Ladies and gentlemen, thank you for standing by and welcome to the Garmin Ltd. Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference to your speaker today, Teri Seck with Investor Relations. Please go ahead, ma'am.
Good morning. We would like to welcome you to Garmin Ltd.'s Third Quarter 2020 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 transcripts will also be available on our website. This earnings call includes projections and other forward-looking statements regarding Garmin Ltd. and its business. Any statements regarding our future financial position, revenues, earnings, gross margins, operating margins, future dividends, market shares, product introductions, future demand for our products, and plans and objectives are forward-looking statements. The forward-looking events and circumstances discussed in this earnings call may not occur, and actual results could differ materially as a result of risk factors affecting Garmin. Information concerning these risk factors is contained in our Form 10-K and Third Quarter 2020 Form 10-Q filed with the Securities and Exchange Commission.
In particular, there is significant uncertainty about the duration and impact of the COVID-19 pandemic. This means that results could change at any time, and any statement about the impact of COVID-19 on the company's business results and outlook is the best estimate based on the information available as of today's date. Presenting on behalf of Garmin Ltd. this morning are Cliff Pemble, President and Chief Executive Officer, and Doug Boessen, Chief Financial Officer and Treasurer. At this time, I would like to turn the call over to Cliff Pemble.
Thank you, Teri, and good morning, everyone. Earlier today, Garmin reported record third quarter operating results. Consolidated revenue exceeded $1.1 billion as strong demand for active lifestyle products fueled growth of 19% over the prior year. Gross margin was 60.2%. Operating income increased 21% year-over-year to $317 million, and operating margin expanded to 28.6%. This resulted in GAAP EPS of $1.63 and pro forma EPS of $1.58 for the quarter, up 24% over the prior year. We are pleased with our performance so far in 2020, especially considering the unprecedented challenges caused by the COVID-19 pandemic. Trends in the business are stabilizing, which gives us confidence to provide fiscal 2020 guidance, which I will cover shortly. First, I'd like to offer a few remarks on the performance of each of our business segments.
Starting with Marine, revenue increased 54% as we experienced growth in multiple product categories led by strong demand for chartplotters. Gross and operating margins were 61% and 31% respectively, resulting in operating income growth of over 150%. There are two key factors driving these results. First, the market is expanding as new customers embrace boating and fishing. Second, our strong lineup of products and game-changing technologies are driving market share gains. We continue to be recognized for our innovation and achievements in the Marine industry. For the sixth consecutive year, the National Marine Electronics Association named Garmin Manufacturer of the Year, and we received four Product of Excellence awards. We were also recognized as one of the top 10 most innovative Marine companies by Soundings Trade Only, a B2B news and information provider for the recreational boating industry.
Looking forward, we anticipate that interest in boating and fishing will remain strong. We plan to capitalize on these trends by offering a compelling lineup of products with innovative features and disruptive technologies. Turning next to the Fitness segment, revenue increased 35%, driven by strong demand for advanced wearables and cycling products. Gross and operating margins were 54% and 27% respectively, resulting in operating income growth of 75% over the prior year. The pandemic continues to highlight the importance of living a healthy life, and our Fitness segment benefited from this trend. During the quarter, we launched the new Forerunner 745, expanding the features offered in our mid-tier multi-sport product range. We also launched Clipboard, an app that facilitates team training and performance monitoring using Garmin devices.
In the advanced wellness category, we launched the Venu Sq, an entry-level smartwatch that combines daily wear style with industry-leading activity tracking and health monitoring features. Looking forward, we expect the broader trends in fitness and wellness to continue. We plan to leverage our recent acquisition of Firstbeat to offer products with unique health, wellness, and fitness features. In addition, we intend to capitalize on the indoor cycling opportunity with our Tacx product line. Turning next to the outdoor segment, revenue increased 30%, with strength in all major categories led by strong demand for adventure watches. Gross and operating margins were 67% and 44%, respectively, resulting in 40% operating income growth. The segment benefited from increased consumer interest in outdoor activities. inReach is an important technology that provides critical emergency and communication services in places where cell phones simply don't work.
