Subtitles section Play video Print subtitles Good day, and welcome to the Fitbit Second Quarter 2018 Earnings Call. This call is being recorded. At this time, I would like to turn the conference over to Tom Hudson. Please go ahead, sir. Good afternoon, and welcome. Fitbit distributed a press release detailing its quarterly results earlier this afternoon. It's posted on our website at www.fitbit.com and also available from normal financial news sources. This conference call is being webcast live on the Investor Relations page of our website where a replay will be archived. On this call, all financial measures are presented on a non-GAAP basis except for revenue, which is a GAAP measure. A reconciliation of GAAP to non-GAAP financial measures is provided in our posted earnings release or in other earnings presentation materials posted on the Investor Relations page of our website. This conference call will contain forward-looking information, which is subject to risks and uncertainties described in Fitbit's filings with the SEC and in today's press release. Actual results or events may differ materially. We will begin with a commentary from James and Ron and we'll then open the call to questions. We are going to limit the call to about an hour, so we apologize in advance if we don't get to all your questions. Let me introduce Fitbit's Chairman and CEO, James Park. James? Thank you, Tom. Thank you to everyone participating in today's call. I'm pleased to report that for the sixth quarter in a row, we have delivered on our financial commitments and are making progress in our multiyear transition, which include adapting to the changing wearable device market, transforming the business from an episodic-driven model centered around device sales to more non-device recurring revenue, deepening our reach into health care and increasing our agility and optimizing our cost structure. Revenue for the quarter was $299 million. We saw continued momentum from our mass appeal smartwatch, Fitbit Versa, which sold out in the quarter. The introduction of Versa strengthened our brand and relevancy and highlights the opportunity to regain market share as we progress the smartwatch category and continue to deliver both hardware and software offerings that consumers find compelling. Fitbit sold 2.7 million devices in the second quarter, up sequentially and with a year-over-year rate of decline in devices sold dropping to 20% and hardware and software offering versus 27% in the first quarter. The success of Versa has improved the company's positioning with retailers, fortified shelf space with Fitbit brand and has provided a halo effect to our other product offerings. Retailers have been looking for a counterbalance for Apple and Versa has delivered. In the second quarter, Fitbit Versa outsold all Samsung, Garmin and Fossil smartwatches in North America combined. With the strong consumer receptivity for Versa, demand has outpaced supply and we have chosen to add additional production lines. Since launch, we have also seen a significant uplift in North America POS trends. We also believe the channel reduction of trackers has on its course and have increased confidence that Q2 will mark the trough in the year-over-year decline in Tracker sales. Our confidence in the trough and the decline in Tracker sales is driven by clean Tracker channel inventory levels, consumer feedback and our product pipeline. As we look forward, we believe our improved forecasting and lower-risk approach in new product introductions reduces the risk of an imbalance between sell-in and sell-through and gives us confidence in the path ahead. In the second quarter, 60% of activations came from new users while 40% came from repeat buyers. Of the repeat buyers, 51% were previously inactive for 90 days or more. The percentage of repeat buyers coming from previously inactive customers has significantly improved from 39% in the second quarter of 2017, demonstrating that our newest devices can reengage inactive customers and bring them back to the Fitbit platform. We have always emphasized there's no one-size-fits-all when it comes to health and fitness, and we have always provided a choice for consumers across form factor, feature and price. While smartwatches continue to grow at a rapid pace and present a strong opportunity for future growth, there is still a large community of users who prefer the Tracker form factor and who are looking for powerful health and fitness features at a more accessible price. For example, we sold 50% more Alta HR devices in the U.S. during the 2018 Amazon Prime Day than the prior year. In addition, our Charge franchise has sold over 35 million devices and Charge 2 continues to be our best-selling Tracker with over 15 million sold nearly 2 years after it launched. Industry analysts also note that Trackers will continue to be an important part of wearable categories overall. According to IDC, sales of Trackers are expected to reach 46 million units in 2018 compared to 43 million smartwatches globally. We see an opportunity to reinvigorate the category through innovation to successfully serve the needs of this large consumer segment. Fitbit Ace, our recently introduced kids' device as a great example. With this product, we are introducing a wearable to a younger demographic while making fitness fun and helping families connect and build healthy habits together. In addition, we continue to invest in our social and software features. We believe our active community of users provides a barrier to commoditization and a unique value proposition. 