Garmin Q2 2022 Earnings Call Transcript

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July 27, 2022

There are 9 speakers on the call.

Operator

You for standing by, and welcome to the Garmin Limited Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. As a reminder, today's program may be recorded. And now I'd like to introduce your host for today's program, Theresa Seck, Director of Investor Relations.

Operator

Please go ahead.

Speaker 1

Good morning. We would like to welcome you to Garmin Limited's 2nd quarter 2022 earnings call. Please note that the earnings press release and related slides This earnings call includes projections and other forward looking statements regarding Garmin Limited and its business. Any statements regarding our financial our future financial position, revenues, earnings, gross margins, operating margins, future dividends or share repurchases, Market share 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.

Speaker 1

Information concerning these risk factors is contained in our Form 10 ks Filed with the Securities and Exchange Commission. In particular, there is significant uncertainty about the duration and impact of the COVID-nineteen pandemic. This means that results could change at any time and any statement about the impact of COVID-nineteen on the company's results could change at any time. Business results and outlook is the best estimate based on the information available as of today's date. Presenting on behalf of Garmin Lemons this morning are Cliff Pemble, President and Chief Executive Officer and Doug Besson, Chief Financial Officer and Treasurer.

Speaker 1

At this time, I would like to turn the call over to Cliff Pemble.

Speaker 2

Thank you, Terry, and good morning, everyone. As reported earlier today, consolidated revenue came in at $1,240,000,000 Down 6% from the strong pandemic driven comparable of 2021, we generated $293,000,000 of operating profit for quarter, which was down 21% from the prior year and operating margin was 23.6%. Our performance in the quarter was influenced by several factors. First, the U. S.

Speaker 2

Dollar strengthened significantly over the prior year Relative to other major currencies and unfavorably impacted second quarter revenue by approximately $57,000,000 Our strategy for managing currency fluctuations of this nature is to increase prices where we are able and reset pricing as we introduce innovative new products. We believe this approach is very effective in managing currency changes over the long term, But the rapid and relentless strengthening of the U. S. Dollar will be a significant headwind for the remainder of the year. From a business segment perspective, underperformance in fitness had a significant impact on our results, which I will cover in more detail in just a moment.

Speaker 2

And finally, we continue to experience supply chain constraints, which limited the orders we could fill in the quarter, specifically in Marine and Aviation. Considering our performance so far, we're adjusting expectations for the remainder of the year. We now anticipate revenue of approximately $5,000,000,000 which is flat to the prior year and EPS of $4.90 representing a year over year decline of approximately 16%. This new guidance assumes currency exchange rates stabilize at current levels And we have adjusted growth expectations for fitness and marine, which reflect the current trends. Doug will provide more details on our financial results And updated guidance in just a moment, but first I'll provide highlights on the performance and outlook of each business segment.

Speaker 2

Starting with fitness, revenue decreased 34% to $272,000,000 Gross and operating margins were 49% and 9%, respectively, resulting in operating income of $23,000,000 The 2nd quarter decline was broad based impacting all categories in the segment and was primarily driven by demand normalization In the advanced wearable and cycling categories, these are categories which benefited significantly from pandemic fuel demand In the first half of twenty twenty one, although our Q2 performance was disappointing, we are encouraged by the response to our new product introductions. During the quarter, we celebrated Global Running Day with the launch of 2 new running watches, the Forerunner 255 and the Forerunner 950 The 4955 Solar version is our 1st running watch with solar charging capability, which provides up to 20 days of battery life in smartwatch mode. We also launched the Edge 1040 cycling computer Featuring solar charging capability for superior battery life and multi band GPS technology for accurate high performance positioning In the most challenging ride environments, such as those found in urban areas or dense tree cover. Given the year to date performance and current trends, we now expect fitness revenue to decline 25% for the year. Moving to outdoor, revenue increased 18% to $382,000,000 With growth across multiple categories led by Venture Watches, gross and operating margins were strong 66% 40% respectively, resulting in operating income of $154,000,000 During the quarter, we launched the Tactix 7, a premium smartwatch with unique capabilities such as night vision compatibility, as well as advanced tactical performance and risk based navigation features.

