Fitbit's (FIT) CEO James Park on Q4 2015 Results - Earnings Call Transcript

| About: Fitbit, Inc. (FIT)

Fitbit, Inc. (NYSE:FIT)

Q4 2015 Earnings Conference Call

February 22, 2016, 05:00 PM ET


Brad Samson - IR

James Park - Chairman and CEO

William Zerella - CFO


Katy Huberty - Morgan Stanley

Erinn Murphy - Piper Jaffray

Marjorie Lopez – Barclays

Ross Sandler - Deutsche Bank

Steven Wardell - Leerink Partners

Robert Peck - SunTrust

Matt Schindler - Bank of America

Jim Duffy - Stifel

Betty Chen - Mizuho Securities

Stanley Kovler - Citi Research

Brad Erickson - Pacific Crest Securities

John Kernan - Cowen


Good day, and welcome to the Fitbit Fourth Quarter Full Year 2015 Earnings Call. As a reminder, today's call is being recorded.

At this time, I would like to turn things over to Mr. Brad Samson. Please go ahead, sir.

Brad Samson

Good afternoon. Fitbit distributed a press release detailing its quarterly and year end results earlier this afternoon. It is posted on our website at 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 we will refer to both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in our posted earnings release. This conference call will contain forward-looking information which is subject to risks and uncertainties described in Fitbit's filings and with the Securities and Exchange Commission and in today's press release and actual results or events may differ materially.

We will begin with commentary from James and Bill and then we’ll 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 questions.

Let me now introduce Fitbit's Chairman and CEO, James Park. James?

James Park

Thanks Brad. Good afternoon, everyone. Fitbit had an outstanding holiday season to finish remarkable year of operating and financial results, as well as significant progress on our strategic direction.

A year ago we introduced several new products that added important new capabilities that changed the market for connected fitness wearables and devices. We are beginning 2016 with what we believe are significant steps forward in our products’ value proposition.

Our 2015 growth in the U.S. and in 62 other countries around the world, demonstrated that people desire for data, inspiration, and guidance in pursuing their fitness journeys is a worldwide movement.

While Fitbit is known as a consumer brand, the real potential of our brand and technology is to become a digital health platform that improves people's health and integrates into the healthcare ecosystem.

Digital health refers to the emergence of powerful technologies that combined can help people lead healthier lives, reduce healthcare costs, and broaden the reach of our healthcare system. These technologies include what Fitbit is already pioneering, more powerful sensors that continuously monitor useful biometrics, mass [indiscernible] of health data in the cloud where analytics enable insights, and guidance and coaching to help consumers make important changes to their lifestyles and daily behaviors.

We also believe that preventative care will be a much more visible and important part of the entire healthcare system and that one significant outcome of digital health will be to make health data more actionable and meaningful when it comes to maintaining people's health.

Fitbit can play a key role. Our platform consisting of devices, apps, social motivational features, advice and personalized coaching is aimed at helping people make key behavioral changes to be more active, exercise more, eat smarter, eat better and manage their weight. These are exactly the kinds of behavioral change that experts in diabetes, hypertension, asthma, obesity, and sleep apnea, as well as mental health conditions such as depression and anxiety, believe can change the course of those diseases.

The size of the problem we address is enormous. For example, the world health organization reported in 2015 that 39% of adults globally, 3 billion people are overweight. Let me give you some more tangible examples of the early part of our journey towards digital health.

Fitbit trackers are distributed as the device of choice in several disease management programs for two of the largest U.S. health insurers. One program is focused on diabetes management and has been offering Fitbit trackers to its members as a component of the overall program since 2013.

The other programs focused on weight management provides personal coaching to improve nutrition activity, blood pressure, cholesterol levels, and overall health. Fitbit Zip trackers are offered as part of the program. Over a six month period, 73% of participants lost weight with an average weight loss of 5% of total body weight.

We are also beginning to see improved health outcomes for the employees of some of our Fitbit wellness customers. Indiana University Health reported that of the participants in its wellness program, 40% saw reduction in BMI and those participants with diabetes saw a 60% reduction in their hemoglobin A1 C levels.

Fitbit also is increasingly active in the medical research community by supporting researchers who are incorporating Fitbit trackers and interactive features into their efforts. We offer the researchers flexibility in working directly with our open API infrastructure or through partners like Fitabase who have specialized tools to cater specifically to the needs of the research community.

While it's early, some of the initial examples we are seeing are very exciting. Mayo Clinic published research that by monitoring activity data, it could more accurately predict surgical recovery time. The study demonstrated that patients who took the most steps everyday were significantly more likely to leave the hospital earlier than those who are less mobile.

Those who walked 818 or more steps by the second day after surgery spent less than 5 days in the hospitals, while those who walked 220 or less steps were hospitalized for more than 6 days.

Another example is a study of postmenopausal women in their 50s and 60s who are overweight and generally not very active. The researchers found that the women who use the Fitbit tracker increased the amount of time they spent for exercise by about an hour per week while those who used speedometers do not have significant improvements.

All of this progress has been powered by advanced technology research which is staffed by experts and scientists in fields such as biomechanics, [indiscernible] biomedical engineering, exercise physiology, biomedical signal processing.

An example of our advanced research is PurePulse 24/7 continuous optical heart rate technology which was developed in-house, as were nearly all of the core technologies for things like step counting, calorie burned, floors, reminders to move, real time pace and distance. These developments have played a significant role for us to cross a number of products and we’ll continue to do so in the future.

