PND Woes Hit Garmin Results, Guidance

Zacks

Garmin Ltd. (GRMN) reported fourth quarter earnings that missed the Zacks Consensus Estimate by 8 cents, or 10.8%. Currency had a 2 cent negative impact on earnings, and if excluded would have raised the EPS by a similar amount.

The earnings miss in the last quarter was because of a greater-than-expected decline in personal navigation device (:PND) market. Garmin has been diversifying its revenues and continues to generate a higher percentage of revenue from a growing number of higher-margin products across all segments.

However, the advent of smartphones based on new operating systems mainly from Apple (AAPL) and Google (GOOG) have taken a toll on its traditional area of strength. If Microsoft’s (MSFT) new operating system is anywhere as popular as it is expected to be, Garmin’s PND business will suffer further.

Garmin is deferring lifetime maps, connected services and premium traffic over their economic lives. Net deferrals after taxes were 11 cents a share in the last quarter.

Revenue

Garmin’s fourth-quarter revenue of $768.5 million was up 14.3% sequentially due to positive seasonality, but down 15.5% year over year, mainly due to continued declines in the PND market. Volumes jumped 35.1% sequentially and dropped 18.0% from the year-ago quarter. The blended average selling price (“ASP”) was down 15.4% sequentially but improved 3.1% from the year-ago quarter.

The Americas region was clearly the market driving Garmin’s fortunes, since it 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 the Americas (58% share) grew 17.1% sequentially, the EMEA region (33% share) grew 12.4%, while APAC (9% share) up 6.0%. The three regions grew 8.0%, 18.0% and -13.0%, respectively, from the comparable year-ago quarter.

Revenue by Segment

Garmin’s Auto/Mobile, Outdoor, Fitness, Aviation and Marine segments generated 57%, 15%, 14%, 9% and 5 of the quarterly revenue, respectively.

Seasonality typically makes for significant variations 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 13.6% sequentially and down 24.6% from the year-ago quarter. Garmin expects PND declines to result in a 15-20% decline in total revenue due to the availability of PND substitutes — primarily smartphones.

Garmin remains the number one supplier in the U.S. (with a market share of more than 70%) and one of the largest suppliers in Europe (around 32% market share at the end of the last quarter). The primary focus areas are currently automotive OEMs (for in-dash applications) and emerging markets.

The Aviation segment revenue was down 4.1% sequentially and 2.1% year over year. Garmin’s aviation business has not had a very good year in terms of revenues as recovery in the aviation market is slow and generally lags market recovery.

However, Garmin did mention some important wins in the business jet category, as well as continued success of its cockpit solutions that should drive revenue in 2013. New products, opportunities in the retrofit segment, opportunities in the military and government markets, and share gains in the helicopter market could be other positives for 2013.  

The Outdoor segment was up 12.3% sequentially and down 2.1% year over year. Garmin is seeing particular success in this segment because of the many new products it has introduced that are gradually expanding its markets and enabling it to enter new categories.

The golfing market, which didn’t even exist a couple of years back, continued to do well in the last quarter. Its dog tracking and training products and GPS-enabled watch for hunters and outdoor enthusiasts were added positives for the quarter. New products are expected to remain an important driver of segmental growth.

The Fitness segment jumped 60.5% sequentially and 9.7% year over year, the only segment to have posted both sequential and year-over-year increases. Management stated that the existing portfolio of cycling and multi-sport product lines continued to do well in the last quarter.

Additionally, Garmin’s running business benefited from the newly-launched Forerunner 10, which is targeted at the low-end segment. The continued move toward higher-margin products, especially in the running category will help segment margins. GPS-enabled running and cycling products are gaining popularity all over the world, which is good news for Garmin, the market leader.

The Marine segment was down 11.7% sequentially and 8.6% from the year-ago quarter. Apart from normal seasonality, Garmin suffered on account of the weak economic conditions across the world and particularly in Europe. Garmin’s acquisition of Nexus Marine and the host of new products are intended to strengthen its position in the traditional fishing market and pursue growth in the recreational boating segment.

Garmin’s strategy here has been the building of a solid portfolio of products (including through acquisitions) and the strengthening of strategic relationships with marine OEMs.

Gross Margin

The gross margin for the quarter was 48.6%, down 476 basis points (bps) sequentially and up 96 bps year over year. While stronger volumes offset a weaker ASP in the sequential comparison, the opposite was true for the year-over-year comparison.

The gross margin shrunk sequentially across all except the aviation segment. However, gross margins in both the aviation and Auto/mobile segments grew year over year.

The gross margin by segment was as follows — Auto/mobile 38.1% (down 514 bps sequentially, up 29 bps year over year); Aviation 73.2% (up 432 bps sequentially, up 872 bps year over year); Outdoor 62.4% (down 617 bps sequentially, down 545 bps year over year); Fitness 60.2% (down 447 bps sequentially, down 419 bps year over year) and Marine 50.6% (down 1,323 bps sequentially, down 921 bps year over year).

Operating Performance

The operating expenses of $224.1 million were up 12.6% from the previous quarter’s $199.0 million and down 4.1% from $233.7 million in the year-ago quarter. The operating margin shrunk 432 bps sequentially and 251 bps year over year to 19.5% in the last quarter.

Cost of sales and advertising increased sequentially as a percentage of sales, with R&D and SG&A declining. Specifically, cost of sales increased 476 bps sequentially, followed by advertising (down 161 bps). R&D and SG&A dropped 143 bps and 62 bps, respectively.

On a pro forma basis, Garmin reported a net income of $129.3 million, or a 16.8% net income margin compared to $140.3 million, or 20.9% in the previous quarter and $165.6 million or 18.2% net income margin in the fourth quarter of last year. The fully diluted pro forma earnings per share (EPS) were 66 cents, compared to 72 cents in the Sep 2012 quarter and 85 cents in the comparable prior-year quarter.

There were no one-time adjustments in either the previous or year-ago quarters.

Balance Sheet

Inventories were down 12.1% sequentially, with inventory turns increasing from 2.8X to 4.0X. Days sales outstanding (DSOs) went from 69 to around 72. The cash and short term investments balance increased $14.7 million to around $1.38 billion, with the company generating around $175 million from operations.

Garmin spent around $12 million on capex, yielding a free cash flow of around $163 million. Garmin has no long term debt and long term liabilities were around $378 million at quarter-end.

2013 Guidance Disappoints

Garmin expects 2013 revenue of $2.5-2.6 billion (down over 6% from 2012), gross margin of 53-54% (slightly better than 2012), operating income of $480-500 million (down nearly 19% from 2012), operating margin of 19-20% (down 270 bps) and pro forma EPS of $2.30 to $2.40 (down significantly from 2012). The Zacks Consensus Estimate for 2013 has moved down 50 cents since the company reported.

The main reason for the disappointment is the expected decline of 15-20% in auto/mobile revenues, which will not be offset by the 5-10% growth expected of the outdoor, fitness and marine revenues, and the 10-15% growth in the aviation segment.

Conclusion

The longer-term positives for Garmin remain the many new higher-margin products that the company has been introducing over the last few years and its strategy of increasingly targeting the OEM segment with many of its offerings. The advantage of this strategy is more stable revenues and steadier pricing over the long term.

The primary takeaway from the quarter’s results was the weakness in the PND business, where Garmin’s exposure is significant. We think that its strategy of focusing on auto OEMs for in-dash solutions and by building a presence in emerging Asian countries could ultimately offset some of the revenue loss in the auto/mobile segment.

However, it is apparent that this, as well as revenue diversification across other segments will not help results in the near term, which is the reason for the Zacks Rank #5 on the shares.

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