Good day, ladies and gentlemen, and welcome to the Garmin First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a quick A question and answer session and instructions will be given at that time. I would now like to introduce your host for today's conference, Terry Black, Investor Relations. Please go ahead, ma'am.
Good morning. Would like to welcome you to Garmin Limited's 1st quarter 2017 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/stock. 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 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 the 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
reported 1st quarter consolidated revenue of $639,000,000, up 2% over the prior year. Marine Outdoor Aviation And Fitness Collectively increased 12% year over year and contributed 75% of total revenues. Gross margin improved to 58.3 percent as both segment and product mix were favorable. As a result of our increased revenues and gross margins, while operating income increased 12%. This resulted which includes a significant income tax benefit recognized during the quarter.
Pro form a EPS, which excludes this benefit grew 7% to $0.52 in the quarter. We are pleased with our first quarter results, which delivered growth in revenue, profits, and earnings. However, since Q1 represents the lowest seasonal quarter of our financial year, we are maintaining the guidance issued in February. 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 each business segment. Starting with marine, revenue grew 26 percent ahead of the overall market, resulting in market share gains.
All major product categories performed well. Gross margin improved to 57%, while operating margin improved to 17%, resulting in operating income and we have seen strong demand for our latest product offerings. We started shifting our new GPSMAP chartplotters early in the season, and the feedback from customers has been very positive. Looking forward, we remain focused on gaining market share, through innovations that will clearly differentiate us in the market. Looking next at Outdoor revenue increased 20%.
On strong demand for outdoor wearables. The segment continued to generate strong gross margin and operating margin of 63% and 30% respectively, while operating income grew 24% over the prior year. We began shipping the highly anticipated Phoenix 5 adventure watch series late in the quarter. Orders have been very strong. And we expect that it will take several weeks to catch up with demand.
We also recently hosted our 1st Connect IQ Developer Summit, bringing together application developers and business partners to participate in hands on workshops and breakout sessions with our product managers and engineers. At the event, we announced new capabilities for Connect IQ, including the ability for app developers to implement a revenue model. We also announced new integration partners, including Smart Things, which gives us a strong presence in the emerging home automation market. Turning next to Aviation, we reported solid revenue growth of 16%, driven by growth in aftermarket products, and led by strong growth related to our ADS B offerings. Gross and operating margin remained strong at 74% 31%, respectively, resulting in operating income sign, the next generation integrated flight deck featuring wireless connectivity and enhanced safety features.
We received European certification for the GTX-three forty five, expanding the addressable market for this popular ADSB transponder. In addition, we continue to support Much has been said about the challenging market conditions, which remain a factor. However, we continue to believe that market share gains and new platforms. Provide opportunities for long term growth. Looking next at fitness, revenue declined 3% driven by the rapidly maturing market for basic activity trackers, especially those which lack GPS capability.
Despite this challenge, we are very pleased with the performance of Advanced Wearables with GPS capability, which experienced robust growth during the quarter and nearly offset the steep decline of basic activity trackers. Gross margin increased to 56% as product mix shifted to the higher During the quarter, we launched the 40935, which is our most advanced multi sport watch with new running dynamics features and enhanced performance and recovery monitoring. We also introduced our latest VIVOS Smart III and Ultra slim smart activity tracker with risk based heart rate and an innovative stress tracking feature. While we continue to see the market for basic activity trackers mature, we also see growth opportunities in advanced wearables with GPS, and we are confident in our product roadmap going forward. Looking finally at the auto segment, revenues were down 19% in the quarter due to the ongoing decline of the PND market and partially offset by growth in our auto OEM product lines.
Gross margin was 44%, which is consistent year over year while operating margin declined to 4%. During the quarter, we began shifting our next generation drive family of PND devices, which has wireless connectivity and enhanced driver alerts. We also introduced the dash cam 4555, offering high quality recording in an Ultra Compact form factor. We remain focused on disciplined execution bring desired innovation to the market and to maximize profitability in this segment. Okay.
