Good day, ladies and gentlemen, welcome to the Garmin Ltd. second quarter 2019 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. If anyone should require assistance during the conference, please press star then 0 on your touchtone telephone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Teri Seck, Investor Relations Manager. You may begin.
Good morning. We would like to welcome you to Garmin Ltd.'s second quarter 2019 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, growth and operating margins and future dividends, market shares, price 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 filed with the Securities and Exchange Commission.
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, good morning, everyone. As announced earlier today, Garmin reported strong results, including record revenue and operating income for the second quarter. Consolidated revenue for the quarter came in at $955 million, up 7% over the prior year. Aviation, Marine, Fitness, and Outdoor collectively increased 12% year-over-year. Gross margin improved to 60.3%. Operating margin expanded to 26.8%. Operating income increased 18% to $256 million. This resulted in GAAP EPS of $1.17 and pro forma EPS of $1.16 in the quarter, up 17% over the prior year. We are pleased with our performance for the first half of 2019, and these strong results give us confidence to raise our full-year guidance. Doug will discuss our financial results in greater detail in a few minutes, but first, I'd like to provide a few brief remarks on the performance of our business segments.
Starting with the Aviation segment, revenue increased 20%, driven by growth in both aftermarket and OEM product categories. We experienced strong growth in our ADS-B product offerings. Growth and operating margins remained strong at 75% and 36%, respectively, resulting in operating income growth of 27% over the prior year. During the quarter, we achieved certification of the G5000 Integrated Flight Deck for the Citation Excel and XLS, bringing a state-of-the-art cockpit system to this popular family of aircraft. We also announced the availability of the NXi upgrade for Cessna and Beechcraft models equipped with the original G1000 system. We continue to see strong customer demand and appreciation for this upgrade program. As I mentioned earlier, ADS-B has been a significant driver of growth in our Aviation business. According to the FAA, as of July 1st, 2019, approximately 91,000 total aircraft have been equipped, of which approximately 7,000 are commercial aircraft.
Of the remaining 84,000, Garmin has captured roughly 80% market share. Based on everything we see, it is likely that the ADS-B opportunities will continue into 2020. While ADS-B has been a significant opportunity, it's not the only opportunity for the aviation segment. New OEM platforms, retrofit cockpit systems, NXi upgrades, and the growing demand for trainer aircraft represent opportunities for growth beyond the ADS-B cycle. We are optimistic about the future of our aviation business. Looking next at marine, revenue increased 13% as we experienced strong demand for our chartplotters and Panoptix LiveScope sonars. Growth in operating margins were 61% and 28%, respectively, resulting in strong operating income growth. Last quarter, we mentioned that the Independent Boat Builders, Inc. named Garmin its supplier of the year. I'm pleased to report that our relationship with IBBI has expanded and now includes audio equipment.
Our Fusion brand of marine electronic systems was selected by IBBI as a preferred choice for its members. New markets and new product categories are an area of strategic growth because they represent significant growth opportunities. In keeping with this strategy, at the recent ICAST fishing show, we introduced Force, our first entry into the freshwater trolling motor market. Force was named Best New Boating Accessory and won the coveted Best of Show award for 2019, making Garmin a back-to-back Best of Show winner at ICAST. We are very proud of the accomplishments of our marine team, and we're excited about the new opportunity that Force represents in the segment. Looking next at the fitness segment, revenue increased 12%, driven by growth in running products as well as contributions from our recent acquisition of Tacx.
Gross and operating margins were 54% and 20%, respectively. During the quarter, we began shipping our refreshed line of Forerunners, providing both smartwatch features and enhanced running dynamics for all capabilities of runners. We also completed the acquisition of Tacx and are now in the process of expanding the distribution of Tacx products through Garmin retailers. Turning next to the outdoor segment, revenue increased 4% on a year-over-year basis, driven by growth in our golf and inReach products. We believe this is a remarkable accomplishment, considering the significant impact of the fēnix 5 Plus launch during the first half of 2018. Growth and operating margins were 64% and 34%, respectively. During the quarter, we began shipping the MARQ luxury watch. In addition, we experienced strong demand for golf wearables and the Instinct adventure watch.
We also introduced a refreshed line of handheld navigators, adding inReach satellite communication technology to our flagship handheld devices. Looking finally at the auto segment, revenue decreased 13% due to the ongoing decline of the PND market. Gross and operating margins improved year-over-year to 48% and 16%, respectively. Our global market share position in the PND category remains very strong. We launched the DriveSmart 65 with integrated Alexa personal assistant, bringing enhanced voice control functionality to drivers. We also announced the Garmin Overlander, an all-terrain GPS navigator specifically designed to fit the needs of the growing Overlanding community. This is a unique product offering for those looking to explore off the grid. In summary, we are very pleased with our results in the first half of 2019.
