Good day, ladies and gentlemen, and welcome to your Garmin 3rd Quarter Earnings Call. And instructions will follow at that time. As a reminder, this conference is being recorded. Now like to introduce your host for today's conference, Terry Sec. Ma'am, you may begin.
Good morning, everyone. We would like to welcome you to Garmin Limited's 3rd quarter 2016 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 webcast site. 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, market shares, product introduction, future demand for our products 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 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 Cymbl.
Thanks, Terry, and good morning, everyone. As announced earlier today, Garmin reported 3rd quarter results highlighted by both revenue and EPS growth with 4 of our 5 business segments delivering double digit sales growth and increased profitability. Consolidated revenue increased 6% year over year with fitness, outdoor, marine and aviation collectively growing 24% while contributing 70% of total Each of our business segments produced strong results, which I will highlight shortly. Gross margin expanded to 56 0.2% from 53.3 percent in the prior year as sales shifted towards products with higher margin profile. Operating margin expanded to 22.1 percent from 18.5% in the prior year, and operating income grew 27 percent on a consolidated basis.
These strong results generated $0.66 of GAAP EPS, pro form a EPS came in at $0.75, an increase of 47% over the prior year. Wearable products were a major contributor to our strong third quarter performance and we continue to expand into new product categories with the launch of the Vivo Fit Junior and the Phoenix Cronos. Nextcell highlights segment specific results and initiatives. Starting with business, revenue increased 32% year over year, led by strong demand for our wearables. Gross margin came in at 55% and operating margin was 24% and expansion of more than 500 basis points over the prior year.
Operating income grew 68% in the quarter. During the quarter, we expanded our market with the launch of the VivoFit Junior. This activity tracker is designed specifically for kids with colorful one piece bands that fit comfortably on a child's wrist. Evifid Junior shares many of the unique differentiators of our RevoFid line, such as an always on display, fully waterproof design, and 1 year battery life, while adding a compelling parent controlled mobile app that helps motivate kids to stay at We also launched the 435, bringing Garmin Elevate risk heart rate technology to our entry level running product line. The 435 features GPS, multiple activity profiles, smart alerts, and a new high resolution display that is perfect for both indoor and outdoor use.
In the corporate health market, we recently announced partnership with Cerner, a health information technology company. Through this partnership, Garmin will provide devices that capture powerful health and wellness data that can be integrated into Cerner's Wellness And Population Health Solutions. Looking next at Outdoor revenue increased 28 percent year over year on strong demand for our outdoor wearables and contributions from our recently acquired DOLAREN subsidiary. The Outdoor segment generated strong gross and ARPA operating margins of 63% 35%, respectively, and operating income grew 32% over the year ago quarter. We recently launched the Phoenix Cronos, our first offering in the Luxury Watch category, The Phoenix Cronos line is crafted from premium jewelers grade materials and is designed to look spectacular in any business, social, or personal setting without sacrificing the rugged multi store capabilities associated with our brand.
We continue to invest in our traditional outdoor product lines as evidenced by the recent launch of the RHINO 700 series. Which features a 3 inches multi touch display and Bluetooth connectivity for real time weather and physician reporting. Looking next at marine, revenue increased 12% year over year, driven by growth in multiple product lines, and led by strong demand for our fish finders. Gross margin increased to 57% in the quarter, while operating margin expanded to 15%. Operating income grew 80% in the quarter.
For the 2nd consecutive year, we were recognized by the National Marine Electronics Association as manufacturer of the year. This award, along with 7 product of excellence awards, confirms our dedication to designing, manufacturing and selling industry leading products for the marine market. In addition, at the International Boat Builders Exhibition, we received an innovation award for our recently launched Phantom Solid State Radar. Turning next to Aviation, revenue grew 14% over the prior year as we experienced growth in both OEM and aftermarket product categories. Gross and operating margins remained strong as 75% and 28%, respectively, resulting in a 28% increase in operating income.
During the quarter, we received certification of the G5000 equipped Beach 400 A and we began deliveries of this system to installers. We announced earlier this week that we were developing a G5000 integrated flight deck upgrade for the Citation Excel and the XLAS. This upgrade will feature 3 high resolution displays a modern fully digital flight control system and enhanced safety features. We expect to receive certification this system in late 2018, Looking finally at the auto segments, revenue were down 21% in the quarter, primarily due to the ongoing P and D market contraction, and headwinds caused by revenue deferrals associated with consistent year over year at 12% while the PND market continues to decline, our global market share remains strong. During the quarter, we launched at thirty frames per second.
