Good day, ladies and gentlemen, and welcome to the Garmin Ltd First Quarter 2015 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 be given at that time. As a reminder, this conference call is being recorded. I'd like to introduce your host for today's conference, Carrie Thurston, Director of Investor Relations.
Please go ahead.
Thank you. Good morning, everyone. We'd like to welcome you to Garmin Limited's first quarter 2015 earnings call. Please note that the earnings press release and the related slides are available at Garmin's Investor Relations site on the internet at www.garmin.comstock. An archive of the webcast and a 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 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 result of risk factors affecting Garmin. Information concerning these risk factors is contained in our Form 10 K, which was filed with the SEC. Presenting on behalf of Garmin Limited this morning are Cliff Pemble, President and CEO and Doug Besson, CFO, and Treasurer.
At this time, I'll turn the call over to Cliff.
Thank you, Carrie, and good morning, everyone. As announced earlier this morning, Garmin reported solid 1st quarter revenue and margin performance. Consolidated revenue was flat year over year in what is typically a seasonally weak quarter. Revenue from aviation, fitness, marine, and outdoor grew 9% on a combined basis. These segments contributed 63% of total revenue and 80% of the operating profit in the first quarter.
Gross margin improved year over year to 59%, while operating margin came in at 19%. The slight reduction in operating margin from the prior year reflects continued investments in advertising and R&D. The stronger U. S. Dollars created a headwind for most businesses, including ours, We estimate that recent currency movements reduced our revenue by approximately $38,000,000 and operating income was reduced by approximately $11,000,000.
As everyone can appreciate, these list. Please note that our pro form a calculations do not account for these factors, but we wanted to mention it for clarity. Strong margins combined with a lower effective tax rate resulted in $0.55 of pro form a EPS in the quarter, which is flat on a year over year basis. We are maintaining the guidance we issued early in the year as our performance thus far is consistent with our expectations. Doug will discuss our financial results in greater detail in a few minutes, but first, I'll walk through a few highlights for each business segment.
Beginning with the fitness segment, revenue grew 31 percent on a year over year basis with strong contributions from activity trackers multi sport and cycling products. We delivered gross and operating margins of 63% and 26%, respectively. Operating margin was lower on a year over year As you are aware, the fitness market is highly competitive and thus requires additional R and D investments in order to bring innovations to market faster. In addition, we are deliberately investing in our point of sale presence as we roll out new products and prepare the way for our spring advertising campaign. Recycling, we announced the vector 2 and 2S, our latest petal based power solutions.
These new vectors simplify the installation process and deliver advanced cycling metrics that are useful for improving cycling efficiency. Business has been an exciting growth driver for our business in recent quarters, we believe there are more opportunities to capture. We are well positioned with our current product breadth and depth and will continue to invest for future growth and expansion. Looking at Outdoor, revenues declined 10%, which fell short of our expectations as the currency situation disproportionally impacted both fitness and outdoor due to the geographic revenue profile of these segments. Additionally, we experienced some supply constraints, which affected percent 31% respectively, allowing us to deliver operating income growth on lower revenue.
Finally in Outdoor, we announced the Verb X and XE and all new family of action cameras. These cameras deliver unique immersive experience through G metrics. Which adds insightful context to any video. In addition, our updated VERT mobile application provides the ability to create edit and publish videos on the go. We're excited about the capabilities of these new cameras and believe they offer unique differentiators in which we can grow in the category Turning next to as we faced a more challenging comparable from Q1 2014 when the segment grew 19%.
While gross and operating margins remained strong, operating profit declined opportunities. During the quarter, we announced enhancements to our ADS B product offerings. Our current lineup offers the most comprehensive set of solutions across a range of price points and aircraft categories. We believe we are well positioned to capitalize on modernization mandates around the globe, which are rapidly approaching. We continue to support numerous OEM partners in the development and certification of multiple aircraft and helicopter platforms.
