Garmin Ltd. (GRMN) reported first quarter earnings that beat the Zacks Consensus Estimates by 16 cents, or 48.5%. Currency had a 6 cent negative impact on earnings, and if excluded would have raised the EPS by a like amount. The results were driven by better-than-expected revenue and helped by a significantly lower tax rate.
Garmin is deferring lifetime maps, connected services and premium traffic over their economic lives. Net deferrals after taxes were 9 cents a share in the last quarter.
Revenue
Revenue of $507.8 million was down 39.4% due to seasonality. Garmin’s revenue was up 17.8% year over year, which was encouraging given that revenue declined double-digits in the two preceding quarters.
Volumes were down 58.7% due to seasonality, but up 17.0% from last year. However, the blended average selling price (“ASP”) was up 46.7% sequentially and flattish (up 0.7%) from last year.
North Americais clearly the market driving Garmin’s fortunes, since the region accounts for over half its revenue. Garmin also has the leading market position here. While seasonality is witnessed across all its served markets, it is the most pronounced in this region.
As a result, North America revenue (55% share) declined 47.9% sequentially, followed by Europe (34% share), which declined 27.2% and then Asia (34% share), which declined 13.3%. The three regions were up 15.0%, 17.8% and 33.8%, respectively, from the comparable year-ago quarter. The quarter’s performance seems to indicate that Garmin is gaining ground in the still under-penetrated Asian market.
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 52%, 14%, 13%, 11% 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 52.7% sequentially and up 19.7% year over year, mainly on account of lower volumes. The increase from the year-ago quarter was due to easier comps. 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. and one of the largest suppliers in Europe, but this position is not likely to be sustained 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 2.7% sequentially and up 4.6% 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 higher-margin retrofit and portable product lines drove the increase in the last quarter, evidence that the strategy is paying off. Garmin expects tat a stronger aviation market, nw products and recent wins at OEMs will boost aviation revenues in the back half of 2011.
The Outdoor segment was up 11.9% year over year. Garmin has launched a host of products over the past year or so that have met with great success. Two of these products, the GPS Map 62 and the Astro dog tracker (both in the Americas and Europe) were particularly strong in the last quarter. New products should continue driving long term growth in this segment.
The Fitness segment was up 30.0% year over year. The strength in the last quarter was driven by the 2011 cycling season in Europe, which resulted in significantly higher demand for its high-end cycling products. Management stated that GPS-enabled running and cylcling products were gaining popularity all over the world, which was good news for Garmin, the market leader in the segment.
The company has launched many new products targeting the segment and product introductions may be expected to continue in the foreseeable future.
The Marine segment was up 38.1% sequentially and 24.2% year over year. Segment revenues were helped by a recovery in the market, as well as seasonal strength on account of the upcoming boating season. Garmin’s startegy here has been the building of a solid portfolio of products and strengthening strategic relationships with marine OEMs. This strategy has already started contributing to revenue growth.
Gross Margin
Gross margin for the quarter was 46.9%, up 160 basis points (bps) sequentially and down 663 bps year over year. ASP increases offset the volume decline, accounting for the sequential expansion. The decline from the year-ago quarter was on account of refining of warranty estimates that reduced costs in the year-ago quarter. Additionally, deferral of some high-margin reveneus also impacted the gross margin in the last quarter.
The gross margin by segment was as follows — auto/mobile 31.2% (down 464 bps sequentially, 1,170 bps year over year; aviation 68.7% (up 327 bps sequentially, down 146 bps year over year); outdoor 62.2% (down 262 bps year over year); fitness 59.9% (down 245 bps year over year) and marine 64.7% (down 172 bps sequentially, up 605 bps year over year).
Operating Performance
The operating expenses of $163.6 million were down 16.2% from the previous quarter’s $195.1 million and up 10.9% from $147.6 million in the year-ago quarter. The operating margin shrunk 732 bps sequentially and 462 bps year over year to 14.7% in the last quarter.
The decline from the year-ago quarter was entirely on account of higher cost of sales, as all other expenses declined as a percentage of sales. Significantly higher R&D and SG&A expenses as a percentage of sales were responsible for the sequential decline.
On a pro forma basis, Garmin reported a net income of $95.5 million, or a 18.8% net income margin compared to $132.9 million, or 15.9% in the previous quarter and $37.3 million or 8.7% net income margin in the first quarter of last year. The fully diluted pro forma earnings per share (EPS) were 49 cents, compared to 68 cents in the December 2010 quarter and 19 cents in the comparable prior-year quarter.
There were no one-time adjustments in the last quarter. Accordingly, the GAAP net income was the same as the pro forma net income of $95.5 million (49 cents a share), down from income of $132.9 million (68 cents a share) in the previous quarter and $37.3 million (19 cents a share) in the year-ago quarter.
Balance Sheet
Inventories were down 6.0% sequentially, with inventory turns dropping from 4.7X to 2.6X. Days sales outstanding (DSOs) went from 81 to 78. The cash and short term investments balance decreased $33.0 million to around $1.21 billion, with the company generating $207.6 million from operations.
Garmin spent around $7.2 million on capex, yielding a free cash flow of around $200.4 million. Garmin has no long term debt and long term liabilities were $274.4 million at quarter-end.
2011 Guidance Reiterated
Garmin reiterated guidance for 2011. The company expects revenue of $2.4-2.5 billion, gross margin in the 50-51% range, operating income in the $500-560 million range, operating margin of 21-22%, a tax rate of 12% and pro forma earnings of $2.25 to $2.50 per share. The Zacks Consensus Estimate was $2.32 when Garmin reported earnings, lower than the guidance at the mid-point.
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 couple of 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/fitness segment. 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 continued dependence on the personal navigation device (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. Therefore, 2011 results would continue to show declines.
Garmin shares carry a Zacks #4 Rank, implying a Sell rating in the short-term (1-3 months).
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