The verb Ultra 30 also includes first to market features, such as voice control, color LCD with touch screen, onetouch live streaming and our geometric sensors. Finally, with 3 quarters of the year behind us, are raising our projected revenue for the year to $2,950,000,000, up approximately 5% over 2015. We are projecting gross margin of approximately 55 percent and operating income of approximately $580,000,000 for the year. Factoring in an effective tax rate of approximately 18.5 percent,
pro form
a earnings per share is expected to be approximately 2 point $5. Looking at our guidance by segment, we have increased year over year growth expectations by roughly 200 to 400 basis points for all segments except auto, where we are holding our guidance of down 17% for the year. That concludes my remarks. Next, Doug will walk you through additional details on our financial results. Doug?
Thanks, Cliff. Good morning, everyone. Let's begin by reviewing our third quarter results and move to comments on the balance sheet and cash flow statement. We posted revenue of $722,000,000 for the 3rd quarter, representing a 6% increase year over year. Gross margin was 56.2 percent, a 290 basis point increase from the prior year.
Operating expense, the percent of sales was 34.1 percent, a seventy basis point decrease from the prior year. Operating income was $160,000,000, a 28% increase over the prior year. Operating margin was 22.1 percent, a 360 basis point increase from the prior year. Our GAAP EPS was $0.66, a 6% growth for the prior year quarter and pro form a EPS was $0.75, a 47% growth in the prior quarter. We'll discuss gross margin, operating expenses in more detail later.
Next, we will look at 3rd quarter revenue by segment. During the third quarter, we achieved double digit growth in 4 or 5 segments, led by robust growth in our fitness and outdoor segments and solid growth in marine and aviation segments. Collectively, these four segments were up 24% compared to the prior year quarter. Looking next at 3rd quarter revenue charts. The auto segment represented 30% our total 3rd quarter 2016 revenue compared to 40% in third quarter of 2015.
Fitness grew 26 percent of revenue in the current period compared to 21% the prior year, where Outdoor grew to 19% from 16%. You can see from the charts illustrate our profit mix by segment, Outdoor fitness, marine and aviation, collectively, delivered 84% of operating income in the third quarter of 2016. Fitness operating income as a percentage of total operating income increased from 21% to 28%. And Outdoor increased from 29% to 31%.
Looking at year over year
gross margin by segment, all segments posted a gross margin rate increase as sales shifted toward products with increase from 18.5 percent to 22.1 percent, primarily due to gross margin improvement. Looking next at operating expenses. 3rd quarter operating expense increased by approximately $9,000,000 or 4%. Research and development increased $10,000,000 year over year, but was flat as a percent of sales. We continue to invest in innovation The increasing resources focused primarily on aviation, fitness and outdoor.
Our advertising expense decreased $4,000,000 for the prior quarter represented 4.6% of sales, a 90 basis point decrease. The decrease in advertising was primarily in auto. We expect our 4th quarter advertising spend to increase both sequentially and year over year to support our wearable products. SG and A was up $3,000,000 compared to the prior quarter. However, decreased 40 basis points as a percent of sales to 13.4%.
The increase in SG And A was driven primarily by expenses associated with the addition of the Delorum Business. A few highlights on the balance sheet, cash flow statement and taxes. We ended the quarter with cash and marketable securities over $2,400,000,000. Cat received will decrease sequentially as a result of seasonally lower sales in the third quarter, but increased year over year to $461,000,000 on stronger sales. Our inventory balance increased sequentially to $535,000,000 compared for the fourth quarter remains higher year over year due to new product offerings.
In the third quarter of 2016, we generated free cash flow of $199,000,000, a $75,000,000 increase for the third quarter of 2015. Also during the quarter, we paid dividends of approximately $96,000,000 to purchase approximately $20,000,000 of company stock. We have roughly $103,000,000 remaining in share repurchase program, which is authorized through December 31, 2016. We expect to repurchase as business market conditions warrant. Effective tax rate was 16.5% in the current quarter compared to 27.6 percent in the prior quarter.
The decrease in effective tax rate was primarily due to projected income mix by jurisdiction compared to prior year. Please our formal remarks. Esther, could you please open the line for Q
Our first question comes from the line of Joe Whitting with Longbow Research. Your line is now open.