At year end 2015, R&D headcount increased to 624 compared to 226 at year end 2014. As a key part of our overall increase in R&D in 2016, we plan to further expand our capability to create breakthrough technologies.

While it's still early in Fitbit's integration into the larger healthcare world, we believe the connected health and fitness market has great potential to help people to take ownership of their health, and deliver better health outcome. We believe we have an important role to play that will allow us to become a broader digital health company.

Next, I want to focus on active users, sales, channel growth, and marketing. Much of our success is due to the power and size of our user community. People are more likely to buy our products because their friends and family are already users and they are less likely to leave to a competitive ecosystem due to the same dynamics.

This is a powerful competitive mode for business. This is supported by our latest full year active user and registered device data. At December 31, 2015, there were 16.9 million Fitbit active users compared to 6.7 million at December 31, 2014 for a growth rate of 152%. Active users represented 59% or 28.8 million registered device users at year end 2015.

What's exciting to me is that we added 18 million new registered device users in 2015 of which 13 million or 72% were active users at year end 2015. These gains are driven by our new products for which we have seen improved engagement and retention data.

In that regard, a key focus for us has been to increase the density of our social graph as measured by the average number of friends. This metric climbed 53% in 2015 to 7.5 friends from 4.9 at the end of 2014.

This is important because having more friends typically results in increased personal activity levels. I think that speaks directly to the engagement of the total Fitbit user experience.

As I switch gears to talk about sales and distribution trends, let me start with an update on our two newest products Fitbit Alta and Fitbit Blaze. In our latest data from last week, preorder volume for our new products exceeded our internal forecast as to the accessory attach rate.

Further, even though the product hasn't yet shipped, as of last week Blaze was a number two best seller in Amazon smartwatch over $100. While that early data is not guarantee of future sales, we believe these are all positive signs.

Looking at distribution, we finished 2015 in more than 50,000 stores worldwide compared to 45,000 at the end of 2014 and we are now in 63 countries around the world. The U.S. comprised 74% of full year 2015 revenue. In the U.S. with greater inventory availability in 2015 compared to 2014, many of our retailers more than doubled their Fitbit sales. I'm sure you saw many of the comments by U.S. retailers about Fitbit's contribution to their 2015 holidays.

For 2016 we are comfortable with our U.S. store account and are working with our major retailers to expand shelf space for new products and accessories. Internationally we have a lot of room for growth. We are now in 62 countries beyond the U.S. In many of those countries we are early in our ramp up.

The EMEA region comprised 11% of our 2015 revenue with the U.K. as the most developed markets, with opportunities for growth in other countries through retailers such as, Media Markt, Saturn, Finack and Darty.

Just the EMEA countries in which we currently have our presence have a population of more than 500 million people. For the APAC region, which comprise 10% of our 2015 revenue, Australia continues to be our most penetrated country where we experience the strong holiday season.

In the Indian market which we entered last summer, we are now the two largest retailers Chromo and Reliance. We are also selling to Amazon India's online represents a significant channel there. Other channel opportunities in sports and department stores remain. We implemented strong marketing activities for the November Diwali holidays, helping ramping our sales in the country.

For China we continue to expand our distribution even while we are still working on localizing our firmware for China, Japan, and Korea. UNI, the largest brick and mortar retailer in China is rolling out in a measured process starting with the largest stores in key urban centers such as Nanjing, Shanghai, Longzhu and Beijing.

Online represents a significant channel in China as well. In share numbers, APAC represents our biggest global opportunity with three billion people just in the countries we are touching today.

Many other regions, countries, especially China and India, have growing middle classes which are trending on the same kinds of health issues that we’ve experienced in the west. For example, there are 150 million people in China with type-2 diabetes which is preventable.

Next, let me talk about Fitbit’s marketing activities. We believe that our marketing engine is a core asset and competitive differentiator. Fitbit’s marketing activities play a critical role in driving our growth in all regions, and is carefully coordinated with our sales and marketing development processes in each individual market.

We have developed the playbook that turns on key marketing support timed with the development of our market channels. Let me give you a couple of examples. Expect that all of you saw our Blaze commercial during the Super Bowl.

Television advertising went from non-existence before Q4, 2014, to become a key part of our playbook as we ramp in each region with campaigns in 19 countries in 2015. There's one specific market example in India since launching there in the summer in Q4, we reached sufficient channel availability that we could ramp up our marketing and peer activities to drive interest in retail traffic.

As a result, we saw a strong ramp in sales with Diwali festive. PR is also one of our key tools. In the U.S., for example, over the fourth quarter, Fitbit was featured in 113 gift cards, 93% increase from 2014. The coverage that PR generates is key to ramp up and brand building in every country.

Another core strategy is infiltrating popular culture and creating a health and fitness movement powered by Fitbit. That includes, sponsoring a wide range of events and programs. Great examples of performance events include running and cycling venues such as our first cycling sponsorship this fall, tied to our search cycling ambassador Jens Voigt for the significant visibility achieved by integration with version of dancing with the stars.

In Q4, we did a charity program called Fit For Good tied to the American Heart Association, the American Diabetes Association, and the National Multiple Sclerosis Society. Participants walked for one of the charities to which Fitbit donated.

We had more than 300,000 participants, who logged more than 25 billion steps and generated tremendous social activity, media coverage, and celebrity participation from people like Shaquille Okay.'Neal, Amy Schumer, Star Jones, and Patty LaBelle.

These big events drive tremendous visibility and brand power. We also are focused on broader based everyday events that augment our brand. In the U.S., we created a series of free monthly workout from cities across the country led by local fitness experts.

