Garmin Ltd. (GRMN) Earnings Call Transcript

[Audio Gap] After today's prepared remarks, we will host a question-and-answer session. [Operator Instructions] I will now hand the conference over to Teri Seck, Director of Investor Relations. Please go ahead.

Good morning. We would like to welcome you to Garmin Limited's Third Quarter 2026 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/investors. 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 Ltd. and its business. Any statements regarding our future financial position, revenues, segment growth rates, earnings, gross margins, operating margins, future dividends or share repurchases, and market shares, product introductions, foreign currency, tariff impacts 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 Besson, Chief Financial Officer and Treasurer. At this time, I would like to turn the call over to Cliff Pemble.

Thank you, Terry, and good morning, everyone. As announced earlier today, Garmin achieved another quarter of record-breaking financial results and a continuation of the positive trends we've been experiencing over the long term. Consolidated revenue increased 12% to nearly $2 billion, with gross margin of 63.3%. We experienced a robust expansion in consolidated gross and operating margins. the majority of which is attributable to favorable segment mix and lower product costs. Margins also benefited from tariff refunds of $33 million recognized in the third quarter. Even when excluding this benefit, our gross margin performance was impressive by any historical comparison, reflecting the strength of our product lines and the efficiency of our vertically integrated business model. Through strong operational execution, we delivered significant leverage to the bottom line. Operating income increased 34% to $612 million and pro forma EPS increased 39% to $2.76. With most of 2026 behind us and considering the momentum we are experiencing entering the important Q4 holiday season, we anticipate delivering another record year of double-digit growth in revenue and profits. We now anticipate revenue of $8.15 billion, an increase of $100 million over the prior guidance and an increase of 12% over the prior year. We expect gross margin of 61% for the full year, which assumes higher cost for raw materials, particularly memory, which I will expand upon in a moment. We further expect an operating margin of 29% and an expansion from our prior estimate and a tax rate of 16.5%, which is unchanged from my prior estimate. These assumptions result in pro forma EPS of $10.80, an increase of $0.80 over the prior guidance and a 26% increase over the prior year. Before covering segment highlights, I want to provide additional context on supply chain matters. As previously mentioned, our results will soon reflect the higher cost of memory and other raw materials, which have increased significantly since last year, driven by both high demand and limited supplies. Our results have benefited from our safety stock of memory purchased at lower prices. New supplies are being purchased at current market prices, which are significantly higher than last year. This represents a headwind going forward and drives higher inventory amounts on our balance sheet. Additionally, our inventory strategy is focused on product availability, which translates to higher inventory levels of certain critical components. And from time to time, we make prepayments to secure additional supplies. While it's too early to offer a comprehensive outlook for 2027, we expect our consolidated gross margin profile will return to a historical range, primarily due to higher memory costs. We believe a return to historical gross margin levels represents impressive performance given the unusual supply chain circumstances affecting many companies. As we formulate our 2027 plan, we will look for every opportunity to offset this headwind by leaning heavily on our vertical integration and scale of operations and through strategic and selected mitigations which we have successfully used in the past. Doug will discuss our financial results in greater detail in a few minutes, but first, I'll provide a few remarks on the performance of each business segment. Starting with fitness. Revenue increased 16% to $694 million, a new third quarter record, primarily driven by broad-based wearable growth. Gross and operating margins expanded to 63% and 33%, respectively, resulting in operating income of $231 million. During the quarter, we launched the Circa Smart band, a screenless wearable offering rich wellness and fitness insights that expands our addressable market for wellness devices. Initial demand for circa has been very strong and feedback from customers has been positive. We recently announced the next-generation edge cycling computers. The Edge 1060 features a built-in microphone and speaker for hands-free voice control and the easy-to-use Edge XPLORE3 is designed for riders of all levels. The Fitness segment has achieved outstanding performance throughout the year, and we expect this trend to continue in the fourth quarter. We are very pleased with these results and expect that the Fitness