We recently added inReach to our popular Montana series. We announced that inReach has facilitated over 5,000 SOS incidents since its launch in 2011. This is a significant milestone, reflecting the important role inReach technology can play in changing outcomes. Looking forward, we expect the broader trends in outdoor to continue. We plan to leverage this opportunity by offering unique products that maximize the enjoyment of outdoor activity and adventure. Turning next to the auto segment, revenue decreased 6% as the decline in consumer PND was partially offset by growth in specialty categories and revenue from new OEM programs. Gross and operating margins were 45% and 3%, respectively. The auto segment continues to transform as we launch new specialty products like the Garmin Catalyst, an industry-first real-time coaching tool designed to optimize track racing performance.
New OEM projects are also making contributions and will further diversify the revenue mix in the segment. During the quarter, we began production shipments of the BMW MGU 2020 computing module, marking the beginning of our relationship with BMW Automobiles as a Tier 1 supplier. In addition, we began shipments of a complete infotainment solution for the Daimler Vito van. Looking forward, we will continue to pursue growth opportunities in specialty product categories. In addition, we will be making major investments to complete OEM projects we have won in recent years, and we will continue to pursue new opportunities as a Tier 1 supplier of innovative electronic solutions for a broad range of vehicles. Looking finally at the aviation segment, revenue decreased 19% due to lower revenue from OEM product categories and the expected decline of the ADS-B market. Gross and operating margins were 71% and 19%, respectively.
While the OEM market has experienced some headwinds, we see positive signs in the smaller aircraft segment, especially in owner-flown aircraft. In addition, when adjusting for the impact of ADS-B, we see encouraging signs in the retrofit market as aircraft owners take advantage of the latest cockpit technologies. During the quarter, Autoland achieved FAA certification on the Cirrus Vision Jet, which is the first jet aircraft to incorporate Autoland technology. This latest certification brings the Autoland-equipped aircraft to three models, including the previously certified Piper M600 and the Daher TBM 940. Autoland is receiving notable recognition as an important new safety technology for general aviation. Aviation Week Network recently selected Autoland as the Grand Laureate winner for its achievement in the category of business aviation.
Looking forward, we believe that the general aviation market will stabilize as impacts from the pandemic, the associated economic fallout, and the ADS-B mandate begin to fade. We will continue to invest in compelling new products and technology in anticipation of the next chapter of growth for the general aviation market. In summary, I'm very proud of what Garmin associates have accomplished so far in 2020 while facing circumstances that no one could have anticipated just one year ago. Considering our growing confidence in business trends, we are issuing full-year 2020 guidance. We now project revenue of approximately $4 billion as growth in marine, fitness, and outdoor more than offset the expected declines in aviation and auto. We anticipate gross margin of approximately 59% and operating margin of approximately 24%. Assuming a pro forma effective tax rate of 10%, pro forma earnings per share are expected to be approximately $4.70.
Looking at full-year 2020 revenue guidance by segment, we expect the Marine segment to grow 25%, the Fitness segment to grow 20%, and the Outdoor segment to grow 15%. We expect the Aviation segment to decline 17% and the Auto segment to decline 20%. That concludes my remarks this morning. Next, Doug will discuss additional details on our financial results. Doug?
Thanks, Cliff. Good morning, everyone. I begin by reviewing our third-quarter financial results through the comments on the balance sheet, cash flow statement, and taxes. We posted record revenue over $1.1 billion for the third quarter, representing 19% growth year-over-year. Cost margin was 60.2%, a 50-basis-point decrease from the prior year. Operating expense as a percent of sales was 31.6%, 110-basis-point decrease from the prior year. Operating income was $317 million, a 21% increase year-over-year. Operating margin was 28.6%, a 60-basis-point increase from the prior year. Our GAAP EPS was $1.63, and pro forma EPS was $1.58, a 24% increase from the prior year. We look at our third quarter revenue by segment. We achieved revenue of over $1.1 billion, with three of our five segments posting growth of 30% or more, led by the Marine segment, a robust revenue growth of 54%.
