Garmin Ltd. (GRMN) Q2 2023 Earnings Call
Garmin Ltd. (NYSE:GRMN) Q2 2023 Earnings Conference Call August 2, 2023 10:30 AM ET
Company Participants
Teri Seck - Director of IR
Clifton Pemble - President & CEO
Doug Boessen - CFO
Conference Call Participants
Joseph Cardoso - JPMorgan
Benjamin Bollin - Cleveland Research Company
George Wang - Barclays
David MacGregor - Longbow Research
Ivan Feinseth - Tigress Financial Partners
Erik Woodring - Morgan Stanley
Operator
Thank you for standing by. My name is Wallace and I will be your conference operator today. At this time, I would like to welcome everyone to the Garmin Limited Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Thank you.
I would now hand the call over to Teri Seck, Director of Investor Relations, you may begin your conference.
Teri Seck
Good morning. We would like to welcome you to Garmin Limited's second quarter 2023 earnings call. Please note that the earnings press release and related slides are available at Garmin's Investor Relations site at www.garmin.com/stock. An archive of the webcast and related transcript will also be available on our website.
This earnings call includes projections and other forward-looking statements regarding Garmin Limited and its business. Any statements regarding our future financial position, revenues, segment growth rates, earnings, gross margins, operating margins, future dividends or share repurchases, market shares, product introduction, 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 Limited 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.
Clifton Pemble
Thank you, Teri. And good morning, everyone. As announced earlier today, Garmin reported second quarter consolidated revenue of $1.32 billion, up 6% over the prior year, driven by growth in three of our five business segments. Gross in operating margins were 57.5% and 21.5% respectively. And we generated $284 million of operating income in the quarter. GAAP EPS was $1.50 and pro forma EPS came in at $1.45, up 1% over the prior year.
We feel positive about our results for the first half of the year, and are updating our full year 2023 guidance accordingly. We now expect revenue of approximately $5.05 billion, and EPS of $5.15 during the year. Before turning the call over to Doug, I'll provide highlights by segment and then look at what we see ahead.
Starting with the fitness segment, revenue increased 23% to $335 million, driven by broad based growth across all product categories. Gross in operating margins were 52% and 16% respectively, resulting in improved year-over-year operating income of $54 million. During the quarter, we launched the Edge 540 and 840 cycling computers featuring dynamic performance insights, advanced mapping capabilities, and solar charging to help cyclists ride longer, smarter and train more effectively. Given the year-to-date performance and current trends, we now expect fitness revenue to grow approximately 10% for the year.
Moving to outdoor revenue decreased 3% to $448 million, as growth in adventure watches was more than offset by declines in other categories. Gross in operating margins were 63% and 31% respectively, resulting in operating income of $138 million. During the quarter, we launched our next generation fenix 7 Pro Series Pro Series with enhanced performance insights, built-in LED flashlight and additional mapping capabilities. We also launched the epix Pro Series in three sizes, all with bright AMOLED displays and a built-in LED flashlight.
Also during the quarter, we launched the Approach S70 premium golf smartwatch, available in two sizes featuring a bright AMOLED display. And with the built-in barometer for a more accurate reading on how each shot is playing. We expected the first half of the year to be challenging in comparison to the outstanding performance of the prior year.
Given our year-to-date performance and the timing of the adventure watch launches, we now expect outdoor revenue to be approximately flat compared to the prior year.
Looking next at the Aviation segment, revenue increased 6% to $217 million, with growth driven by OEM product categories. Gross and operating margins were strong at 74% and 29%, respectively, resulting in operating income of $63 million. We recently announced the imminent certification of our revolutionary Autoland and Autothrottle systems in select beach craft King Air models, marking the first time we have offered these highly important safety technologies to the retrofit market as well as the first time we have certified our Autoland system in a twin-engine aircraft.
