Good day, ladies and gentlemen, and welcome to the 2nd Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will follow at that time. I would now like to introduce your host for today's conference, Terry Sac. Ma'am, you may begin.
Good morning. We would like to welcome you to Garmin Limited's 2nd 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 slash 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, market shares, product introductions, 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 Wesson, Chief Financial Officer and Treasurer. At this time, I would like to turn the call over to Cliff Himble.
Thank you, Terry, and good morning, everyone. As announced earlier today, Garmin reported 2nd quarter results, highlighted by both revenue and EPS growth. Consolidated revenue increased 5% year over year with fitness, outdoor, marine and aviation collectively growing 20% while contributing 70% of the total revenue in the quarter. Each of our business segments produced strong results, which I will highlight shortly. Gross margin expanded to 57% from 54.2% in the prior year as new products and margin improvement efforts made a clear impact on our business.
Operating margin expanded to 24.7% from 21.5% in the prior year, and operating income grew 20% on a consolidated basis. These strong results generated $0.85 of GAAP EPS Pro form a EPS came in at $0.87, an increase of 21% over the year ago quarter. Wearable products were a major contributor to our strong second quarter performance. Over the past year, we've expanded our wearable product portfolio with the goal of offering a wearable device for First, we've been expanding the availability of Garmin Elevate risk heart rate technology across our wearable product lines. Garmen Elevate is now available in multiple models of our running products, in our activity trackers, and in our Phoenix series of outdoor adventure watches.
Customers have embraced Garmin Elevate and the feedback we are receiving is very positive. The second important objective is to increase customer engagement by offering applications, widgets, and watch faces through our connect IQ App Store. Momentum in the App Store continues to build as we now offer over 2000 apps, watch faces and widgets, and we have surpassed 13,000,000 downloads from the store since this launch early last year. While I'm pleased with the progress we've made so far, there is certainly much more to do. We remain focused on a strong product roadmap and building engagement through Connect IQ and our Garmin Connect community.
Looking now at segment highlights our fitness segment experienced robust revenue growth of 34% on a year over year basis, driven by growth within all product categories. Gross margin came in at 56% and operating margin was 25%, and expansion of more than 400 basis points over the prior year. This generated operating income growth of 60% in the quarter. Recent new product launches include the 400735 XT, a lightweight multi sport running watch, and the Vivo Smart HR Plus, which adds GPS capability to our smart activity tracker. As a result of these and many other recent product releases, we estimate that our share of to approximately 57% today according to market share data.
During the quarter, we also introduced the Vivo move, a fashionable analog watch with activity tracking features and a 1 year battery life. Looking next at Outdoor, which also experienced robust growth, revenue increased 23% year over year on strong demand for our outdoor wearables and a full quarter contribution of Delarms sales. The Outdoor segment generated strong gross and operating margins of 64% and 36% respectively, representing an expansion over the prior year. Operating income grew 31% over the year ago quarter. 1 of the many benefits of our business model is the ability to share product platforms, technologies and components across multiple market segments.
Recent examples include the Approach X40, a GPS based activity tracker with Garmin Elevate risk heart rate technology and a built in database of over 40,000 golf courses providing distance to the front, middle, and back of the green. We also introduced our next generation dog tracker, the Astro4 30, which when paired to a Drive Track 70 P and D, can track up to 20 dogs from a vehicle. The Astro 4 30 can also pair with a Phoenix 3 wearable, for convenient tracking and alerts at the risks. Looking next at marine, revenue increased 8% over a very strong 26%. Operating income grew 19% in the quarter.
Our new Fishfinders have been well received and which enables voters to create maps of their lakes with all processing and storage taking place right on the device. We recently enhanced quick draw by offering a community feature called quick draw community, which is a free cloud based mapping platform for sharing user generated HD mapping content. We believe quick draw community will positively impact customer engagement and will expand the availability of HD mapping content particularly on smaller fishing lines. Turning next to Aviation, revenue grew 6% over the prior year as we experienced growth in both OEM and ADS B systems. Gross and operating margin remained strong at 74% 28%, respectively, resulting in a 13% increase in operating come.
