Fitbit ( FIT), the market leader in wearable fitness-tracking products, reported second-quarter earnings and revenue that beat expectations, sending FIT stock soaring in after-hours trading. Shares gained as much as 6 percent in the minutes after the release.
Fitbit reported adjusted earnings per share of 12 cents on revenue of $586.5 million, up 46 percent from a year ago. Analysts were expecting FIT stock to earn 11 cents per share on revenue of $578.5 million. A year ago, Fitbit earned 21 cents per share on revenue of $400.4 million.
Third-quarter guidance was right about where analysts thought it would be; Fitbit guided for adjusted EPS between 17 cents and 19 cents on revenue between $490 million and $510 million. Consensus estimates called for EPS of 17 cents per share on revenue of $498.5 million, an increase of about 22 percent from the previous year.
"Fitbit has been pushing to stay atop the latest fitness fads, investing heavily to drive sales and reduce the time between product launches," says James Gellert, CEO of Rapid Ratings, a financial health ratings firm. "The next few quarters will tell if these high operating costs are the company’s norm, but it seems like the company is able to envision the next big thing and act on it quickly."
Fitbit has a history of beating earnings and revenue expectations but still seeing its stock price tumble. The market has been adept at finding the downside in earnings reports past, with the most recent concern being slumping margins. That appeared to be the case again immediately after the second-quarter report, when shares initially wavered after the earnings release.
Fitbit shares have been rocked this year, with the stock off more than 55 percent in 2016 going into Tuesday's report.
Fitbit went public in June 2015, and going into its second-quarter report on Tuesday the company had never missed on earnings – or revenue. The company is now a perfect 5-for-5 when it comes to earnings and revenue beats, so Wall Street's embrace of the stock makes sense after a long history of exceeding expectations and going unrewarded.
The main source of pessimism from investors has come from the company's rhetoric, which in previous quarters has been heavily focused on investing. For some myopic traders on Wall Street, that translates into nothing more than higher expenses, which put a dent in the bottom line.
To be fair, the ramp-up in spending in areas like research and development and sales and marketing has been fairly dramatic: In the second quarter, R&D spending jumped 162 percent to $79.9 million, while sales and marketing spending soared 69.5 percent to $118.1 million.
In the first quarter, R&D spending was up 222 percent to $72.2 million while sales and marketing expenses jumped 144 percent to $107.1 million, so the spending spree appears to be slowing down somewhat.
Non-GAAP gross margins fell from 47.2 percent in the year-ago quarter to 42 percent last quarter. The decrease was due to higher warranty reserves for legacy products, a figure that's expected to normalize going forward, allowing margins to rebound to more normal levels. That said, as a result of the warranty issue, Fitbit did reduce its gross margin guidance for 2016 from between 48.5 percent and 49 percent to roughly 47 percent, so that is indeed a negative.
As for competition though, it's had little effect on Fitbit's sales, as evidenced by last quarter's 46 percent surge in revenue.
The Apple (AAPL) Watch, once thought to be a threat to Fitbit's grip on the wearables industry, has failed to live up to the hype surrounding it. One issue may be the price point: The cheapest version of the Apple Watch, the 38mm Apple Sport, sells for $299. The priciest, the gold-plated Apple Watch Edition, goes for $17,000.
There isn't a single Fitbit device that goes for as high as $299. Its most expensive, the Fitbit Surge, sells for $250, and several products retail for $100 or less.
Garmin (GRMN), Xiaomi, Samsung, Alphabet's (GOOG, GOOGL) Android Wear line, and many other competitors have also entered the fray.
According to the International Data Corp., increased competition has indeed driven down Fitbit's market share in the wearables space from 32.6 percent in the first quarter of 2015 to 24.5 percent in this year's first quarter. But while Fitbit's slice of the pie is shrinking, the pie itself is growing rapidly, allowing Fitbit to keep growing on an absolute basis in the process.
In the first quarter, IDC estimates that the wearables market grew 67.2 percent overall; Fitbit, despite its slip in share, still remains the top global vendor in the space by shipment volume.
Going into the second-quarter earnings report on Tuesday, FIT stock traded for less than 10 times projected 2017 earnings, a steep discount to the Standard & Poor's 500 index, which trades for more than 18 times forward earnings.
While international growth could eventually be one of the main drivers for FIT stock, the U.S. is still far and away the most important market. Nearly 76 percent of revenue came from the U.S. last quarter, and domestic sales surged 42.4 percent to $445.2 million last quarter, up from $312.7 million a year ago.
Still, international sales accounted for 24 percent of overall revenue, up from 22 percent a year ago despite the closing of a prominent Australian retailer denting results last quarter.
More importantly, Fitbit teamed with Alibaba Group Holding's (BABA) TMall online retailing platform in a new partnership, in a deal that reportedly drove 100 million consumer impressions last quarter. The company also released products aimed at native Chinese, Japanese, and Korean speakers, which should aid sales growth in those regions.
At last check, 35.4 percent of Fitbit shares – a total of 43.6 million shares – were sold short. High short interest can trigger what's called a "short squeeze," where those betting against the stock are forced to "cover" their position, buying back the stock and sending the price higher.
Short squeezes are most common when there's reason to be optimistic about the stock in question, making bears want to close their trade. While Fitbit's second-quarter results were good in and of themselves, we could be seeing certain aspects of a short squeeze at work in the post-earnings rally as well.
By: John Divine (U.S. News & World Report).
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