Our Smart Glide system was recently selected for a FLYING Magazine Editor's Choice Award, the 15th time we received this prestigious award. As you can see, our focus on aviation safety technology is unwavering, and I'm proud of what the aviation team has accomplished. We are pleased with how our Aviation segment has performed so far this year. Given the year-to-date performance and the stronger comparable from the back half of 2022, we are maintaining our 5% growth estimate for 2023.
Turning next to the Marine segment. Revenue decreased 11% to $216 million, primarily due to the timing of promotions, which benefited Q1 and contributed to the lower revenue from chartplotters in Q2. Gross and operating margins were 56% and 21%, respectively, resulting in operating income of $46 million.
During the quarter, we expanded our trolling motor series to a wider range of boats with the launch of the Force Kraken. This powerful new trolling motor features a pivot style mount for easy installation on a wider range of boats. The Marine market has experienced significant growth in recent years, due to increased interest in boating and fishing driven primarily by the pandemic. The pandemic drivers of this growth have mostly normalized, and we now believe the market faces increasing headwinds caused by higher interest rates and greater economic uncertainty.
While our first half performance was essentially flat to that of the prior year, we see signs that the market is softening, which impacts our revenue outlook for the remainder of the year. With this in mind, we believe the Marine segment revenue will be down approximately 7% in 2023.
Moving finally to the Auto OEM segment. Revenue exceeded $100 million of quarterly sales for the first time in our history, increasing 77% primarily driven by shipments of domain controllers to BMW. Gross margin was 24%, and we recorded an operating loss of $18 million driven by ongoing investments as new programs move into production.
During the quarter, we received production approval for a new domain controller for safety-critical instrument cluster functions, which will be incorporated into multiple BMW models throughout the remainder of the year. Given the year-to-date performance, we now expect Auto OEM revenue to grow approximately 35% for the year.
That concludes my remarks. Next, Doug will walk you through additional details on our financial results. Doug?
Doug Boessen
Thanks, Cliff. Good morning, everyone. I'll begin by reviewing our second quarter financial results, by comments on the balance sheet, cash flow statement, taxes, updated guidance.
We posted revenue of $1.32 billion for the second quarter, representing a 6% increase year-over-year. Gross margin was 57.5%, a 120 basis point decrease from the prior quarter. The decrease was primarily due to segment mix. Operating expense as a percent of sales was 36%, a 90 basis point increase. Operating income was $284 million, a 3% decrease. Operating margin was 21.5%, a 210 basis point decrease. Our GAAP EPS was $1.50 pro forma EPS of $1.45.
Next, look at our second quarter revenue by segment and geography. During the second quarter, we achieved growth in three of our five segments, double-digit growth in both the Fitness, Auto OEM segments. By geography, Americas region declined 1%, while the EMEA and APAC regions achieved double-digit growth of 11% and 22%, respectively.
Looking next, operating expenses. Second quarter operating expenses increased by $39 million or 9%. Research and development increased $22 million year-over-year, primarily due to engineering personnel costs. SG&A increased $13 million compared to the prior year quarter, primarily due to increases in personnel-related expenses, information technology costs. Advertising expense increased approximately $3 million, primarily due to higher media spend.
A few highlights on the balance sheet, cash flow statement and taxes. We ended the quarter with cash and marketable securities of approximately $2.8 billion. Accounts receivable increased both year-over-year sequentially to $717 million following the seasonally stronger second quarter.
Inventory balance decreased both year-over-year and sequentially to approximately $1.4 billion. We're executing on our strategy to optimize inventory, the reductions in our consumer inventory increases associated with our auto OEM business.
For the second quarter of 2023, we generated free cash flow of $221 million, $216 million increase in the prior year quarter primarily due to a lower use of cash and purchases of inventory. Capital expenditures for the second quarter were $53 million. We expect full year 2023 free cash flow to be approximately $750 million, capital expenditures approximately $250 million.