By geography, we achieved 19% growth in Americas, EMEA, and APAC. Looking at our year-to-date revenue for the first three quarters of 2020, our consolidated revenue is up 7% with the prior year, with three of our five segments posting double-digit growth, led by the Fitness segment with 25% growth, followed closely by the Marine segment with 24% growth. Looking next, operating expenses. Our third quarter operating expenses increased by $45 million, or 15%. Research and development increased $26 million year-over-year, primarily due to investments in engineering resources. Our advertising expense increased by approximately $1 million due to higher spend in our Outdoor segment. G&A increased $17 million compared to the prior year quarter, primarily due to increases in information technology costs, personnel-related expenses. A few highlights on the balance sheet, cash flow statement, and taxes.
We ended the quarter with cash and marketable securities approximately $2.7 billion and no debt. Accounts receivable increased sequentially to $658 million, an increase year-over-year in line with third quarter sales. Inventory balance increased on both a sequential year-over-year basis, prepared for the seasonally strong fourth quarter split on increasingly diversified product lines. During the third quarter of 2020, we generated free cash flow of $236 million, a $78 million increase with the prior quarter. For full year 2020, we expect free cash flow to be approximately $750 million to approximately $175 million capital expenditures. During the quarter, we paid dividends of $117 million. During the third quarter of 2020, we report an effective tax rate of 6.9% compared to the effective tax rate of 11.6% in the prior quarter. The decrease is primarily due to an intellectual property migration transaction.
We expect our full year 2020 pro forma effective Tacx rate to be approximately 10%. This concludes our formal remarks. Joelle, could you please open the line for Q&A?
Thank you. As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Paul Chung with JP Morgan. Your line is now open.
Hi, guys. Thanks for taking my questions, and congrats on the quarter. Just on Fitness, on Tacx, you've had this asset for more than a year now. Can you give us a sense of how much incremental growth you have driven by kind of leveraging your distribution network, and then assume the pandemic has accelerated sales in that business, if you could confirm any sense for the outperformance there, and then I have a follow-up.
Yeah, Paul, I think Tacx has been a wonderful acquisition for us. Definitely, leveraging the Garmin network is helping us. Tacx did not have a strong presence in the North American market, so we're able to expand that now, and of course, Asia is another opportunity. They were mostly strong in Europe before we bought them.
Okay, thanks for that. On Firstbeat, how do we size up this business? Assume the margins are quite high given the license model. Is it a meaningful contributor, or is it kind of more of an added feature you'll roll across more of your smartwatches?
Well, it's a contributor, and as you say, it's high margins because it's licensing business. For us, we look at it as an important technology provider for our products and being able to support the existing wellness and fitness features as well as developing new advanced metrics that we can have in our smartwatch and cycling products.
Okay. Lastly, it's not very common for you to have kind of uniform year-over-year growth across all the regions. Any trends across your regions that stand out during the quarter or what you're seeing early in Q4? Thank you.
Yeah, I would make a couple of notes there. I think that it is kind of interesting to see 19% across the board. In the Americas, that growth would have been even stronger if you adjust for the impact of the ADS-B surge last year. Americas is even stronger than what we're showing there in terms of the other consumer products. In Asia, I would say that they have been slower to come back from the COVID-19 impact, but we do see signs of stabilization, and each country is different, but we do see positive signs in some of the major countries as they emerge out of crisis mode.
Thank you.
Thank you.
Thank you. Our next question comes from Charlie Anderson with Colliers Securities. Your line is now open.
Yeah, thanks for taking my questions, and congrats on a really strong quarter. It was great to hear, Cliff, that there's some stabilizing trends in aviation. I wonder if you could maybe expand on that a little bit. I know you serve many portions of that market in terms of size and platforms. I'm also sort of curious, looking within the various categories in aviation, where do you see stabilization versus what's still impacted in a large way by the pandemic? I've got a follow-up.
