Garmin Ltd. (GRMN) reported first quarter earnings that beat the Zacks Consensus Estimates by 4 cents, or 10.0%. Currency had a 1 cent negative impact on earnings.
Garmin is deferring lifetime maps, connected services and premium traffic over their economic lives. Net deferrals were 9 cents a share in the last quarter.
Garmin’s first-quarter revenue of $556.6 million was down 38.8% sequentially on seasonality. It was up 9.6% year over year due to stronger demand. Volumes were down 55.7%, but better than in the year-ago quarter. The blended average selling price (“ASP”) increased 38.2% sequentially and 1.5% from last year, due to the mix of business in the last quarter.
North America is clearly the market driving Garmin’s fortunes, since the region accounts for over half its revenue. EMEA (largely Europe) accounts for another third of its business. While seasonality is witnessed across all its served markets, it is the most pronounced in North America and Europe.
This resulted in a sequential decline of 44.9% and 33.9%, respectively, in the North America and EMEA regions, which however increased 5.7% and 16.6%, respectively, from the year-ago quarter. Asia/Pacific was down 13.9% sequentially and up 8.5% year over year.
The performance in Garmin’s key geographies will see a secular decline due to the shrinking of the PND market that Garmin has not been able to offset through in-dash applications.
Revenue by Segment
The Auto/Mobile, Outdoor, Fitness, Aviation and Marine segments generated 50%, 14%, 13%, 13% and 10% of first 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 down 51.8% sequentially and up 5.6% year over year. The increase from the year-ago quarter was driven by share gains in PNDs, stronger automotive sales and recognition of previously deferred revenue. However, pricing was stronger than the fourth quarter of 2010.
The PND 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. and one of the largest suppliers in EMEA, but this position is not likely to help given the poor market conditions. The primary focus areas are currently automotive OEMs (for navigation and infotainment applications) and emerging markets.
The Aviation segment revenue was up 2.1% sequentially and up 5.4% year over year. The aviation market continues to lag the overall economy in terms of recovery from the recession, but Garmin appears to have outperformed the market, given its new wins, penetration into the helicopter segment and focus on the retrofit market. Management stated that the growth in the last quarter came from both the new and retrofit business.
The Outdoor segment was down 36.3% sequentially and up 16.1% year over year. Despite the seasonal weakness, increase from the year-ago quarter was possible because of continued strength in several new products, such as GPS-enabled golf products and dog tracking and training systems.
The Fitness segment was down 24.8% sequentially and up 26.3% year over year. The increase from last year was due to the success of Garmin’s Forerunner 910XT, a multi-sport device. 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 cycling products are gaining popularity all over the world, which is good news for Garmin, the market leader in the segment.
The Marine segment was up 29.6% sequentially and 9.3% year over year. A milder winter in the U.S. appears to have brought forward the marine season, which was the reason for the strong performance in the last quarter.
Management stated that demand was broad-based across all of Garmin’s marine products. Garmin’s strategy 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 shallow but steady growth over the years.
Gross margin for the quarter was 51.0%, up 329 basis points (bps) sequentially and 404 bps year over year. ASP increases offset the volume decline in the sequential comparison. However, the expansion from the year-ago quarter was more volume-related.
The gross margin by segment was as follows — auto/mobile 39.3% (up 156 bps sequentially, up 812 bps year over year); aviation 68.2% (up 369 bps sequentially and down 50 bps year over year); outdoor 61.3% (down 663 bps sequentially and 98 bps year over year); fitness 61.1% (down 329 bps sequentially, up 112 bps year over year) and marine 59.7% (down 6 bps sequentially, down 496 bps year over year).
The operating expenses of $193.4 million were down 17.2% from the previous quarter’s $233.7 million and up 18.2% from $163.6 million in the year-ago quarter. The operating margin shrunk 577 bps sequentially and expanded 151 bps year over year to 16.2% in the last quarter.
Despite the gross margin strength and the typical post-holiday-season decline in advertising expenses, both SG&A and R&D increased significantly as a percentage of sales, which in combination resulted in the sequential decline. SG&A increases were the most significant on a year-over-year basis, although all except cost of sales were up.
On a pro forma basis, Garmin reported a net income of $86.9 million, or a 15.6% net income margin compared to $165.6 million, or 18.2% in the previous quarter and $95.5 million or 18.8% net income margin in the first quarter of last year. The fully diluted pro forma earnings per share (EPS) were 44 cents, compared to 85 cents in the December 2011 quarter and 49 cents in the comparable prior-year quarter.
There were no one-time adjustments in any of the above quarters, so the GAAP net income was the same as the pro forma income as discussed above.
Inventories were up 2.4% sequentially, with inventory turns increasing from 4.8X back to 2.8X. Days sales outstanding (DSOs) went from 61 back to 71. The cash and short term investments balance decreased $23.2 million to around $1.40 billion, with the company generating $122 million from operations.
Garmin spent around $5.8 million on capex, yielding free cash flow of around $117 million. It also spent $77.9 million on dividends, $2.8 million on acquisitions and around $0.3 million on share repurchases. Garmin has no long-term debt and long term liabilities were around $351 million at quarter-end.
2012 Guidance Reiterated
Management stated that Garmin’s performance in the first quarter, which is typically its weakest, was largely in line with internal expectations for the year. Therefore, it reiterated the guidance provided earlier.
Given expectations of 5-10% growth in the Marine segment, 5-10% growth in the Aviation segment, 5-10% growth in the Outdoor segment, 20-25% growth in the Fitness segment and a 7-10% decline in the Auto/Mobile segment, Garmin is expected to see revenue of $2.7-2.8 billion for the year. The gross margin is expected to be flat to slightly up, operating expenses in the $520-540 million range, operating margin of 19-20% and a tax rate of 13% resulting in EPS of $2.45-2.60.
The Zacks Consensus for the year was $2.85, above the guided range.
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.
We also see increasing opex this year, as management intends to invest in both the aviation and marine segments. This will be a downside to earnings.
Garmin shares carry a Zacks Rank of #3, implying a Hold rating in the short-term (1-3 months).
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