During the second quarter, we paid dividends of approximately $140 million. Also, we purchased $26 million of company stock at approximately $27 million remaining at quarter-end in the share repurchase program, which authorized through December of 2023. Reported effective tax rate of 8.9% compared to 7.6% prior year quarter. Year-over-year increase in effective tax rate is primarily due to a larger amount of reserve releases in the prior year.
Turning next to our full year guidance. We estimate revenue of approximately $5.05 billion repaid to our previous guidance of $5 billion. We expect gross margin to be approximately 57.2%, which is lower than our previous guidance of 57.5% primarily due to anticipated full year segment picks. We expect an operating margin of approximately 20%. We also expect a pro forma effective tax rate of 8.5%, is higher than our previous guidance of 8% due to projected full year income mix by tax jurisdiction. This results in expected pro forma earnings per share of approximately $5.15.
This concludes our formal remarks. Wallace, could you please open the line for Q&A?
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from the line of Joseph Cardoso from JPMorgan.
Joseph Cardoso
Good morning. And thanks for the question. If I take a look at your full year guide for outdoor and fitness, is the implication or the assumption we should make is that we should see typical seasonality heading into the back half? And if so, what's driving your confidence tracking to the seasonal level of demand, just given concerns around overall consumer spending? And then I have a follow-up. Thanks.
Clifton Pemble
Yes, I think -- Joseph, this is Cliff. I think fitness and outdoor probably should be looked at differently because there's different dynamics in each one of those. In the Fitness segment, we had a very strong first half because of the sell-in of new products, which, of course, won't repeat as much in the second half. In outdoor, we were comping against a very strong first half in the prior year. And moving into the back half, we see stronger results comping with our new products. So each one is different. I think so far, I would say that we don't see signs of the kind of consumer behaviors that are present in some other segments. Each segment probably has a little bit different dynamic, but we believe both of these segments should be strong in the back half.
Joseph Cardoso
Got it. And then maybe just as a quick follow-up. Can you just touch on how much of a benefit you're seeing in your gross margins from moderating headwinds from components and freight and et cetera, some of these elevated costs that we had seen over the past couple of years here in 2Q? And then how much of that is still remaining as you enter the back half of the year? And then, I guess, just quickly, is the largest offset to those tailwinds from easing component costs coming from the increasing mix of auto? Or are there other variables that I should be appreciating here? Thanks for the questions.
Doug Boessen
Joseph, this is Doug. I'll give you kind of a perspective on gross margins. First, the year-over-year decrease on a consolidated basis was due to a segment mix, and that is based upon where you see fitness and auto OEM, which have a lower gross margin than the consolidated average coming a larger percentage of the total year-over-year.
As some of the other components, there's a lot of different moving parts within gross margin, but you mentioned freight. Yes, we are seeing some favorable freight and that favorable freight is due to two pieces, one of which is its lower ever rates as well as we're shipping a larger percentage of our products ocean versus air. So that's offset by other factors, including a product mix within the segments. So with each one of the segments, each one of the products you have a different gross margin there depending upon how that mix is one quarter versus the other quarter, that does impact that in there.
So there's a lot of different moving parts in there. And also as it relates to freight, I think you mentioned a question what for the future, so we've seen some good benefits in freight year-over-year. We would expect that year-over-year benefit to decrease just because we saw some of the freights come down toward the back half of the year. But we should -- we're not expecting the overall rates to change that much, but the year-over-year favorability and the year-over-year gross margins will decrease.
Operator
Our next question comes from the line of Ben from Cleveland Research. Please goa head with your question.
Benjamin Bollin
Good morning, everyone. Thanks for taking my question. Cliff, I was hoping you could talk through how we should think about the profitability glide path within the auto OEM business. You've got really remarkable year-over-year growth and really not much movement on the EBIT line. So at what point does that start to scale? And then I have a follow-up.
Clifton Pemble
Good morning, Ben. I would definitely say the results in at OEM are getting better. I think the operating loss was cut by third this last quarter on a year-over-year basis. So we're seeing improvements. I think there's gives and takes every quarter as the business is somewhat dynamic in the forecast from OEMs changes according to their business conditions. But in general, I would say we're on the path that we expected.