Hi, thanks. Congratulations. Obviously, that top line number ex auto is is impressive. First question, the implied 4th quarter guide assumes a really healthy uptick in operating expenses think, Doug, you touched upon it quickly, but can you talk about where that falls on a segment basis and walk us a little bit more detail through the rationale? I'm guessing a lot of ad spend for the holiday season, but I wouldn't expect anything else in there.
Yes, exactly right. For the Q4, advertising will be higher dollars as well as a percentage of sales year over year. When we think about advertising for the full year, we think advertising as a percentage of sales will be comparable to 2015. Also a few additional things in operating expenses one of which is the 53rd week we previously talked about last quarter, which we have, as well as we have additional expenses due to the LoRaM acquisition.
Well, with that, because I assume it's mostly focused in fitness, will you expect profits within the segment to grow in the fourth quarter either sequentially or year over year however you want to talk about it?
We don't give that type of guidance.
Okay, fair enough. And then maybe moving on for a follow-up here. Verb isn't discussed much, but the new product is impressive with some first to market features, as you said, and some unique features still as well. So curious what you're seeing, if anything from a share perspective, now that the products in the market since new products are showing up in the main competitor there as well? Thanks.
Yes, Joe. Definitely, it's early days in terms of a verb We do have somewhat limited distribution mostly online. And as we've talked about before, the market is very mature with with an entrenched, dominant competitor. So initially, our feeling is it's doing well compared to our expectations, but but we're admittedly taking a conservative view.
Our next question comes from the line of Charlie Anderson with Dougherty and Company. Your line is now open.
Congrats as well on really strong results. Yes, so just looking at the fitness guide, you guys raised it by 200 basis points for the year. So it assumes a pretty healthy slowdown in Q4 coming off these 30% growth down to 15% or so. And you do get that extra week. So I wondered if you could maybe speak to while you're assuming that larger slowdown, I think you do get an easier comp to, just generally how you're feeling about the category, both running activity tracker how the holiday season looks compared to last year, competitive wise, shelf space wise, promotional.
Any other color there would be helpful?
Okay. Yes. So we feel good about the fourth quarter. We would highlight that we're up against stronger comparables from last year when we launched very strong products, the 400,235, and the Vivo Smart HR, particularly. So this year, we're comping against those and and just anticipating a competitive market.
And then on Aviation, you guys did update a strong quarter and you updated your growth there. Just generally how you're feeling about that market? I think generally the market still seems fairly soft, but maybe of the platforms you're on doing a little bit better. How should we think about the long term outlook for aviation for you guys right now?
I think currently, the macro outlook is somewhat soft as you pointed out. We feel like we've been able to do well, particularly driven by ADS B products as well as the pull through of other products that we sell in addition to ADS B when somebody upgrades their panel. I think long term, we're feeling good about aviation and the opportunities that are there, but it will take some time to play out and invest to get there.
Thanks so much. Thanks, Charlie.
Our next question comes from the line of Simona Jankowski with Goldman Sachs. Your line is now open.
Yes, hi. I just wanted to ask you about your expectations into the 4th quarter. In terms of shelf space with retailers compared to last year and also promotional activity that you expect from your retailer partners And then with all the recent introductions, over the last couple of quarters, was this September quarter still one where you were benefiting from net inventory additions into the channel or was sell in and sell through more closely aligned?
Yes. So in terms of the first question, believe our shelf space actually has improved over what we had last year. For instance, this year, we have expanded shelf space in Best Buy stores and their top 2 twenty stores going from 4 feet to 8 feet with 4 feet in other stores. So that was an improvement over over last year. We have additional space, for instance, for Vivo Pit Junior in many retailers.
So in general, we feel pretty good about our shelf space situation. And retailers, we believe our getting behind the products in terms of flyers and promotions and the specials for the holidays. So we feel good about that. In terms of sell in sell through balance, we feel like things are fairly well balanced right now. We did have some product introductions in the quarter such as the $435,000,000 in the Vivo Pit Junior.
But in general, those were somewhat limited sell in, in Q3, and we expect additional sell in to occur in Q4.
Our next question comes from the line of Brad Erickson with Pacific Crest. Your line is now open.
Thanks for taking my questions. So relative to mix, give us a sense of what ASPs did directionally for fitness year over year and sort of how significant that was contributing to this growth we're seeing?
Well, I think we are selling a number of products that are higher ASP, particularly in what we would call our tracker category, although the the categories are somewhat blurring in terms of the lines between them. For instance, we have the Beboe active HR this year, which is a mid-two $100 category for us, but it is generally tracked as a tracker product. And we're also doing very well on the running side with mid to higher range devices. So that's balanced by increased volume and lower fees on basic trackers, but overall, we think that we've done well in those other categories.
