Fitbit (NYSE:FIT) reported better-than-expected results for the third quarter of 2018, including a return to profitability on an adjusted basis. Shares rallied on the news, helping the stock get back to breakeven on the year.
The wearables maker has been rebounding with sales of its new smartwatches while simpler fitness trackers continue to decline -- but smartwatches were always expected to yield results once Fitbit got around to making them. If Fitbit's stock is going to sustain a rally to the upside, it needs something more than just hardware sales.
Mediocre sales in a strong retail environment
A couple of years ago, Fitbit lost its title as the leading wearable health tracking company. Consumers moved on from basic health wristbands to more feature-rich smartwatches, like the Apple (NASDAQ:AAPL) Watch, which now claims the title of best-seller.
The release of the affordable Fitbit Versa in the spring of 2018 helped Fitbit grab the No. 2 spot in the smartwatch category, but overall sales keep falling year over year. So far in 2018, the company has sold 8.4 million devices versus 10 million a year ago. That slide is beginning to moderate, however, as 3.5 million devices were sold during the third quarter against 3.6 million in 2017.
Fitbit has been able to offset lower volume with higher pricing from the Versa (average selling prices were up 3% in the third quarter), but the company's declines are disturbing. Industry-wide, fitness tracker and smartwatch sales have kept climbing this year. According to tech researcher IDC, Apple and Chinese maker Xiaomi's wearable sales are both up double digits in 2018. Despite an optimistic consumer base springing for tech-enabled watches and devices, Fitbit has simply fallen behind in the competitive wearables industry. That makes a new business segment all the more important to the struggling company.
More healthcare needed in Fitbit's news feed
Despite stubbornly falling device sales, Fitbit's bludgeoned stock rebounded on optimism that the worst is behind it. Sales have been up quarter over quarter all year, and the company is now starting to lap the truly ugly numbers it first started posting 12 months ago. That bodes well for a rebound.
However, history has shown that tech is driven by innovation, and Fitbit may be falling behind again in a new key category. Even Apple, which has made a success out of hardware sales unlike any other company, has been migrating to a diversified portfolio of recurring service revenues rather than relying solely on event-driven new product releases. For example, the Health app -- supported by the iPhone and Watch -- is a very visible display of the company's aspirations in the healthcare industry.
It makes sense that software-based subscriptions and services are the next step for technology companies. The revenues are more stable and predictable, and healthcare services specifically are more necessary than they are discretionary. Fitbit has been making a little headway in this regard as well but doesn't have the breadth of Apple and other rivals, and is limited to playing in the healthcare space.
On that front, it's been slow going. Healthcare revenue increased 26% in the third quarter. That's a respectable growth rate, but management didn't release more specific numbers because the segment is so small it's immaterial to overall results. CEO James Park said that healthcare revenue was less than 10% of overall revenue, and that investors should expect "slow-and-steady" growth. Given the flat overall revenue growth -- driven by a slight decline in devices offset by higher selling prices -- I'd say that segment is actually a long way from 10% of the total. That means healthcare services, despite the double-digit increases, will likely remain immaterial for some time.
Park said to expect more transparency in 2019, but barring a big breakthrough, there likely won't be much to write home about on the services side of the business. With Fitbit still relying almost solely on device sales, investors should tread cautiously around this rebound.
Nicholas Rossolillo and his clients own shares of Apple and Fitbit. The Motley Fool owns shares of and recommends 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.