During the quarter, the G3000 equipped Piper M600 received type certification, and we are pleased to be the Avionics provider for this aircraft. As we continue into the back half of 2016, We will focus on a number of additional certifications, including the aftermarket G5000 system for the BeachJet 400A and the HOCER 400 XP. We announced several new products and product enhancements at the Oshkosh Air Show taking place this week. One such announcement is the Flightstream 510, which is a multi mode wireless radio system built into a multimedia card which also includes storage for a variety of flight databases. The flight stream 510 is important because it simplifies the task of updating flight databases by leveraging the connectivity of a smartphone or tablet.
Flightstream 510 also shares flight plans, traffic, weather and physician information with smartphones and tablets running our Garmin pilot mobile app. Slide stream 510 significantly enhances the ability to incorporate consumer devices in the cockpit. Looking finally at the auto segment, revenues were down 18% in the quarter, primarily due to the ongoing P and D market contraction and headwinds caused by revenue deferrals associated with certain auto AM programs. Gross margin came in at 46% and operating margin expanded to 16%. We remain strategically focused on new opportunities in the auto OEM market.
While we are typically thought of as a navigation and infotainment supplier, We are also leveraging our competencies and other technologies such as cameras and driver assistance to expand our ability to serve the market. At the recent 2016 Beijing auto show, Pujot, it showcased its model 3008, which includes a factory installed digital video recorder, designed and manufactured by Garmin. So in summary, we are pleased with our performance in the first half of twenty sixteen and we believe are well positioned for the remainder of the year. With this in mind, we are raising our projected revenue for the year to $2,900,000,000, up approximately 3% over 2015. We are projecting gross margin of 55% and operating margin of 19% for the full year.
Factoring in an effective tax rate of approximately 19.5%, pro form a earnings per share is expected to be approximately $2.50. Looking at our outlook by segment, we have increased growth expectations for fitness and outdoor to 20% for the year. Aviation and marine are unchanged, while the outlook for auto has been reduced slightly based on current market trends. That concludes my remarks. Next, Doug will walk you through additional details on our financial results.
Thanks, Cliff. Good morning, everyone. I'd like to begin by reviewing our 2nd quarter results, move to comments on the balance sheet and cash flow statement. We posted revenue of $812,000,000 for the 2nd quarter, representing a 5% increase year over year. Gross margin was 57 percent, a 280 basis point increase from the prior year, driven primarily by segment and product mix.
Operating expense as a percent of sales was 32.3 percent, a 40 basis point decrease in the prior year. Operating income was $201,000,000, a 20% increase with the prior year. Operating margin was 24.7% 320 basis point increase from the prior year. Effective tax rate was 21% in the current quarter, which is comparable to the effective tax rate of 20.6% the prior year quarter. Our GAAP EPS was $0.85, 18% growth for the prior year quarter, our pro form a EPS was $0.87, a 21% growth for the prior year quarter.
We'll discuss gross margin, operating expenses in more detail later. Next, we look at 2nd quarter revenue by segment. During the 2nd quarter, we had growth in 4 of our five segments, led by robust double digit growth in our fitness and outdoor segments and single digit growth in our marine and aviation segments. Collectively, these four segments were up 20% compared to the prior year quarter. Looking next at 2nd quarter revenue charts.
The auto segment represented 30% for our total second quarter 2016 revenue compared to 39% in the second quarter of 2015. Fitness grew to 26 percent of revenue in the current period compared to 21% in the prior year, while Outdoor grew from 14% to 17%. See from the charts illustrate our profit mix by segment, outdoor, fitness, marine, aviation, collectively, delivered 80 percent of operating income in the second quarter of 2016. Finest operating income as a percentage of total operating income increased from 20% to 27%. Now outdoor increased from 22% to 24%.