Speaker 2

The Outdoor segment has been a strong performer so far We are maintaining our revenue growth estimate of 20% for the year. Looking next to it, aviation revenue increased 13% to $205,000,000 driven by growth in both OEM and aftermarket categories. Gross and operating margins were strong at 72% 30% respectively, resulting in operating income of $62,000,000 During the quarter, supply chain constraints eased, bringing back orders down from historically high levels, but we have more work to do to meet the strong demand for our products. We recently announced that we now have more than 25,000 integrated FlightDecks in service Across a broad range of application from Piston Trainers to Transcontinental Business Jets, This achievement demonstrates the unmatched versatility and capability of our integrated flight deck systems. The Aviation segment has delivered solid performance so far and we are maintaining our revenue growth estimate of 10% for the year.

Speaker 2

Turning next to the Marine segment, revenue decreased 7% to $243,000,000 Demand for our products was even higher than it was during the historic Q2 of 2021, but we were unable to satisfy all of the demand due to supply chain constraints. Growth and operating margins were 57% and 28 respectively, resulting in operating income of $69,000,000 Since it was first introduced in 2018, Our LiveScope sonar system has been a game changer for the inland lake fishing market and has been a growth catalyst for the marine segment. We recently expanded our product lineup with the introduction of the LiveScope XR system, which operates at greater depths and expand the addressable market for live action sonar to coastal and deep lake fishing applications. We're excited to bring LiveScope technology to the deepfishing market and believe it represents another growth opportunity for the marine segment. Given our performance so far this year and the anticipated return of normal seasonality patterns in the marine market, We will now expect revenue growth of 5% for the year.

Speaker 2

Looking finally at auto, revenue decreased 6% to $139,000,000 with declines in both consumer and OEM categories. Consumer was impacted by lower sales of consumer P and Ds, while OEM was impacted by reduced orders from automakers to face their own supply chain challenges. Gross margin was 40% and we recorded an operating loss of $15,000,000 driven by ongoing investments in auto OEM programs. During the quarter, we entered a new product category with the launch of our first diesel headset, Offering truck drivers high quality audio, up to 50 hours of continuous talk time and unique integration features with our diesel navigator units. While the first half of the year has been slightly below expectations, we believe growth will resume in the second half As automaker production improves, as a result, we are maintaining our revenue growth estimate of 5% for the year.

Speaker 2

So in closing, while we are facing a variety of headwinds, it's important to remember our diversified business model provides many opportunities For growth within each segment, we have a very strong product lineup and more new products are on the way. We remain focused on what we can control and will be agile and opportunistic as we navigate the evolving macroeconomic environment. So that concludes my remarks. Next Doug will walk you through additional details on our financial results. Doug?

Speaker 3

Thanks, Cliff. Good morning, everyone. I'd like to begin by reviewing our Q2 financial results, provide comments on the balance sheet, cash flow statement, taxes and updated guidance. We closed a revenue of $1,041,000,000 for the 2nd quarter, representing 6% decrease year over year. Gross margin was 58.7 percent, relatively flat compared to the prior year quarter as favorable segment and product mix Offset the unfavorable impact of foreign exchange rates and higher freight costs.

Speaker 3

Operating expense as a percentage of sales was 35.1%, 230 basis point increase the prior year quarter. Operating income was $293,000,000 a 21% decrease. Operating margin was 23.6 percent, a 440 basis point decrease. Our GAAP EPS was $1.33 The former EPS is $1.44 Next, look at our 2nd quarter revenue by segment and geography. For the Q2, double digit growth in the Outdoor and Aviation segments were more than offset by declines in the Fitness, Marine and Auto segments.