56% of our active users viewed the Feed in the second quarter. Our recently introduced female health tracking feature has also been well received with more than 2.9 million sign-ups. We know that wearable devices can help people get healthier. The question now is how these devices will continue to evolve and what role they will play in health care. We have been working to lay the foundation for growth into the health care channel by strengthening our relationships with key players in the health care ecosystem, building out our direct sales team, adding capabilities at the human coach platform and collaborating with developers to create health-focused apps and clock faces. The strength of our consumer offerings and our ability to engage people and drive behavior change directly supports our health care efforts. We see ongoing evidence that health care use cases continue to grow and evolve. Some examples include payers embracing wearables and providing financial incentives to motivate behavior change, condition management, clinical research or connecting patients and care teams. I'm proud to say that as of today, Fitbit Health Solutions has the ability to provide solutions to over 100 health plans across the U.S., including Blue Cross Blue Shield and Humana. In terms of clinical research, we continue to help researchers pioneer new ways to use our devices to drive better health outcomes. In a new study, researchers from Cedars-Sinai Medical Center and Johns Hopkins University found that a Fitbit device successfully gathered real-time objective data in patients with cancer, helping clinicians predict outcomes. We are also expanding the work we are doing with the University of Michigan's Intern Health Study, which this year will follow 2,000 new doctors better understand how intense and changing work schedules contribute to a resident's mental health. When it comes to health, we want to leverage the investments we are making across both our consumer and Health Solutions business. As such, we are focused on chronic condition areas that have corollaries on the consumer side: diabetes and weight management, heart health and fitness, sleep apnea and sleep quality and mental health and stress. Our ultimate goal is to help providers, health plans and clinical researchers better support their patients outside the walls of the clinical environment and help our users better understand their overall health and wellness. We often receive testimonials from our customers telling us how their Fitbit devices either raised awareness about a potential medical issue or changed their lives by changing their behavior. These examples include a young mother of 3 who identified that she had a serious condition called postural orthostatic tachycardia syndrome or how a teenage girl discovered she was suffering from supraventricular tachycardia, a defect that causes a faster-than-normal heart rate due to an error in electrical impulses. It is these types of testimonials that give us confidence that we have the building blocks to create a device and software offering. We also introduced a number of key health apps in Q2 that brings important health information like blood glucose numbers to the wrist, helping to bridge the gap between consumer and health care. As part of this program, we introduced new health partner apps and clock faces, including Walgreens, One Drop and Limeade. Built using Fitbit's software development kit, the apps and clock faces will give Fitbit smartwatch users new options to improve wellness and help manage conditions like diabetes. Wearable devices are easy to use, unobtrusive and motivating while the benefits of increasing activity and health awareness come with virtually no side effects. Finally, before turning the call to Ron to discuss our financials in more detail, I wanted to discuss our operating efficiency. We continue to be on track, reduce operating costs 7% but made a conscious choice to pull forward costs and increase our media and advertising spend to support the launch of Versa. As I mentioned earlier, Versa's success strengthens channel partner relationships and we believe provides momentum into the back half of the year. Also, we continue to make progress transitioning our data infrastructure to Google's cloud where we expect cost savings to begin in 2019. I am also excited to announce that we have hired a new leader for engineering organization, Koby Avital. Koby joins us from Priceline.com where he was their Chief Technology Officer. As Executive Vice President of Engineering, Koby will focus on hardware, software and firmware engineering. Eric Friedman will maintain his role as CTO, focusing on data security and advanced research. With that, let me turn the call over to Ron to discuss the quarter in more detail. Ron? Thanks, James. My prepared remarks will be focused on the financial overview of the second quarter results. I will then provide our guidance for the third quarter of 2018. Before I go through the details, I would like to remind investors that all financial references are to non-GAAP measures, except for revenue, unless I specify otherwise. And all financial comparisons are on a year-over-year basis unless otherwise specified. Fitbit sold 2.7 million devices and generated $299 million of revenue in the quarter, down 15%. The 15% decline