Benjamin Bollin
Okay. If you look at -- there's been some headlines out there perhaps for Doug, on what's happening in Switzerland with the global minimum tax? Could you share any ways we should think about this, how an Ackman or when the federal accountant may do something, how this could influence potential tax rate into the future?
Doug Boessen
Yes, Ben. Yes, we don't give future guidance on our ETR beside the current year. But you're correct. There are some global minimum tax legislation out there. And with that, it's stating basically a minimum tax of 15%. So if that gets enacted, that would basically have our tax rate at least 15%.
Now I should say that there's a lot of moving parts in our effective tax rate that may impact that also relating to income by mix, reserve for leases and such. But yes, depending on what -- how that the legislation and when it's enacted, the situation is that our effective tax rate would be at 15% or possibly even higher.
Benjamin Bollin
That's great. And then my last question, looking at the Marine business, Cliff, could you talk to how -- you talked about softer expectations in the back half, but any thoughts on how aftermarket versus new boat delivery play into that? Are they both softening, one worse than another? Just any thoughts there? And that's it for me. Thank you.
Clifton Pemble
Yes, I think there's a few moving pieces in what's going on in marine. I would say that from the midrange on up in terms of both sizes, the market is still very healthy and both from the OEM and aftermarket perspective, it seems like the weakness is more from the lower -- mid-range to lower end. And of course, new boat buying activity generates both refits and equipment added to the boat at the time of purchase.
So these are the things that are just all coming into play. And another factor really is this seasonality that we're seeing return that we haven't seen over the course of nearly four years now. So I think there's a lot of dynamics. I believe the market is still a very, very good market. It's one of the last ones to really show this normalization that we've seen in every other market. And we expected that it would come, but it's with us now. And I think going forward, we'll concentrate on new products and driving growth through innovation.
Operator
Our next question comes from the line of George Wang from Barclays. Please go ahead with your question.
George Wang
Thanks for taking my question. Firstly, can you comment on the buyback prospects just given incremental higher free cash flow kind of healthy business profile? Just curious if the strategy in terms of capital return has changed. I noticed kind of buyback ticked lower in 2Q. Just curious if any color on that.
Doug Boessen
So is the question regarding the buybacks?
George Wang
Yes.
Doug Boessen
Yes. Basically, we'll evaluate our share repurchase just based upon the business and market conditions. The situation is we have a $300 million authorization through the end of '23, we have $26 million, $27 million of that remaining. It was really just based upon business conditions and market conditions.
George Wang
Okay. Great. Just if I can, I can squeeze in a quick follow-up. But just can you comment on the backlog and the channel inventory, really two parts kind of on the industrial business, kind of marine and aviation incrementally weaker. You mentioned that it's more seasonal for the marine. Can you comment on the backlog across marine and aviation? Also, any thoughts on the channel inventory on the fitness and kind of wearable side of the business?
Clifton Pemble
Yes. I think backlogs have come down a lot, and most of that is due to the easing supply chains that we've seen allowing us to fill the orders much faster than we were last year for both aviation and marine. I think some of those dealers across aviation and marine in the past year were interested in keeping more safety stock on their shelves because they wanted to make sure they could serve customers coming into the shops. And as lead times have come down, they have relaxed a little bit their concern over being able to serve their customers. So that's also part of the moving pieces that we're seeing as things normalize in both aviation and marine. I would say that the channel inventory is mostly healthy. And as we go forward, it will be replenishment type of activity that goes on.
George Wang
Okay, great. Thanks.
Operator
Our next question comes from the line of David McGregor from Longbow Research. Please go ahead, with your question.
David MacGregor
Yes. So, good morning, everyone. Thanks for taking my questions. Cliff, just a question on the automotive OEM and just go back to a previous question on this. Just trying to think about profitability and trying to understand the economics around this business. But is there any way to separate the start-up costs and kind of the one-times and the ramp-up costs from the profitability of the volume that you are shipping?