We did our first Fitbit local event in California in the fourth quarter and expect to expand the program this year. Another example is a weekly non-profit park-run club in the U.K. that leads weekend runs in a 100 parks across the country.

Evolution of our merchandising is increasingly important as the complexity and breadth of our products and accessory options grow. Tremendous work goes into that and you’ll see continued expansion and greater interactivity in our displays. For example, trialing a touch table interactive display that provides a much more robust customer experience.

Finally, partnerships enhance a customer’s perception of community and value, strengthening engagement with our brand. We've talked previously about our partnerships with Tory Burch, mind-body connect and thermos. Two weeks ago, we announced a new partnership with fashion house public school, where new Fitbit tracker accessories were part of public school’s runway show during New York fashion week.

There is so much more I could share with your from our global efforts but I think these examples should help you understand the strength of our marketing engine as a core asset and competitive differentiator, enabling Fitbit to become one of the leading health and fitness brands in the world.

Let me wrap up with some commentary about our Fitbit wellness programs. In the fourth quarter, we continue to see momentum in the corporate wellness market, particularly given the growing body of positive evidence.

For example, a recent study performed by the health enhancement research organization found that companies that invested in best practice, health and well being programs, outperformed the SMB 500 index over a six year period.

We believe that the Fitbit wellness platform provides a means for companies to be successful with their programs by driving more engagement participation.

Our data indicates that many C-level executives could be strong proponents of wearable technology investments as part of employee benefits and wellness. In a recent survey we conducted with 200 CEOs of companies with a 1,000 to 10,000 employees, we found that 95% of the CEOs were interested in providing additional incentives to employees who use a fitness tracker.

In 2015, we added over 1,000 new enterprise customers with integrated Fitbit wellness into their overall wellness strategies. The corporate wellness channel closed out Q4, 2015 by adding notable customers including Fortune 500 companies such as Wendy’s, and Marathon petroleum and not-for-profit organizations such as YMCA, Teach for America, and University of Kentucky.

We have also been encouraged by the results that our customers have been seeing such as the Indiana University health results I noted earlier, the 40% of participants decreasing their BMI and 60% of users with diabetes decreasing their hemoglobin A1C levels.

Our corporate wellness business is predominantly U.S. based. And we'll be working to expand that to select international markets in the future. I covered a lot of ground today, but I think it’s important for you to see our long term vision of Fitbit as a digital health leader.

It’s also important to see Fitbit’s key differentiating assets of innovation and technology leadership, user community, distribution strength, and brand power. Let me now give Bill Zerella, our CFO, a chance to provide some financial highlights. Bill?

William Zerella

Thank you, James, and for all of you joining us today. My prepared remarks will be focused on our financial overview of the fourth quarter and full year of 2015, as well as our related business trends. I will then provide our guidance for the first quarter and fiscal year of 2016.

The fourth quarter marks our third quarter out of the gate since going public. We are once again very proud of the operational performance that generated these outstanding results.

Q4 revenue, up $711.6 million represents a 92% increase year-over-year from $370.2 million in the fourth quarter of 2014, this on a very strong holiday season, especially in the U.S. We achieved this strong revenue result in a foreign exchange environment that continues to be challenging.

In fact, if adjusted for the change in currency rates year-on-year, our fourth quarter revenue would have been $728.2 million. Full year 2015 revenue was 1.86 billion, a 149% increase from 2014 compared to our most recent guidance of $1.77 billion to $1.8 billion.

Adjusting for currency effects, the growth in full year revenue would have been 157%. Geographically, revenue from the United States accounted for 75% of our Q4 revenue, followed by 12% for EMEA, 8% from Asia Pac, and 5% from the Americas excluding the U.S.

The strength of this year’s U.S. holiday season tipped the balance even more heavily towards the U.S. than last year’s fourth quarter. Fourth quarter revenue from the United States grew 100% year-over-year. Revenue from EMEA grew 191%, and Asia Pac grew 6%. Asia-Pac grew only marginally due to channel fill in the fourth quarter of 2014, in connection with our then new products. Americas, excluding the United States grew 77% year-over-year.

We believe growth in our existing international markets and expansion into new countries continues to represent exciting opportunities for Fitbit and justify our increased investment in sales and marketing to increase our presence in these regions.

Our fourth quarter revenue growth continues to be driven by our three newest products; Charge, Charge HR, and Surge, collectively accounting for approximately 79% of our revenue. The mix shift towards higher priced products resulted in our average selling price for devices increasing 23% year-over-year to $85, from $69 in the fourth quarter of 2014.

That also represents a modest sequential 71 basis point increase from Q3, 2015. As a reminder, my remaining remarks about financial performance, all financial references are to non-GAAP measures unless I specify otherwise.

Gross margin in the fourth quarter of 2015 was 48.8%, up 286 basis points year-over-year at 50 basis points sequentially from Q3. Adjusting for FX, Q4 gross margin was 50%. That compares to 45.9% in the fourth quarter of 2014.

Adjusting for FX, the year-on-year increase in gross margins is due to the benefit of continued unit cost reductions on Charge, Charge HR, and Surge, which are maturing in terms of cost efficiencies such as production yields and material costs down.

For the full year 2015, gross margin was 48.5% compared to 50.7% in 2014, primarily reflecting the impact of currency effects and a much lesser impact of new products introduced at slightly lower margins.

We undertook activities to mitigate currency effects in 2015, with some further progress in the fourth quarter. Operating income for the fourth quarter increased 59% year-over-year to $118.3 million or 17% of revenue compared to $74.2 million or 20% in the fourth quarter of 2014.