Finally, before turning the call over to Doug, I wanted to mention the recognition we recently received from Forbes Magazine, ranking us among the top 100 most reputable companies in America. Our employees work very hard to make Garmin the best at everything we do. And to operate the business with integrity. It's a special honor for all of us to be recognized in this way. So that concludes my remarks.
Next, Doug will walk you through additional sales of our financial results.
Thanks, Cliff. Good morning, everyone. I'll begin by reviewing our first quarter financial results. And move to comments on balance sheet, cash flow statement, and taxes. We posted revenue of $639,000,000 for the first quarter, representing a 2% increase year over year.
Gross margin was 58.3 percent, a 380 basis point increase from the prior year, driven by the shift towards segments with higher margin as well as product mix within certain segments. Operating expense as a percentage of sales is 40.1%, 30 basis point increase from the prior year. Operating income was $116,000,000, a 12% increase year over year. Operating margin was 18.2 percent, 160 basis point increase in the prior year, as the increase in gross margin was an offset increase in operating expenses. Our GAAP EPS was $1.26 to include the $169,000,000 income tax benefit due to the revaluation of certain Switzerland deferred tax assets, and pro form a EPS was $0.52, a 7% increase in the prior year.
Next, we look at our 1st quarter revenue by segment. In the first quarter, we achieved 2% consolidated growth led by double digit growth in 3 of our five segments. Collectively, marine, outdoor, aviation and fitness were up 12% compared to the prior year quarter. Looking next, the first quarter revenue charts, collectively, the marine, outdoor, aviation and fitness segments contributed 75% total revenue in the first quarter 2017 compared to 69% in the prior year quarter. Marine grew from 13% to 16% Oliviation grew from 17% to 19% and afterwards grew from 16% to 18%.
The achievement of charge illustrated profit mix by segment, marine, outdoor, aviation, fitness segments collectively delivered 94% of operating income in the first quarter of 2017 compared to 82% first quarter of 2016. Marine, outdoor aviation fitness segments at a year over year increase in both operating income dollars and operating margin. Looking next at operating expenses. 1st quarter operating expenses increased by $20,000,000 or 8%. Research and development increased $14,000,000 year over year or 180 basis points to 19.1% of sales.
We continue to invest in innovation, increasing resources focused primarily on aviation, fitness, outdoor marine, where we see long term growth opportunities. SG and A was up $6,000,000 compared to prior year quarter and increased 70 basis points as a percent of sales to 16%. Increased spending in SG And A is primarily driven by increased legal related expenses, information technology costs. Average on expense was relatively flat compared to the prior year quarter, represented 4.9% of sales. A few highlights on the balance sheet and cash flow statement.
We ended the quarter with cash, marketable securities of approximately $2,300,000,000. Cash receivable decreased as expected was sequentially year over year $391,000,000. Our inventory balance increased over the prior year sequentially to $533,000,000 as we compare for the seasonally strong second quarter. In the first quarter of 2017, generated free cash flow of $95,000,000, a $21,000,000 decrease for the prior year quarter. Also during the quarter, we paid dividends of $9,000,000 to $6,000,000 we purchased $28,000,000 of company stock and $47,000,000 remaining purchased through December 2017.
In the first quarter of 2017, we reported income tax benefit of $150,000,000, which represents includes a $160,000,000 income tax benefit due to the evaluation of certain Switzerland deferred tax assets. Excluding the $160,000,000 income tax benefit, first quarter 2017 pro form a effective tax rate was 21.3% compared to 18.1% in the prior year quarter. The 320 basis point year over year increase in the pro form a effective tax rate is primarily due to the company's election to align certain Switzerland tax positions, international tax initiatives. We continue to expect our full year 2017 pro form a effective tax rate to be approximately 22%. To close our formal remarks, Christy, to please open the line for Q And A.
Our first question is from the line of Charlie Anderson, Dougherty and Company. Your line is open.
