Garmin Ltd. (GRMN) reported first quarter earnings that beat the Zacks Consensus Estimates by 27 cents, or 54.4%. Currency had a 6 cent positive impact on earnings, and if excluded would have lowered the EPS by a like amount.
The results are a reflection of the continued decline in the PND business that Garmin is diversifying away from, strength in new high-margin products and positive mix changes.
Garmin is deferring lifetime maps, connected services and premium traffic over their economic lives. Net deferrals after taxes were 8 cents a share in the last quarter.
Revenue
Garmin’s third-quarter revenue of $667.0 million was down 1.1% sequentially and 3.7% year over year, as softness in personal navigation devices (PNDs) continued to impact the company’s business. Volumes were down 7.3%, and down 8.6% from last year. However, the blended average selling price (“ASP”) was up 6.7% sequentially and 5.4% from last year, due to a higher mix of non-PND business.
North Americais clearly the market driving Garmin’s fortunes, since the region accounts for over half its revenue. While seasonality is witnessed across all its served markets, it is the most pronounced in this region. Revenue in North America (54% share) declined 1.9% sequentially, followed by Europe (39% share), which grew 2.1% and then Asia (9% share), which declined 9.1%. The three regions grew -14.9%, 19.6% and -9.8%, respectively, from the comparable year-ago quarter.
The performance in North America was impacted by the secular decline in PNDs that Garmin has not been able to offset through in-dash applications. The improved performance in Europe was attributed to the Navigon acquisition, as well as share gains in a weak market. Asia remains a growth market, although the sequential decline in the last quarter was impacted by mix and timing, while the year-over-year comparison was impacted by $5 million of mobile handset shipments in the year-ago quarter.
Revenue by Segment
Garmin changed its segment presentation beginning in the first quarter of 2011, splitting its Outdoor/Fitness segment into the Outdoor and Fitness segments. The rest of the segments are being presented as before. Accordingly, the Auto/Mobile, Aviation, Outdoor, Fitness and Marine segments generated 58%, 11%, 14%, 10% and 7% of third quarter revenue, respectively.
Seasonality typically makes for significant variation in quarterly revenue, with the most significant increase in the December quarter, followed by the most significant decline in the March quarter.
The Auto/Mobile segment was up 5.9% sequentially and down 13.1% year over year, mainly on account of lower volumes. The business has been severely hindered by the availability of PND substitutes — primarily smartphones from the likes of Apple Inc (AAPL), Research In Motion (RIMM) and others running on Google Inc‘s GOOG) Android OS — as well as some aggressive pricing from competitors, such as TomTom.
Garmin remains the number one supplier in the U.S. (60% share) and one of the largest suppliers in Europe (30% share), but this position is not likely to help given the poor market conditions. The primary focus areas are currently automotive OEMs (for in-dash applications) and emerging markets.
The Aviation segment revenue was down 3.0% sequentially and up 17.6% year over year. The aviation segment continues to lag the overall economy in terms of recovery from the recession, but retrofit products are ideal for driving revenues during this time.
Garmin has been building its retrofit product line over the past few years. Management stated that the retrofit business again helped results in the last quarter, evidence that the strategy is paying off. The aviation market does not appear to have strengthened as Garmin expected; however, new products and slightly stronger business from OEMs contributed to the increase in aviation revenues.
The Outdoor segment was up 16.9% sequentially and 4.9% year over year. Garmin’s results in the last quarter benefited from the recent acquisition and management stated that the lack of new product availability restricted further growth. The situation is expected to improve in the fourth quarter. Some of the popular new products in the category include the GPS Map 62 and the Astro dog tracker. New products are expected to be an important driver of segmental growth in the long term.
The Fitness segment was down 11.5% sequentially and up 28.7% year over year. Seasonality impacted sequential performance, while growth from last year was the result of the many new products that Garmin continues to introduce in the category. The important drivers in the segment remain the relatively high-end Forerunner and Edge line of products, which is a good thing even as far as margins are concerned. GPS-enabled running and cylcling products are gaining popularity all over the world, which was good news for Garmin, the market leader in the segment.
