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Garmin Ltd. (GRMN - Analyst Report) reported second quarter earnings that beat the Zacks Consensus Estimates by 28 cents, or 41.4%. Currency had a 4 cent negative impact on earnings, and if excluded would have raised the EPS by a similar amount.

The results are a reflection of the successful diversification of revenues and a growing number of high-margin products across all segments.

Garmin is deferring lifetime maps, connected services and premium traffic over their economic lives. Net deferrals after taxes were 5 cents a share in the last quarter.

Revenue

Garmin’s second-quarter revenue of $718.2 million was up 29.0% sequentially and 6.5% year over year, helped by particular strength in the outdoor segment, which increased double-digits from both periods. Higher volumes (up 44.4% sequentially, 3.8% year over year) were the main reason for revenue growth from both the previous and year-ago quarters. The blended average selling price (“ASP”) was down 10.7% sequentially but increased 2.6% from the year-ago level.

The Americas region was 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 the Americas (55% share) grew 33.9% sequentially, the EMEA region (37% share) grew 32.6%, while APAC (8% share) declined 6.2%. The decline in APAC was on account of a major customer shifting the shipping location from the region. The three regions grew -10.2%, 5.0% and -8.0%, respectively, from the comparable year-ago quarter.

Revenue by Segment

Garmin’s Auto/Mobile, Aviation, Outdoor, Fitness and Marine segments generated 55%, 11%, 14%, 11% and 9% 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 40.4% sequentially and 8.1% year over year. However, Garmin continues to expect a 10-15% decline in both shipment and revenue for the core PND market due to the availability of PND substitutes — primarily smartphones from the likes of Apple (AAPL - Analyst Report), Research In Motion and others running on Google’s Android OS.

Garmin remains the number one supplier in the U.S. (growing its market share to more than 70%) and one of the largest suppliers in Europe (35% 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 up 4.2% sequentially and 3.7% year over year. Results in the last quarter benefited from stronger sales into the OEM segment. However, the benefit was partially offset by weaker sales in the after-market.

The recovery in the aviation market as been slower than expected; however, new products and stronger business from OEMs contributed to the increase in aviation revenues. 

The Outdoor segment was up 30.2% sequentially and 24.1% year over year. Garmin is seeing particular success in this segment because of the many new products it has introduced that are graduially expanding its markets and enabling it to enter new categories. The golfing market, which didn’t even exist a couple of years back, did very well in the last quarter, driving results for the company. New products are expected to remain an important driver of segmental growth.

The Fitness segment was up 14.9% sequentially and 4.9% year over year. Growth continues to be driven by new higher-margin products, especially in the running category. Garmin is also entering new segments (such as swimming in the last quarter). 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 20.9% sequentially, while declining 14.3% from the year-ago quarter. The decline from the year-ago quarter was on account of weakness at both OEMs and in the after-market, which Garmin said was because of the shrinking of the global marine electronics market.

Garmin’s strategy here has been the building of a solid portfolio of products and strengthening strategic relationships with marine OEMs. This could be the reason for the strong sequential growth.

Gross Margin

Gross margin for the quarter was 58.7%, up 775 basis points (bps) sequentially and 1,095 bps year over year. While volumes alone drove the sequential expansion, the higher ASP helped the expansion from last year. Additionally, segment-specific matters also contributed.

The Fitness and Auto/mobile segments saw the greatest expansions. The Fitness segment saw easier comps because there was some heavy discounting on end-of-life products in the year-ago quarter. Auto/mobile was helped by recognition of previously deferred high-margin revenue.

The gross margin by segment was as follows — Auto/mobile 51.2% (up 1,191 bps sequentially, up 1,573 bps year over year); Aviation 71.4% (up 322 bps sequentially, up 222 bps year over year); Outdoor 66.6% (up 531 bps sequentially, up 120 bps year over year); Fitness 69.3% (up 819 bps sequentially, up 1,094 bps year over year) and Marine 63.6% (up 389 bps sequentially, up 776 bps year over year).

Operating Performance

The operating expenses of $217.8 million were up 12.6% from the previous quarter’s $193.4 million and up 14.3% from $190.5 million in the year-ago quarter. The operating margin expanded 1,218 bps sequentially and 889 bps year over year to 28.4% in the last quarter.

All except advertising expenses declined sequentially as a percentage of sales, but cost of sales declined the most (775 bps), followed by R&D (314 bps) and then SG&A (237 bps). Advertising expenses increased 109 bps.

On a pro forma basis, Garmin reported a net income of $185.9 million, or a 25.9% net income margin compared to $86.9 million, or 15.6% in the previous quarter and $109.5 million or 16.2% net income margin in the second quarter of last year. The fully diluted pro forma earnings per share (EPS) were 95 cents, compared to 44 cents in the March 2012 quarter and 56 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 5.7% sequentially, with inventory turns increasing from 2.7X to 3.1X. Days sales outstanding (DSOs) went from 71 to 62. The cash and short term investments balance dropped $10.3 million to around $1.36 billion, with the company generating around $223 million from operations.

Garmin spent around $12 million on capex, yielding a free cash flow of around $211 million. Garmin has no long term debt and long term liabilities were around $350 million at quarter-end.

2012 Guidance Much Better than Expected

Garmin provided very strong guidance. Revenue for the year is expected to be $2.75-2.80 billion, with the gross margin at 52-53%, operating margin of 21-22% and EPS of $2.70 to $2.85. The Zacks Consensus Estimate for the year was $2.64.

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 growing strength in segments other than PND, we are growing increasingly positive about Garmin.

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.

Garmin shares carry a Zacks #3 Rank, implying a Hold rating in the short-term (1-3 months).

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