Clifton Pemble
Yes. I mean, we also look at that. That really relates to building scale in the business as revenues increase. We haven't really talked about those kinds of number externally because we're a company that focuses on true GAAP financials. So we include all of our costs as are expensed, and we all try to make our -- all of our businesses profitable and perform well on that basis.
David MacGregor
Okay. And how are you thinking about second half revenues for the automotive OEM in your annual guidance?
Clifton Pemble
Yes. I mean I think we raised our guidance outlook for the full year, reflecting strength that we've seen in the business and acceleration into the back half. So that reflects our current view of the business.
David MacGregor
Okay. You mentioned that you'd added another controller program. I'm just wondering if it's possible that we will continue to see program additions. Or do you just ship under the programs that you have now?
Clifton Pemble
Well, I think these devices are being incorporated across model lines. And so that takes some time, and it's dependent on BMW's own engineering work and scheduling into production. So we're basing our forecast on what we have been told for their production plan for cars containing our devices.
David MacGregor
Okay. Thanks for that. And then my follow-up question is really around the discussion of promotional expectations for the rest of the year. And obviously, there's a seasonal pattern at play here, but I'm just wondering how you're thinking about your required spending on promotional programs and promotional support into the second half of the year versus second half of last year?
Clifton Pemble
Yes. I think we expect it to be more like normal than ever before in recent memory. We've seen this trend in recent quarters where the markets are returning to the level of promotions and discounting and sales that we saw in the past. So we're expecting that. It will probably be very similar to what we've seen over the past year. Honestly, it kind of more normalized even last year. So that's what we expect going forward is really a normal cadence.
David MacGregor
Thanks very much. Good luck.
Operator
Our next question comes from the line of Ivan Feinseth from Tigress Financial. Please go ahead, with your question.
Ivan Feinseth
Thank you for taking my questions. And congratulations on the great automotive OEM progress. Can you go into a little detail about the opening of the first B analytics lab and like what your expectations are and what you think you can gain from that? And also since everybody is talking about AI, what are your thoughts on how AI can help product -- your product development and product functionality?
Clifton Pemble
I think the first B lab reflects our commitment to ongoing research and innovation in the area of biometrics and performance for athletes as well as wellness features in our products. So we continue to invest in that area, and it's something that's important to us to differentiate our products from others.
In terms of AI, we've been using AI techniques in our products and in our algorithms on both cloud-based applications as well as on our devices for quite a while. We continue to see this trend, and we continue to develop our capabilities in that area as well. I think in terms of how we deploy that in the company, there's probably a mixed bag of responses there that I would say. Some of it is good and can be helpful to us in productivity and other applications of AI that have been broadly discussed in the media may not be for us. But in general, we're approaching it with prudence.
Ivan Feinseth
Then one last question. A lot of your new products that you've introduced like the recent golf watch have come with a delineation on the application for an upgrade and a subscription. Can you give me your views or outlook on as far as creating subscription revenue and tiering the functionality and pricing for some of your apps?
Clifton Pemble
Yes. I think what you're seeing reflects our intentional strategy to increase revenues from subscription-based sources. And so the golf apps [ph], our tax trainers, inReach, aviation databases, outdoor maps, all of these things are playing into our desire to increase revenues from recurring sources.
Ivan Feinseth
Great. Thanks again.
Operator
Our next question comes from Erik Woodring from Morgan Stanley. Please go ahead, with your question.
Erik Woodring
Good morning, guys. Thank you for taking my question. A few, if I may. The first one, I know it's early, but can you maybe just give us some color on customer reception to the new epix Pro and the new fenix 7 Pro series launched in the quarter? And I would just love if you can kind of weave that into your sense of what the health of the consumer is? Are you seeing demand stabilize?