As I mentioned in the remarks, the OEM categories reflecting owner-flown aircraft are doing reasonably well in this environment, and we've seen encouraging signs there. On the retrofit side of things, as I mentioned, if we eliminate the impact from ADS-B, we see positive signs in retrofit, particularly driven around new display systems and autopilot systems for existing aircraft on the market. I think the technologies are super. The safety technologies that come in the retrofit market with our autopilot system and our display systems is something that people recognize as great value, and we see a lot of strength there.
Okay, great. For my follow-up, I'm curious on automotive, we're going to now go through this transition where OEM essentially becomes larger portion of the revenue now that BMW has begun. I wonder if you could speak to the margin profile of that segment from a go-forward basis. Looks like we're not going to make much money in that segment this year, but I'm sort of curious as that layers in how that impacts margins going forward. Thanks.
Yeah, definitely the margin on the OEM categories is lower than the trends on the consumer side, especially as we see the consumer side transition to more specialty products, which are also higher margin. We'll see that mix of revenues impact the OEM segment. As I mentioned in my remarks, we're still investing heavily to bring these programs to market. We've brought the first BMW program to fruition, which we're a build-to-print supplier, second source basically for that module, which is designed by another party. On the other program that we won, we're the lead design partner with BMW on that, and others are build to print for us. Consequently, we're investing heavily in bringing that technology to market.
Okay, great. Thank you so much.
Thanks, Charlie.
Thank you. Our next question comes from Will Power with Baird. Your line is now open.
Oh, great. Thanks. Yeah, I guess a couple of questions. Maybe just to kind of follow up on the previous Auto question, just trying to, I guess, wondering if you could help us think about the cadence of additional OEM projects behind BMW and what that could mean in terms of turning the quarter on, getting that to break even and maybe positive growth. What's kind of the outlook or timing of that transition and improving the growth outlook there?
We do have additional projects that are underway, which we can't really talk about the specifics. The major one, of course, is the BMW project that we announced about a year ago. In terms of revenue performance in this environment, as we bring new projects online, definitely we've said before that 2020 and into 2021 is going to be an inflection point for revenue growth as these new programs start to contribute.
Okay. Maybe just to switch gears to outdoors continues to be strong performance. Any further color there as to the key drivers? I suspect the fēnix line continues to be probably the lead driver there, but any color on other key contributors there in the quarter?
Yeah, I would say that fēnix and Instinct are both very strong product lines for us. We launched new versions of those products with solar charging technology, which is a unique differentiator for Garmin. Those products were very popular in the quarter as we sold into the channel, and they're starting to sell through now. We do see strength across other categories. Basically, everything that involves adventure and outdoor activity, especially golf. Golf is very strong as well. We felt very good about the performance of our categories in the quarter.
Okay. Yeah. Actually, maybe if I could sneak in one for Doug, just on thinking about taxes and the potential change in administrations next week. Any early thoughts as to how a potential change could impact Tacx strategy and how you look at your plans on that front?
Yeah. We do not provide any extra or any additional guidance beside the current year for any effective Tacx rates. There's a lot of moving parts that go into that Tacx rate. Obviously, the statutory rates, the income by jurisdiction, deduction sets. We'll kind of wait to see how it all plays out.
Okay. Thank you.
Yeah. Thank you, Will.
Thank you. Our next question comes from Ben Bollin with Cleveland Research. Your line is now open.
Good morning, Cliff, Doug, Teri. Thanks for taking the question. Cliff, could you talk a little bit about what you're seeing from a product availability perspective across categories? Seems like some may have been short in the quarter. Could you talk to maybe fitness or marine or outdoor, if you're seeing any tightness in delivering product, and then if you're seeing any raw material shortages associated with those builds? I have a follow-up.
Product availability has been fairly tight. The demand has been strong, and we did make adjustments coming out of the significant drop in activity associated with Q2 when all of the lockdowns took place. Since that time, we've been working hard to ramp back up to the levels needed to fill demand. I think we're doing okay, but the backlogs are very strong for us right now. So we're working hard to fill those. In terms of raw materials, we've mostly been okay. I would say there's a few shortages here and there, and especially as our forecasts change to the upside, we have to deal with that situation within lead times from our suppliers. We've had very good cooperation. We've been able to mostly get everything that we need.