Given this strong performance, we are raising our projected revenue to approximately $3.6 billion for the year, representing an 8% increase over the prior year. Gross margin is projected to be 59.5% for the year. Operating margin is projected to be 23.2%, assuming a pro forma effective tax rate of 16.5%. Pro forma EPS is expected to be approximately $3.90. Looking at our annual revenue by the outlook by segment, we have increased our growth expectations for the Aviation segment to 17%, the Marine segment to 12%, and the Auto segment to down 15%. Fitness and Outdoor are unchanged. That concludes my remarks. Next, Doug will walk you through additional details on our financial results. Doug?
Thanks, Cliff. Good morning, everyone. I begin by reviewing our second quarter financial results, including comments on the balance sheet, cash flow statement, and taxes. We posted revenue of $955 million for the second quarter, representing 7% increase year-over-year. Gross margin was 60.3%, 180 basis point increase from the prior year. Operating expense as a percentage of sales was 33.4%, 80 basis point decrease from the prior year. Operating income was $256 million, 18% increase year-over-year. Operating margin was 26.8%, 250 basis point increase from the prior year. Our GAAP EPS was $1.17. Our pro forma EPS was $1.16 a 17% increase from the prior year. We look at our second quarter revenue by segment, which achieved record second quarter revenue of $955 million. Consolidated revenue grew 7% led by double-digit growth in our aviation, marine, and fitness segments. The outdoor segment had solid growth during the quarter.
A combined basis, Aviation, Marine, Fitness, and Outdoor were up 12% compared to the prior year quarter. Looking next at second quarter revenue and operating income. On a combined basis, Aviation, Marine, Fitness, and Outdoor segments contributed 83% of total revenue in the second quarter of 2019, compared to 80% in the prior year quarter. Aviation grew from 17%-19%. Marine grew from 15%-16%, and Fitness grew from 25%-26%. You can see from the charts that illustrate our profit mix by segment, a combined basis, Aviation, Marine, Fitness, and Outdoor segments delivered 90% of operating income in the second quarter 2019, compared to 94% second quarter 2018. The Aviation, Marine, and Auto segments had strong year-over-year increases in operating income dollars, improved operating margins. Looking next at operating expenses. Second quarter operating expenses increased by $13 million, or 4%.
As a percentage of sales, operating expenses were 33.4% in the second quarter of 2019, 80 basis point decrease in comparable quarter last year. Research and development increased $7 million year-over-year due to investments in engineering resources. App development expense was down $2 million from the prior quarter due to lower expenses in the auto segment. SG&A was up $8 million compared to the prior quarter, relatively flat percentage of sales. Increase was primarily due to personnel-related expenses, incremental costs associated with recent acquisitions. A few highlights on the balance sheet and cash flow statement. We ended the quarter with cash and marketable securities approximately $2.4 billion. Accounts receivable increased sequentially and year-over-year to $584 million due to strong second quarter sales. The inventory balance increased sequentially year-over-year to $648 million due to timing of new products, raw material requirements, acquisition of Tacx.
During the second quarter of 2019, we generated free cash flow of $80 million, a $77 million decrease from the prior quarter. Also during the quarter, we paid dividends of $108 million. During the second quarter of 2019, we reported effective tax rate of 18.9% compared to effective tax rate of 19.4% prior quarter. We continue to expect our full year 2019 to perform effective tax rate of approximately 16.5%. Gigi, can you please open the line for Q&A?
Ladies and gentlemen, at this time, if you have a question, please press the star, then the number 1 key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question is from Charlie Anderson from Dougherty & Company. Your line is now open.
Thanks for taking my questions and congrats on those strong results and the upside guidance.
Hi, Charlie.
Yeah. I wanted to start just within the guidance. I think outdoor, you had sort of single digit growth in the first half, but you're still calling for 10% for the year. I wonder if you could just kind of speak to what you anticipate happening in the second half to sort of re-accelerate the growth rate there. On Tacx, I guess I'm just sort of curious sort of where things stand now. You're integrated to some degree, but how much headroom is there to improve gross margin and also some of the sales distribution there? I've got a follow-up.