Looking at year over year gross margin by segment, all segments posted gross margin rate increase due to shifts in product mix. Total corporate operating margin increased from 21.5 percent to 24.7 percent due to gross margin improvement. Looking next at operating expenses. 2nd quarter operating expense increased by about $10,000,000 or 4%. Research and development increased $5,000,000 year over year, was flat as a percent of sales.
We continue to invest in innovation and increasing resources focused primarily on aviation, fitness and outdoor. Our advertising expense decreased $1,500,000 in the prior year quarter represented 5.5 percent of sales, 50 basis point decrease. Additional advertising spend in fitness was more than offset by decreases in auto and marine. SG and A was up $6,000,000 compared to the prior year quarter increasing 170 basis points, percent of sales to 12.8%. Increase in SG And A was driven primarily by expenses associated with addition the Deloran business and compensation related costs.
A few highlights on the balance sheet cash flow statement and taxes. We ended the quarter with cash and marketable securities of about $2,400,000,000. Account receivable increased both sequentially and year over year to $510,000,000. Inventory balance decreased sequentially to $508,000,000 as we exit the seasonally strong 2nd quarter remains higher year over year due to new product offerings. For the second quarter of 2016, we generated free cash flow of $135,000,000, a $71,000,000 increase for the second quarter of 2015.
Also during the quarter, we paid dividends of approximately $97,000,000 repurchased about $25,000,000 company stock, approximately $123,000,000 remaining for purchase through December 2016. As Cliff mentioned, we're updating our tax guidance and anticipated full year tax rate of approximately 19.5%. Concludes our formal remarks. Jamie, can you open the line for Q and
And our first question comes from Charlie Anderson with Dougherty and Company. Your line is now open.
Yes, thanks and thanks for taking my questions and congrats on a great quarter. Thank you. I wanted to ask, Cliff, it's been interesting. Garman Elevate has been very helpful for you this year. I wonder how much do you think the rest of the product portfolio can get penetrated with that technology?
And then also just thinking about, as that's helped you this year and if I think about future versions of these products, there are other biometric sensors you feel like you can add so that this is a sort of a continuous trend for you as opposed to maybe a 1 or 2 year phenomena?
Yes. So in terms of penetration of the heart rate technology, we have expanded it broadly across the line, as I mentioned, in my remarks. I think we're mostly there. There's probably still a few areas where we believe we can add and we will do so. But I think for the most part, over the past year, we've been able to accomplish what we set out to do.
In terms of other sensors, we're certainly working on that as a lot of people say they are. I think the biggest challenge is the next level of sensing technology has to prove that it is it has utility for the customers and it has to be technologically feasible And so I think, we like everyone else is searching for that next breakthrough.
And then follow-up question for me on gross margin. Very strong in fitness and outdoor in the quarter. I think implied in the guidance is that we come down a little bit off that level in the back half of the year. I wonder if you could talk about the puts and takes there.
Yes, I think the back half will certainly come down in terms of gross margin because of promotional activities and going into the fourth quarter.
Great. Thanks so much.
All right. Thank you.
Thank you. And our next question comes from Ben Bollin with Cleveland Research. Your line is now open.
Good morning. Thanks for taking my questions. A couple of items. The first one, looking at the outdoor and fitness businesses exiting 2Q, Could you tell us your impressions of channel inventory, where it stands with a large number of products that you've launched, how you feel going into 3Q, And then also, any impressions or thoughts you have longer term about the growth in operating margin profiles of those businesses? How are you how are you managing them?
What's kind of your targets? And then I have a follow-up.
Okay. Thanks, Ben. So in terms of channel story, especially with the launch of new products. I think, it probably varies by regions and by stores, but in general, we feel like The inventory is in a good situation. We feel like our products are selling out well, so we don't think that there's any issue with new products stacking up in the channel.
In terms of growth in margins, certainly we've been on a deliberate effort to improve our margins across all of our business segments. I would say that in fitness as the mix continues to shift towards the activity trackers that that profile We'll continue to have pressure on it while in outdoor. It's probably, somewhat stable, at its current levels.