We rely on our safety stock, of course, in our business, so we do have inventories of things that we can continue to build products. Our vertical integration model is something that allows us to be flexible in what we build and when.
Okay. The other question is, as it relates to your partners, it seemed like early on with COVID, a lot of the retailers did the same thing. They drew down working capital and inventory, and now they're trying to replenish going into the holidays. Do you have any thoughts on where finished goods inventory is with partners, and how you think that could be playing into your overall visibility as you look forward? Thanks.
Many partners are experiencing the same things that we are, so the increased demand. Even though they're taking more products, they also are selling out very quickly as well. We believe that the channel inventory on most of the consumer categories is not high. In fact, it's very lean. In a lot of cases, we find customers looking for our products. Again, we're working hard with our partners to fill the demand and to help customers find what they want.
Thank you.
Thank you. Our next question comes from Nick Todorov with Longbow Research. Your line is now open.
Thanks. Good morning, everyone. I just wanted to look at the implied fourth quarter guidance. I think the implications for sales is to be up sequentially, but I think if you look at the implied EPS for the fourth quarter, that's down more than 15% quarter-over-quarter. I know typically you have a sequential decline in fitness margins in the fourth quarter due to promotions, which is okay, but I guess the sequential decline, it seems a little bit on the EPS side, it's a little bit more than usual. I guess, can you talk about any additional puts and takes?
I think Q4 is different than Q3, as we look at the promotions that are going to go on over the holiday season, as well as the product mix and the segment mix. There's a lot of different factors that go into play there. We'll also be doing more advertising sequentially. These are all factors that come into play there with our guide.
Okay. On the aviation segment, I think you spoke about signs of stabilization, which is encouraging. At the same time, I think if I look at the guidance for 17% decline for the year, I think that implies an acceleration in year-over-year declines, where the comp from an year-over-year perspective is easier from last year. I'm just wondering if there is anything particular that affects the December quarter?
Yeah, that has a very simple explanation. Q4 of 2019 was a huge quarter with ADS-B and the surge in equipage that was going on. That's a headwind that will quickly fade as we move past Q4.
Last question from me. I just want to make sure, the major investments that you talked about in OEM, there's nothing new incremental there, it's just that you guys have to keep up with the ramp up. I don't know, is there any way you can size up how much of a net investments you guys are putting into those programs?
Yeah, basically, as Cliff mentioned, we are continuing to invest in our OEM businesses, primarily the R&D investments as we get closer to production. Also in the CapEx, we did have increased year-over-year CapEx relating to manufacturing facility we have in Europe there.
Okay. Just a quick follow-up. On Tacx, I believe you guys were expecting new capacity to come online here in the second half of this year. I just wonder if you can give us an update on that, if it's ready to go and you guys are going to be able to supply product into the December quarter?
Yeah, the new Tacx facility is operating. We're starting to do some production functions there, as well as distribution of the products out of that facility. Now in Q4, we should be ramping up physical production lines on the various products to be able to manufacture them in the new facility. We're very pleased with that, and we believe that's going to be a big incremental adder to filling the Tacx backlog that we have.
Got it. Thanks. Good luck, guys.
Thank you.
Thank you. Our next question comes from Ivan Feinseth with Tigress Financial Partners. Your line is now open.
Thank you. Thanks for taking my question, congratulations on another great quarter.
Thanks, Ivan.
Congratulations on this cadence of new products that you've been able to continue during this difficult time. Now in April, on your Q1 call, you had said that you were seeing strong demand for marine, and no better way to social distance than be in the middle of a lake on a boat. It seems you have brought out a lot of new products that provide ancillary participation in marine, including fishing and diving. Did you have these products already in the pipeline, or were you able to pivot toward meeting that demand, and that ability to do that has driven your great success? Your adaptability, did you have these new products planned, or did you kind of develop them as you saw this need growing earlier this year?
