Image source: Fitbit.
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Back in November, Fitbit (NYSE: FIT) got crushed when it reported third-quarter earnings. The main contributing factor for that fall was reduced guidance for the fourth quarter. Fitbit's sales forecast for the full year was cut by 8% at the midpoint, with adjusted earnings per share guidance getting cut by over half. At the time, CFO Bill Zerella acknowledged some "softness in overall demand" that was exacerbated by supply constraints for its Flex 2. Fitbit had to reduce its revenue guidance for the fourth quarter to a range of $725 million to $750 million.
The company has just released preliminary results, and sales missed that already-reduced forecast -- by a lot.
Fitbit expects that it sold 6.5 million devices during the fourth quarter, which should translate into revenue in the range of just $572 million to $580 million. That will put full-year revenue growth at around 17%, well below the prior forecast growth of 25% to 26%. The shortage up top means the bottom line will meaningfully swing to the red, too.
Data source: SEC filings.
Co-founder and CEO James Park said in a statement that management remains confident that the poor performance does not reflect Fitbit's long-term potential and brand strength, while conceding that demand for fitness trackers in mature markets has been poor. Emerging markets like its Europe, Middle East, and Africa segment are putting up solid results, though, with sales in that region jumping 58% in the fourth quarter. Fitbit thinks this is but a temporary speed bump, but is still going to go ahead and cut operating costs.
Fitbit finished 2016 with an operating expense run rate of over $1 billion, and it hopes to reduce this by $200 million for the coming year to $850 million. That will include laying off 110 employees, or 6% of its global headcount. That's a tough pill to swallow considering the fact that Fitbit has recently acqui-hired some number of engineers from three recent acquisitions: Coin, Pebble, and Vector. Those purchases were focused primarily on software assets and intellectual property, but members of those respective teams joined up. It's not clear how many employees came with the acquisitions.
Adjusted gross margin in the fourth quarter will also be "materially" below the forecast of 46% because the company had to write down tooling equipment and component inventory ($68 million), increase promotional activity ($37 million in reduced revenue), boost its return reserves because of elevated channel inventory (increase of $41 million), and increase its warranty reserves for older products ($17 million).
Fitbit has gone ahead and offered preliminary 2017 guidance, expecting revenue of $1.5 billion to $1.7 billion, well below the $2.3 billion that analysts were modeling for. That should translate into a non-GAAP net loss per share of $0.22 to $0.44 and non-GAAP free cash flow of negative $50 million to $100 million. Fitbit is dropping its long-term gross margin target from 50% to 45% also.
With shares now at all-time lows, the retention value of equity grants is significantly diminished. Fitbit hopes to boost retention of key employees by introducing a program where employees can trade underwater options for restricted stock units, which will require shareholder approval (not that there will be any uncertainty there, since insiders hold supervoting Class B shares and can easily approve the program). Executive officers and directors collectively control 82% of all voting power, according to the most recent proxy statement.
A small consolation
There was but a single silver lining in the announcement. Park noted that Fitbit finished the year with 23.2 million active users. This is a metric that Fitbit only updates annually, and for reference, the company had 16.9 million active users at the end of 2015. The active user base grew 37% in 2016; technically, that's deceleration but 2015's active user growth (152%) was coming off a much smaller base (6.7 million) so it's less useful to compare growth rates. The active user growth is the only consolation for the bad news. But the most important question that Fitbit faces right now is whether or not it can successfully transition to smartwatches, as it's becoming increasingly obvious that the fitness tracker market may be peaking, at least in mature markets.
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