Which will result in future growth opportunities Looking next at Marine, revenue grew 7% in the quarter, driven by the recent acquisition of Fusion. Our organic business was relatively flat on a year over year basis as we started delivering Profitability improved in the first quarter, which resulted in operating income growth of 20% for this segment. While industry activity remains below historical levels, we recognize that innovation is essential to deliver long term improvements in market share and profitability. We will continue to invest in the category In our auto segment, revenues were down 11% in the quarter with P and D industry volumes declining in line with expectations. On a year over year basis, profitability as we continue to experience gains in global market share on the strength of our product portfolio.
As indicated in our February guidance, we expect the market to decline 10% to 15% on a global basis during the year We will focus on growth opportunities in OEM, trucks, RVs, dash cameras, and other specialty automotive products to partially offset lower consumer P and D volumes. Finally, I want to highlight the recent introduction of NuVACAM, which is the first PND to offer advanced alerts such as forward collision and lane departure warnings. NuVACAM also includes an integrated dash camera that saves video images whenever cash or user initiated event occurs. We are excited to deliver these advanced features to the PND market, and we anticipate top similar products OEM customers in the future. So that concludes my remarks for the morning.
Doug will now walk us through Q1 Financials in more detail. Doug? Thanks, Cliff. Good morning, everyone.
I'd like to briefly review our financial results then move to summary comments on the balance sheet and cash flow statement. We posted revenue of $585,000,000 for the quarter, with pro form a net income of $106,000,000. Our pro form a EPS was $0.55 per share, excluding the FX loss. During the quarter, we faced significant exposure to foreign currency fluctuations, which resulted in a revenue headwind of $38,000,000 or 6.5 EPS for the quarter by approximately $0.05 or 9 percent of pro form a EPS. In addition, amortization of deferred revenue is now a year over year headwind, negatively impacted revenue by $14,000,000, pro form a EPS of approximately $0.05 Excluding these headwinds, revenue growth would have gross margin was strong at 59 percent, a 210 basis point increase from prior year, driven by favorable segment and product mix.
Operating margin was 5. Effective tax rate decreased to 12.3% in the current quarter compared to 16.6% in the prior year due to an improved income mix outlook for 2015 as compared to our outlook We still anticipate a full year at least a $5,000,000 of tax reserves as a percentage of lower pretax income. During the quarter, we shipped over 3,000,000 units, a 22% increase reduced average selling price in the quarter due to product mix, FX, reduced contribution from deferred revenue. Not seeing any significant price reductions on like for like products. Next, we look at how our first quarter revenue breaks down by segment.
The Allo segment represented 37% our total Q1 2015 revenue compared to 42% in Q1 2014. We continue to diversify our revenue base with growth in fitness, marine and aviation. Black to now briefly discuss gross margin, which increased to 59% as segment and product mix was favorable during the quarter. Looking at year over year changes by segment, Outdoor Marine posted significant improvement with reduced discounting and favorable product mix. Business gross margin declined slightly to 63%, remained strong as the full portfolio of products continue to perform well.
Total corporate operating margin was 19% as operating expense growth outpaced revenue growth. Excluding the headwinds from FX, amortization of deferred revenue, operating margin would have been flat. Next, we look at operating expenses. 1st quarter operating expenses increased by $22,000,000 or 10 percent. This a 360 basis point increase as a percent of sales.
Research and development increased $10,000,000 year over year 160 basis points to 18.1% of sales. Continue to invest in innovation, growing engineering workforce and increasing resources focused primarily on aviation, fitness and outdoor. Our advertising expense increased $3,000,000 over the prior year quarter, represented 4.7% of sales, 50 basis point increase. Additional spending was focused on fitness, investments in point of sale presence with key retailers to produce long term revenue results. In preparation for the launch of a spring wearables advertising campaign.
SG and A was up $9,000,000 compared to the prior quarter. Increasing 150 basis points to a percent of sales to 16.9%. Increased spending was driven primarily by legal costs, IT expenses, and product support costs as our customer base continues to grow rapidly. Just a few quick highlights on the balance sheet and cash flow statement. We ended the quarter with cash and marketable securities of $2,700,000,000.
