Shares of Fitbit Inc. rose $1.22, or 25.8 percent, to $5.95 Thursday after the fitness tracker leader returned to profitability on a non-GAAP basis for the first time in two years on surging sales of smartwatches. The just-launched Fitbit Charge3 is also seeing a strong reception.

“I’m really proud of our performance this quarter,” said CEO James Park on a conference call with analysts. “We demonstrated that we can gain share in the smartwatch category, deepen our reach in healthcare and successfully manage our operating expenses, which resulted in a return to profitability.”

Adjusted earnings reached $10 million, or 4 cents per share, versus consensus estimates of a loss of a penny per share. In the 2017 third quarter, Fitbit lost $2.8 million, or 1 cent a share. In the first six months of the year, losses had totaled $95.2 million, or 39 cents a share.

Adjusted EBITDA in the latest period came to $21.0 million, up from $5.9 million in the same period last year. The net loss came to $2.1 million against $113.4 million a year ago.

Revenue came in at $393.6 million, about even with $392.5 million a year ago, ahead and up $100 million sequentially, and exceeding Wall Street’s target of $381.2 million. Sales had been down 16.1 percent in the half.

GAAP gross margin was 39.0 percent and non-GAAP gross margin was 40.1 percent, versus 44.5 percent and 45.2 percent, respectively, a year ago. Margins were negatively impacted by the change in mix towards smartwatches, partially offset by improved warranty costs.

The bottom line was helped by the stabilization in sales and a reduction in operating expense by 15.4 percent to $171.3 million, or 43.5 percent of sales; from $202.4 million, or 51.5 percent, a year ago.

Devices sold decreased slightly to 3.5 million from 3.6 million a year ago, but average selling price increased 3 percent year-over-year to $108 per device driven by the growing mix of smartwatches. New devices introduced in the past year, Versa, Fitbit Charge 3, Fitbit Ace and Fitbit Aria 2, represented 62 percent of revenue.

U.S. revenue represented 58 percent of revenue or $230 million, down 6 percent year-over-year. International revenue represented 42 percent of revenue and increased 10 percent year-over-year to $163 million: EMEA revenue increased 17 percent to $104 million; Americas excluding U.S. revenue declined 2 percent to $25 million; and APAC revenue was relatively flat at $34 million, all year-over-year, respectively.

On the call, Park noted that the performance marked the seventh quarter in a row that we have delivered on its financial commitments while noting that operating expenses were reduced by 17 percent on a non-GAAP basis.

On the growth side, he highlighted the 10 percent growth internationally and the 26 percent growth achieved in health solutions business. Fitbit’s health solutions portfolio includes more than 1500 customers and 100 health plans but still makes up less than 10 percent of Fitbit’s revenue.

But he spent much of the time discussing the success of the versa smartwatch and Fitbit Charge 3.

“Fourteen months ago, we had zero share of the smartwatch category and today we’re the number two player in the US, which is a significant achievement and something I’m very proud of,” said Park. Shipments for both smartwatch and tracker device sales accelerated sequentially. Smart watches represented 49 percent of Fitbit’s revenue in the quarter, and demand for versa remains solid, outselling each of the competitive offerings from Samsung, Garmin and Fossil in the US.

Said Park, “Despite smartwatch as being a more competitive segment of the wearable market, we have demonstrated that we can quickly and effectively gain market share. This underscores the power of our brand and our ability to deliver devices consumers want.”

Fitbit also began shipping towards the end of the quarter its most advanced tracker yet, the Charge 3, to “strong” sell throughs. The update shows “the lines are blurring between trackers and smartwatches.” Advanced sensors include a relative SBOT sensor that can unlock future health programs like the Fitbit Labs Sleep score, second party apps like weather and the ability to process payments.

Said Park, “Charge three is already at a number one selling Android compatible wearable device in the US, outselling the number two player at point of sales by more than three fold over the past two weeks. Early press reviews have been very positive with PC Magazine giving up their editor’s choice awards stating, there’s still a place for dedicated fitness trackers and they don’t get much better than a Fitbit Charge 3.”

Park also noted that 42 percent of its total activations came from repeat buyers. Of the repeat buyers, 49 percent were previously inactive for 90 days or greater. He said, “This gives us confidence in a lessening decline and further stabilization of the tracker category and our ability to grow device sales, as we move into the final quarter of the year and begin to focus on ’19.

Fitbit’s online software offering is being amplified by the popularity of Fitbit Labs sleep score beta. The company also Fitbit will continue to look towards clinical validation and regulatory approval of its software for use in detecting health conditions such as sleep apnea and atrial fibrillation

Ron Kisling, the company’s CFO, also noted that retail channel inventory is “relatively clean” as holiday delivery starts. Said Park, “We enter Q4 with positive momentum and are well positioned to deliver on our 2018 guidance and maintain our profitability.”

For the fourth quarter, Fitbit expects revenue to be greater than $560 million against $570.8 million last year. Device sales are planned to be down with higher average selling prices expected. Non-GAAP net income per share is expected to be greater than 7 cents a share versus analyst estimates of 6 cents and compared to an adjusted loss of 2 cents a year ago. Gross margins are expected to trend slightly higher from the third quarter.

For the full year, Fitbit reiterated its revenue guidance of approximately $1.5 billion, down from $1.62 billion. Average selling prices are expected to rise, offset by a decline in device sales. Tracker device sales are projected to decline and smartwatch device sales to increase. Fitbit said it’s on-track to deliver or come in under its full year operating expense target of $740 million.

Photo courtesy Fitbit