Fitness tracker and smartwatch company Fitbit (NYSE:FIT) reported its third-quarter results after the market closed on Oct. 31. Revenue edged up for the first time in two years, and the bottom line greatly improved thanks to significant cost cuts. Fitbit has emerged as a strong contender in the smartwatch market thanks to its affordable Versa, which offset slumping fitness-tracker sales in the third quarter.

Fitbit results: The raw numbers

Metric

Q3 2018

Q3 2017

Year-Over-Year Change

Revenue

$393.6 million

$392.5 million

0.3%

Net income

($2.1 million)

($113.4 million)

N/A

Non-GAAP earnings per share

$0.04

($0.01)

N/A

Devices sold

3.5 million

3.6 million

(2.8%)

Data source: Fitbit.

What happened with Fitbit this quarter?

  • Fitbit's average device selling price rose 3% year over year to $108, driven by increasing sales of smartwatches.
  • Smartwatches accounted for 49% of total revenue, up from less than 10% in the prior-year period.
  • Products introduced in the past year, which include the Versa smartwatch, Charge 3, Ace, and Aria 2, accounted for 62% of revenue.
  • U.S. revenue slumped 6% year over year to $230 million; Europe, Middle East, and Africa revenue rose 17% to $104 million; Americas excluding U.S. revenue slumped 2% to $25 million; and Asia-Pacific revenue was flat at $34 million.
  • Fitbit's non-GAAP gross margin tumbled from 45.2% in the third quarter of 2017 to 40.1% in the third quarter of 2018. The mix shift toward smartwatches was to blame.
  • GAAP operating expenses declined by 15.4% year over year to $171.3 million. This cost-cutting offset the slump in gross profit.
  • An $18.8 million tax benefit boosted net income on a GAAP basis.
  • The healthcare business grew by 26% year over year, but Fitbit didn't disclose healthcare revenue.

Fitbit provided the following guidance:

  • Fourth-quarter revenue is expected to be at least $560 million, with lower device sales and a higher average selling price versus the prior-year period. Fitbit generated $570.8 million of revenue in the fourth quarter of 2017.
  • Fourth-quarter gross margin is expected to be slightly higher than in the third quarter.
  • Fourth-quarter non-GAAP earnings per share are expected to be at least $0.07.
  • Full-year revenue is expected to be about $1.5 billion. The company expects higher smartwatch sales, lower fitness tracker sales, lower device sales overall, and a higher average selling price.
  • Full-year free cash flow is expected to be about $52 million, or a loss of $20 million excluding a tax refund payment.
The Fitbit Versa.

The Fitbit Versa. Image source: Fitbit.

What management had to say

CEO James Park discussed the company's smartwatch progress during the earnings call: "Fourteen months ago, we had zero share in the smartwatch category and today we are the No. 2 player in the U.S., which is a significant achievement and something I'm very proud of. Shipments for both smartwatch and tracker device sales accelerated sequentially; smartwatches represented 49% of revenue in the quarter; and demand for Versa remained solid, outselling each of the competitive offerings from Samsung, Garmin, and Fossil in the U.S."

Park also discussed the company's strategy around healthcare: "So the growth reflects the fact that we added to our customer base of 1,600 health plans for enterprises. And looking forward, we're trying to shift our model away from being purely device-centric to being a more solutions oriented business that combines both devices and software services..."

Looking forward

Fitbit expects sales in the holiday quarter to decline slightly from last year, with smartwatch sales unable to fully offset declining demand for fitness trackers. The company expects to turn a profit on a non-GAAP basis, with cost cuts counteracting lower sales and a lower gross margin.

Fitbit's turnaround is still a work in progress, but the third-quarter report had plenty of positives. It may be able to return to growth in 2019 if it can stabilize the fitness tracker business and maintain its smartwatch momentum.

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.