Fourth quarter operating expenses were $228.8 million, up 139% year-over-year and up 96% quarter-over-quarter. The year-over-year increase was driven by continued investment across all function of roots while the sequential increase has driven large part by increased sales and marketing expenses due to the launch of significant media campaigns for the holidays in several markets.

It was also a substantial increase in R&D spending both year-over-year and sequentially. Fourth quarter R&D was $46.9 million, increasing 174% year-over-year and 27% sequentially. We continue to invest in software and fitness tracker device development and see R&D as the key investment for maintaining our track record of innovation that drives our differentiation.

For the full year 2015, operating income increased 99% to $372.9 million or 20% of revenue compared to $187.6 million or 25% of revenue for full year 2014. Full year 2015 operating expenses were $528.5 million compared to $190.4 million in 2014, predominantly driven by our increasing investments in R&D and sales and marketing.

Yearend total headcount increased to 1,101 from 905 at the end of Q3, 2015 and 469 at the end of 2014. We expect to continue to hire aggressively as we enhance our existing products and services, design and develop new products and services, and expand internationally.

Fourth quarter 2015 adjusted EBITDA increased 66% year-over-year to $125.3 million or 18% of revenue, compared to $75.6 million or 20% of revenue in the fourth quarter of 2014. The year-over-year decrease reflects our higher spending level on sales and marketing and R&D.

For the full year 2015, adjusted EBITDA increased 104% to $389.9 million or 21% of revenue compared to $191 million or 26% of revenue for full year 2014. Net income was $87.4 million for the fourth quarter of 2015, a 99% increase year-over-year resulting at earnings per diluted share of $0.35.

Fourth quarter EPS benefited from an effective tax rate for the quarter of 26.1% compared to 39% in the year ago fourth quarter. There were $246.6 million diluted shares used to calculate the fourth quarter of 2015 diluted earnings per share.

Net income for the full year 2015 was $254.1 million, 123% increase compared to the full year 2014. Resulting an earnings per diluted share of a $1.07. Full year 2015 EPS benefited from an effective tax rate for the year, up 31.2% compared to 37.5% for 2014.

Turning to the balance sheet, we ended 2015 with $664.5 million of cash and short term investments and no debt. This is an increase of $89 million from the end of Q3, 2015 and included net proceeds of $84 million as a result of our follow on offering in November 2015.

At year end, accounts receivable increased $230 million year-over-year to $469.3 million. In Q4, 15 DSOs were 56 days compared to 48 in Q4, 2014. Inventory was a $178 million, a decrease of $98 million from September 30, 2015, reflecting a burn down of inventory during the holiday season, resulting in an increase in inventory return to 6.4% from 3.7% in the prior quarter. Because we were supply constrained in 2014, year-over-year inventory returns decreased from 9.1% in Q4, 2014.

Turning to guidance, we expect 2016 revenue in the range of $2.4 billion to $2.5 billion driven by new product introductions and geographic expansion, with gross margins ranging from 48.5% to 49% driven by the margin profile of our new products as well as our accessory strategy.

Operating margins reflect strategic investments we are making this year to further develop our digital health strategy as outlined by James, expand our corporate wellness offerings, support our 2017 and 2018 product road map and further build our back office infrastructure to support our increasing scale and global breadth, including migrating our business systems to SAP.

With this in mind we expect 2016 EBITDA ranging from $400 million to $480 million and EPS ranging from $1.08 to $1.20. Stock based compensation is expected to be in the range of $85 million to $95 million.

Our guidance reflects an effective tax rate of approximately 30%, which will vary depending upon the mix between domestic and international revenue, and a fully diluted share count of 245 million to 251 million.

Turning to Q1, 2016, we expect several dynamics will drive our results. For the first time in our history, we will be doing a global launch this quarter of our new products, Blaze and Alta. This entails launching media campaigns around the world, driving higher sales and marketing expenses for the quarter.

Also the timing of shipment into our sales channels will result in the majority of reorders especially for Alta in Q2. Lastly we expect to incur additional manufacturing cost in Q1 to maximize production of our new products to meet expected demand which will impact gross margins.

With those dynamics in mind, for the first quarter of 2016, we estimate revenue in the range of $420 million to $440 million. Non-GAAP gross margin is expected to be approximately 46.5%. We expect this to result in non-GAAP diluted net income per share in the range of $0.00 to $0.02.

First quarter adjusted EBITDA is projected to be in the range of $5 million to $16 million, and stock based compensation expense is estimated at $18 million to $20 million.

This concludes my prepared remarks. I will now turn the call back over to James. James?

James Park

Thank you all for joining us today. We believe we began 2016 with strong customer engagement and retention, plans for accelerating pace of innovation and competitive differentiation, and a foundation of significant revenue growth and profitability.

Operator, we are ready to take some questions.

Question-and-Answer Session


[Operator Instructions] Your first from Katy Huberty with Morgan Stanley.

Katy Huberty

Yes, thank you. During the year, you added 10 million active users but you sold over 20 million new devices, why isn’t that ratio higher for the Company and then maybe you can talk about what initiatives you have in place to either improve the length of engagement or just to better monetize that active user base that you do have?

I know around the IPO you talked a lot about the potential to invest in software and services for that monetization story, and we haven’t seen much on that front over the past six to nine months, thank you.

William Zerella

Hi Katy, it's Bill, how are you doing? So, just to make sure we have all numbers correct here. So, we added 18 million new registered device users in 2015, of which 13 million of those were active users at year end. Okay?