Cat received will decrease sequentially to $426,000,000 following the holiday quarter. Our inventory balance increased to $470,000,000 we have built inventory levels to support the launch of new product categories in preparation for a seasonally stronger second quarter. We continue to generate strong free cash flow across our business with $64,000,000 generated during the first quarter of 2015. During the quarter, we paid dividends of $92,000,000 repurchase $16,000,000 of company stock with $284,000,000 remaining for purchase December 2016. This concludes our formal remarks.
Ashley, do you open the line for
Our first question comes from Samona Jankowski of Goldman Sachs. Your line is open.
Wanted to ask you first on any thoughts you might have on, plans for sourcing your maps in the event that, the hair business from Nokia is sold to a vertically integrated vendor?
Yes, Simone. I think, have always operated with here under long term contracts. And so, while the process Nokia has been going through, has been rather public. We don't have any concern right now in terms of what our mass supply situation will be.
Because the contract would go with the company?
Yes.
Okay. And then on the fitness business, you commented out, an FX impact. Even with that, it seems, like, it came a little weaker than I think we had expected Can you just comment on the competitive environment there? And then specifically to some of the consumer feedback you've had on, syncing issues with the mobile app what actions do you think you can take to address that and in what timeline?
Well, the market is definitely getting more competitive as some of the major players are, have or are introducing now their new products for the year. So we recognize that definitely the competition is getting more intense. In terms of product feedback, of course, we're, very sensitive to that. And have been working hard to improve our mobile app and, product software in order to be able to be, the most robust as possible. I think though that this is part of the reality of mobile phones and Bluetooth connections, which are somewhat unreliable and software has to try to be as robust as possible, but there's still side effects.
Is do you have any visibility on, the timeline to when you might be able to address those concerns?
Well, we've already introduced updates to Garmin Connect Mobile. And I believe it's working much better. And we also have a roadmap to release updates through the year as well.
And then just last quick question for me on the legal expense, which I think was the biggest reason for the increase in SG and A of 10%. What was the what was that related to?
This relates to some lawsuits that we had previously described in the 10 K, but some of those hopefully will come to a trial the next few quarters.
Okay. Thank you.
Thank you. Thank you. Our next question comes from Mark Zu of RBC Capital Markets. Your line is open.
Thank you and good morning. I'd like to focus on Garmin's ability to operating income considering that EPS will be mostly flat year on year this year, particularly as we look at the two segments of Outdoor and Fitness, where competition is increased seeing, and you do have more insurance. Are we at a point where a garment needs to spend more in advertising and and spend more on point of sales to try the incremental unit growth. How should we think about the balance between operating margin improvements and your ability to grow earnings?
Yes, Mark, it's absolutely true that, that, particularly fitness and somewhat in outdoors is more competitive. There is a need to invest more in advertising and that's something that you've been seeing us doing over the past few quarters. We increased our investment in Q1, mostly around point of sale material. Preparing the way for our new products and also a spring advertising campaign that's coming up.
Might actually start winding down, or is this more of a full throttle push to drive that, to the balance of the year?
Well, right now, the market is growing rapidly and we're in a mode of gaining market share. And so we're focused on that at the moment. And, taking advantage of the growth opportunity that's there.
Okay. That's helpful. And Doug, maybe on FX, the volatility is quite odd. Any inclination to look at boards or options or certain callers, at this point because of the big currency moves. I know the cost of hedging is quite high at the moment, but maybe your thoughts longer term on hedging?
Yes. So with that, we currently do not have intentions to hedge. We have not hedged historically the foreign currencies will move up and down. So at this point in time, we do not have current plans to hedge.
Okay. Thank you.
Thank you.
Thank you. Our next question comes from James Faucette of Morgan Stanley.