I think really we focus on long-term roadmaps and the products that we introduced yesterday, for instance, in the marine market, were products that we've been planning throughout the COVID-19 cycle, since before it was a known thing. We didn't waver from the investment we were making in our product roadmaps. I think that's the key thing, and we were able to maintain our product release schedules, even in the face of significant challenges that we've had, like every company, with working from home and distancing in the workplace. I'm super proud of what our team has accomplished. I'm actually amazed sometimes at what they've been able to do, and I think our products are a testament to their determination to be successful in the face of this pandemic.
Absolutely. The pandemic, this whole stay at home, play at home, and gaming has been a huge thing since the pandemic, then you brilliantly come out with an e-sports watch. I like the way that you are taking advantage of or adapting to the environment. You mentioned the indoor cycling. What is your plan there to expand your presence in the super hot indoor cycling and indoor fitness market?
Well, our response from the customers on Tacx has been very strong. We have a lot of backlog for those products, and we're working hard to fill those, especially as we look towards the winter season as people are going to be in more. The Tacx facility, the new production facility, is a big part of our plan to take advantage of that and expanding our distribution, especially in the Americas and Asia for those products.
What other areas, say, more specialty auto products like the Catalyst? What other types of products do you have envision coming out?
Well, we have other categories in the works. I can't share details on those. We have a creative team that are active participants in lifestyles. I anticipate we're going to see more new categories in the future in auto, targeting the specialty categories.
All right. Thank you very much, and congratulations again.
Thanks, Ivan.
Thank you. Our next question comes from Erik Woodring with Morgan Stanley. Your line is now open.
Hey, good morning, guys. Congrats on the fantastic results. I just wanted to get your kind of high-level thoughts here on just how do you think about your end markets now from the perspective of, are we seeing TAM expansion? Are we seeing a pull forward of demand from potentially 2021 into the summer months? Just based on your answer there, kind of what gives you the confidence in your answer?
Well, I think each market probably has a different story. As we mentioned in marine, we're seeing what you would probably call TAM expansion as new customers come into the market. In fitness and outdoor, it's a strong demand for people that want to be healthier and to engage in fitness and outdoor activities. Again, those could possibly be described as TAM expansion. There's also market share gains that are factors in those things as well. We don't see anything that's happening right now as pull forward into 2021. The demand is strong throughout the back end of this year, and we anticipate through the discussions with our partners that 2021 will also have similar trends based on the behavior of people during the pandemic.
Awesome. Thank you for that color. I guess, how should we think about the strength in the consumer, the fitness and outdoor segments, in terms of ASP versus unit driven? Maybe asked a different way, maybe can you comment on the mix shift that you're seeing either to higher priced devices versus lower priced devices?
Yeah, I think that there's a combination of things going on there. There's definitely ASP increases as we launch new products like the fēnix Solar line and the Instinct Solar line. There's also unit growth as well as we look at our advanced wellness products in fitness, for example. It's a combination of things, and the customer base that we're targeting, I think, are those that appreciate the value and the capability of the products that we offer.
Okay. That's super helpful. Just one, if I could just squeeze it in here. I realize your marine business has been remarkably steady, basically throughout all four seasons. I looked. I count one down quarter in the last 30 quarters. Can you just help us kind of understand from a high level, how do the drivers of the marine business change during, for example, the winter months versus the summer months, if at all?
Yeah. Marine is historically very seasonal. In normal times, we would expect that the market would slow down in Q3, late Q3 especially, and into Q4, and then ramp up again when the new year arrives. This is anything but an ordinary year, we saw boating activity continuing to take place throughout Q3, and demand for our products was very strong, not just, in the sell-in sense, but also in the sell-through sense at our retailers. It's an extraordinary year as people take advantage of time on the water. As we look at Q4, the retailer enthusiasm around marine products and the plans that they have for promotions are very strong, we should also see a very strong Q4 for marine, unlike we've seen in past years as well.
That's great. Thanks for the color. Congrats again, guys.
All right. Thank you.
Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Teri Seck for closing remarks.
Thank you all for joining us today. Doug and I are available for callbacks. Have a wonderful day.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.