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Garmin Ltd. (GRMN - Analyst Report) reported first-quarter earnings that missed the Zacks Consensus Estimate by a penny, or 2.4%. Currency had a 4 cent negative impact on earnings, and if excluded would have raised the EPS by a similar amount.

The basic story surrounding Garmin has not changed much during the course of the last quarter, except for the aviation business that grew strongly.

With a significant percentage of revenue continuing to come from personal navigation devices (PNDs), Garmin’s overall sales continue to suffer. This is because smartphones based on new operating systems mainly from Apple (AAPL - Analyst Report) and Google continue to hurt its traditional area of strength. If Microsoft’s (MSFT - Analyst Report) new operating system is anywhere as popular as it is expected to be, Garmin’s PND business will shrink quicker than the 20% rate management expects for this year

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 first-quarter revenue of $532.0 million was down 30.8% sequentially from the seasonally strong fourth quarter. It was also down 4.4% year over year, mainly due to continued declines in the PND market. Volumes dropped 50.0% sequentially and 7.4% from the year-ago quarter. The blended average selling price (“ASP”) jumped 38.4% sequentially (driven by the PND decline and recognition of previously deferred revenue). It was also 3.2% higher than the year-ago quarter.

While seasonality drove sequential revenue declines across all geographies, the decline from the year-ago quarter was indicates that the Americas continue to drive Garmin’s fortunes. Since it accounts for the largest share of Garmin’s revenues, even a slight softness in the market has more of an effect on its total revenue. While seasonality is witnessed across all its served markets, it is the most pronounced in this region.

Specifically, revenue in the Americas (54% share) dropped 35.7% sequentially, the EMEA region (36% share) declined 24.5%, while APAC (10% share) down 22.5%. The three regions were down 3.4%, 4.0% and 11.3%, respectively, from the comparable year-ago quarter.

Revenue by Segment

Garmin’s Auto/Mobile, Outdoor, Fitness, Aviation and Marine segments generated 47%, 14%, 14%, 15% and 9% of its quarterly revenue, respectively.

Seasonality typically makes for significant variations in quarterly revenue, with the most significant increase in the Dec quarter, followed by the most significant decline in the March quarter.

The Auto/Mobile segment was down 42.2% sequentially and 9.6% 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 30% market share). The primary focus areas are currently automotive OEMs for in-dash applications (it signed on Mercedes Benz in the last quarter) and emerging markets.

The Aviation segment revenue was up 15.1% sequentially and 10.4% year over year. Garmin’s aviation business benefited from notable strengthening of the OEM segment as well as continued share gains in the helicopter segment. The light jet segment, in which Garmin is greatly dependent, remains soft. Recovery in the aviation market is slow and generally lags market recovery.

New products, opportunities in the retrofit segment, opportunities in the military and government markets, and share gains in the helicopter market remain positives for 2013. 

The Outdoor segment was down 35.7% sequentially and 1.3% year over year. The sequential decline was attributed to seasonality although mix changes toward lower-end products affected both comps. 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, its dog tracking and training products and GPS-enabled watch for hunters and outdoor enthusiasts should continue to drive sales through the year. New products across most categories are expected to remain an important driver of segment growth.

The Fitness segment declined 30.3% sequentially, while growing 1.7% year over year. The sequential decline was seasonal. The year-over-year comps were difficult because of Garmin’s Forerunner product line that was introduced in that quarter.

However, new cycling products were strong and helped results in the last quarter 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 grew 27.3% sequentially and declined 10.3% from the year-ago quarter. The sequential increase was seasonal, due to the boating season. What is more significant is the decline from the year-ago quarter, which was attributable to the aging product lineup, bad weather and economic uncertainty.

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 51.9%, up 326 basis points (bps) sequentially and 93 bps year over year. Volumes were down from both the previous and year-ago quarter, even as prices strengthened.

The outdoor, marine and aviation segments saw gross margins declining, while fitness and auto/mobile margins expanded. Outdoor and marine were also down from the year-ago quarter.

The gross margin by segment was as follows — Auto/mobile 42.4% (up 436 bps sequentially, up 308 bps year over year); Aviation 69.9% (down 331 bps sequentially, up 171 bps year over year); Outdoor 58.4% (down 404 bps sequentially, down 286 bps year over year); Fitness 62.1% (up 190 bps sequentially, up 100 bps year over year) and Marine 50.6% (down 418 bps sequentially, down 1,333 bps year over year).

Operating Performance

The operating expenses of $196.2 million were down 12.4% from the previous quarter’s $224.1 million and up 1.4% from $193.4 million in the year-ago quarter. The operating margin shrank 446 bps sequentially and 120 bps year over year to 15.0% in the last quarter.

Cost of sales and advertising declined sequentially as a percentage of sales, with R&D and SG&A increasing. Specifically, cost of sales was 326 bps lower sequentially, while advertising was down 191 bps. R&D and SG&A increased 565 bps and 398 bps, respectively.

On a pro forma basis, Garmin reported a net income of $79.5 million, or a 14.9% net income margin compared to $129.3 million, or 16.8% in the previous quarter and $86.9 million or 15.6% net income margin in the fourth quarter of last year. The pro forma earnings per share (EPS) were 40 cents, compared to 66 cents in the Dec 2012 quarter and 44 cents in the comparable prior-year quarter.

One-time adjustments in the quarter included currency-related losses and tax adjustments.

Balance Sheet

Inventories were up 1.6% sequentially, with inventory turns declining from 4.0X to 2.6X. Days sales outstanding (DSOs) went from 72 to around 77. The cash and short term investments balance fell $145.3 million to around $1.24 billion, with the company generating around $59.4 million from operations.

Garmin spent around $11.6 million on capex, yielding a free cash flow of around $47.8 million. Garmin has no long term debt and long term liabilities were around $347 million at quarter-end.

2013 Guidance

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 guidance will be updated after the second quarter.

The expected revenue decline is because the 15-20% decline in in auto/mobile revenues 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 #4 on the shares.

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