I wanted to ask a couple of questions. First from a high level perspective, I recognize that the first quarter is a seasonally weak quarter. But I'm wondering if you can talk a little bit more broadly about where you're seeing strength versus potential headwinds as we go through the rest of this year and as you reiterate guidance kind of the things that you're feeling confident about versus what worries you And then I also wanted to touch on the specifically the aviation business. I know that you're up against a tough compare versus last year, how should we think about the growth prospects and particularly as new platforms continue to grow for the rest of this year and into 2016? Thank you
James, I think right now, in terms of strengths and weaknesses, each of our segments is performing pretty much in line with where we would expect at this moment. It's still very early in the year, only 1 quarter behind us. So right now, we're not changing any of our outlook in terms of the growth across each of our segments. In terms of aviation, it definitely was weaker this first quarter, but we were up against a 19% growth in Q1 of 2014 when several new platforms hit the market at once. I would expect that the growth should increase as the year goes forward as new platforms hit the market, particularly the new Sesna Latitude, as well as SERIS SF-fifty and the Honda Jet.
Thank you. Our next question comes from Charlie Anderson of Dougherty and Company. Your line is open.
Good morning, and thanks for taking my questions. I know it's only been a few weeks, but I wonder if you're getting any feedback yet from the retailers and in terms of sell through of your fitness products since the Apple Watches debut both on a pre order basis and then now launching.
Well, I would say just in terms of availability of the Apple Watch, it's only been a few days, in limited quantities. But, but at this moment, we, we don't, hear of any or expect any significant change. Our products are positioned differently than the Apple Watch and we appeal to a strong active lifestyles.
Second question for me is, a number of your competitors in fitness have embraced the optical kind of on wrist heart rate monitor you guys have always favored chest worn. I wonder as you think about product roadmap, do you evolve to that feature? And how much more expensive would it be to add it to the device versus this $50 premium that you're adding now for the chest worn?
Well, risk based heart rate is definitely a functionality that customers are embracing and it's a differentiator for our competitors. We anticipate we'll close this gap in our product line in the near future.
Thanks so much.
Thank you. Our next question comes from Jeremy David of Citigroup Your line is open.
Bakshoom camera. First on timing, in your press release today, I said that shipments will start in Q2. The product announcement referred to a summer launch. So should we think of the verb as, ramping in Q2 or more in Q3 3. And then my second question is, going back to the launch of the initial verb a year and a half ago, I think one of the issues you had was that not many retailers where interested in carrying the product in their stores.
Do you believe that distribution for the next gen product will be broader than for the initial product? And if so, why would that be the case? Thank you.
We'll be ramping in the back half of Q2. So that's the timing that we're working with right now. In terms of, retailer interest in this product, we do see much more interest in this product than our first verb. I think the form factor appeals to people, the ability to use the product without a protective case is differentiator, and people are excited about the new enhancements we've made to our, PC software and our mobile applications to be able to edit and publish videos easily. So we're getting good feedback and we would anticipate that we will be able to have better distribution based on the strength of the product features.
Our next question comes from Ben Bollin of Cleveland Research. Your line is open.
My first question, when you look at the outdoor and the fitness business. You talk to the increased R and D and advertising emphasis you're placing How sustainable are you anticipating that investment to be? Is that a 15 event? Is this a more perpetual event? And do you have any thoughts on the associated margin profiles of these businesses in, more normal environment when you're not pushing these expense line as aggressively.
And then I have a follow-up.
Yeah. In terms of the R and D investment, and the sustainability of that, the markets right now are very competitive. And so, of course, we have to innovate and bring features to market in order to be competitive and superior in our offerings. Right now, we see the growth opportunities in terms of of the long term look at that, I think these markets can move up and down very quickly. So we would adjust our business and our investment based on the opportunity that's that's out there.
In terms of the margin profile, particularly in fitness, it's, it's definitely true that the ASP of this particular segment is coming down because of the contribution of the activity tractors. The margin profile will also certainly come down, although we we do believe that our mix of products across the range from low end to high end will tend to balance and we'll still have strong margin profiles in fitness going forward.
And then looking at the automobile business, How do you feel about the progress and traction you're realizing on the auto OEM front? And how well do you feel you're positioned for autonomous vehicles into the future? Thank you.