Okay. And then looking at the automobile business on a standalone basis, a little worse year on year performance there. Any adjustments to your thoughts longer term? It's kind of been a declining mid teens type business. Any reason it gets progressively worse from that level?
I think what we saw, so far in the first half of twenty sixteen is that the European market has weakened more than what it had been up to that point. So I think that's probably the big change in our outlook But generally, we still feel like it's a good market and we feel like we're doing very well in that market in terms of market share.
Thank you.
Thank you. Securities. Your line is now open.
Hi, thanks for taking my questions. First, I guess, you mentioned the market shared data and I believe it was the GPS enabled smartwatches. So that was helpful. In terms of activity trackers, can you kind of provide any market share update for that particular sub category?
Yes, Brad, the market share and activity trackers, we believe we're roughly at the 10% level in the U. S. Market. Internationally, there's areas strength and weakness across the whole world, but we're actually doing very well in bigger European countries and also in Asia.
Got it. And then you've obviously come out with a lot of new products here in fitness recently. Can you kind of talk about second half and how we should be thinking about the cadence of new products on a relative basis to first half? Thank you.
I think the first half was certainly a big part of what we had planned for the year, but still have some additional releases that we'll be announcing here in the second half as well.
Thank you. And our next question comes from Travis McCourt with Raymond James. Your line is now open.
Hey, thanks for taking my question. I've got a few of them. But first for clarification, can you remind us what your previous guidance was for year over year decline in the auto segment
It was minus 15.
Okay. So you think rest of the year will look more similar to what we saw in Q2?
I think roughly similar, yes.
All right. And then if I look back now, going back 6 quarters or more, you've had a nice run here in your Asia Pacific business? And I'm wondering, is all of that attributable to, fitness wearables? Or are you seeing some broader strength beyond fitness in that region?
We're doing very well in fitness and outdoor wearables in that region.
Got it. Doug, do you have the impact from net deferred revenue drawdown in the quarter?
Yes. Overall, deferred revenue had a headwind of about $8,000,000 We anticipate probably full year, probably about a $0.08 to $0.10 headwind. Preferred revenue.
Got it. And then, and Cliff, a product question, you mentioned in your prepared script, vivo move. And this was an interesting one, I think, because, really a departure from the look and feel of Garman's activity trackers historically. And so I know it was just very recently launched, but do you have any early indications of, sell through on that device?
I think it is still very early. I think that product appeals to a slightly different kind of customer than our traditional base. So we're waiting to see how does.
All right. Fair enough. Thanks very much.
All
right. Thanks, Travis.
Thank you. And our next question comes from Stanley. Your line is now open.
Hi, thank you. Can we talk a little bit about some of the drivers for earnings in the second half of the year. It looks like your gross margin will be better compared to second half of last year. So it looks like this is the lower year over year earnings in the second half this year mostly has to do with higher OpEx, maybe higher advertising. Can you talk about any other drivers potentially fewer product launches or anything else?
Yes. As it relates to the gross margin in the back half, you'll see probably some improvement related to segment mix, there primarily, but looking at the gross margins for the full year, we anticipate most of the segments for full year to be comparable to 2015, except for fitness, which Cliff previously mentioned will probably be lower due to higher percentage of activity tracker, wellness. We think that's probably going to be fitness, gross margins full year probably in the low 50s. As it relates to expenses, a couple of things to think about expense in the back half, the first of which is relating to acquisitions. Delorum will have full 2 quarters of expenses, relating to the Lorum acquisition as well as in 2016, this is the year we have a 53rd week.
So we have 1 extra week of expenses in 2016 compared
to
percentage of sales will be comparable year over year. So there'll probably be some increase in dollars, talking about for full year here, in there. But as a percentage of sales, we think advertising will be relatively comparable, to 15.
Got it. And then just one question in terms of the different geographies. It looks like America's maybe a little weaker in the second quarter. I know you said EMEA was probably weaker, but maybe just some details on the Americas growth rate? And then going forward, would you expect, because of the, of the depreciation in the pound any need to maybe raise prices there and potentially any demand impact from that?
