By Thomas J. Ryan

Fitbit (NYSE:FIT) is falling behind Wall Street’s expected pace.

Shares of the fitness tracking company were trading down about 30 percent mid-day on November 3 after it cut sales forecasts for the crucial holiday season.

On a November 2 conference call with analysts, Fitbit officials cited challenges in the Asia-Pacific region, some softening of demand and production issues with its new Flex 2 wristband for the weak outlook. “We are starting to see some headwinds in our business,” CEO James Park said on a conference call. “But we think the market opportunity ahead is large.”

The leader in fitness wearables has been spending heavily on research and development to diversify its portfolio while also re-positioning itself as a digital health platform. But Wall Street has long been concerned about heightened wearable competition from Chinese electronics company Xiaomi on the lower end, as well as a host of others such as Garmin, Samsung and Apple targeting the category.

Fitbit’s revenues in the fourth quarter are expected to range between $725 million and $750 million, representing year-over-year growth of 2 to 5 percent. That compares with Wall Street’s consensus estimate of $981.3 million. In the fourth quarter of 2015, revenue vaulted 92 percent. Fitbit forecast fourth-quarter 2016 profit, excluding certain costs, of 14 cents to 18 cents a share, which is short of the average analyst estimate of 17 cents.

Said Park of the lower forecast, “We are taking steps to adjust, particularly to ensure that expense growth is commensurate with revenue growth, without sacrificing innovation.”

Fitbit’s third-quarter results were largely in line with expectations. Earnings fell 43 percent to $26.1 million, or 11 cents a share. Excluding certain expenses, such as stock-based compensation, Fitbit said it would have posted net income of $45.7 million, or 19 cents a share, in line with Wall Street’s average target.

Revenues grew 23.1 percent to $503.8 million, only slightly below the consensus target of $507 million. But sales in the Asia-Pacific region tumbled 45.1 percent in the quarter to $35.7 million, suggesting pressure from cheaper wearables made by Xiaomi and others. Park said sales in Asia were “not what we had hoped” and the company is “hoping to refine our marketing based on continued research” in the region. In other regions, sales in the U.S. grew 33.4 percent to $361.2 million. Sales in the Europe, Middle East and Africa region were particularly strong, jumping 64.4 percent to $80.9 million. Sales in the Americas outside the U.S. were up 7.3 percent to $25.9 million.

Fitbit sold 5.3 million of its fitness-tracking devices in the quarter, up from 4.8 million units a year ago. Gross margins in the quarter were flat year on year at 48 percent, but came in at the lower end of guidance. Flex 2 production challenges resulted in higher-than-expected waste and increased strap costs, which will continue to influence Q4.

Fitbit’s earnings in the quarter were also impacted by a ramp-up in operating expenses this year to support the launch of new products. Operating expenses jumped 52.4 to $196.2 million, with R&D costs nearly doubling and sales and marketing expenses ahead 22.7 percent

In August, Fitbit released new versions of its Charge HR and Flex fitness bands. But part of the fourth-quarter shortfall will reflect challenges manufacturing the Flex 2. The device was so small that manufacturing it also required robots, resulting “in a non-optimal initial production process,” Park said. The company estimated about $50 million in revenue shortfall due to a smaller supply of Flex 2’s.

Fitbit’s revenue forecast for the fourth quarter is also being impacted by a shift of revenue that went into the third quarter instead of the fourth, because of the timing of the shipment of another new product, the Charge 2. The company said it shipped more Charge 2 devices to the retail channel than it originally thought it would during the third quarter.

Park remained confident that Fitbit would continue to benefit as the leader in the space as well as overall potential of the category. He noted that based on the company’s internal research, 66 percent of people in the U.S. care about health and fitness and have a smart phone or computer tablet. But only 20 percent of U.S. adults in a recent independent survey indicated that they own a connected health and fitness device. Said Park, “Our opportunity is in that gap, and we feel that we are the best positioned company to take advantage of it.”

Photo courtesy Fitbit