Garmin Ltd. Misses Earnings Expectations as Fitness Growth Stalls

Garmin shares were basically flat by 1:30 p.m. Wednesday following the release of its second-quarter earnings. Although Garmin's earnings fell short of analyst expectations, its report was in line with the preliminary results it had released earlier this month.

Let's dig in to Garmin's report.

One of Garmin's fitness watches, the Forerunner 620. Image source: Garmin.

Sales better than expected, but earnings fall shortEarlier this month, Garmin shares tumbled more than 10% following the release of its preliminary earnings results. On July 15, it announced that it was on track to earn $0.70-$0.72 on revenue of $770 million to $775 million. Analysts, however, had anticipated earnings of around $0.80 on revenue of $770.8 million. The disappointing earnings figure likely fueled the sell-off.

Fortunately, Garmin's actual results fell within its range, as it earned $0.72 on revenue of $774 million. Garmin cited a strong U.S. dollar to explain its results, writing that it weighed on its total revenue by 8%. It also cited a more competitive market for its fitness products.

Fitness growth slows to a crawlIn terms of sales, fitness is not Garmin's largest segment -- it generates about 20% of revenue -- but its fitness category is arguably its most important, as it's been the fastest-growing portion of the company's business. Garmin sells a variety of fitness gadgets, including basic wrist-worn activity trackers and high-end fitness watches.

Garmin has seen booming demand for its fitness products in recent quarters. In the fourth quarter last year, Garmin's fitness-related revenue rose 70% on an annual basis; in the first quarter, it grew 31%.

In the second quarter, Garmin's fitness revenue rose only 5% on an annual basis, an obvious slowdown compared to the prior quarter. This sluggish growth is even more stark when compared to the second quarter of 2014. In that quarter, revenue rose a stunning 79%. In its earnings release, Garmin acknowledged that its fitness growth is slowing, but argued that comparisons were challenged, as it sold more inventory into the sales channel in the second quarter last year.

Gross margin and operating margin also dropped, to 56% and 21%, respectively, from 65% and 42% in the same quarter last year. The company blamed its declining margins on currency, but also increasing competition. Garmin has had to boost its fitness advertising, and increase its spending on research and development.

The growing demand for fitness trackers has boosted Garmin's results in recent quarters, but it's clear that competition is intensifying. In addition to facing traditional competitors like Fitbit and Jawbone, Garmin had to contend with the release of Apple Watch last quarter. Apple Watch isn't a dedicated fitness tracker, but does include some basic fitness functionality, and may have appealed to those who otherwise would've chosen one of Garmin's trackers.

Auto continues to decline, marine surgesGarmin's largest segment is automotive, which generates nearly 40% of its revenue. It's composed, primarily, of the GPS systems it sells to car manufacturers, and the personal navigators it sells to consumers. Given the continued rise of GPS-equipped smartphones, this business has been in decline for some time. That continued in the second quarter, with Garmin's auto-related revenue falling 15% on an annual basis. The drop is in line with Garmin's expectations, as management had previously said to expect annual declines in the range of 15% going forward.

Garmin's fastest-growing category was marine, which enjoyed sales growth of 41% on an annual basis, fueled by the acquisition of Fusion Electronics. It remains Garmin's second-smallest segment -- it generated about 13.4% of its sales -- but could serve as a key driver in the coming quarters. Garmin doesn't expect such rapid growth to continue, but believes the segment will post revenue growth of around 15% this year.

Garmin's other two segments -- outdoor and aviation -- were less notable. Sales in those categories increased 4% and 5%, respectively. Notably, Garmin's aviation segment carries its highest gross margin (73%).

For the year, Garmin expects to generate revenue of around $2.9 billion, in line with its previous forecast. The stronger U.S. dollar remains a challenge for Garmin, but investors should be mindful of changing dynamics in the activity-tracking business.

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