Speaker 3

By geography, Americas region was flat, contributed about half of revenue for the quarter. The EMEA and APAC regions, Both impacted by foreign exchange rates declined during the quarter. Looking next at operating expenses. 2nd quarter operating expenses increased by $26,000,000 or 6%. Research and Development increased $15,000,000 year over year, primarily due to engineering personnel costs.

Speaker 3

SG and A increased $10,000,000 compared to prior year quarter, primarily due to increases Personnel related expenses, information technology costs. Our advertising expense is relatively consistent The highlights on the balance sheet, cash flow statement and taxes. We ended the quarter with cash and marketable securities approximately $2,900,000,000 Contreceivable increased sequentially to $699,000,000 Following a seasonally stronger Q2, declined year over year, relatively in line with our sales decline. Inventory balance increased year over year to approximately $1,500,000,000 We're executing our strategy to increase days of for increasingly diversified product lines, optimize the mix of ocean versus air freight shipments and to carry sufficient levels of raw materials, safety stock to mitigate increased lead times. In the Q2 2022, we generated free cash flow of $5,000,000 $115,000,000 decrease from prior quarter, primarily due to lower operating income and increased operating capital needs.

Speaker 3

Capital expenditures for the Q2 were $75,000,000 We expect full year 2022 free cash flow to be approximately $500,000,000 Capital expenditures approximately $300,000,000 Also during the quarter, we paid dividends of $129,000,000 Repurchased $31,000,000 of company shares, leaving $260,000,000 remaining share repurchase program Authorized through December 2023. For the Q2 of 2022, we put an effective tax rate of 7.6% Compared to 14.8% in the prior quarter. The decrease in effective tax rate is primarily due to income mix by tax jurisdiction An increase in U. S. Tax deductions and credits.

Speaker 3

Turning next to our full year guidance. We estimate revenue of approximately $5,000,000,000 compared to our previous guidance of $5,500,000,000 As previously mentioned, strengthening of the U. S. Dollar, a significant unfavorable impact on our 2nd quarter revenue. Assuming the euro will be at parity with the U.

Speaker 3

S. Dollar The remainder of the year, the year over year unfavorable revenue impact will accelerate in the back half of twenty twenty two. We expect gross margin to be approximately 56.7 percent, which is lower than our previous guidance, 57.5%, primarily due to anticipated full year unfavorable impact of foreign exchange rates. We expect operating margin of approximately 20%. Also, we expect a pro form a effective tax rate of 8.5 percent, which is lower than our previous guidance of 10.5 percent We projected full year income mix by tax jurisdiction.

Speaker 3

This results expected pro form a earnings per share approximately $4.90 This This concludes our formal remarks. Jonathan, could you please open the line for Q and A?

Operator

Certainly. And our first question comes from the line of Paul Chung of JPMorgan. Your question please.

Speaker 4

Hi. Thanks for taking my questions. So just first up on fitness, where are we on kind of the Channel levels on some of the cycling products and what's been the initial demand kind of feedback for Refreshing some of the Forerunner lines, including the 955, and how should we think about kind of the seasonality for the balance of the year

Speaker 5

Yes. So I

Speaker 3

have a follow-up.

Speaker 2

Okay. Good morning, Paul. Channel levels in cycling, I would say you have to kind of look at 2 different sides of that. 1 is the cycling Computer side and the other is the indoor trainer side. The cycling computer side and the response to the new 1040 is Very good.

Speaker 2

And so the inventory levels at the channel I think are fine. The indoor cycling side of things with the tax trainers, I think generally the market right now is heavy on inventory of all kinds of trainers from every manufacturer. And so There's kind of a backup at retail of those products which impacts our sell in. It's going to take some time I think for retailers to work through that. But in general, the retail demand is generally what people would expect for this time of the year.

Speaker 2

It's not really the season yet In the Northern Hemisphere and we should see improved retail sales in the back half as winter approaches. In terms of the other fitness products, the 955 and the 255, the demand has been very good. And we're working through actually back orders on those as well.