Well, we've demonstrated consistent progress in our auto OEM business with some high profile customers like Daimler and Honda. And we continue to work closely with multiple target customers on several opportunities that are out there. Of course, giving more color on those opportunities, we're unable to do that at this time because of confidentiality. But we view this as a marathon effort and not a sprint, so we continue to be patient, and invest In terms of, our positioning around autonomous vehicles, we, we certainly offer technologies much like introduced recently in our newbie cam that could serve in those kinds of vehicles. But at this point, we don't see ourselves as a driver vehicles themselves or as the main integrator of that technology.
Our next question comes from Travis of Raymond James.
2 of them. First, on the on the inventory build, Doug, I think you mentioned that was in preparation for, I think, your your wording was new product category launches? And I'm trying to get a sense of, are these products that you've announced already or entire new category, maybe just a definition definitional issue, but obviously, the the inventory trend in Q1 is a little different than historical average, so maybe a little more clarity around that. And Cliff, I have a question on the, the new Nuvee, with the integrated, more decision warning and dash cam. Some of the smartphone, based solutions like that have been pretty clued you, to be honest.
So, you know, are are you comfortable that you're able to to provide a good quality of service, especially on the Ford collision warning and lane departure without professional installation. I think that's where the where the smartphone systems run into a bit of an issue? Thanks.
Great. I'll take the inventory question. As it relates to the inventory, that relates to already announced products. So basically we have a lot of the fitness products as well as some of the bird we talked about in there that we're building up to make sure that we meet demand. The retailers.
And Tavis, with regard to, the NuVicam and the collision warning and lane warning type of features. In terms of what I've seen and I've used the product quite a bit, I feel pretty good about the capability and the performance of the product. We've tested the product versus integrated solutions and vehicles that offered on the market today, and we feel like it compares very favorably. So we feel good about our technology. We've invested in optics technology for a while now, and it's starting show up now across our product lines, including, products like Movie Cam.
Thank
you. Our next question comes from Will Power of Robert Baird. Your line is open.
Great. Thanks. Couple of questions, but maybe just come back to the fitness operating, margin outlook. And I think you referenced, spring marketing campaign, and obviously you've got more competition in the marketplace. Should we expect just to be credit operating margins to dip further sequentially in Q2 due to the competitive dynamics or was a lot of that marketing would expand at spent and reflected in the Q1 margin level?
I think in terms of sequential movement, we would not expect it to dip we would expect that our revenue profile will be increasing because of gift buying seasons that are coming up. But in terms of year over year performance we do believe it will be lower.
All right.
Okay. And then a separate question, looking at the buyback, the quarter somewhat limited. I mean, what's the thought process or I guess just the process generally to consider accelerating the current buyback authorization or even upsizing it from here?
Yes. So So we previously announced a $300,000,000 authorization in February. So our current plans are to complete that $300,000,000 within that 2 year period of time, December 2016. So the amount that we purchased in Q1 was just from the time of all So it's obviously less than the amount we had last year when we had a full quarter. But we can anticipate probably similar pace is what we've seen in Q1, but making sure that we do complete that authorization within our 2 year period of time.
Okay.
And then just I wanna make sure I was clear on on the tax rate, which came in lower in the quarter and so that there was one time impacts there? What's the right tax rate now to use for the full year?
Full year, similar guidance we gave 16% to 17%. It's a full year rate. What we saw there was in the first quarter since it's a low income quarter to $5,000,000 of tax reserve we had there at a larger percentage on that.
Thank you. Our next question comes from Brad Erickson of Pacific Crest Securities. Your line is open.
Hi, thanks for taking my questions. Just a few follow ups from some that have already been asked. First, just around these fitness margins in the incremental or the, I guess, the spending around R&D and advertising you've talked about. Just to be clear, is that incremental relative to kind of previous expectations that were set on the fitness business?
No. In terms of the expectations we sent, we, we are operating according to plan we feel like our current spending is in line with what we had planned for in our budget.
Got it. That's great. And then just in terms of the return of capital, I think historically, you've kind of committed the returning basically all of free cash flow. Can you comment just on yours and your board appetite to return potentially more than 100 percent of free cash flow at some point?
Yes, I think at this moment, we're, we're comfortable with the level that's being returned, we do have unique limitations around the shareholder structure and control of foreign corporations as well as our capital structure in Switzerland. So we feel like the current approach is is adequate.
