Fitness wearables company Fitbit (NYSE:FIT) reported its first-quarter results after the market closed on May 2. Device unit sales plunged as demand for the company's fitness trackers weakened, leading both the top and bottom lines lower. Smartwatch sales are growing fast, with the inexpensive Versa leading the way, but it wasn't enough to avoid a double-digit revenue decline. Here's what investors need to know about Fitbit's first-quarter results.

Fitbit results: The raw numbers

Metric

Q1 2018

Q1 2017

Year-Over-Year Change

Revenue

$247.9 million

$298.9 million

(17.1%)

Net income

($80.9 million)

($60.1 million)

N/A

Non-GAAP EPS

($0.17)

($0.15)

N/A

Devices sold

2.2 million

3 million

(26.7%)

Data source: Fitbit.

What happened with Fitbit this quarter?

  • Sales of fitness trackers were negatively affected by a reduction in retail channel inventory. Fitbit says that the retail channel is now "relatively clean."
  • Smartwatches accounted for 30% of total revenue, with sales doubling from the fourth quarter of 2017.
  • U.S. revenue slumped 18% year over year to $140 million. The U.S. accounts for 56% of Fitbit's total revenue.
  • Europe, Middle East, and Africa revenue tumbled 26% year over year to $65 million, Asia-Pacific revenue grew 33% to $28 million, and Americas excluding U.S. revenue slumped 19% to $16 million.
  • Fitbit's Ionic and Versa smartwatches boosted the average selling price by 16% year over year to $112. The cheaper Versa smartwatch became available at retail in early April.
  • New products were responsible for 34% of total revenue during the quarter.
  • The Versa enjoyed strong preorders, with the best sell-through sales in North America of any device in the company's history in the first week of availability.
  • Non-GAAP gross margin was 47.1%, up from 40% in the prior-year period.
  • GAAP operating expenses declined 5.8% year over year as part of the company's efforts to reduce costs.

Fitbit provided the following guidance for the second quarter and the full year:

  • Second-quarter revenue is expected to decline around 19% year over year to a range of $275 million to $295 million. The company pointed to reduced demand for fitness trackers as the main driver, with smartwatch sales growth driven mostly by the Versa partially offsetting that weakness.
  • Second-quarter non-GAAP earnings per share is expected to be a loss of $0.23 to $0.27. Free cash flow is expected to be a loss of around $85 million.
  • Full-year revenue is expected to be approximately $1.5 billion, unchanged from the company's previous guidance. The company expects smartwatches to account for the majority of revenue in the second half of the year. Fitbit Health Solutions is expected to produce immaterial revenue growth.
  • Full-year gross margin is expected to decline in 2018 thanks to a greater mix of smartwatches. Operating expenses are expected to be about 7% lower compared to 2017.
  • Full-year free cash flow is still expected to be break-even, inclusive of an $80 million tax refund payment.
Five of Fitbit's Versa smartwatches.

The Fitbit Versa. Image source: Fitbit.

What management had to say

While overall demand for Fitbit's bread-and-butter fitness trackers is weak, CEO James Park identified one source of solid demand during the earnings call: "And despite the decline in tracker growth, we still see demand for trackers in the market across price-conscious users in the healthcare system, so we will continue to adapt how we approach this segment category in order to maximize our share of the overall wearable device market."

Park also explained how developing the Versa was a lot easier than developing the Ionic: "Fitbit Versa is a great example of this working on the smartwatch side of the portfolio as many other foundational assets from Fitbit Ionic like the Fitbit OS and SDK were already in place. And that result was a product launch that required approximately 45% less development hours than Fitbit Ionic."

Park emphasized that the company's strategy is focused on the long term: "This evolution is less about providing near-term revenue in '18 and more about setting ourselves up to grow durable sources of revenue in '19 and beyond. We are focused on driving efficiency in the device side of our portfolio and redeploying the contribution margin into our growth vectors, specifically international, Fitbit Health Solutions and software service."

Looking forward

While smartwatches are expected to make up the majority of revenue later this year, they're not as profitable as the company's fitness trackers. Fitbit expects its gross margin to suffer from its smartwatch expansion, which will put further pressure on the bottom line. Even if Fitbit manages to return to revenue growth in 2019, profits may not follow suit.

Fitbit has two things going for it. First, the Versa smartwatch appears to be doing well so far. That's important, because the more expensive Ionic smartwatch failed to meet the company's expectations. Second, Fitbit still has a fortress balance sheet with enough cash to muddle through years of bad results. The company can afford to adopt a strategy focused on the long term at the expense of today's results.

But given the stock's performance lately, investors don't appear all that confident in Fitbit's turnaround plans.

Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Fitbit. The Motley Fool has a disclosure policy.