Speaker 4

Great. And then on Aviation, you saw some record kind of quarterly revenues kind of resulting in very nice operating leverage for the Segment now it's above that 30% mark again. Can you expand on some of the strength you're seeing in the segment Product mix, market share, and you've kind of provided the revenue outlook, but how should we think about Margin outlook for aviation in the second half.

Speaker 2

Yes. So definitely a good quarter. I think that we were able to catch up on some of our lingering back orders In the segment, most of those were targeted to the aftermarket. Our both sides of the aviation segment, the OEM side And the aftermarket grew in the quarter. We expect that to continue in the back half because OEMs of course Are working to fill the back orders that they have for airplanes, which are still very strong and we're still catching up on orders in the aftermarket side Thanks as well.

Speaker 2

In terms of market share, as we said before, we're very strong in everything from The Piston singles on up through the midsize business jet and we continue to win more platforms in those categories and are working on Projects to build our revenues for the future. And then margin wise, I would say that aviation has been very solid when it comes to our margin profile. And in that 70% margin range for gross margin, which funds a very heavy R and D investment to create the products that we offer And kind of that mid to upper 20 range for operating margin is kind of the sweet spot. As We get more leverage, of course, it goes up, but generally, we tend to target in that range.

Speaker 4

Great. And then lastly, if I could fit one more in. Outdoor, Very strong quarter with the refresh of the Phoenix despite some tough comps. How is the sell through kind of tracking there and You know the status of the channel there? And then do you have a sense for kind of upgrade versus new users to the platform, particularly for the Phoenix?

Speaker 4

And any thoughts there would be great. Thanks.

Speaker 2

So the refresh has gone very well. I think It's taken us some time that we are getting close to being caught up on the initial demand for the Pfenex and the Epix Since it was launched earlier this year, there's still some pockets of lingering back orders in those categories that we're working to catch up on. In terms of the channel, we think it's very healthy and seems to be normalizing right now with kind of the sell in sell through being balanced. In terms of user profile, we're seeing pretty much what we have seen in recent launches, which is roughly about Half of our users coming into those families are new users and then we have upgrade users coming from All kinds of products from much older generation Phoenix to even our Advanced Wellness customers who are looking to upgrade to A more capable watch.

Speaker 4

Great. Thank you.

Speaker 2

Thank you.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Ben Bullock from Cleveland Research. Your question please.

Speaker 6

Good morning, everyone. Thanks for taking the question. Cliff and Doug, I had a bigger picture question on inventory levels. When you think about your current balance sheet and the exposure to inventory, I know there's been some targets to build that. How have those thoughts evolved?

Speaker 6

And then a follow on, Based on the behavior you're seeing from your partners, your go to market partners, give me thoughts about what they're thinking about Going into the holiday selling season and their overall commitments to inventory levels from where they stand right now.

Speaker 2

Yes. So maybe just a high level comment on our overall inventory. As you know, component lead times have been very long. And so in order to ensure we have the materials to be able To meet demand, we've had to increase our weeks of supply on the raw material side. In some cases, we've been faced with what we're typically Before the pandemic, 13 to 26 week lead times, now extending 26 to 52 week lead times.

Speaker 2

So it's a very challenging situation. And what we don't want to do is be left with demand with no inventory to build. Additionally, on the inventory side, the freight Side of things has been really challenging. And in order to solve the freight cost issue, we have to have more inventory coming on boats, which is a lower cost Mode of shipment and that takes a very long time and so it simply just extends the amount of inventory that we have to carry. We feel like the inventory we have is good inventory.

Speaker 2

We're very versatile. We can reuse components and Materials that we have across many different product lines and we feel like in general that most of our product lines are Solid long term, long lifecycle products that we can sell over time. So we feel very good with where we're at right now. In terms of go to market and their outlook for the upcoming holiday season, it's still early days. So There's work being done to finalize all of that.

Speaker 2

The early indications that we have In some of the segments is a very strong commitment to promoting products in big quantities for the holiday season. So that's what we know so far, but again it's probably very early days.