That's great. Thanks. Thank you.
Thank you. Question comes from Andrew Spindola of Wells Fargo.
You had a nice improvement year over year in the auto gross margin about 120 bps. But I think if you were to account for the FX and the deferred revenue impact, I estimate maybe over 400 bps improvement. And you referenced in the press release that there was less discounting and more improvement in cost materials, but it seems like a very large improvement. And I'm just wondering if you can help us understand, is this something that's sustainable going forward? Is it maybe more of a Q1 trend because there's less discounting post the holiday with less seasonality.
What how much of this is sustainable and how much is just the Q1 impact going forward?
I think there's some element of that that's this Q1 impact because we're comparing the discounting that took place in Q1 of 2014 versus 2015 which is probably more seasonal spike. But in terms of the cost structure and those other factors, we would see that going forward. And we're the business for market share and profitability.
Our next question comes from Ron Epstein of Bank of America Merrill Lynch. Your line is open.
Hi. This is actually Christine Liwag calling in for Ron this morning.
Good morning.
Good morning. In your press release, you mentioned you're now offering an ADS B piece that provides the most comprehensive line of solutions. Can you provide more details on how your product compares to the competition? And then also, can you please quantify the size of the market that you could address?
Yeah. In terms of the breadth of products that we offer, we offer, products that can work with portable solutions We have a product that can work with, tablets. We have a product that's fully installed and integrates with our panel mount equipment. We have products that operate through our transponders as opposed through through separate, 978 Megahertz UAT transceivers. So just have a broad set of offering that can appeal to almost any aircraft, whether they have MOD S capability or if they're on the lower end in the piston side.
And your second question, please.
Can you quantify the size of the market?
The size of the market is in the hundreds of 1,000,000 of dollars.
Great. And then a separate question. What metrics do you look at internally to measure the brand awareness of Garmin products? And also the effectiveness of your advertising dollars?
Yes, I think these are very, challenging things to to specifically measure, because each kind of approach that you use might yield a different result. But we look at and web trends. We look at trends on our websites. We look at trends on major retailers online retailers. And we get a sense out of those, types of investigations.
And can you provide us or give us some idea of where you're tracking right now?
No, we, we don't have details we can share right now.
Thank you. We have a follow-up from Travis McCourt of Raymond James. Your line is open.
Yeah, thanks. Doug, I wonder if you could give us kind of an updated view on on what to expect the, deferred revenue decline to be on the, on on the balance sheet this year. Pardon me? The decline in deferred revenues or the, the Oh, sure.
So Yes, sorry about that. So from that perspective, we anticipate a headwind, right, consistent to what we had probably in the first quarter there.
For the full year? Yes. So all so all of the headwind would be recognized in the 1st quarter
no, no, no, no, consistent type of headwind.
And then, Cliff, I want to follow-up on kind of the auto mobile question. If I look at revenues and then back out the deferral impact, it looks like rev revenues were probably down more like 7 percent. And if I assume some some FX exposure, it's pretty close to flat. And and I'm wondering if you look at it on that basis, Is that something that's sustainable or was there, some puts and takes in terms of the year over year comp that that would make that get a bit worse with your progress. Thanks.
Well, as I mentioned in my my comments, Travis, we we were, pleased with the underlying bid business and, those other factors didn't really tell the whole story in terms of the strength that we saw. But keep in mind that on a year over year basis, last year, We probably had a higher level of inventory in the channel, and thus, shift more into the channel or less into the channel. At that time as we discounted and tried to help our retailers clear it. This year, the channel was cleaner. And, we had the ability to ship pretty much what retailers wanted.
So there is some puts and takes along that regard. And we do anticipate that the overall market will decline in the 10% to 15% range for this year. Thank
you. I'm not showing any further questions in queue. I'd like to turn the call back over to Kerry for any further remarks.
Thanks, Ashley. Thanks, everyone, for joining us this morning. And Doug and I will be available throughout the day for follow-up calls as well as, on the road over the next 3 weeks. Thanks.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a wonderful