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Fitbit Analysis ahead of Q3 Earnings 2016

Fitbit will report their earnings after the markets close today. They will most probably beat their expectations and it won’t affect the stock price a single cent. However, there are something that will. Let me explain.
Let’s start with the expectations for the quarter:

Company’s Expectations For This Quarter

Outlook and Guidance

Fitbit’s outlook for the third quarter of 2016 is as follows:

  • Revenue in the range of $490 to $510 million
  • Non-GAAP gross margin of approximately 48% to 49%
  • Adjusted EBITDA in the range of $70 to $80 million
  • Non-GAAP diluted net income per share in the range of $0.17 to $0.19
  • Non-GAAP diluted share count between 244 and 247 million
  • Stock-based compensation expense in the range of $26 to $28 million
  • Non-GAAP tax rate of approximately 30%

Fitbit’s outlook for the full year of 2016 is as follows:

  • Revenue in the range of $2.5 to $2.6 billion
  • Non-GAAP gross margin of approximately 47%
  • Adjusted EBITDA in the range of $430 to $490 million
  • Non-GAAP diluted net income per share in the range of $1.12 to $1.24
  • Non-GAAP diluted share count between 244 and 250 million
  • Stock-based compensation expense in the range of $92 to $97 million
  • Non-GAAP tax rate of approximately 30%

Earnings Call

Moving to guidance, we remain optimistic for the second half of the year. As James mentioned, we expect to enter the holiday season with the most compelling lineup of new products than any previous holiday period. For Q3 we expect revenue of $490 million to $510 million, gross margins of 48% to 49%, EPS of $0.17 to $0.19 and adjusted EBITDA between $70 million and $80 million. Stock-based compensation is expected to be in the range of $26 million to $28 million. Our revenue guidance reflects the impact of seasonality combined with clearing the channel of several legacy products.

While we expect to start refilling the channel in the latter part of Q3 2016 in connection with new products for the holidays, revenue will be dependent on the production ramp coming out of the factory. This guidance also reflects further reductions in channel inventory in Asia-Pac during the quarter before an expected resumption of growth in that region in Q4 2016. I want to emphasize that even with this channel clearing, the midpoint of our guidance reflects a 22% year-over-year increase in revenue and a 58% sequential increase in adjusted EBITDA reflecting the expected improvement in operating leverage beginning in the second half.

(We have been pretty conservative in terms of projecting further burn down in inventory in Asia-Pacific and that is what we have Incorporated into our guidance.)

Our Q3 2016 gross-margin guidance is driven by the margin profile of both Blaze and Alta and our other new products since they will represent a significant portion of our revenue for the quarter. We will also be closely managing our OpEx level to be consistent with seasonality and therefore expect a significant sequential decrease in marketing spend before we reramp during the holidays.  – Bill Zerella CFO

Analysts’ Expectations For This Quarter

Analysts’ estimates Fitbit to report $506.93mm in revenues on  $.19 a share. This represents roughly 24% revenue growth and an earnings decline of $.05 a share from the same period a year ago. Earnings are expected to decline, in part, due to increased production, distribution gains and higher A&P spending from new product introduction.

What’s interesting to see here is that the Analysts has set expectations at the higher end for Fitbit’s forecast and the stock is still trending downwards as we approach today’s earnings report. Shaving off 11% of Fitbit’s market cap during the last month. An interesting fact is that Fitbit has never missed their own guidance. Last quarter came close with just a 0.25% beat on revenue and 9% beat on earnings. There is a reason for that and we’ll get to it, but let’s looks at reasons why the stock is down.

User Base

One good measure ist to look  that the download of the Fitbit app, this is a 6-month chart of the iOS downloads. The trend is not going in the right direction.
fitbit-ios-downloads

Another indicator is submitted reviews. It’s somewhat more accurate as it’s quantifiable.

fitbit-ios-reviews-2016

Looking at the aggregated reviews to get a guidance on the percentage growth is one way to set expectations. The third quarter of 2016 had 15% more reviews than 2015, well below the 24% expected revenue growth.

The Secret Sauce is Called Sell-In

Fitbit reports sell-in results,  as do most every consumer goods companies.  Sell-in refers to Fitbit selling products to distributors in certain markets and retailers in others.  What Fitbit doesn’t report is sell-through results or the sales to end users/consumers. E.g  Fitbit realizes their revenue when they sell to BestBuy and they put it on their shelves, not when the customer buys the product.

The Insiders Perspective

Nasdaq is pretty good on sharing insider trades in a digestible format. (You can find it here)


insider-trades

Insider Trades of their EVP of Interactive Design

tim-roberts

Insiders decreased their positions this past quarter and I decided to dive a bit deeper to their officer transactions, I only found one. Most of the time insider has automatic buy and sells, those should be ignored. However, when they go out and sell additional share it is of interest like the 38k shares on September 7th. This is a negative sign for this quarter and it’s interesting to pair this with James Park’s (Fitbit CEO) statement on the top management team holding on to their stock throughout the year.

The Bearish sentiment

While the company is not GoPro (GPRO) or Skullcandy, the business model is identical.  Fitbit does have a higher addressable market than does GoPro based on units sold since product introduction, but nonetheless as it is with all hardware providers, revenue growth is only achievable during expansion periods where distribution gains can be had by the company.  It has been the case with this business model throughout history.  With this in mind, that is why the revenue growth deceleration has been and is expected to be so steep and until revenue declines are exhibited.  Furthermore, that is why the short participation is so extreme with these hardware business models.  Shorts understand it is just a matter of “when” revenue and other metric declines are found, not “if”.  For that matter, the short interest is a constant and will not decline under 25% of float regardless of upcoming results.  No short squeeze will be presented, but rather a repositioning of short interest should higher stock prices be presented. Keep an eye on long-dated option open interest come 2017. – Seth Golden

Margins

In the last quarter, the average selling price was $99 ($88 in the same quarter in 2014 and $63 in 2013), and we can expect that the average selling price will continue to go up as there is only one device that costs less than $100 regularly – the Fitbit Zip for $60. The two devices which accounted in the last quarter for 54% of revenue – the Fitbit Alta and the Fitbit Blaze – cost $130 and $200. The most sold device in the last years was probably the Fitbit Charge, which costs $150 right now.

Intrinsic Value

Fitibit now has a 44% short float and this is because of the “one-trick pony” concept where a company creates something and cannot innovate with new products. When a stock is pushed to the bottom it’s always interesting to look at the fundamentals and discounted cash flow will help us with that. Fitbit is now trading at 13.28 , if FIT would only grow with 2% per year and setting a 8% discount rate would give it an intrinsic value of $13.57.
So if we set low but more proper expectations with revenue growth of 25%, 20%, 15%, and then 10% for 5 years, and finally 3% in perpetuity. We can even raise the discount rate to 10%, and it would still give us a price of 17.25 per share. Finally, if we increase their Net income margin from 6% with 0.5% each year  for the next 9 years the intrinsic value would be $27.56 per share.

 

Conclusion

Even though Fitbit sees some trouble with selling to end customer there is a brighter future around the corner. They just released their updated Charge 2 and Flex band ahead of the holidays plus they have held back on their marketing until Q4 to really push their sales. The stock price is already low enough that it has all of these factors included, so a positive outlook for next quarter will bring the price back up. If they have stuffed the pipeline the stock till tumble to new lows and it will be an interesting buy opportunity for value investors.

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