segment will be the strongest contributor to our full year consolidated growth. Moving to outdoor. Revenue increased 20% to $597 million primarily driven by strong demand for adventure watches following the launch of the Phoenix 9 series. Gross and operating margins expanded to 68% and 39%, respectively, resulting in operating income of $233 million. During the quarter, we launched the Phoenix 9 and the Phoenix 9 Pro series with an all-titanium watch case option and the largest available AMOLED screen in our flagship adventure watch lineup. We also launched the Garmin Drive navigators that feature high-resolution ultra-wide displays and an elevated all-new user experience. Looking forward, we expect growth momentum to continue in Q4, primarily driven by the Phoenix 9 series, resulting in improved full year growth rates when compared to 2025. Looking next at Aviation, revenue increased 5% to $253 million, with growth primarily driven by OEM product categories. Gross and operating margins expanded to 78% and 26%, respectively, resulting in $66 million of operating income. We recently announced that the G1000 integrated flight deck for the iconic King Air aircraft has surpassed 1,000 systems in the field, marking a significant milestone as one of the most successful retrofit [indiscernible] programs in aviation history. We also announced that more than 2,500 aircraft are now equipped with our revolutionary Autoland system. Autoland is available in more than 15 models from piston powered aircraft to twin-engine jets, bringing added peace of mind to a growing number of pilots and passengers across the aviation industry. Just this quarter, Pilatus aircraft and Epic aircraft announced the certification of government Autoland on the PC-12 Pro and the E-1000 airplanes. During the quarter, we introduced the G2000 Prime, bringing prime flight deck functionality to the high-performance piston and electric aircraft market. Also during the quarter, we announced the certification of an all-glass retrofit cockpit for the original Cessna Citation jet. And finally, we made important updates to Garmin Pilot, adding Smart Charts coverage for Canada and Mexico as well as mobile clearance delivery, which allows pilots to obtain clearances electronically through the Garmin Pilot app. We are pleased with the performance of Aviation during the first 3 quarters of the year, and we expect fourth quarter year-over-year growth to be similar to that of Q3.. Turning to the Marine segment. Revenue increased 16% to $310 million with broad-based growth across multiple product categories led by sonar products following the launch of Live Scope 2 sonar systems. LiveScope is widely considered to be one of the most consequential innovations in modern fishing electronics. LiveScope 2 builds on this legacy of disruptive innovation by offering improved range and unprecedented image clarity. Gross and operating margins expanded to 64% and 30%, respectively, resulting in operating income of $94 million. The primary driver of margin expansion was the tariff refund recognized during the quarter, although margins improved even when excluding this benefit. During the quarter, we expanded our sailboat product lineup with the GMI 40 instrument display and the Smart Drive steering actuator. We also launched the JL Audio A60 head unit series and the M200 speaker system. We were recently named Manufacturer of the Year by National Marine Electronics Association for the 12th consecutive year, an honor that's particularly meaningful because it reflects the opinion of the broader NMEA community for innovation, product quality, service and support. We also received 6 product of excellence awards for multiple product categories as selected by NMEA dealers, certified installers in the industry professionals. We are pleased with the performance of Marine during the first 3 quarters of the year and believe we are on track to achieve full year growth that is consistent with the prior year. Moving finally to the auto OEM segment revenue decreased 20% to $132 million, primarily driven by domain controllers. Gross margin was 16%, and the operating loss narrowed year-over-year to $12 million as we shifted R&D resources to other segments. We expect fourth quarter revenue to decrease year-over-year, consistent with Q3 as domain controllers continue to decline as expected. We look forward to the launch of our next major domain controller program with Mercedes Benz, which we expect will drive significant growth in 2027. Wrapping up, I'm very proud of what our team has accomplished. We delivered strong growth, expanded profitability. We invested in future innovation and introduced new products across nearly every segment of our business. We look forward -- as we look forward, our product portfolio is very strong, and we are confident in the opportunities that lie ahead. We believe success is driven by our commitment to create products that are essential to our customers and supporting them with industry-leading quality, reliability and innovation. So that concludes my remarks. Next, Doug will walk you through additional details on our financial results. Doug?