Speaker 6

Okay. And then one follow-up would be, specifically as you look at the outdoor business for the adventure watches, How are you thinking about the performance of that business through year end? And how are you balancing the potential risks of Maybe you've already seen some pull forward. You just haven't seen it yet given the refresh versus the stronger underlying secular demand. And that's it.

Speaker 6

Thank you.

Speaker 2

Yes. So our guide for the year is up 20%. We had a strong first half. So As you can infer from the data, we expect that will moderate in the back half. We believe our product line is very Strong and we believe that that is achievable right now.

Speaker 2

And we also have more new products coming which should boost Our overall ability to grow in the back half.

Speaker 6

Thank you.

Operator

Thank you. One moment for our next question. And our next

Speaker 7

First question on Marine. I guess, Cliff, can you talk about where do you see the constraints? I know you had some constraints in prior quarter, but it seems like they have worsened. And also, it seems like you're building through a strong backlog. How much of that do you consider perishable given the macroeconomic backdrop?

Speaker 2

Yes. So the constraints Nick, I would say they're not worse, but they in some cases they didn't get Much better during the quarter. The main issue there was key components for our chart plotters in order to be able to deliver Those higher end plotters and we prioritize customers in the segment that impacted our selling prices. But in general, I would say the backlog, we've made some progress into Q3 and covering some of that. And we are assuming that we'll have a greater level of seasonality more typical of the segment.

Speaker 2

Q2 is usually the highest quarter of the year and then it falls off as people in the Northern Hemisphere bring their boats out of the water and put them in storage and They wait to upgrade boats and work on them in the spring. So we're assuming some of that may be deferred, but that's why we Brought our guide down to about 5%.

Speaker 7

Okay. And then second question I have is that maybe On the OpEx side, maybe can you talk about what are the changes you're implementing following the revision in the outlook? How is the OpEx lines changing given the

Speaker 3

new outlook?

Speaker 2

Yes. I think we're definitely taking a look at that and we're looking Two different areas. We're being very selective in our hiring to make sure that we don't outgrow our revenue growth. And we're also looking at our general OpEx, focusing on priorities and essentials and making sure that We narrow the priorities to the most important things. So we're trying to manage that and steer it for the long term.

Speaker 7

Okay. Last one, if I can squeeze. Fitness gross margin, should we expect given the current environment and the inventory overhang that The high 40s is kind of the norm in the near term? Or is there any potential puts and takes that can change that direction?

Speaker 3

Yes. In the fitness gross margin, there's a lot of, I mean you said puts and takes in it. We did see some unfavorability relating to the Foreign exchange rates, which we would anticipate that to continue in the back half. Cliff talked about also freight. Freight's also impacting our gross margins also there from that standpoint.

Speaker 3

And so you've seen some of the other segments that may have Seeing some improvement in there like outdoor from product mixes where they have and some things we're watching higher percentage of those. But it was really going to be a function of what is that product mix portfolio and mix up that fitness side of things. But Probably, I'd say, as you said, probably similar to what Qve indicated be our gross margins for the go forward. But we do have some headwinds there we're currently facing. Thanks

Speaker 4

guys and good luck.

Speaker 6

Thank you, Nick.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Ivan Feinseth from Tigris Financial. Your question please.

Speaker 8

Thank you for taking my question and congratulations on the good aviation Following the introduction of the diesel headset, do you think there's an opportunity for you to expand into aviation cockpit headsets considering That's really only dominated by 2 companies and none of those have the cockpit pressure presence that you have.

Speaker 2

Yes. I think, good morning, Ivan. We're really excited about the diesel. And as I've mentioned Many times in the past, our strategies for growth are introducing new products and new product categories, entering new markets and this reflects That commitment. Right now, we're focused on attacking the opportunities on the truck side And then we're exploring other avenues where this kind of technology might be useful.

Speaker 8

Based on your overall bigger picture hiring and space expansion plans in Olathe, do you think that Some of what you're going through that you're seeing right now is just more of short term headwinds and what do you feel the bigger picture growth opportunities continue to be?

