By Thomas J. Ryan
Despite falling profits due to continued investments in research and marketing, Fitbit Inc. (NYSE:FIT) continued to defy critics by reporting sales that continued to surge in the second quarter.
The gains were driven by the successful introduction of its two new products, Blaze and Alta, and related accessories, which accounted for 54 percent of revenue in the quarter. Both Blaze, a smartwatch, and Alta, a wristband, were released in March. About two-thirds of the total activations of Alta and Blaze were by new customers, while the rest were by those who own or previously owned another Fitbit device, the company said.
Net revenues jumped 46.5 percent to $586.5 million, reaching the high end of guidance. Analysts on average were expecting revenue to hit $578.5 million.
“U.S. unit and dollar growth accelerated over Q1 despite an unusually strong Q2 of last year that benefited the full availability of charge HR, and we demonstrated continued growth into an expanding long-term international market opportunity,” said James Park, chairman and CEO, on a conference call with analysts.
“In addition, given consumer response to Fitbit Blaze and Alta so far this year, the early positive response from retailers seeing the new products we have for the fall is increasing brand strength and distribution footprint, the network effects from our large active user community and the continuing R&D investments we are making to integrate more deeply into the healthcare ecosystem, which will make our devices an essential part of people’s lives. I’m confident in the company’s future for the rest of this year and beyond,” said Park. “In fact, I’m so confident that I will not sell any stock until the end of the year.”
Fitbit sold 5.7 million devices in the quarter, up 27 percent year over year, its second-highest quarter behind last year’s holiday season.
In North America, U.S. devices sold were up 20 percent, while revenue was up 42 percent and showed sequential acceleration from Q1 2016. Said Park, “We continue to be comfortable with our store count in the U.S. and Canada, and are predominantly focused on driving more volume to these outlets with our retail partners.”
Park said the company is rolling out new modular display materials inside stores, accompanied by shelf space expansion in most of its North American retail outlets. A small amount of expansion is anticipated in certain retailers in the fall for additional accessories.
“We experienced a solid Mother’s Day and Father’s Day,” added Park of Fitbit’s North America performance. “We saw no meaningful impact from the U.S. sporting goods retailer bankruptcies, primarily because these were not our highest volume outlets.”
In EMEA, devices sold were up 100 percent year over year, reflecting continued progress in several key European markets. Like North America, the EMEA region is focused on driving more through the doors it already has in Europe today with leading retail partners. EMEA benefited from investments in more localized marketing, PR and advertising. Blaze and Alta helped drive the gains.
In China, online sales make up a higher percentage of the total than they do in the U.S. “which gives us some additional optimism about the future of this relationship,” said Park.
On a reported basis, net earnings slumped 64.4 percent to $6.3 million, or 3 cents a share.
On an adjusted basis, non-GAAP earnings were down 42.5 percent to $29.5 million, or 12 cents a share. Analysts were expecting 11 cents a share. EBITDA declined 44 percent to $48.3 million.
The earnings decline reflected a hike in operating expenses to $235.3 million from $107.1 million, as spending on research and development reached a new high and investments in marketing soared.
Gross profit margin narrowed to 41.8 percent from 46.8 percent a year earlier, due to an increase in warranty charges around its legacy products — around $50 million, plus an additional $10 million for customer service. It also accounted for more than $9 million in legal expenses for its ongoing feud with Jawbone. Gross margins, however, are expected to bounce back to the 48 to 49 percent level of last year for the rest of this year, due to new products like the $200 Blaze.
Park promised that several new products will be launched in the back half of the year to build on the success of Alta and Blaze. He stated, “The positive response we have received from retailers who have had the chance to preview these new products under NDA in recent weeks strengthens our confidence in our guidance for the year. Fitbit will have more new products for consumers to choose from for this year’s holiday season than we’ve ever had before.”
The company reiterated its guidance for the year. For the current quarter, Fitbit projected adjusted earnings of 17 cents to 19 cents a share on $490 million to $510 million in sales, compared with analysts’ estimate of 17 cents a share in earnings on $498.5 million in sales.
Skeptics have expected to see a slowdown at Fitbit, given the challenges at GoPro and a host of competitors coming into the wearables space, including Apple, Chinese electronics company Xiaomi, Garmin and Samsung.
Park spent time addressing the slowdown concerns. He said that with IDC predicting a 20 percent compounded annual growth rate to more than 200 million wearable devices shipping in 2020, “an opportunity of this size will naturally attract a great deal of competition.”
But he called it a “misconception” that the increasing number of competitors would create headwinds for Fitbit. He added, “It’s not the number of competitors that is important, but their impact on the market. The reality is that most of these entrants have not altered the competitive dynamics of our industry.”
He listed many advantages that Fitbit has over competitors, including its nine-year history providing a “deep understanding of what consumers want in a health and fitness device.”
He said Fitbit over that time has become “the brand of choice” in the space, a claim supported by the popularity of apps. For social reasons, Park also said people are “more likely to buy a Fitbit over a competitor because their friends and family are more likely to be already participating in the Fitbit social experience, and we believe people are less likely to leave to a competitor due to similar dynamics.”
He also pointed to the merchandising support and “good margins” it offers to retailers, as well as its commitment to spending on R&D.
But he also agreed with IDC that the overall wearable market has massive potential for growth.
“We believe that smartphone penetration provides a reasonable point of comparison for addressable opportunities in different markets, as we believe a significant portion of smartphone users can become Fitbit users over time,” Park said.
He noted that this year, there are expected to be more than 2 billion smartphones in use around the world. Through the end of the second quarter 2016, Fitbit has shipped a lifetime total of 35.6 million Fitbits in the U.S., which represent only 15 percent of the approximately 230 million smartphones in the region. In its five primary European countries — UK, Germany, France, Italy and Spain — it has sold roughly 5 million Fitbits against a total potential market of approximately 200 million smartphones today. Finally, in its five primary Asia-Pacific countries — Australia, India, China, Japan, and Korea — roughly 4 million Fitbits have been sold to date against a total potential market opportunity of 1.1 billion smartphones.
Said Park, “At the pace at which we can develop these markets, we expect to have tremendous long-term opportunity and will continue to evolve and expand our products and experiences to engage consumers with their health.”
Lead photo courtesy Fitbit