For taking my questions. Cliff, I noticed in Outdoor Marine And Aviation, you're sort of well ahead of where you laid out the segment guidance for the year. So I wonder if you could kind of talk about, how that flows the rest of the year considering? We started at these kind of high levels to begin the year.
And then
I have a follow-up.
Yeah. I think, you know, for outdoor and marine, the first quarter tends to be the lowest quarter, particularly in outdoor and marine is a little higher. Aviation is more sequential. In aviation, we did see some benefit from increased mandate activity, some of which are expiring. So, you know, just looking forward, we felt like it's, best to to maintain where we're at until we have more clarity around, 2nd quarter.
Okay. Then on Phoenix 5,
I know it's very early right now, but I know part of the rationale for that product was to expand the market beyond the current users. Wonder if you have any data back yet on who's buying it. Are they existing, you know, garment owners? Are they are you getting new people? Are the demographics changing?
Any color on that would be helpful. Thanks.
Definitely the demographics are changing, particularly around the 5 S model, which was designed specifically around a female adventure audience. And, the data we're getting back through our online registrations and, of course, our cloud platform, Garmin Connect suggested we're being very successful with that.
Great. Thanks so much.
Thanks, Charlie.
Thank you. Our next question is from the line of Simona Jankowski of Goldman Sachs. Your line is open.
Hi. Thank you very much. Can you give us a sense for the split within the fitness segment between the basic activity trackers and the advanced wearables?
It's about even.
It's about even. Okay. And then, your inventory days were really high, 183, which which I think may be an all time record. And I did hear your comments about preparing for the seasonally strong second quarter, but it still seems like a high level of inventory. So is that because you're seeing stronger than usual demand in the June quarter?
Or is there something in there that, you know, like, activity trackers that, is maybe a result of some of those categories coming a bit short of expectations?
No. I wouldn't say it's due to shortness at all. We are preparing for what is what has become Q2 has become nearly as big as Q4 in terms of its overall contribution. We do have some new product ramps such as the Phoenix 5, which which are driving additional inventory. I think our our goal is to have in stock situation so that we can ship to any customer that wants our products during high season.
And we'll continue to manage it pragmatically then throughout the rest of the year.
Thank you very much.
Thanks, Simona.
Thank you. Our next question is from Tavis McCourt of Raymond James. Your line is open.
Hey, guys. Thanks for taking my question or questions. Just a clarification, Cliff, on the roughly fifty-fifty split in fitness between, basic and GPS enabled, given the ASP differences, is that a a unit split or a or a revenue split?
I think it's a revenue split.
Okay. And then, a couple of other follow ups on cost structure. So Obviously, we've seen big increase in in memory prices the last 6 months or so. How has that impacted you guys in the first half of this year? Or is there an impact that we should expect in the second half of the year related to that?
And then, it looks like ad expenses, advertising expense was down year over year for the first time in a while. Is that something you would expect to continue, or is that, was that timing, related?
Yes. So on the memory prices, definitely there's a tighter market and prices have been going up. We have some longer term buying arrangements that have, allowed us to continue at at more favorable pricing during the 1st part of the year. We do expect to see some impact towards the later half of the year, but we think the impact will be minimal. In terms of ad spending, you know, Q1, we basically have reserved a lot of our activity until Q2.
So I would expect that can increase sequentially and possibly a little year over year as well. But since Q2 is, one of the higher quarters we're going to be promoting our more popular wearables, particularly during the quarter.
Great. And and I just wanted to make sure I understood correctly your your commentary around, aviation, given the strong Q1, Was this stronger than you had expected entering the quarter, or did you expect a lot of the aftermarket strength, and that'll ebb and flow throughout the year?
Yeah. We were we were pleased. We outperformed our expectations for sure. And, as I mentioned, there's some mandates, particularly around, EMS helicopters that that drove some sales plus we did have very popular aftermarket products that that, also performed well along with ADS B.
Great.
Thanks very much.
Thanks so much.
Thank you. Our next question is from Joe Whitney of Longbow. Your line is open.