Okay. And then geographically, can you just rank order the contributors that drove the fitness growth that we're seeing? Thanks.
Well, we're seeing growth across the globe in all major regions. So it has been particularly strong in Europe, where the market is developing, is behind in its development compared to that particularly in North America and we also saw strong growth in APAC.
Our next question comes from the line of Travis McCourt with Raymond James. Your line is now open.
Hey, thanks, Cliff, for taking my question and good quarter. First, on the aviation segment, obviously, your commentary seems a little different than your 2 largest competitors who seem to have some bigger struggles there. And I'm wondering, and then also your Q4 guidance on Aviation seems to suggest more of a flattish quarter year over year. So was there timing of shipments that positively in of this quarter or better execution on ADS B or kind of any commentary around why the higher growth rate this quarter. And then secondly, if you could comment, Doug, on foreign currency, specifically the pound, is that a big enough move yet given your limited exposure there to guide?
Thanks.
So in terms of our experience in the aviation market, I think one of the things we see is the the growth in the ADS B category. That did go very well for us in Q3 and it has second order effects as we sold additional products and display systems into cockpits that we're getting ADSD upgrade. So that drove a big part of the overall growth in the aviation side. In terms of Q4 and our outlook there, the market has been sauce for a long time. And so we're taking somewhat of a conservative approach as we look at Q4 and just kind of wait and see how the market develops.
Yes. And regarding the FX impact, for Q3, we saw about $6,000,000 of a revenue headwind, primarily due to the pound So given some of the increased weakness there, we probably anticipate a little bit more than that going into Q4. But, I should say also that the percentage of our business, depending upon the pound is about 5%. So it's not a significant percentage of our business.
Great. And if I could ask you a quick follow-up, Cliff, on the ADS B, those are relatively at a standalone product, relatively low ASP. Should we think about that as lower gross margin business? But if you're able to effectively use that to cross sell to sell bigger retrofit systems, then it becomes a much bigger positive impact to Garmin. Is that a good way to think about
We feel like the gross margin is consistent. It's in line with the overall segment, so not really a lower margin category for us.
Great. Thanks very much.
All right. Thank you.
Our next question comes from the line of Jerry Lee with Morgan Stanley. Your line is now open.
Thanks. So first question on gross margin. If I look at the December quarter, full year guidance implies about a 52% gross margin down a little over four points sequentially. Historically, fourth quarter tends to be a little bit lower sequentially, but this year seems to be a bigger magnitude than the last few years. So I wanted to to see what are the main reasons?
Is it product mix? Do you anticipate more promotions? Anything else?
Yes, in terms of overall gross margin, we do see both mix and promotional activities as driving the lower gross margin. Of course, the promotional activities drives the margin by product categories and then mix of categories in terms of the sales volume and one drives the overall situation mix.
Okay. And maybe just a bigger your question. When you look at some of your fitness tracker competitors, like Apple recently, Aetna announced they will subsidize Apple Watches. And if they just hired any VP of Digital Health, seems like your competitors are looking at pilots and partnerships with insurers and others in the health care industry. So wanted to get your take on that.
What's your strategy? Do you see any opportunities to getting to either the health care space or to work more with employers to subsidize some of these devices? Thank you. Well, as we
mentioned in the remarks, we are pursuing that kind of business as well. We partnered with Cerner recently. Also have partnerships with insurance companies like Manulife and others and we also do deals with individual corporations as well. So it's an opportunity we're pursuing
Our next question comes from the line of Will Power with Robert W. Baird. Your line is now open.
Great. Thanks. Yeah. Just a couple of questions. Maybe just to come back to the fitness.
You had a couple of these high profile launches. You had the 2nd generation Apple Watch that has GPS for the first time. I guess I wonder whether you've seen any impact on your running watch, business since it's at least somewhat more of a competitor with GPS or is it still too early? And I guess likewise with the new Fitbit device, I was wondering if you could any commentary around share shifts, etcetera, that you might be seeing there?
Yes. So in terms of the recent developments with the Apple Watch and GPS, as you point out, it is still early days But at this point, we don't see any detectable impact. I think we've said in the past that our products tend to appeal to a slightly different audience than the Apple Watch, although there is some overlap, but generally that's true. So that's the way we see things right now. And of course, how things develop.