Thanks, Cliff. Good morning, everyone. I'll begin by reviewing our third quarter financial results, provide comments on the balance sheet, cash flow statement, taxes, updated guidance. Post a revenue of $1.986 billion for the third quarter. represent a 12% increase year-over-year. Gross margin was 63.3%, a [indiscernible] basis point increase in the prior year quarter. [indiscernible] was primarily due to favorable segment mix lower product costs due to the weakening of the Taiwan dollar, approximately $33 million in refunds of previously paid tariffs. . Operating expense as a percentage of sales was 32.5%, 80 basis point decrease. Operating income increased 34% to $612 million. Operating margin expanded to 30.8%, a 500 basis point increase compared to prior year quarter. Our GAAP EPS was $2.80, and our pro forma EPS is $2.76. Next, we look at our third quarter revenue by segment and geography. During the third quarter, we achieved consolidated double-digit growth, led by the outdoor segment with 20% growth, followed by the fitness marine segments with 16% growth. By geography, we achieved growth in all 3 regions, led by 15% growth in Americas, followed by 12% growth in EMEA and 4% growth in APAC. APAC sales growth is lower than America's name due to the challenging market conditions in China. Excluding China, APAC sales growth would have been more comparable to the other regions. Looking next at operating expenses. Research and development expenses increased $26 million, approximately 9%, primarily driven by personnel-related expenses. SG&A expenses increased $30 million, approximately 10%, primarily driven by personnel-related expenses and advertising expense. A few highlights on the balance sheet, cash flow statement and taxes. Ended the quarter with cash and marketable securities of approximately $4.1 billion. Accounts receivable increased year-over-year to approximately $1.1 billion, while on the strong sales in the third quarter. Inventory increased year-over-year and sequentially to approximately $2.3 billion. We're executing our strategy to increase inventory of certain components to mitigate the risk of supply constraints. Also, the cost of certain components has increased significantly year-over-year. During the third quarter of 2026, we generated free cash flow of $293 million, $132 million decrease from the prior year quarter. Decrease is primarily due to an increase in on-hand inventory, prepayments of inventory to secure future delivery strategic components, primarily offset by improved operating results. Capital expenditures for the third quarter 2026 were $101 million, approximately $40 million higher than the prior year quarter. We expect full year 2026 free cash flow to approximately $1.1 billion capital expenditure of approximately $500 million. Decrease in our free cash flow estimate compared to the previous estimate is primarily due to increase in on-hand inventory repayments or inventory. During the third quarter of 2026, we paid dividends of approximately $202 million and purchased $41 million of company stock. At quarter end, we had approximately $47 million remaining share repurchase program authorized through December 2028. For an effective tax rate of 18.1% compared to 21.2% in the prior quarter. Decrease in effective tax rate is primarily driven by an increase in U.S. deductions due to certain provisions of the U.S. tax legislation enacted in 2025, come effective in 2026. Turning next to our full year guidance. Based on our performance during the first 3 quarters of 2026, and our positive outlook for the fourth quarter. We now estimate revenue of approximately $8.15 billion compared to our previous guidance of $8.05 billion. The result of year-to-date performance, we have increased our gross margin to approximately 61%, which is 130 basis points higher than our previous guidance. and is 230 days higher than a full year 2025 gross margin. We expect higher memory costs to impact the fourth quarter, which has been factored in a full year gross margin guidance. We received the majority of our expected tariff refunds and our updated gross margin guidance only includes the benefit of share refunds already recorded in the year-to-date results. We expect our operating margin to be approximately 29% to 200 basis points higher in our previous guidance. Also, we expect a pro forma effective tax rate of 16.5%, consonant with our previous guidance. We expect to pro forma earnings per share is approximately $10.80 compared to our previous guidance of $10. This concludes our [indiscernible] remarks. Christy, could you please open the line for Q&A?

[Operator Instructions] Your first question comes from the line of Tim Long with Barclays.

Maybe 2, if I could. Could you touch a little bit on some of the new launches, the CNX 9s and circa. It sounds like initial feedback positive. But could you just kind of give us a sense of how you're viewing the ramp of those products over the next several quarters? And then second, I just did want to follow up on the gross margin. I mean, it sounds like this is largely memory and it's hitting you a little bit later since you had some advanced buys. But maybe as we look into next year, I'm assuming you're talking [indiscernible] as the more historic gross margins. If you could just clarify that and let us know the other puts and takes there.