in revenue resulted from a 20% decline in devices sold, partially offset by an average selling price increase of 6% to $106 per device. The average price of Trackers sold declined year-over-year, driven primarily by a mix of fewer Blaze units rather than competitive dynamics. Versa's sales, at an average selling price higher than Blaze, more than made up for the Tracker delta. However, with Versa contributing the vast majority of smartwatch sales in the quarter, having a sales price less than Fitbit Ionic, smartwatch ASPs declined from the prior quarter. Accessory and other revenue added an additional $5.23 per device sold. Accessory revenue was negatively impacted by fewer units sold while non-device paid revenue grew 34% but remains immaterial to overall results. U.S. revenue represented 61% of total revenue or $182 million, declining 8% in the quarter. International revenue declined 24% to $117 million but growth varied significantly between regions. APAC revenue advanced 66% to $35 million while EMEA revenue declined 39% to $66 million, driven by higher promotional activity and weakness in the U.K. market. The U.K. market has lagged in its transition to smartwatches and thus was disproportionately exposed to contraction in the Tracker market. We expect a reversal of this trend in Q3 and a return to growth. Americas, excluding the U.S., declined 35% to $16 million. As James indicated, broadly speaking, retail channel inventory is relatively clean with some Versa demand unable to be fulfilled, given supply constraints and Tracker inventory now in line with expected consumer demand. Our direct consumer business, Fitbit.com, represented 14% of revenue and declined 9% to $43 million. Gross margin declined 210 basis points to 40.9%. Decline was expected, driven by the growing mix of smartwatch revenue, partially offset by lower warranty costs and lower customer support contact rates. Operating expenses increased 1% to $194 million. Research and development cost increased 6% to $72 million. Despite an objective to lower our operating cost, we are maintaining our investment and innovation to transform the business. Our goal is to drive efficiency in our device business while investing in software, services and Fitbit Health Solutions. Sales and marketing costs were flat year-over-year at $96 million. We increased investment with higher media spend to support the launch of Versa but benefited from the improved quality of our devices. As DPPM has improved, case volume has shrunk, leading to lower customer support spend. In addition, we spent less on point-of-purchase displays. General and administrative expenses were $25 million. In addition, we have reduced our real estate footprint in San Francisco. This not only lowers our operating expense run rate but removes approximately $81 million in lease obligations from our future commitments. Operating loss was $71 million with other income of $4 million. We recorded a tax benefit of $12 million, resulting in a net loss per share of $0.22 in the quarter. Cash flow from operations was a negative $67 million, and capital expenditures in the quarter were $16 million, resulting in a free cash flow loss of $83 million, better than our expected free cash flow loss of $85 million. We ended the quarter with $580 million in cash and short-term investments and no debt. In addition, on July 3, we received a $72 million tax refund payment from the IRS. We expect to receive approximately $8 million in additional tax refund payment but the timing is uncertain. Now let me turn and address our guidance. We expect third quarter results to benefit from the lessening in year-over-year decline of Tracker revenue and continued growth of our smartwatch franchise. We expect revenue to decline approximately 3% on a year-over (sic) [ year-over-year ] basis to a range of $370 million to $390 million and roughly flat gross margins in the second quarter. As a percentage of revenue, we expect Q3 operating costs to trend materially lower. We expect free cash flow of approximately negative $30 million in Q3 and net income per share between a $0.02 loss and a $0.01 profit. Our tax rate will vary on our ability to achieve profitability and the geography of income. We expect tax to shift from a benefit to an expense of approximately 2% and a basic share count for approximately 247 million shares. Stock-based compensation is expected to be approximately $26 million. We are reiterating our full year 2018 guidance. We have increased confidence that Q2 market trough and the year-over-year decline in Tracker sales anticipate continued strength in smartwatch growth. Similar to Q3, we anticipate gross margins to be roughly flat to Q2's at approximately 41%. The device mix shift will also benefit average selling price on a year-over-year basis but will not offset the decline in Tracker devices sold, and as such, we are forecasting an overall year-over-year decline in devices sold. Relative to Q2, average selling price is expected to be roughly flat. We expect to continue to grow our Fitbit Health Solutions business and increase our premium subscribers, but this growth will be relatively immaterial to our wearable device revenue. The net result is that we are maintaining our revenue expectations of approximately $1.5 billion. We are on track to reduce operating expenses by approximately $60 million from 2017 levels to $740 million, consistent with our previously stated commitment.