In terms of the new Fitbit launches, in terms of our market share, we feel like it's generally stable. They've released new products, of course, and they have very strong share, but ours has also remained about where it was. We think it's in the 10% range.
Okay. And then just on the auto business, it seems like we've seen a bit of an acceleration in the year over year declines. I guess I wonder if you had any more color on the drivers of that. And is this somewhat of an anomaly looking at the past couple of quarters? Or is this 20% kind of year over year decline?
Is this perhaps a new normal?
Yes. So I think we did see the softness earlier in the year. And last quarter, we updated our guidance to be slightly more down than what we had previously projected. The weaknesses are primarily driven in Europe where the market has gotten softer. We think for the fourth quarter that there'll be some opportunity to kind of flatten that curve a little with promotional activity, but it is somewhat of a wait and see situation.
Our next question comes from the line of Ben Bollum of Cleveland Research. Your line is now open.
Good morning. Thanks. Cliff, Doug, Terry. I appreciate the question. First item, when you look at the fitness business, How would you characterize the organic growth of the market as a whole?
And then kind of beyond the organic growth of the market, How would you say that, what's the benefit from incremental shelf space or stores versus kind of product refresh and expanded SKUs as you've expanded into deeper into that category?
Yes. So in terms of organic growth, there's multiple categories within fitness from the low end trackers on up to high end running watches, but we've seen growth in those categories on a global basis market growth, if you will, over the past year. I think some markets are more mature than others, as I mentioned earlier. So the situation probably different in Americas versus euro versus APAC, but generally the market has been growing. In terms of a benefit I think again, it depends on category, but new product releases always generate excitement for sure.
But at the same time, shelf space is vitally important. So we're working hard to have both good shelf space presence in retailers as well as strong product offerings.
When you look at the overlap you characterized with Apple, Where do you see the most overlap across your portfolio when you look at Apple? Which specific product or features do you think you have the most overlap? And then one last follow-up.
Well, I think that's somewhat of a challenge because if you look at our business product line. We have one kind of product and the features and the style that that's there. Versus outdoor and our Phoenix line, which has yet a different kind of style. But generally, I would say that the kind of customer that overlaps with with Carmen would be those that are probably more on the entry level side to running and activity and are looking at what kind of device they could use to
enhance
their performance in running and other kinds of sporting activity. So that's generally the customer profile that would be overlapping with us.
Okay. And the last item, looking at the Aviation business, there was an announcement during the quarter, you're expanding your capacity What is the company's long term view on the ability to gain share with OEMs? And how are you thinking about the potential timing of winning more business, even in regional commercial opportunities. And last, I apologize, last one on linearity of ADS B, how do you think about that between now 2020? Does it build as we approach that?
Is it pretty linear between now and then? What's the right way to think about how that how that grows? Thanks.
Yes. So in terms of our long term view, as highlighted by the announcement we made, where we're investing in the aviation business. Absolutely, we have a strong view for the future of that business. And currently, we're running at near capacity in our current production facilities. And so in order to meet the anticipated demands of the future, We felt like it was the right time to invest in our facilities.
In terms of opportunities to win business, I think there many opportunities to win business. Our G, three thousand and five thousand lines are very strong. And we believe that those products should appeal to a broad range of business jet platforms that we are currently not present in. Regarding the linearity of linearity of ADSV. Of course, we're seeing accelerating growth in that area as people become more aware of and interested in applying with the mandate.
And we would expect to see stronger growth in ADS B as we move into 20172018.
Thank you.
All
right. Thank you.
We have a follow-up question from the line of Joe Whitting with Longbow Research. Your line is now open.
Thanks. Appreciate it. In automotive, can you give any sense of what the OEM business looks like on an organic or apples to apples basis light vehicles, so to exclude the impact of deferred?
Yes. So from auto OEM business, yeah, excluding deferred, basically, we did see some improvement there on a cash basis.
Is the an improvement so you're, you are growing year over year or the rate of growth is improving or both?
Yes, we are improving, yes, dollars.
Okay, got it. And then maybe just finally, Doug, tax rate question, what's a good place to land our 2017 model given you changed the 16 number here given the change given the change in Swiss tax laws, we're all monitoring as well.
Yes. So we'll actually give guidance on 2017 February. So it's a little too early for that at this point in time. We'll go through our planning process over the next few months.
At this time, I'm showing no further questions. I would like to turn the call back over to management for any closing remarks.
Thanks, everyone. Doug and I will be available for callbacks. Have a great day.
Everyone, have a wonderful day.