The Marine segment was down 39.3% sequentially and up 4.3% year over year. Segment revenues were impacted by typical third-quarter seasonality. Garmin’s startegy here has been the building of a solid portfolio of products and strengthening strategic relationships with marine OEMs. This strategy is paying off, with the segment showing small but steady growth over the years.
Gross Margin
Gross margin for the quarter was 51.6%, up 384 basis points (bps) sequentially and 194 bps year over year. ASP increases offset the volume decline, accounting for the performance. Additionally, change in estimated deferrals per unit had a positive impact on the gross margin in the last quarter.
The gross margin by segment was as follows — auto/mobile 43.5% (up 795 bps sequentially, up 289 bps year over year); aviation 66.4% (down 278 bps sequentially, down 393 bps year over year); outdoor 65.9% (up 50 bps sequentially, down 316 bps year over year); fitness 60.1% (up 176 bps sequentially, up 12 bps year over year) and marine 54.9% (down 99 bps sequentially, down 535 bps year over year).
Operating Performance
The operating expenses of $197.0 million were up 3.4% from the previous quarter’s $190.5 million and up 11.1% from $147.6 million in the year-ago quarter. The operating margin expanded 257 bps sequentially and declined 198 bps year over year to 22.1% in the last quarter.
The sequential increase was due to the stronger gross margin. The decline from the year-ago quarter was almost entirely on account of higher SG&A, as cost of sales declined as a percentage of sales, while other expenses were flattish.
On a pro forma basis, Garmin reported a net income of $150.4 million, or a 22.5% net income margin compared to $109.5 million, or 16.2% in the previous quarter and $165.5 million or 23.9% net income margin in the third quarter of last year. The fully diluted pro forma earnings per share (EPS) were 77 cents, compared to 56 cents in the June 2011 quarter and 85 cents in the comparable prior-year quarter.
There were no one-time adjustments in either the September or June quarters of 2011, but there was a $114 million tax adjustment in the year-ago quarter, which raised the GAAP EPS by 58 cents in the year-ago quarter.
Balance Sheet
Inventories were up 19.6% sequentially, with inventory turns dropping from 3.7X to 2.8X. Days sales outstanding (DSOs) went from 67 to 71. The cash and short term investments balance decreased $19.3 million to around $1.46 billion, with the company generating $186 million from operations.
Garmin spent around $12 million on capex, yielding a free cash flow of around $174 million. Garmin has no long term debt and long term liabilities were around $353 million at quarter-end.
2011 Guidance Raised
Garmin stated that the lower-than-expected deferrals related to the PND business and strength in other segments, it now expects 2011 to bring revenue of $2.6 billion, up from the $2.4-2.5 billion expected earlier. The gross margin estimte was however lowered to 47-48% (50-51% range forecast earlier), operating margin of 18-19% (previously 21-22%), a tax rate of 12% (unchanged), resulting in pro forma earnings per share of $2.30 to $2.40 (previously $2.25 to $2.50). The Zacks Consensus Estimate was $2.35 when Garmin reported earnings, in the middle of the guided range.
Conclusion
We think Garmin’s strong results were helped by the many new higher-margin products that the company has been introducing over the last few years and the company’s strategy of increasingly targeting the OEM segment with many of its offerings. The advantage of this strategy is more stable revenues and steadier pricing.
At the same time, it has focused on individual customers in the outdoor and fitness segments. Given its strength in segments other than PND, we have a long-term (3-6 months) neutral recommendation on the shares.
The primary negative for Garmin is its still significant exposure to the PND segment, which is on a secular decline. We think that Garmin could ultimately improve upon the situation by focusing on auto OEMs for in-dash solutions and by building a presence in emerging Asian countries.
However, Garmin has entered the race a bit late, so competition will be stiff. Despite successful diversification of the business, we think Garmin will see revenue pressure over the next few quarters, as PND sales continue their downward trajectory.
Additionally, 2011 is a transitional year, as Garmin’s basic reporting style will be altered to accommodate higher deferrals.
Garmin shares carry a Zacks #3 Rank, implying a Hold rating in the short-term (1-3 months).