Hi, thanks. In fitness for the half of the segment that's non GPS, Cliff, are you able to give some sense of the magnitude of the declines you're seeing in that market for simple devices?
Well, just to clarify, fitness consists of both the wearable business trackers as well as the running watches and then and then bike. But in terms of of of, overall, its contribution, we we saw lower, sharply lower revenues in the quarter, and offset by very strong growth in the running products.
Are you able to provide any sort of idea that just the the severity of those declines to help us level set our models?
Yes, I
think, we don't break it out by segment for sure, but as we expected, when we came into Q1 based on what we saw in the latter half, of 2016 activity trackers were down sharply. I think, you know, there's probably lots of different reasons for that, and I think there'll be obviously more color around that, even as we move through the day. But but, it seems like there's a lot of inventory in the channel, particularly with market leaders, it's being worked through. And as that clears and as new products get in such as our Vivo Smart 3, we believe that it will moderate as the year goes forward.
With that dichotomy between the low end and the high end, are you making any strategic changes to your development resources for the segment either pulling back on the low end or reassigning to higher end devices? Or is the strategy to remain every bit as committed to continuing to add features to the to the below GPS product set?
We have a strong roadmap on the basic trackers, as we've evidenced by the the release of our initial products this year. We have additional products coming, but obviously we're we're taking a pragmatic approach to the investment and and applying it where we see the most opportunity.
Okay. And then finally for me, Phoenix5, the availability remains pretty spotty. Including through April, a bunch of big retailers still don't have it. I don't think you're selling atgarment.com just yet. So you referenced orders strong.
I just want to confirm there's no supply side issues to be aware of. And I suppose it's more difficult to manage than prior launches given the higher number of individual SKUs than previously. Yeah.
I think, definitely, we're pleased with the initial response and, and, it's it's not just a matter of of low supply we've been delivering, in in very nice quantities for sure, but but the orders and the reorders have been very strong. So it's going to take some time to work through, all of the orders that we have.
Thank you. Our next question is from Paul Coster of JP Morgan. Your line is open.
Thanks for taking my question. As the mix shift goes towards more advanced devices in the where in the fitness category, what should the impact on gross margins and operating margins in that segment be? Please?
Well, it will definitely mix us because the higher end devices tend to have a higher gross margin. So we would expect it will have an overall positive impact on gross margin percentage and operating margin percentage.
Okay. And my second question is, you appear to be gaining market share again, in marine and possibly in aviation. Can you just talk us through what's giving rise to that? And how that's coming about and can it be sustained?
Well, I think our product lines, particularly in marine and and, also I mentioned some strength in aviation too, but our product lines are very strong. We've been keeping them fresh. And as a result, we we believe that customers are seeing the value and the differentiation that the government brings to the market. Keep in mind, these are both very niche segment, with without a lot of dynamics in terms of the overall channel and and the consumer. So consequently, I I think obviously there's some some limit to to, what the potential growth trajectory, it looks like over the long term, but but our goal is to be the market share leader, and to continue to be able to grow with the market.
Great. Thank you.
Thanks, Paul.
Thank you. Our next question is from Yee Anderson of Morgan Stanley. Your line is open.
Great. Thanks for taking my question. A question on gross margins, just overall, you saw a good improvement year over year in Q1. But just kind of assuming things kind of trend back towards your 56% guidance for the year. Are there certain segments that are see more volatility than others?
Just any color will be helpful there.
Yes, I think a lot of it's going to depend again on product and segment mix. In Q1, we had the benefit of, higher than expected growth in marine and aviation, which mixed the overall consolidated up more. As we move into Q2, which is seasonally higher and sequentially higher, we'll see how that mix develops both in terms of segments and products.
Got it. And then just a question on fitness. Is it fair to say that did you see a pause in shipments ahead of the new product launches in Q1? So are you expecting to kind of make back a lot of that in Q2?