Yeah. Outdoor, we do anticipate in the back half that we'll be refreshing product lines, so that's built into our assumptions on the outdoor segment. As far as Tacx goes, it's early days, but we are on the process of integrating them into our business infrastructure, including our supply chain, and they are also working on updating their factory facilities in order to build trainers. In terms of gross margin, again, early days, but there's probably opportunity to improve over time, but that would take some amount of time to be able to realize those savings as we go along.
Perfect. Doug, just real quick on inventory. It seemed like it was up a decent amount year-over-year. I wonder if you could just expand on what was going on there.
Sure. Yeah. Inventory is up by year-over-year. It's due to a number of factors, one of which is just timing of product launches, this anticipation of product launches in the back half. Also, some raw material requirements, just making sure we have appropriate levels of safety stock. Also, we acquired Tacx, so that basically was incremental increase year-over-year. Also, looking at the prior number, we're probably a little bit lighter last year on inventory than we'd liked to have been. Kind of looking at inventory on the go forward for the rest of the year, I probably would expect the year-end inventory balance to be pretty similar to what I saw in Q2.
It will probably go up some in Q3, probably similar type of year-over-year change I saw in Q2, but it'll come down some. We just want to make sure we have appropriate levels of inventory to meet our continuing demands.
Perfect. Okay. Thanks so much.
Thank you.
Thank you. Our next question is from Rich Valera from Needham & Company. Your line is now open.
Thank you. Good morning. Strong performance in aviation, and you attributed that to ADS-B, and I guess just wanted to follow up if you thought or why you thought that the ADS-B activity would continue into 2021, or sorry, 2020. Just what your thoughts are there.
ADS-B was definitely a growth factor for the segment, but it's not the only factor. As I mentioned, there's really broad-based growth across many product categories and also the segments of the market, OEM and aftermarket. In terms of our views of the activity after the mandate, we're basing that on feedback from our installing partners who are telling us that they are booked out, some now into 2020, and just looking at the total number of aircraft that remain to be equipped and the rates at which they're currently being equipped, we feel like there's a good chance that those will continue into 2020.
Got it. That's helpful. Just on the Tacx acquisition, can you say how much of the growth, the year-over-year growth in 2Q was from Tacx? You made reference to the margins there. Can you just give us a sense of what their gross margins are, either in absolute terms or relative to historical fitness gross margins?
As it relates to the amount of tax for Q2, it was a little bit under half. We do expect tax for the full year to be about a half of the year-over-year growth in the fitness business. As it relates to the gross margins, we don't give a specific gross margin by each one of our product lines. Like Cliff mentioned, we're looking to improve those over time.
Okay. Thank you.
Thank you.
Thank you. Our next question is from Ben Bollin from Cleveland Research. Your line is now open.
Good morning, everyone. Thanks for taking my question. Cliff, could you talk a little bit more on aviation? Any thoughts on the mix of OEM versus retrofit? Then you talked about ADS-B continuing into next year. Do you have any thoughts about Have you seen any pull forward of other retrofit activity last year, this year, as those aircraft go out of service? How do you think about that implication on a look-forward basis out late 2020 and beyond? Then I have a follow-up.
Okay. Ben, the mix in terms of OEM and retrofit, we don't break it down in detail, but we've said directionally in the past that it's roughly split between the two evenly, and that remains to be true. We saw pretty much identical growth rates between those two categories of product for the quarter. There's strength across both categories of the markets that we serve. In terms of pull-forward impact on ADS-B, for sure, those people that have equipped with ADS-B and have taken the time to fully upgrade their panels with new technology, they obviously are not going to be upgrading in 2020 again, per se. There's many, many more aircraft out there that are needing new technology.
Some of them are flying with equipment that's decades old, and we believe this is an opportunity for people to reassess the electronics in their aircraft and upgrade to new technology that's available now.
Okay. Within the automobile business, could you talk maybe a little bit about how the revised guidance, is that all inclusive of first half? Is it inclusive of contribution from BMW China later this year? Any longer-term thoughts or color you can provide on the lead design opportunity with BMW. Where are you in the facility, and when does that become more material over time? Thank you.
Okay. Our automobile guidance takes into account everything we've experienced so far. We're rolling forward the benefits that we've had into the guidance and not making bold assumptions about where the market will go. Although we're pleased with how the performance of certain product categories in the segment have performed, particularly the higher-end PND lines have been stronger than what they've been in the past. That's all good news. In terms of BMW, the first set of our programs is scheduled to be a 2020 program, and that's progressing. As we have said before, there'll be minimal impact in 2019. That's been built into our guidance, obviously.
