Slowly but surely, Fitbit (NYSE:FIT) has been making progress with its turnaround, thanks in large part to its Versa smartwatch. The company reported third-quarter earnings results last night, and Fitbit has returned to profitability after a string of quarterly losses that were attributable to consumers rapidly shifting away from basic fitness trackers toward more capable smartwatches. Fitbit was able to beat its guidance on numerous fronts.
Here's what investors need to know.
Back in the non-GAAP black
Revenue in the first quarter was up modestly at $393.6 million, topping both its own forecast ($370 million to $390 million) as well as analyst expectations ($381 million). Fitbit sold 3.5 million devices during the quarter, with average selling prices (ASPs) rising 3% to $108, as the product mix is shifting toward higher-priced smartwatches. Smartwatches now account for 49% of revenue, impressive progress in the face of intense competition from Apple, which launched its Apple Watch Series 4 at the tail end of the quarter.
The company has also executed well on cutting costs, with total operating expenses falling 15% to $171.3 million. All told, Fitbit posted non-GAAP net income of $10 million, or $0.04 per share. Fitbit's guidance had forecast adjusted earnings per share of negative $0.02 to positive $0.01, and the Street was modeling for an adjusted net loss of $0.01 per share. On a GAAP basis, Fitbit lost $2.1 million, or $0.01 per share.
Fitbit also said that 58% of activations in the quarter were new users. Of the remaining 42% that were existing Fitbit users, nearly half had previously been inactive for three months. That's a good sign for the company, as it has long argued that reactivating dormant users is an opportunity to strengthen the platform.
Fitbit is now the No. 2 player in smartwatches
A year ago, Fitbit had precisely 0% market share in smartwatches. Today, the company is the No. 2 player, which CEO James Park rightly says is "a significant achievement and something I'm very proud of." Park is likely referring to IDC's estimates on the wearables market for the second quarter that were released in September. While Fitbit still trails Xiaomi in wearables, the Chinese company's unit volumes are largely dominated by basic trackers. When it comes to smartwatches, a subset of the broader wearables market, Fitbit only lags Apple.
Versa outsold smartwatches offered by Samsung, Garmin, and Fossil in the U.S. "Despite smartwatches being a more competitive segment of the wearable market, we have demonstrated that we can quickly and effectively gain market share," Park added. Versa is positioned as a midrange device, and Park said Fitbit's smartwatch portfolio will grow over time as the company continues to invest in the category.
Turning to guidance for the critical fourth quarter, Fitbit expects revenue to be at least $560 million. Devices sold are expected to decline, offset by higher ASPs. The company is forecasting adjusted earnings per share of $0.07, and gross margin should expand slightly on a sequential basis. Free cash flow should be around $90 million.
Fitbit has undeniably executed well on transitioning to smartwatches, taking strategic advantage of Google's missteps in the sector. Wear OS (formerly Android Wear) continues to flounder, leaving an opening for Fitbit to capitalize on. This is going to be a long game, though, as all platform plays are. The company will get no reprieve from having to continuously develop new hardware that entices consumers while building out Fitbit OS, all while competing with the richest company in the world.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Evan Niu, CFA owns shares of AAPL. The Motley Fool owns shares of and recommends GOOG, GOOGL, AAPL, and Fitbit. The Motley Fool has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool has a disclosure policy.