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Fitbit Earnings: The Spiral Continues

By Leo Sun – May 6, 2018 at 2:11PM

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Can the beleaguered wearables maker pull out of this nosedive?

Shares of Fitbit (FIT) plunged 12% to an all-time low after the wearables maker posted its first quarter numbers. The company beat Wall Street's low expectations, but its guidance for the current quarter calls for steeper revenue declines and wider losses.

Fitbit's revenue fell 17% annually to $248 million, which beat expectations by $0.65 million. Its non-GAAP net loss widened from $34.4 million to $41 million, or $0.17 per share, which topped estimates by two cents.

Fitbit's Versa.

Fitbit's Versa. Image source: Fitbit.

But for the current quarter, Fitbit expects its revenues to fall 16%-22%, and estimates it will post a non-GAAP net loss between $0.23 and $0.27, compared to break-even earnings a year earlier. It also expects to post a negative free cash flow of $85 million, compared to negative $2 million in the first quarter.

For the full year, Fitbit expects its revenue to fall 7% to $1.5 billion. That's better than its 26% decline in 2017, but Fitbit also expects its gross margin to contract throughout the year as it relies more on smartwatches and less on fitness trackers.

These numbers indicate that Fitbit is being squeezed by tough competition from cheaper fitness trackers and higher-end smartwatch players like Apple (AAPL 3.10%). Could Fitbit's stock actually drop to zero if it fails to turn things around? Let's dig deeper to find out.

Looking for flickers of life

Fitbit's rough headline numbers overshadowed a few positive figures. Fitbit's total wearables shipments fell 27% annually to 2.2 million, but its average selling price rose 16% to $112 per device thanks to higher sales of the Ionic, Versa, Aria 2, and Flyer, which together generated 34% of its revenue.

Fitbit's margins have also been improving. Its non-GAAP gross margin rose 710 basis points annually to 47.1% during the quarter. Excluding the impact of lower warranty costs and a $12 million reserve release from the bankruptcy of tech wholesaler WYNIT, it expanded 400 basis points to 44%.

During the conference call, CFO William Zerella attributed that margin expansion to the "improved product quality" of its newer devices and the "reduction of warranty provision from the exploration of legacy products." Unfortunately, that improvement was largely overshadowed by Fitbit's forecast for contracting gross margins later this year.

Fitbit also reduced its operating expenses by 4% annually to $174 million, led by a 20% reduction in sales and marketing expenses. However, cutting its sales and marketing expenses in the face of escalating competition might not be the best long-term move.

Fitbit's Ionic.

Fitbit's Ionic. Image source: Fitbit.

Fitbit's adjusted EBITDA loss narrowed from $52.3 million to $46.2 million, but that improvement was also overshadowed by its widening non-GAAP loss and its GAAP loss of $80.9 million -- which was wider than its loss of $60.1 million a year earlier.

Plenty of headwinds

Despite those improvements, there are also clear signs that Fitbit's core business may struggle to survive. Fitbit's global market share in wearables dropped from 21.5% in 2016 to 13.3% in 2017 according to IDC. Meanwhile, Apple's share jumped from 10.8% to 15.3%, allowing it to claim the wearables crown.

Despite Fitbit's best efforts, smartwatches like the Ionic and Versa will likely struggle against new versions of the Apple Watch. Meanwhile, its cheaper fitness trackers will continue struggling against low-cost rivals like Xiaomi, which claimed 13.6% of the wearables market last year.

Fitbit also posted double-digit revenue declines in the US, Americas (excluding the US), and EMEA (Europe, Middle East, and Africa) regions. Its only growing market is the Asia-Pacific region, which remains highly exposed to Chinese rivals like Xiaomi and Huawei.

Lastly, some bulls claim that Fitbit's digital health ecosystem -- which includes its subscription service Fitbit Coach, the cloud healthcare platform Twine Health, and a new partnership with Alphabet's Google Cloud for Healthcare -- will lock in more users. But during the conference call, Zerella stated that the growth of that ecosystem would "be relatively immaterial" to its wearable revenues.

So will Fitbit head to zero?

I don't think Fitbit will drop to zero anytime soon, since it finished last quarter with over $658 million in cash, cash equivalents, and marketable securities, and no debt to speak of.

Therefore, Fitbit still has time to turn things around -- if management sharpens its vision and finds fresh ways to counter the competition. But until that happens, I'd steer clear of this beaten-down stock.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, and Fitbit. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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