The newer sets of business that we've won with BMW is an ongoing effort that will take some number of years now to develop, but we're in the process of investing in the capital infrastructure that we need to be able to support that program, including upgrading some of our existing factories and establishing a new facility in Europe.
Thank you.
Thank you.
Thank you. Our next question is from Paul Chung from JPMorgan. Your line is now open.
Hi. Thanks, guys. Thanks for taking my questions. Just a follow-up on aviation. Your guidance kind of suggests a slowdown in second half relative to the first half. Is that just some conservatism there or do you think ADS-B upgrades have kind of peaked in Q2?
I think we definitely see some reason to be a little more cautious in the second half. We're comping against really strong growth numbers last year. The installation capacity in the field is pretty much established and fixed, it's harder to grow on big numbers like we did in the past. We believe that's a solid guide for the segment. Inevitably, as we approach the deadline, there will certainly be a wind down of the activity as we go forward. We're looking forward to that as well.
Okay. Thanks for that. A follow-up on outdoor margins. With the kind of refresh of fēnix probably coming in the second half, how should we kind of think about operating margins there? We're kind of hitting some tough comps there as well. Is there some possible uplift, maybe to ASPs on the refresh?
I can't comment on specific plans for the line, but I would say that like every other product launch that we do, there's opportunities for improved margin, both gross and operating margins as new products come into the mix and we promote the older products that are being phased out.
Okay. Last question on fitness. Thanks for the reiterated six points of growth from Tacx this year. Is that mainly from the existing base European business and does not include any Americas or Asia expansion potential? What's your initial read on possible demand in those regions?
Yeah, I think it's based on what we see from the Tacx business historically, and rolling out the product into new markets does take some time, so there's some incremental benefit from that, but that's already figured into our outlook.
Thank you.
Thank you.
Thank you. Our next question is from Ivan Feinseth from Tigress Financial Partners. Your line is now open.
Thank you for taking my question, and congratulations on another great quarter.
Thanks, Ivan.
I have two questions. First, there's a coming European ADS-B mandate that looks like it starts in June of 2020. What type of opportunity do you see there?
Yeah, that's an opportunity we're obviously watching and preparing for. It's certainly going to be a much smaller opportunity than what we've seen in the Americas because the majority of ADS-B potential aircraft are in the American market. Still, it remains an opportunity for us to be able to serve that mandate as well.
Very good. Now on the Tacx product line, what type of opportunity or new product introduction do you see in their fitness equipment in addition to, I guess, what they call the fitness trainers, is where it attaches to a bicycle, but they have a really nice treadmill and exercise bike, which I think that could be a big opportunity. What is your outlook or vision for bringing new products in those lines to market and their marketing plans?
Well, we won't comment on specific plans, but I would say that we do have a solid roadmap in the Tacx division for air products, and we're investing more in R&D to be able to bring those to market.
Okay. Very good. Thank you.
Thanks, Ivan.
Thank you. Our next question is from Will Power from Baird. Your line is now open.
Great. Thanks. Maybe first question on fitness. I know you introduced some new Forerunners. I guess, any early color on what sell-through is looking like versus initial sell-in on those products?
Yeah, we think the sell-through is very strong. The products have been received very well by the market. We're excited about the new products.
Okay. On the outdoor front, I guess it's probably early, but you look at some of the new products introduced, I guess, the MARQ Instinct. Any initial thoughts on demand there? I guess this is the first time in a while we haven't heard fēnix called out. I'm guessing that's a function of timing and refresh. Do we expect that to get refreshed in the second half?
Yeah. Marq, we're very pleased with how things have gone out of the gate. The sell-in was delightful for us, and then the sell-through has been something that we think is very strong. The Instinct has been a very strong product for us. It's expanded the base of new users in the adventure watch market. It's got a strong following, a strong sell-through. The fēnix, obviously, it's been a little over a year now since we introduced the fēnix 5 Plus, and we expect to have additional new product announcements coming shortly.
Okay. Thank you.
Thank you.
Thank you. Our next question is from Erik Woodring from Morgan Stanley. Your line is now open.
Hey, good morning, guys. Congrats on the quarter. I guess I just want to start out on aviation again, since you brought up the new data point from the FAA. I just want to confirm if we're 90,000, 91,000 or through 91,000 planes, does that imply basically that there's something like 10,000 to 70,000 more upgrades to go before year-end? I have a follow-up.