In terms of the newer launches, -- we believe those were very successful. We're still catching up on some of the initial demand, especially on Circa, although fenix is also very, very strong. And so we're working hard to fill that backlog of demand we have for those new products. And Doug, maybe you can answer the question on the gross margin. .

Yes. So maybe I'll talk a little bit about the gross margins here in the quarter than we expect in Q4 than in the future. So yes, in Q3, there are 3 big drivers of that year-over-year improvement, one of which was favorable segment mix as Auto OEM is a lower percentage of our total this year versus last year. The second of which is lower product costs, primarily due to the weakening of Taiwan dollar. And then we did have some benefits relating to tariff refunds and we did receive a majority of our tariff refunds. There's some that we'll hopefully receive here in Q4 next year, but we'll record those as they're realized or realizable. So then another thing relating to memory costs. We did see a small impact of increase [indiscernible] cost in Q3, but there will be more impact in Q4, and that's primarily due to our inventory, our inventory returns from a standpoint. Then as we get into 2027, there's a lot of moving parts relating to the gross margin from a standpoint, we'll have a segment mix, a situation where we have the ramp of Mercedes coming in. So therefore, there are probably some unfavorable segment mix. We'll have the continued higher increased cost of memory that go through there also. But then also, there's a lot of other moving parts in our gross margin between FX, product mix and such and their standpoint. But we'll give you better feel for that when we get into 2027.

The next question comes from the line of Erik Woodring with Morgan Stanley.

Cliff, I'd love to maybe step back from the quarterly results and -- could you just maybe rise a little bit on how you're seeing the competitive landscape evolve across the broader wearables market traditional smartwatch players kind of increasingly emphasizing fitness and performance. You have new competitors with kind of specialized health and wellness use cases. Just where is Garmin's competitive positioning strengthening -- and then do you see any areas where you see just greater competitive pressure? And then a quick follow-up, please.

Well, it is Erik. It is a very competitive market for sure. It's also a very market that's been around a while now. So the -- I think the players are fairly well entrenched in terms of their positions in the market. I think many of them are catching up to what we've known all along that health and fitness are very important drivers of interest in wearables. And so we're continuing to lead, I believe, in terms of product features and sensor capabilities and the ability to to help a user on their journey, whether it's a health and wellness focus or a fitness focus. And I believe that trend is very durable. I believe that trend is something that's always going to be of interest of people, especially as there's more and more focus on health and wellness across every level, whether it's from the government side and also cohorts of generations that are more interested in their health. So we're very excited about it. We believe there's lots of opportunity ahead of us.

Okay. Awesome. No, I appreciate that. And then maybe just -- maybe this is a Doug question, but if we take a step back, realizing that you guys -- you do keep a lot of safety stock inventory, but we're in probably the most inflationary component environment we've seen in a long time. That's not just memory, but you just expanded Aviation gross margins 200 basis points year-over-year. Marine ex tariff refunds was up 200 basis points year-over-year outdoor in Fitness both expanding very strong. When you talk about product cost reductions, can you just maybe be a little bit more specific or granular on exactly not just what is happening, but why happening now, why maybe you couldn't execute on the year or 2 years ago, just given we're kind of in like -- it's just very counterintuitive given the environment we're in. So just trying to understand like exactly what it is and why now?

Yes. Maybe I'll start and Doug can certainly add to it. But as I mentioned in my remarks, our vertical integration is really paying off, both in terms of our flexibility and ability to to bring in the right components and the right -- and build the right products at the right time. But also the scale is really important. Our volumes have increased a lot, and so we have a lot of scale, which is helping in our overall efficiency. We did get some benefit from the Taiwan dollar. So that's part of our product cost, but also our products, many of our new ones, especially are premium in nature and have a lot of desirable features and capability. And so we're able to command higher margins for those products as well, which become a higher part of our mix.

The next question comes from the line of Joseph Cardoso with JPMorgan.