Would any of that be factored into your guidance? Thank you.
Yes, Jerry, I think in terms of all the factors you mentioned, it's definitely rolled into our guidance. Americas has been a little weaker for two reasons. One is that we are more exposed in this market on the Americas market to the P and D market cycle. So that's one dynamic And then the second thing is that the activity tracker market in the Americas is more competitive than what we see in the other areas of the world where we're doing comparatively better. So those are 2 moving pieces there in terms of America's performance.
In terms of specific impact to the pound, we're definitely working that situation and much like what we did with the euro situation last year. There could be some impact on prices, but But I think all of this is like threading a needle. You need to see where you have the ability and the power to raise prices and also where you do not and make the appropriate moves.
And our next question comes from Will Power with RW Baird. Your line is now open.
Great. Thanks. Yeah. Maybe just to follow-up, a bit on the previous question, thinking about the Americas and the competition you're seeing in wearables there. I think one of the market share leaders planning new products here in the second half of the year.
So is that a segment that can stabilize year over year for you? Or should we expect that to actually worsen and be offset by this continued better performance in EMEA and APAC?
Well, I think longer term, we would expect the Americas to grow as well. But again, the near term dynamics of the P and D decline are outweighing the growth we've had in some of the other segments.
Okay. And then I had a couple
of financial questions. Just looking at R&D, at least on an absolute dollar basis, at a higher level this quarter, is that the right number to kind of look at moving forward as you move into Q3 and Q4, were there some things that elevated that this quarter?
Yes. So as I mentioned, R and D we'll be increasing primarily because of that de Lortum acquisition, which we'll be adding in there. And also as we add headcount just for new product introductions. So we'll see overall from operating expenses percent of sales will be increasing overall full year.
Okay. All right. And then just on the buyback, I know you still have, some remaining, but I wonder if you could give us a broader thought process on use of cash once you exhaust that. Do you return to a buyback or how do you think about buybacks cash once you get through the current authorization?
Yes. So when we look at, we basically, our goal is to return about 100% our free cash flow back to the shareholders between dividends and, share repurchase. As it looks at share repurchase, we look at a number of things there. One of which obviously is our business conditions as well as our market condition there and we'll play that out depending upon how that those throughout the rest of the year and future.
Thank you. And our next question comes from Paul Coster with JP Morgan. Your line is now open.
Thanks. This is Paul Chung on for Paul Coster. Thanks for taking my question. Can you confirm the delorm contribution to both margins and top line in 2Q and in which segments can we expect incremental M and A given a large cash balance?
Yes. So in terms of delorme's contribution, in margins. We don't break any of that down. I would say in terms of top line, it's attributed to the outdoor segment. And it represented less than half of the overall growth that we had in the segment for the quarter.
In terms of our outlook for M and A, we don't really comment on our plans, of course, as you can understand. I think our strategy has always been to look for good fits in technology or product lines that would complement our overall portfolio. And that's what we've been doing and that's what we continue to do.
Okay, thanks. And then quick housekeeping, the recognition was deferred to, slowed somewhat. How should we think about the timeline to recognize the full balance? I know you mentioned some incremental was booked this quarter, but that seems like a one off Thank you.
As it relates to deferred revenue? Yes. Yes. So basically, in the 2nd quarter, we had $8,000,000 of headwind on deferred revenue. And for the full year, we're anticipating headwind of our EPS of between 8% 10%.
So it'll probably be a little bit less than that in the back half.
Thank you. And our next question comes from Simona Janowski with Goldman Sachs. Your line is now open.
Hi, thank you. First, in terms of gross margins in the quarter, which obviously expanded quite a bit both in fitness and outdoor, Could you help us quantify and understand the drivers behind that? I imagine there's some benefit from leverage, but then other factors like pricing or mix within those segments, that would be helpful.