I think there's admittedly some amount of shifting definitions of those numbers provided by the FAA, and we interpret the 90,000 obviously as including everything like I highlighted, including commercial as well as experimental aircraft. The 100,000-160,000 aircraft probably only includes just those GA aircraft, and people aren't really thinking about the high-end experimentals that also want to have that equipment. We see a pretty significant runway, even if you ignore those nuances and just look at it for what it is. We think that the 100,000 number is certainly too low, and if you look at the higher number, the 160,000, it would appear that we have nearly the same amount of market left to go in the cycle. That represents a significant opportunity.
Awesome. Thank you for that color. I guess if we could just talk about marine quickly. You raised guidance. I'm just wondering if that's a result of general market growth in the marine business, a result of macro factors, or is it more a function of you guys getting more share than you originally expected?
I think there's a combination of those factors. Certainly, the market has been strong, especially in the higher-end boats, and that's where our equipment and our content is very strong. We also see market share gains as we've introduced these disruptive new technologies like Panoptix LiveScope. That's caused people to rethink their choices and purchase new equipment that's compatible with our system so that they can take advantage of the new technology.
Awesome. Thank you again.
Thank you.
Thank you. Our next question is from Nick Todorov from Longbow Research. Your line is now open.
Hey, guys. Thanks for squeezing me in. Cliff, on ADS-B, we've been talking about tight capacity for a while now. We saw some inflection in ADS-B installations this quarter. In your view, where did the capacity came from in order to accommodate those installations? You're obviously guided to upside in aviation relative to prior expectations. There seems to be some incremental demand that's coming up. Where do you see that capacity, I guess, coming from?
A few factors. One is that the market is certainly gravitating towards quicker solutions as we get closer to the mandate. People are realizing that they need to be compatible with the mandate, they're selecting some solutions right now that will get them by. We expect some of those will come back in the future to do more. We've also been working proactively to expand our install base, that's helped improve the throughput, certainly of our equipment. That's yet another factor that's out there. Finally, I think shops have figured out how to be more efficient, they've obviously been hiring people. The labor rates have been improving, which of course attracts employees into the field. There's many different combinations of things that are going on that have improved the throughput in recent months.
Okay. Just as a follow-up on ADS-B. There's some indication that suggests that a lot of the remaining planes that are yet to be equipped with ADS-B are older airframe machines that the owners may hesitate whether to upgrade or just scrap the airplane. What are you hearing from your partners and dealers in terms of the mix of remaining aircraft that need to get equipped with ADS-B in terms of what's the likelihood that we're going to get to that 160 high end of estimates?
Certainly, hitting the high end is more of a challenge than hitting the lower numbers, but we do think it's possible to do. For the airframes that are out there where people might be contemplating the upgrade versus scrap, I think those airplanes probably aren't candidates anyway, so they've already been factored into the projected numbers.
Okay, got it. Doug, on OpEx, we've talked about this in the last couple of quarters, have your expectations changed? I'm just asking because the first half growth in OpEx trailed growth in sales, the guidance kind of implies a pretty steep growth, maybe a little bit abnormal in OpEx in the second half. I know Tacx is playing a factor, I guess, can you please refresh your expectations there?
Yeah, sure. You're exactly right. Tacx and acquisitions will play a bigger factor in the back half, that will cause our OpEx to grow at a faster rate in the back half. Give you kind of a rundown between the different OpEx. Overall, operating expense is consolidated. We'd expect as a percentage of sales, probably about a 50 basis point increase year-over-year. Looking at advertising, I still think as a percentage of sales, that will probably be relatively flat year-over-year. Probably have some year-over-year increases in advertising just as we have new product launches come out in the back half, and they're a little bit higher year-over-year increase than we saw in the first half. As it relates to R&D, I would expect that to be relatively, as a percentage of sales, consistent year-over-year.
In SG&A, that'll probably be up about 50 basis points, and that's primarily due to the acquisitions impact on the back half of the year for that full period of time.
Okay. It seems like relative to original expectations, R&D is now expected to be flattish versus previously, I think you were expecting plus 50 basis points.
Yeah.
You got some efficiency there.
That's really because of leverage in sales. We took our sales up from that standpoint. In the R&D area, we're continuing to add headcount there too for our product lines, but continue to optimize that as we go along. Yeah, it's really just due to leveraging basically increased sales.
Okay, that's helpful. Thanks, guys. Good luck.
Yep, thank you.
Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Teri Seck for closing remarks.
Great. Thank you everyone for calling in. Doug and I are available for call backs throughout the day. Have a wonderful one.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.