Speaker 2

Well, first, I think everyone hopes that the economic situation is short term, but none of that is really proved to be true. So we're Making sure we're managing the business for the long term. We are in need of more space in Olathe particularly To be able to bring more people back on to campus and also focusing on those priorities that we have, particularly needing more people In aviation and some of the consumer areas as well and balancing our overall hiring needs. So We're committed to building out and finishing our space expansion here in Olathe. And then I think we're in good shape when it comes to overall space Accommodations for our people for the next kind of phase of growth.

Speaker 8

Right. And in upcoming new products, can you give us Some idea of the areas that we should be stay tuned and focused on, where we'll see some new products introduced this year or the second half of this year?

Speaker 2

Well, we have introductions planned in most every segment. And so stay tuned, but I'm pretty excited about some of what's coming.

Speaker 8

All right. Thank you very much.

Speaker 3

Thank you.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Eric Woodring from Morgan Stanley. Your question please.

Speaker 5

Hey, good morning guys. Thank you for taking my question. Maybe Cliff, I'll start with a kind of high level question for you and then ask one for Doug. I think as we've gone through the pandemic and now kind of in this Quasi pandemic stage, consumer electronics have gone through a near record period of elevated Demand that some could now say is normalizing. I would just love to get your take, Cliff, on just how you think about the TAM for your consumer facing businesses?

Speaker 5

Do How you're thinking about the TAM as we move kind of past the peak of the pandemic?

Speaker 2

Thanks, Eric. Yes, I think that the pandemic certainly highlighted to people the Certainly highlighted to people the importance of health and wellness and fitness. And so I believe that change in people's focus probably is a very long and enduring We did experience a lot of new demand and had new customers coming into our ecosystem. I believe that's a longer term opportunity than as they use those devices and then look for a device with new capabilities, they will Then look to Garmin for an upgrade. So I believe that creates an enduring customer base for us And leads to opportunities in the future.

Speaker 5

Okay. That's helpful. And then maybe Doug, by my math, kind of gross margins in the 2nd half will be a bit below 56%. Operating margins will be around 18.5%. So is there any way you can just kind of help us quantify The impact of the various factors impacting kind of this new lower second half margin outlook?

Speaker 3

Yes. Well, a big factor of that is foreign exchange rates. So as I mentioned, the assuming parity For the euro and U. S. Dollar, we should expect the year over year impact change to accelerate.

Speaker 3

For instance, in Q2 of last year 2021, we're about 120. Then this year, the average for Q2 2022 was about 107, and then it went to buy, I think, 118 and 115. And if you assume parity, which is similar where we're at right now, that year over year change will accelerate. So that is impacting our gross margin there as well for the bigger piece of that piece. But then also, as We mentioned freight is something we are managing through that also.

Speaker 5

And maybe if I could just clarify, would you say The FX is the only kind of incremental headwind or would you say freight is now more of a headwind than you expected 90 days ago?

Speaker 3

It's interesting freight. So freight was probably the biggest story maybe a couple of quarters ago, we were Year over year. Now, as Cliff mentioned, we're managing a piece of that as it relates to our inventory levels. We are We're trying to have a larger percentage of our shipments on ocean versus air, which is helping that. And also On a year over year basis, we saw some of those large increases last year in the rates.

Speaker 3

And I'd probably say some of those rates are maybe a little bumpy here too, but more or less stabilizing. So there will probably be some ups and downs in freight through the back half of the year, kind of see what's going on with the rates, but our ocean there. But It won't be as significant of a driver as the FX for NexGen rate, which I think are going to be a bigger Item that we're going to be headwind against in the back half.

Speaker 5

Okay. Thank you so much for the color guys.

Speaker 4

Thank you.

Operator

Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Theresa Seck for any further remarks.

Speaker 1

Thanks everyone for your time. Doug and I are available for callbacks. Have a great day. Bye.

Operator

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.

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