then just in general, I think our products are very strong around the GPS side and the position location focus of our watches, which make them very strong in the active lifestyles. Music payments and masks are certainly adding to that.
So So we see those as all positive points for the customer. In terms of shifts in the competitive landscape, I would say in terms of TomTom to exit, there's probably some effect depending on the country that you talk about. Some countries still report there's strong inventory of competitive products in the market. And so those areas probably haven't changed as much, well as others the channel is pretty much flushed through. And so that does lead to increased opportunities for our products.
Your next question comes from the line of Ivan Fenseth from Tigris Financial. Ivan, your line is open.
Thank you. Congratulations on another great quarter and thank you for taking my questions.
Thanks, Mike.
I have questions in three areas. First, congratulations on the F5. When can you give us some idea of the number of units and the price of that product?
Yeah, in terms of number of units, of course, these are very specialized aircraft. So it's a small quantity but we view it as a stepping stone into that market and it shows the capability of our cockpit systems to be able to be used in a very advanced specialized application like the F5. In terms of a ship set prices, we can't talk about those details, but But again, we're very excited about the opportunity and we believe it will be a stepping stone for us into more.
Yes, that's my thought. Do you have? Can you give us some color on some other other potential wins in the pipeline?
In terms of things that haven't been announced, we can't speak to those, definitely there are a lot of exciting opportunities that are coming that have been announced. For instance, the longitude is in its final stages of certification. Also, we have positions on the assessment Sky career and the Denali as well.
Very good. Also on your, infotainment platform, can you give us any progress on, potential OEM adoption?
We're very encouraged by what we see in the deal pipeline and we believe that we'll have additional news to share this year in terms of more customers.
And I just have one last area. I see you recently expanded the sleep, monitoring function in the connect app to work with your wearables. And I know that you had announced a partnership with the University of Kansas to focus on sleep apnea Is there some did that come from some of that progress or will you be expanding Can you give us some insight into what's happening with the, research relationship there?
Yes, we believe that our Centrix technology shows a lot of promise in being able to play in the light medical device market. And so Participating in these studies is one way to start verifying the technology and proving that it can be used for certain applications. That's a long pathway in terms of our development there. It involves qualification of the product and certification of the product with various around the world, but it's a step in towards a growth opportunity in the future.
Yes, I really like that because sleep is probably the next frontier in improving health. And I also like the new oxygen sensor in the 5 plus So congratulations again. Thanks for taking my calls.
Your next question comes from the line of Joe Whitting from Longbow Research. Joe, your line is open.
Thank you. No one wants to ask a Phoenix question, I will. Can you talk us through what you've seen so far for Plus? How does the launch comparative of the F5 launch and are there any interesting insights you've gathered on the current mix of Plus versus Phoenix 5 purchases, it seems like you'll be selling them side by side?
Yes, it's still early days, but we're very encouraged by what we see in terms of the the market feedback and the real time information we get as people register their products. I think out of the gate, the higher end versions, the 5X Plus have been very strong and we're starting to see the momentum gathered around the other versions as well.
Can you say how the channel fill will compare to the channel fill for the Phoenix V, which is pretty substantial in the last year's second order? Will it be a little bit smaller because you'll be selling them side by side or not necessarily?
Well, definitely there's factor that a very competent product is side by side with the Phoenix 5 plus. There's no question about that. We will use that in terms our overall strategy in the market in terms of pricing the 2 different versions. But that said, it's still very early days with only just literally days in the back half of the quarter that we had to ship products. We were very pleased with our overall contribution from the Phoenix 5 plus.
Okay, understood. Thanks, Cliff.
Thank you.
There are no further questions in the queue at this time. I'll turn the call back over to Theresa Sek.
And thanks, everyone. Doug and I will be available for callback today. Have a great day.
And that concludes today's conference call. You may now disconnect.