Maybe I just wanted to start first on Fitness. Obviously, you had very strong growth in the quarter. maybe against you guys setting very high standards for yourselves over the couple of quarters and maybe more robust growth. Just wanted to touch on the trends you're seeing in 3Q and obviously into 4Q today, just relative to registration, sell-through inventory, new users, the whole on bit of of kind of KPIs that we will kind of like to hear about? And how are you thinking about maybe the durability here as we're heading into the holiday season? And then I do have a follow-up.

Yes. I think in terms of registrations, that's something we watch very closely, and it's really a near real-time pulse on the overall market. Our registrations did outpace our sell-in. So there's some implication there that the channel is destocking a little bit probably because people are getting ready to bring in more stocks for the holiday season. But the demand for our products and the pull-through at the registration level is very strong. . In terms of durability, again, you know what I've mentioned before that there's a lot of opportunity in this market, and we've demonstrated over the long term that we've delivered strong double-digit growth rates across segments that are highly influenced by wearables, particularly fitness and outdoor. And so looking at Q4, we see more of the same of that. And also the feedback from our retailers and their plans are very strong. As I mentioned, we have significant backlog we're working to fill for the fourth quarter. And so that's our objective in the coming weeks.

Got it. I appreciate the color there, [indiscernible]. And then -- maybe just switching gears here. I wanted to touch on BarminConnect plus traction and what you're seeing maybe an update there. Just particularly just given as we think about when the product was launched and maybe cycling past in a more material way, customers who are enjoying early free trials. How has that trended? And also curious to hear like what you guys are seeing around maybe implications around new products, potentially having features only available via Connect Plus and how you're thinking about the opportunity around that?

Yes. Connect Plus has outgrown the general rates of the underlying segments where those products can benefit from Connect Plus. Of course, that's probably to be understood because it it's growing from a smaller base. But Connects Plus has outpaced our expectations and the renewals and the commitments after the free periods have been very strong for those people that sign up for it. and even products that you wouldn't suspect have would be of interest for Connect Plus, particularly Circa. People are also signing up for comes to get more out of circa. So -- we feel very good about Connect Plus and we have a long-term road map to further expand that. In terms of just offering features of new products only through Connect Plus, I mean, -- we're already doing that today in terms of features like nutrition, that's available with Connect Plus. But in general, our approach to the market has always been to offer rich features on our products that delight our customers and satisfy them. And if they want more, we'll offer more with Connect Plus.

The next question comes from the line of David McGregor with Longbow Research.

I guess I wanted to just ask about kind of channel inventories and the pre-season sell-in. You kind of touched on this in response to a previous question, but how are you seeing that seasonal selling? And do you sense retailers and dealers or maybe just staying lean ahead of the election? Or is there some other reason why maybe we're seeing a little bit of an aberration from what's historically been a pattern there?

Yes, I don't think there's any aberration at all, and I certainly couldn't figure out how to tie it to elections. But as I mentioned in some other comments that retailer interest in Q4 promotions is very strong, and we're working on filling all of their orders for the holiday season.

Okay. Okay. I guess second question just on Thailand, any update on the manufacturing facility there and is production is still expected to begin in 1Q 2017. And I guess when does the capitalization of costs in and the expensing begin?

Yes. I'll maybe make a comment on the time lines and Doug can respond to the capitalization, but we're on track to open the new facility expected to start producing new products in the first quarter of 2027, and it's something we desperately need as our volumes have basically reached our capacity. So we're excited to bring more capacity online.

Yes. As it relates to when it starts hitting the P&L when it basically gets into production at that point in time, it will go through -- flow through the goods at that point in time.

So 1Q '27?

Yes. Yes.

The next question comes from Ivan Feinseth with Tigress Financial Partners.

And congratulations on another record quarter. Starting with the fenix, what kind of uptake on the fenix are you seeing from people who are new to Garmin and new to the fenix versus people who are upgrading from existing watches and what model have they been upgrading the most from?

In terms of new versus existing, as has been the history of the fenix launches, initial demand, particularly is very strong from existing users who are upgrading mostly from more than 1 generation old, it can vary. But the response has been very positive. And then, of course, as the product makes its way further out into the channel, we start to see more new users come to the platform.