Simone, I think probably the biggest factor I would attribute it to is the refreshing of our product lines and the ability to reset pricing with products with new features and that are more competitive in the market. So I think that's the main contributor We're also very focused on product costs. So we're working costs out of the products continually and that's also had an impact on our business.
Thank you. And then a somewhat similar question in the P and D segment. You also refreshed and rebranded that product line earlier in the year. Are you seeing a benefit there from the price increases that you're able to put in? And is there a bit of a change in the trade off that you're willing to strike in P and Ds between pricing and volumes?
Yes, I
think we've definitely seen a benefit in the launch of the new lines. They have great new features that we believe are the best anywhere. But in terms of the limits, certainly there is a limit in terms of pricing versus volume and our goal has been to maximize profitability.
So in other words, are you giving up a little bit of market share there as you try to price higher?
I think, we're certainly, we're certainly sensitive to pricing and profits in the segments, I will say. I think in terms of our current approach and the evidence of the market share that's out there, there could be some slight degradation in market share, but I the evidence is very, very slight for that. And in general, we feel like our market share is still very strong, both globally and in the U. S.
And then just lastly, what was the FX impact in the quarter?
The FX impact in the quarter was about $3,000,000 of headwind, so small amount.
Okay. Thank you.
Thank you.
Thank you. And our next question comes from Ivan Feinsett with Tigris Financial. Your line is now open.
Okay.
It seems like we don't hear Ivan.
Hello, I'm sorry. Thank you. Thank you for taking my question. Congratulations on an incredible quarter. Really putting out some great products.
My question is more about your marketing focus on your marketing spend. There are a lot of places where I expect to see, you know, Garmin presence and I do, but there's a lot of places where I would either expect and hope to see the presence, especially in the wearables and even in the, action camera. And I still don't see it. What is your overall big picture marketing plan and do you see also more integration on a lot of your apps with, let's say, health care or fitness apps or, GM apps and things like that?
Yes. So in terms of product placement, certainly there's there's puts and takes, but we think we're generally represented well at every major retailer. And we also have a very strong presence with the products that you mentioned, particularly in the fitness and the outdoor area in specialty retailers. So generally, we've been working hard on expanding our retail presence. We've been working hard on improving the presentation of our products at retail over the past year.
And we think that we've made a lot of progress In terms of integration of our apps with others, we already do quite a bit of that, for instance, we have integration with MyFitnesspal for nutrition tracking and we also have integration on the cycling side with Strava as well. So, we're very open to partnerships and we've been demonstrating that.
Who do you see as like your strongest marketing partner?
Well, I think we're our strongest marketing partner. We're focused on the Garmin brand and we're focused on partnerships that enhance the Garmin brand.
Thank you. And our next question comes from Andrew Sonola with Wells Fargo. Your line is now open.
I saw the reference to the ADS B contribution to the growth in aviation in the quarter. And I'm just wondering if you could step back and give us a snapshot of where that opportunity is today? I know it's multiyear process. Is it still building? Is it going to become a bigger and bigger contributor over the next couple of years for you?
And is it still are you still as strongly positioned as you were a year or 2 ago there?
Yes. So in terms of where we're at, it's probably difficult to precisely nail it down, but we think it's somewhere in the 20% to 25% equipment that's occurred so far in the market with the vast majority of the equipments yet to come. I think pilots and aircraft owners are just like everybody else. So probably a lot of them will wait until the last minute. So we do see a building momentum as time goes on as we lead up to the 2020 deadline.
In terms of how we're doing, I think we're doing very well. It's one of those areas where it's difficult to precisely nail down market share, but we believe our share so far in the equipped airplanes is north of 70%.
And Doug, how does that
how does the ADS B product line impact the margin profile of aviation? Is it in line or potentially better?
It's in line.
In line. All right. Thank you very much.
Thank you, Andrew. Thank you.
And I'm showing no further questions at this time. I'd like to turn the call back over to Terry Sec for closing remarks.
Thank you all for joining us this morning. Doug and I will be available for callback. Have a great day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.