Garmin Ltd. — Q3 2010 Form 10-Q
Reporting period: Quarter ended September 25, 2010 (13 weeks); year-to-date covers 39 weeks. Financial statements are unaudited. Unless otherwise noted, amounts below are in millions of U.S. dollars.
Business context and key results
Garmin sells GPS-enabled navigation, communications and information products through four segments: outdoor/fitness, marine, automotive/mobile and aviation. Q3 revenue fell 11% year over year, while reported net income rose primarily because of a one-time tax benefit.
| Metric | Q3 2010 | Q3 2009 | 39 weeks 2010 | 39 weeks 2009 |
|---|---|---|---|---|
| Net sales | $692.4 | $781.3 | $1,852.2 | $1,887.1 |
| Gross profit | $344.0 | $409.7 | $966.6 | $957.4 |
| Gross margin | 49.7% | 52.4% | 52.2% | 50.7% |
| Operating income | $166.6 | $236.9 | $452.0 | $494.0 |
| Operating margin | 24.1% | 30.3% | 24.4% | 26.2% |
| Net income | $279.6 | $215.1 | $451.7 | $425.5 |
| Diluted EPS | $1.43 | $1.07 | $2.27 | $2.12 |
| Operating cash flow | Not presented for quarter | Not presented for quarter | $586.2 | $848.6 |
Material changes and segment performance
- Q3 sales declined 11%; unit sales fell 1% to 3.811 million. Automotive/mobile sales fell 19%, with units down 5% and average selling price down 15%, reflecting market saturation and competing technologies. The segment represented 64% of Q3 revenue, down from 70% a year earlier.
- Q3 outdoor/fitness revenue increased 9%, marine 1% and aviation 4%. For the first 39 weeks, outdoor/fitness grew 22%, marine 13% and aviation 6%; automotive/mobile declined 11%.
- Q3 gross margin contracted 270 basis points (company discussion cites 280 basis points), and operating margin fell 620 basis points. Higher R&D spending and weaker automotive/mobile pricing and mix were key pressures.
- Year-to-date gross margin improved 150 basis points, including a 230-basis-point benefit from a $42.8 million refinement to warranty estimates. Excluding that reserve adjustment, the margin comparison would be materially less favorable.
- R&D expense rose 25% in Q3 and 23% year to date, partly due to nearly 450 engineering hires and product development, including the mobile handset initiative. SG&A increased 8% year to date, including Swiss redomestication fees and higher product support and IT costs.
Cash, liquidity and capital allocation
- At September 25, cash and cash equivalents were $1,236.0; marketable securities were $661.0 in total. Current assets were $2,371.4 and current liabilities $569.5. Total assets were $3,658.0 and stockholders’ equity $2,850.2.
- Garmin reported no outstanding long-term debt. Management said cash balances and operating cash flow should cover projected needs at least through fiscal year-end 2010.
- Year-to-date operating cash flow was $586.2, down from $848.6. Cash generation included collections of receivables, while inventory growth of $196.3 million and a $261.1 million reduction in other liabilities were significant uses of cash.
- Year-to-date investing activities provided $91.4, mainly from net redemptions of marketable securities; capital expenditures were $23.0. Financing activities used $513.7, including $299.1 of dividends paid and $223.4 of share repurchases.
- The $300 million repurchase authorization had approximately $76.9 million remaining at quarter-end. Garmin repurchased 7.37 million shares cumulatively under the plan through September 25.
Outlook, risks and unusual items
- No specific full-year revenue or earnings guidance is provided in the filing. Management expected to use operating cash flow for Q4 capital expenditures and working capital, and said liquidity was adequate through year-end.
- Q3 included a $114.6 million tax benefit from one-time tax items, principally the release of uncertain tax position reserves for 2006–2008, partly offset by a U.S. 2007 tax settlement and Taiwan surtax expense. Without those items, the estimated effective tax rate was 22% for Q3 and 20% year to date.
- Foreign currency effects were volatile: Q3 recorded a $35.5 million gain, while the first 39 weeks recorded a $54.6 million loss. Management cited currency movements, especially involving the U.S. dollar, euro and Taiwan dollar.
- Marketable securities included $47.1 million of auction-rate securities classified as Level 3; the company said it intended to hold them until recovery. It also disclosed a $1.3 million other-than-temporary impairment on corporate bonds.
- Garmin described multiple pending patent-infringement cases and said it intended to defend them; adverse outcomes could affect results, liquidity or financial position. It also had approximately $42.0 million of purchase commitments over five years and reported no off-balance-sheet arrangements.
- In the third quarter Garmin acquired MetriGear; after quarter-end it acquired Norwegian distributor Belanor AS. Both were described as immaterial. Garmin completed its redomestication from the Cayman Islands to Switzerland in June 2010.
Most important facts for investors to verify
- How much of the reported earnings increase depends on the $114.6 million one-time tax benefit, and what tax rate is sustainable?
- Whether the $42.8 million warranty-reserve reduction is nonrecurring and whether warranty claims support the revised estimate.
- Whether automotive/mobile pricing, unit volumes and segment margins stabilize amid saturation and competition.
- Whether inventory growth and lower operating cash flow reverse in the holiday quarter, and whether liquidity remains sufficient under the stated plan.
- Potential valuation, recovery timing and liquidity of Level 3 auction-rate securities, and developments in the disclosed patent litigation.