So, that's the metric that we've been most focused on, which is what kind of retention rates are we gaining from primarily our new products and a significant portion of our revenue and devices sold obviously last year were from our new products. So, that's the metric that we look at and that's trending out.

Katy Huberty

And then can you just maybe, James, can you talk about what plans you have in place just from a high level to better monetize that installed base and why we haven’t seen more on the acquisition front as it relates to potential extension to software and services?

James Park

On the acquisition front, obviously that will continue to be a big part of our strategy, but we're in a situation now where we’re still evaluating a lot of opportunities, but we are not in a rush to overpay for properties just yet. But again, it’s still something that we still have a keen eye on.

In terms of improvements for engagement and monetization of existing users, look a lot of our R&D which is going to increase about 100% this year, is going to be focused on the software side and a portion of that is going to be focused on really providing guidance for users to help. So I think 2016 is where we're going to see a lot of software.

Katy Huberty

Thank you.


Our next question will come from Erinn Murphy with Piper Jaffray.

Erinn Murphy

Great, thanks. Good afternoon. Just in terms of cadence bill of the EPS guidance for fiscal '16, can you just help us think about the general shape of the earning cadence in Q2 to Q4. I guess particularly in the fourth quarter, I know the last couple of years that fourth quarters represented somewhat in that mid-30% range contribution of your earnings. Any, kind of, sign post to think about that curve would be very helpful.

William Zerella

Hi, Erinn. So obviously, we'd expect Q4 to continue to be a big part of our year, right, driven by holiday sales. So the cadence between now and then, it’s, frankly, dependent upon the cadence of reorders that we see with our new products.

One of the drivers to Q1 revenues being guided to where they are is that we don't see any reorders for Alta starting to happen until Q2. So there could be some distortions from historical cadence, and it’s really very much driven by some of these other factors.

So all I can tell you at this point is, Q4 will continue to be a pretty big quarter for us. Whether it will be bigger this year than it has in the past, I think it’s too soon to say.

Erinn Murphy

Okay. That's helpful. Then in the second quarter, one would have seen that the second quarter cadence would be a greater contribution than second quarter of last year just based on how you're thinking about that reorder for the new product.

William Zerella

Erinn we are going to stop short of providing any guidance obviously, Erinn, for Q2. So all I can do right now is to give you visibility for Q1, and I'd just say you can look to some of the historical trends but again Q4 will be a big quarter as it has in the past, at least as high as prior years.

Erinn Murphy

Okay. And then, I guess, just a big picture question on how you guys think of door count versus linear footage. You guys mentioned in your prepared remarks that in the U.S., you are kind of where you need to be in terms of number of doors, but there is still an opportunity of when your footage is increasing.

Could you just speak to how you are thinking about that this year? And then taking a step back on the international angle where it does seem you guys still have some more white space, are there any analogs of other consumer tech brands that you look at when you try to think about that door potential in the international market versus where you are at today. Just how do you benchmark that internally? Thanks.

James Park

Yes. So, in the U.S., definitely, the focus is on increasing the square footage that we have in existing channel partners. Lot of that is going to come from launching new products and in particular, having a pretty robust accessory.

So more products and more accessories will lend itself naturally to really justify more square footage. That's the dynamic in the U.S.

Internationally, as you said, there is more room for growth on adding storefronts. I don't know if there is a fair comparison, but clearly, what we hope to do is right now include the percentage of our revenue – potential.

I think we are seeing a lot of progress in each of our key regions. We substantially, APAC has two of the largest countries with potential in China and India. So we continue to gradually aggressively in building our stores.

Erinn Murphy

I guess, James for you, do you see the store count internationally then eclipsing that at the U.S. overtime or just anything you can help us kind of benchmark, could be monitor that channel fill there.

James Park

It's really hard to give any guidance on that because while number of store counts is also important, the productivity and sell-through in each store is also pretty important, and that really reflects the effectiveness of point of sales data that we might have in implication. So it’s hard to give specific guidance.


We will move to our next question now that comes from Matthew McLintock of Barclays.

Marjorie Lopez

Hi, good afternoon. This is Marjorie Lopez on for Matthew McLintock is on a plane. Thanks for taking my question. I was wondering how you're thinking about marketing dollars for 2016. If you could provide more color on how successful the Super Bowl commercial was and with the Olympics coming up, do you see this as a potential for campaigns during this period? Thank you.

James Park

I think TV has continued to be a pretty strong marketing vehicle for us. We see great ROI from our TV campaigns, and so we'll be continuing to invest heavily TV in the future along with digital, cinema, print, well. I mean, particular to Super Bowl ad reflects our strategy to advertise during key sporting events - during the NBA finals, Super Bowl this year. For future sports events, I think it’s more of a wait-and-see but it’s fairly a part of our strategy.

William Zerella

Let me just add few - on your question regarding, there is a marketing spend through the year. We’d expect for the full year - marketing spend to be a similar percent of revenue as it was in 2015. Obviously, we’d expect, based on our comments, that Q1 will be higher than that in connection with the launch of Blaze and Alta. For the full year we’d expect it to be consistent.

Marjorie Lopez

Great. Thank you.


Next up, we'll hear from Ross Sandler of Deutsche Bank.

Ross Sandler

Hi Bill. Two question on the guidance. So first on the topline. The midpoint, if we use the $85 ASP, the midpoint of 1Q in full year comes in at around 30% plus or minus for unit growth. So how do you internally build to that type of a number, given the new products coming in versus the three flagship products, and given new country/retail partner launches? Can you just help us a little bit in terms of bridging from the high growth rate you’ve seen today to that 30% number?