Are you seeing demand from upgrades versus existing upgrades versus new customers? Any difference there? And then any pricing sensitivity you're hearing from the customer? So just an overall read on the customer and how it's impacting some of these new product launches? And then I have a follow-up.
Clifton Pemble
Okay. Yes. So the launch of those two new families, the epix Pro and the fenix 7 Pro, I think, went very well. We feel like the sell-through as indicated through our registrations is going exactly as we had planned. And I think we're seeing very similar trends as what we've seen in the past in terms of mix of new customers and existing customers that upgrade.
So I think I would say that all is pretty much as we would expect and as what we've seen in the past on those two product lines, really no sensitivity from the consumer in terms of softness there relative to any economic issues. I think the question of the consumer health is really depends on the product line that you're talking about. And those products are definitely higher-end products that target more affluent customers. So we feel like everything there is going as we had planned.
Erik Woodring
Okay. That's helpful. Thank you. And then maybe just to follow up on your comments on the marine business, Cliff. I kind of understand the dynamics that you walked us through between the strong first quarter and a bit weaker second quarter. But can you maybe just elaborate on exactly what's going on in the market? And the only reason I say that is I know you called out interest rates and macro concerns as headwinds. But neither of those dynamics are necessarily new. And so just curious, from your perspective, what are you seeing over the last 90 days that has really changed your view from this market growing to this market declining? Thanks so much.
Clifton Pemble
Yes. I think our view is really based on all of the latest data that we see and also talking to all of our retailers and distributors. There's definitely pockets of strength in the market. But increasingly, we're seeing some feedback that there's some hesitancy on the part of some customers who, in the past, felt like they had much more money to spend who maybe now don't or are faced with very high interest rates at their financing a purchase and can't buy it with cash. So these are the kind of initial signs that we're seeing that just want to cause us to be a little bit more cautious for the back half.
Erik Woodring
And maybe if I could just ask one follow-up to that. After just kind of talking about the higher-end products on the consumer side being okay. As it relates to the comments that you just made about hesitancy from customers and what you said earlier in Q&A. Am I correct that, that's largely at the lower end where there might be more economic sensitivity versus the higher end, that might be a bit more resilient, specifically marine?
Clifton Pemble
Yes, that's true.
Erik Woodring
Okay, perfect. That’s it for me. Thanks so much.
Operator
[Operator Instructions] Our next question comes from the line of Jordan [indiscernible] from Bank of America. Please go ahead, with your question.
Unidentified Analyst
Good morning. I just had a quick question. For -- like in the macro environment for Europe and Asia, I know sales were up year-over-year for both. But how are you guys thinking about demand when data is coming out that the macro environment is not improving. And I don't know how are you guys looking at that for the full year?
Clifton Pemble
Well, I think each geography has its own particular situation. And Asia is a big place. So some countries are doing very well and doing well with our new releases, while in some -- in other cases, maybe the economies aren't so good, specifically China. We're not completely dependent on 1 country in Asia for our results. So the diversity of our markets there allow us to show the results that we have. Similarly, in EMEA, I think they're probably on a different time line when it comes to their economic progress. And so when they were a little softer early on, they've been a little stronger, especially as we've introduced some of these new products.
Unidentified Analyst
Right. Okay. And then the only other question I had, too, was on the increase in advertising spend, is it just actually running more promotions or its stronger discounts?
Doug Boessen
Yes. This is related to media spend, primarily relating to the new product launch that we had. So a lot of that media spend is really tied to -- we have new products, making sure that we get to see a message out to our consumers.
Clifton Pemble
And advertising is really the -- advertising is an item related to the specific promotion, as Doug said, of awareness of the product, not necessarily the discounting of the direct itself.
Unidentified Analyst
Got it. Thank you.
Operator
There are no further questions at this time. Ms. Teri Seck, I'll turn the call back over to you.
Teri Seck
Thanks for your time today. And Doug and I are available for callbacks. Have a great day. Bye.
Operator
Thank you. This concludes today's conference call. Thank you for participating, you may now disconnect.
