Garmin Ltd. (Nasdaq:GRMN) reported a significant drop in margins in the third quarter ended Sept. 26 as the cost of keeping up with the Apple, Fitbit and other competitors cut deeply into profits at its fastest growing segment.
The company reported third-quarter sales at its Fitness segment grew 23 percent year-over-year to $143.2 million compared with just 5 percent in previous quarter. The acceleration was driven by strong sales of Vivofit and Vivosmart activity trackers, multisport products such as the Forerunner and Fenix sports watches and cycling products.
Despite the sales jump, gross margin at the Fitness segment plummeted 976 basis points to 54 percent, including a 360 basis point hit from foreign exchange. The remainder of the decline was due to a change in product mix and falling prices.
Garmin has slashed prices on its activity trackers in a bid to gain on market leader Fitbit and a host of other brands jumping into the rapidly growing market. The competition has driven down retail prices on entry-level activity trackers such as the Garmin Vivofit below $99 and as low as $79, compared with $129 a year ago.
Pemble acknowledged that its unlikely Fitness margins will ever reach the 60 percent and higher levels seen prior to 2013 given the high R&D and advertising costs needed to succeed in the market today. Garmin has had to amp up R&D in recent years to keep up with consumer expectations of connectivity.
“It used to be that we could sell a device that was engineered kind of as a stand-alone unit,” Pemble said. “But today we not only have to do the device, but we also have to do the cloud and the mobile application.”
Garmin ramped up spending on its Elevate technology, which enables wrist-based heart rate monitors and personalization of watch displays using different faces, custom data fields and third party apps. Garmin began shipping its first Elevate equipped activity tracker, the Vivosmart HR, on Tuesday and expects it to go on sale at Best Buy Nov. 1. It began shipping its first Elevate enabled watch – the Forerunner 235 – Oct. 21. It also released an upgraded version of its Garmin Connect mobile app.
“The running market dynamics have changed in the past year due to the advent of the wrist-based heart rate being a key feature that customers want,” noted Garmin President and CEO Cliff Pemble. “Forerunner 225 and now 235 have been a little softer in the market because of the absence of that feature.”
Many core runners have been reluctant to embrace wrist-based heart sensors due to a perception that chest monitors are more accurate. But the technology got a major boost this year when Apple used a proprietary version of the technology in its watch, which went on sale in June. Some analysts have estimated Apple will sell 15 million of the watches this year with the bulk of those sales coming in the fourth quarter.
Outdoor scales back camera ambitions
Quarterly revenue declined 5 percent ti $115.3 million for Garmin’s Outdoor segment to due primarily to currency translation, but unfavorable exchange rates and product mix magnified the impact on the bottom line. Gross margin declined 620 basis points to 59.2 and operating margin declined 964 basis points to 32.8 percent.
The Fenix 3 GPS enabled smart watch sold well and recently released color and material options are expected to spur holiday sales. However, Pemble sought to lower expectations for Garmin’s Virb video camera, which it initially positioned as an alternative to GoPro.
“We've taken an approach there of being more of a niche player, particularly appealing to the other segment customers in our product line, particularly Marine and Aviation,” Pemble said. “And we feel reasonably positive about how that has been going as more of a niche category.”
Overall results
The 23 percent rise in fitness sales couldn’t offset declines at its outdoor, auto (down 14 percent to $264.6 million) and aviation (down 5 percent to $94.2 million) segements, along with flat revenues (remaining at $62.3 million) for its marine sector. Overall Garmin reported a 4 percent year-over-year decline in revenue to $679.7 million.
Regionally, Garmin’s net sales declined 10 percent in the Americas, but that came on top of a 12 percent gain a year earlier when the company launched its first line of activity trackers. Garmin sales were flat in EMEA and grew 16 percent in APAC, thanks in part to robust sales of wearables in China and Taiwan.
Garmin revised its full-year revenue and EPS guidance down for the second time Oct. 15 due to pricing pressures and foreign currency headwinds. However, with $2.4 billion in cash and marketable securities on hand at quarter’s end, the company appears well prepared to weather the competitive fight ahead.