And then, the second question is on gross margin and EBITDA guidance. So I think you’ve said for 1Q, 46.5% gross margin. What does that look like when we get beyond the first quarter once the accessories start shipping? Should we get back to the 48 to 50 range we’ve talked about before?

And then also does this imply for the first quarter to get down to your EBITDA guidance as much as like a 125 million in sales and marketing expenses? I'm struggling a little bit to get down to that low of an EBITDA number. Just any color there will be helpful. Thanks.

William Zerella

Okay. So your first question on revenue. So what’s happening in Q1 is we’re obviously going through a product transition where the channel is draining their inventory levels of charge. And we stop shipping charge in Q1. And we're transitioning in the channels preparing for Alta.

Now, our guidance assumes that we will be getting initial shipments out of Alta into the channel, but that because of the timing that no reorders will hit revenue in Q1, and those will start to flow in early Q2.

So, that's a pretty big dynamic. We are also assuming that to a lesser degree with Blaze, and that there will be some reorders hitting Q1, but also because of the timing of shipments, the bulk of those reorders will start to hit Q2.

So that's causing some distortion in terms of the quarter the Q1 versus the full year on year growth rate which is higher. That’s the first dynamic.

In terms of the gross margin, as I mentioned, it’s being driven by additional cost we’re incurring in manufacturing to ramp volumes for both new products. But based on our full year guidance which you can expect is those margins will increase through the balance of the year.

Obviously to hit our full year guidance that implies our margins in the rest of the year will be higher than the full year to compensate for the lower margins in Q1.

Last thing in terms of Q1 OpEx, sales and marketing spend. So we will be spending a lot of money as I mentioned, to launch with the media campaigns around the world. The best direction I can give you is that in terms of percent to revenue for sales and marketing in Q1, it will be similar to what you see in Q4.

And then the rest of it is primarily driven by some sequential increases in G&A and R&D. So it really sales and marketing that’s causing the Q1 EBITDA margins earnings to be where they are. But again, that we’ll leave in out through the full year as I mentioned on one of the previous questions, our full year sales and marketing spend, as a percent of revenue, will be similar to what it was for last year.

So hopefully, that gives you a little more color Ross.

Ross Sandler

Okay. And just going back to the first question I guess, so make total sense for the first quarter but if we use the 2.45 midpoint in the comparable ASP, I think the unit growth would go up to like 32% beyond what happens here in the first quarter. So, given the -- launching all these new products, is there conservatism baked into those numbers or is it just too early to tell what the reception is going to be?

William Zerella

I would say couple of things, I would say that our track record has been to lean on the conservative side in terms of projecting since - where there's limited visibility, we’re really excited about these new products but since they haven’t really got into the market yet, we’re going to lean on the conservative side until we start to see reorder volume and adoption rates and then we’ll adjust our guidance accordingly as we go through the year.

Ross Sandler

Got it, okay – super helpful. Thanks, guys.


Moving on, we'll hear from Steven Wardell of Leerink Partners

Steven Wardell

Hey, guys. Thanks for taking my question. So, do you have any - I wanted to ask you to tell us more about your corporate wellness program. Do you have any expectations around what percent of total revenue will be, a corporate wellness program revenue around, can you tell us how many sales reps you have and is that build-out? Do you have a length of sales cycle, is it built around kind of an annual selling season and the benefits enrollment season or is it more year around?

James Park

Yes, so the guidance that we've given previously is that corporate wellness continues to be less than 10% of our revenue, but it's the very important part of our business, to that effect we are adding significantly to the headcount for that group, both in sales and marketing, and in engineering as well.

And as we mentioned previously, 2015, we’ve seen a lot of success, we added over 1,000 new enterprise customers to the corporate wellness platform, including several new fortune 500 customers such as Wendy's and Marathon Petroleum.

In terms of more detailed metrics, I think what we can say is that, there is an annual selling cycle but overall the volume of sales is really reflective of the amount of investment we’re going to make both in engineering headcount and in sales and marketing.

Steven Wardell

Great, thank you.


Our next question will come from Robert Peck of SunTrust

Robert Peck

Yes, thanks for taking my questions. Just two questions, please. In 2013, it looked like inventory went up in 4Q by about $40 million or so, in 2014 obviously went up another $50 million sequentially from 3Q. But in this quarter we went down a good $90 plus million.

Bill, could you talk a little bit about where we are on channel sale right now and where that stands on the inventory side? And then number two is on the gross margins again, just given that guide of 46.5% can you just quantify for us what’s the one time impacts you are baking in there or a more standardized rate you must be thinking about for gross margins in these new products? Thanks so much.

William Zerella

Yes, okay. I’m sorry, repeat your first question again, Bob?

Robert Peck

It just on inventory trends going from 3Q to 4Q, yes.

William Zerella

Yes, I would say a couple of things. So as we gain more scale we’re getting more effective in terms of managing inventory and working capital in general. Historically the Company has been supply constrained. I think what you're seeing really more than anything else in Q4 is, if you look sequentially we built a lot of inventory in Q3 coming into the holidays and we burn that inventory down over the course of Q4.

And we're were ramping down production levels for Charge obviously, and then starting to ramp production up primarily this quarter for Alta and Blaze. Some of that happens at the end of Q4, but most of that inventory is being built this quarter.

I think the best way to look at the changes in inventory levels, we’re going through a product transition for the first time so it’s distorting some of the year-on-year comparisons. So, I wouldn’t read anything more into within that, but in general obviously we want to minimize inventory levels in order to better manage working capital.