Yes. So we really didn't pre announce any of the products in Q1. We were basically ready to ship when we announced the products. So we didn't see any market impact from announcements that impacted the quarter. That said, with the new products, we've seen excitement around those and we're encouraged by the follow through in the market on those new products.
Thank you.
Our next question is from Ben Bollin of Cleveland Research. Your line is open.
Good morning, everyone. Thanks for taking my question. I wanted to start on the aviation business. Could you talk a little bit about what you're seeing in the OEM category on the business jet side. Any expectations you'd have for how that develops through the year, if visibility does improve and your market share impressions?
And then I have a follow-up.
Yes. So on the OEM side of aviation, I would say It's a business as usual from what we've been reporting for a while now. The overall OEM side of the business has been widely reported by many players has been, kind of lethargic, in terms of the market. We're doing, I would say, okay, but, we we kind of move along with the ups and downs of our OEM partners. We do have the benefit of some newer platforms that we're still comping against from last year.
So that's an incremental benefit, but in general, OEM continue to be somewhat sluggish.
And a broader question, when you when you look at kind of the wearables category as a whole. How do you view the impact of what Apple has done with watch last night, they said, you know, the units for their Apple Watch grew nearly 100% year on year. Curious if you think it's having any impact on your outdoor and fitness business, And then a a last housekeeping item, maybe for Doug, could he talk about the FX impact of, to operating profit in the quarter before including the FX hedges? Thank you.
Yeah. Ben, in terms of, impact from from the Apple Watch, we are also seeing steep growth in our Advanced Wearables category. Doesn't seem to us that there's an impact from the Apple Watch we've said before that we believe the customer base for the Apple Watch versus our devices are slightly different. So consequently, I think we're seeing, a strong performance and even some pull through from from their success as people see the opportunity for improved health and for, pursuing active lifestyles and they probably recognize that Garmin offers, strong products for those pursuits.
Yes.
And regarding the FX impact in Q1, there was a revenue headwind about $6,000,000, so not a significant amount of impact next quarter.
Our next question is from Brad Erickson of Pacific Crest Securities. Your line is open.
Hi guys. Thanks for taking the question. First, can you just lay out how much Q1 outdoor benefited from the Phoenix 5 channel fill or I guess how much it added to the overall outdoor growth rate in the quarter?
We don't break it out by product categories, but we were pleased with what we were able to deliver in Q1.
Got it. And then I guess level question on fitness. Given the maturity in basic trackers you're calling out, is that a business Garmin really wants to be in longer term? We've always known that pricing and margins would inevitably sort of compress in that segment. But with calling out maturity, seems like it's a headwind worth addressing now from a strategic standpoint.
Any comment there?
Yes, I would say it's still a very large market. It's still a market that is adjacent to our interest in the overall active lifestyles. And so it's it's an area that we still have a lot of interest in.
Thank you. Our next question is from Richard Valera of Needham And Company. Your line is open.
Thank you. Cliff, just wanted to try to clarify your comments about the basic trackers being, I think you said 50% of the wearables in fitness, but that would exclude the cycling products. Is that correct?
That's correct.
And so it's less than 50% of the total fitness category revenue, right?
Yes.
And would you be willing to give any sense of how big the cycling piece is?
No, sorry. We don't break it out more than that.
Fair enough. And just on the marine category, I saw very strong growth there. And I would guess you got some year over year benefit from the partial quarter contribution of the LORM in the first quarter of 2016. Would you be willing to give any sense of how much of a year over year benefit you might have gotten from that sort of partial quarter delorm impact in the first quarter of 2017?
Yes. So Delarm is actually recognized in the Outdoor segment. And, the majority of our growth in Outdoor was driven by wearables. With less than half of that really coming from Delorum.
Got it. Okay. Thank you.
All right. Thank you.
Thank you. And that concludes our Q And A session for today. I'd like to turn the call back over to Terry Suck for any further remarks.
Thanks, everyone. Doug and I will be available for our callbacks today. Have a great day. Bye.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a great day.