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  • 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.