In terms of gross margins, so, again the math here is I would focus everyone on the full year and there we're seeing some improvement in gross margins potentially versus last year. So which you’re going to see after Q1 is on average for the rest of the year higher than our full year guidance for the full year for gross margins and that's primarily reflection of the margin profile of all new products.

So, we see these -- as I've mentioned in the past, all of our new products has come into market at closer to our targets than our new products last year, and especially we see the accessories side of this business now growing nicely and being incremental and accretive to gross margins.

So that will depend upon what the take rate is or attach rate rather for accessories. So far out of the gate based on preorders, attach rates are higher than we forecasted, we'll see how that plays out over time.

Robert Peck

Thanks, Bill.


From Bank of America, we'll hear next from Matt Schindler.

Matt Schindler

Yes, hi guys. Just wanted to ask a little bit more about that example you gave of the two large insurance companies using doing projects for weight management, diabetes management. How big are those? Are they tests or are those implementations and also where do you see your relationship with insurance companies going, do you see eventually a possibility for people to see premium reductions based on step count?

William Zerella

Yes, so the programs that we have at the two major insurance companies are in the early stages right now. I think the key thing is that that we are the leading device in both of those programs in the preferred device of the health insurance companies.

Over time, we do see deeper involvement with health insurance and in fact we do have specific examples right now where companies are seeing reductions in their health insurance premiums due to usage of Fitbit.

So, that's an active area of development right now is to see and prove out the correlation between the usage of our devices and lower healthcare costs over time.

Matt Schindler

Thank you.


Next up we have, Jim Duffy with Stifel.

Jim Duffy

Thank you. James, question for you. Your prepared remarks deliberately spoke beyond digital fitness much more around digital health opportunities. Should we interpret this to mean there are sightlines to revenue from digital health specific products and solutions or is it more about investment near term and the revenues in future years?

And then the second question. As you think about these opportunities, how does that change the sales and business model relative to what you have today?

James Park

Yes. So, a lot of investment that we're going to be doing in 2016 reflects a focus on strategy on digital health and integrating more deeply with the healthcare system and I think you'll see the benefits of that in future years. And so lot of that I think will come not just in the hardware but more in the software side where we're going to be developing programs that specifically guide people to reach their health goals or to address certain conditions as I outlined on the recorded portion.

Jim Duffy

Okay. And how would the sales model for that work, would it be a sale to the consumer through retail channels or is this a different avenue, and if so does that change the economics?

James Park

I can let Bill talk about the economics, but on the sales and marketing side it could very well be that there is a different approach there particularly around B2B marketing. And so we don’t expect that portion of the business to be primarily driven by the consumer side.

William Zerella

I think it's a little too soon to say, I mean there are different path potentially on the side of the equation. So I think it's premature for us to speculate on how it plays into the business model.

So, there's a few interesting possibilities here that could be accretive but I think it's really just premature especially since we wouldn’t really see any revenues this year, it would really play into next year and beyond.

So, as we get closer and as we get more clarity as to how this is going to play out, then we'll provide that guidance.


Moving next to Betty Chen with Mizuho Securities.

Betty Chen

Thanks, good afternoon everyone. Given the opportunity you’ve outlined for the international market, I was wondering if you can talk a little bit more about any sort of difference in buying habits. For example, the type of models or devices that might sell better there, any variances in ASP's, so that we can think about the opportunity? And then the SAP system, when should we expect that to occur and any cost that we should factor that into our model as already part of the guide. Thanks.

William Zerella

What was the second - can you repeat the second part of your question, we didn’t quite get that?

Betty Chen

Since the SAP implementation, Bill?

James Park

Well, SAP okay got it.

William Zerella

I will let James start and then I’ll talk about it.

James Park

I think the great thing about what we are doing in our products and services that we're seeing a pretty near universal demand globally and that there is a not a lot of significant cultural differences in each of the regions as it relates to the acceptance of the product.

I think the one place that I will note is that in China for instance there is a preference for higher ASP devices and I think that reflects the kind of the economy in the market where there is definitely a set of people who are attracted to the very little cost devices from company like [indiscernible] but there is a very sizable portion that customer base that are more interested in sophisticated products like a higher ASP devices charge and unsurge more recently.

William Zerella

And in terms of SAP, yes its based into our guidance and there is some OpEx that flows through the P&L as well as cost that get capitalize which is just the typical accounting until you capitalize a lot of the implementation cost until you actually go live. So that’s baked in the portion and then balance goes through OpEx.

Betty Chen

Okay. What was the OpEx portion?

William Zerella

Well, we didn’t break that out. I mean it's - that the bigger portion is the portion that capitalize.

Betty Chen

Okay. And then just to clarify Bill just I think you said that for the full year we should expect sales and marketing rate to be similar to fiscal '15 is that correct?

William Zerella

As a percent of revenue that's correct.

Betty Chen

Okay, great. Thanks so much.


Next we'll hear from Stanley Kovler of Citi Research.

Stanley Kovler

Yes, thank you for taking my question. I apologize for any background noise. I just wanted to understand what the take rates were for the new prices at retail. And those demand changed for - and then also if you could help us understand in terms of the timing of the watches, you had previous conversations - couple of the noted that in terms of Q1 seasonality that were couple of catalyst like New Year resolution and those initial products sales availability of those product to consumer fall a little bit later beyond some of those factor.

So how do you think about the seasonality going into the quarter and then new product launch factoring into would have this decline in inventory for charge. Thank you.

William Zerella

Okay, Stanley we were trying to decide for your questions, so, first selling that's how we record revenue. So our revenue is based on selling not sells through. So in terms of any trends on selling you would just look to our revenue numbers?

James Park

The seasonality - I'm not sure if you are asking about seasonality obviously Q4 is our biggest quarter, Q1 is driven by New Year's resolutions. This Q1 is a little different because of the product transition that we're going through with charge in Alta and because of the timing also of when Blaze is hitting the channel.

So, that's distorting some of the year-on-year comparisons for revenue in Q1 versus historical I'm not sure exactly what other questions you had there on there?

Stanley Kovler

Let me just clarify the selling question its really on sell inventory, I just wanted to get a sense of the amount of channel inventory that you had going into the quarter and then as you think about the available supply, your retailers do recognize - because you have to reorder coming on after the initial sales, was there any push-outs or changes in the amount of inventory that your retailers took or expect to take of these new products.

James Park

Okay. So the dynamic is that our channel partners have been draining down inventory levels of charge right and we stop selling charge in Q1 and preparation for the launch of Alta, all right. So what we have reflected in our guidance is initial shipments of Blaze in Alta, effectively no reorders of Alta until Q2 because of the timing on one Alta is hitting the channel and some reorders for Blaze in Q1 with the majority starting to hit in Q2.

So that's kind of the dynamic that's playing-out in the guidance.

Stanley Kovler

If I could ask last follow up, how many users you have on the platform remaining that actually were from the 2014 registered user base and do you have a sense of how many users have actually upgraded to new platforms as well. Thank you.

William Zerella

What I will tell you is just look at the data that we put out in our press release. We have nearly 17 million active users at the end of the year, that's up from about 10 million versus the prior year with a growth of about 152%. So I would just point it to the data in our release.

Stanley Kovler



Our next question will come from Brad Erickson of Pacific Crest Securities.

Brad Erickson

Hi, thanks for taking my questions, just a couple of follow ups. First you talked a lot on this call so far around the R&D spend and really pointing towards 2017 and 2018 more than 2016. From a device perspective, should we kind of take that to mean sort of a step function improvement in terms of sensors in 2017 or 2018 or kind of more what we have seen this year which is really I guess been largely static offerings in terms of the sensors and sort of smaller incremental improvements in terms of functionality?

William Zerella

As mentioned on the last call, throughout 2016 we are going to continue to release new products and I think it is going to be a mix of improvements on the software side, improvements in battery life, improvements in the fact that we continue to add more smarter features such as caller ID, more advanced notifications et cetera across a lot of our devices but overall we have pretty significant R&D spend, it is going to increase at least 100% this year and that is going to be reflected in more advanced sensors and algorithms over time.

But I can’t really say exactly when they are going to come out for instance PurePulse took over three years to develop and that was a pretty breakthrough technology for us and we have different technologies like that in various states of development, in our R&D pipeline and so you will see those come out over time.

Brad Erickson

Got it. And then on the corporate insurance challenges to follow up on that the deals you mentioned. Are those exclusive agreements and can you just quickly maybe comment on the pricing you're seeing for these types of arrangements relative to wholesale average, thank you.

William Zerella

Yes, what I would say is enterprises elect to work with us and typically most companies will not work with multiple device providers. Right, so they will select one company to work with. So I’m not sure if they are technically from a contractual standpoint exclusive but I believe that virtually all of corporate wellness customers that we work with just work with and distribute Fitbit devices.

The pricing in the corporate wellness side is actually more attractive than the rest of our business. The discount levels are different since we are selling direct enterprises. So it is actually more attractive margin profile than the rest of our revenue.

Brad Erickson

Got it, thanks.

William Zerella

Okay. I will take one more question operator?


That will come from John Kernan of Cowen.

John Kernan

Thanks for squeezing me in guys, congrats on all the growth this year.

William Zerella


John Kernan

Bill, can you just talk about what's embedded for your guidance for the international portion of the business, it does look like Asia-Pac slowed pretty significantly in the fourth quarter. So just trying to understand the different dynamics of international as it relates to your guidance this year?

William Zerella

Yes so first again on Asia-Pac in Q4, the growth rate distorted because of channel fill in Q4 2014 which was in anticipation of our new product set. So, what we are seeing is great traction in the market, so I wouldn’t read anything into that that year-on-year comparison, it is just short because of that fact.

In terms of international and general revenue outside the U.S. was 26% of revenue last year just up slightly from 2014. We see international growing faster in 2016 than it was last year or did last year so that growth could be to 30% or slightly higher in terms of percent of revenue. And that's pretty consistent with what we are assuming in terms of our effective tax rate since that's very much impacted by the mix. So that's kind of way we are looking at things right now.

John Kernan

Okay, that's helpful. And just one more quick follow up question. Just on CapEx this year, can you help us understand how to model that because it does seem like the business will be spinning off a fair amount of cash at these margin levels?

William Zerella

Yes, so CapEx is going to be driven higher because of a couple of dynamic. So first, there will be a lot of production tooling, running through CapEx in 2016. A fair amount of the production tooling for the 2015 new products actually hit Q4 of 2014. So last year didn’t get the full benefit that's number one.

Number two, we are building out additional office space, so there is going to be leasehold improvements that will flow through CapEx. And then number three, with the SAP implementation we’ll be capitalizing some cost.

So directionally CapEx it won't quite double but it will probably go up in the range of 70% to 80% versus the prior year.

John Kernan

Okay. Thanks.


Ladies and gentlemen, with that we will conclude today's conference. We do thank you all for your participation. You may now disconnect.

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