Fitbit's (FIT) CEO James Park on Q4 2016 Results - Earnings Call Transcript

| About: Fitbit, Inc. (FIT)

Fitbit, Inc. (NYSE:FIT)

Q4 2016 Earnings Conference Call

February 22, 2017 17:00 ET

Executives

Tom Hudson - VP IR

James Park - Chairman & CEO

William Zerella - CFO

Analysts

Joseph Wittine - Longbow Research

Travis McCourt - Raymond James & Associates, Inc.

Jerry Liu - Morgan Stanley

Betty Chen - Mizuho Securities USA

Erinn Murphy - Piper Jaffray

Ben Bollin - Cleveland Research

Jim Duffy - Stifel

John Kernan - Cowen

Kunal Madhukar - SunTrust

Operator

Good day, and welcome to the Fitbit Fourth Quarter Full Year 2016 Earnings Conference Call. As a reminder, today's call is being recorded. At this time I'd like to turn the conference over to Tom Hudson, Vice President of Investor Relations. Please go ahead.

Tom Hudson

Good afternoon and welcome. Fitbit distributed a press release detailing its annual results earlier this afternoon. It's posted on our website www.fitbit.com and also available for normal financial resources. 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 post-earnings release.

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 commentary from James and Bill, and then we'll open up the call to discussions. We're going to limit the call to about an hour, so we apologize in advance if we don't get to all the questions.

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

James Park

Thank you, Tom. And thank you to everyone participating in today's call. 2016 was an ambitious year for the company driven by robust product pipeline and the anticipation of launching four new products, we had high expectations coming into the year. However, while we remained a global wearable's leader, we fell short of our goals and did not meet our financial objectives.

I dismiss there were a number of accomplishments that I'm very proud of. We launched Blaze, Alta, Flex 2 and Charge 2; all of which are four stars or better products in Amazon. We delivered exciting new health and fitness features that helped people better understand their overall health like cardio fitness level and guided breathing. We provided greater health insights and we added smarter utility to our devices.

On the digital health side, we added key partnerships with leading companies including Medtronic, an integration with one of the largest U.S. health plans demonstrating the early potential of our devices in different healthcare settings. We started to see the positive impact of Fitbit Group's health programs resulting in cost savings and positive health outcomes for employers and organizations.

At the same time we increased investment in research and development to drive future growth and to scale our business globally. We sold more than 22.3 million devices in 2016, the most in the company's history compared to 21.4 million in 2015. We did see a slowdown in growth but we believe this 4% unit growth number is not represent a category or competition issue despite an aggressive promotional environment in the fourth quarter but rather is a reflection of the saturation of the innovator and early adopter segments of the market. This is particularly true in the United States and we believe corresponds to our 19% penetration estimate of the eligible population.

From a U.S. market share perspective given our 81% dollars share, in order to successful we need to grow the overall U.S. connected health and fitness tracker category. For the full year revenue grew 17% at $2.17 billion . However, the rate of growth decelerated over the course of the year. In the United States revenue grew 11% but declined 28% in the fourth quarter. Other Americas revenue showed similar trends, up 19% for the full year but down 12% in the fourth quarter. APAC revenue dominated by the Australian market which comprised nearly half of the regions revenue contracted 26% for the full year and 56% in the fourth quarter. Excluding Australia, APAC revenue expanded but we have yet to get much traction in large markets like China and Japan. India revenue grew 248% for the full year.

EMEA, a region of the world that is less penetrated in terms of overall the wearable's category produced strong growth, up 86% for the full year and 58% in the fourth quarter and continues to represent an attractive growth opportunity for us. The United States comprised 71% of full year 2016 revenue, EMEA 18%, APAC 6%, and the other Americans 5%. We are confident this performance is not reflective of the value of our brand, market-leading platform, and the company's long-term potential.

While consumer's interest in their own health and fitness may naturally have in the flow, we believe the idea of improving one's health is not a fad. In fact, with an increasing proportion of healthcare costs shifting from employers to employees, chronic diseases making up approximately 86% of healthcare spend, most of which can be addressed by behavioral and lifestyle changes; we believe interest and the connected device health and fitness category will only grow and that Fitbit is uniquely positioned to help solve this issue.

To address the reduction in growth in what we believe is a temporary slowdown in transition period, we're taking clear steps to reduce our operating costs and restructure our organization. On a tactical level, it will be provide details about our inventory and one-time charges taken in the fourth quarter.

From an organizational perspective, I would like to address what we are doing differently and how we are realigning the company. First, we are focusing on improving efficiencies across the company. We have reorganized the business and reduced our 2016 exit operating expense run-rate by $200 million, including the separation of 107 employees representing 6% of the global workforce. We have restructured our accessories business choosing to partner and license rather than bearing the bulk of the cost of designing and producing accessories ourselves.

We also have a continued focus on improving quality and we have set an ambitious target to reduce our defect rate. As part of this effort, we hired a new Executive Vice President of Operations, Jeff Devine. Jeff brings more than 25 years of operating experience ailing global technology brands like Cisco, Nokia, Hewlett Packard. He will be responsible for operations, customer support, and overall quality reporting to me.

Second, we increased promotional activity. We entered the fourth quarter anticipating a high level of demand and built-out inventory. With demand less than expected and face the intense competitive environment, we responded with discounting. Consumers responded and we saw an uptick in purchases. However, with inventory levels high, our revenue growth trajectory lag sell-through obscure true consumer demand. For example, Fitbit U.S. NPD sell-through data in the fourth quarter showed a 6% unit decline versus our sell-in which experienced a 21% unit decline. We expect this disconnect to continue into 2017 as we support efforts to reduce overall inventory in the system.

Third, we continue to invest in the right strategic areas for the company to reignite growth. When looking at the technology adoption curve and utilizing the U.S. market as a proxy, we have successfully captured a large portion of the innovator and early adopter segments in tracker market. We believe the early and late majority segments of the tracker market represents an additional significant target opportunity of between $40 million to $80 million new tracker customers.

We plan on capturing these new potential users and penetrating the market more broadly by streamlining our tracker portfolio which will help consumers better understand which device is best for them and also by moving beyond tracking basic biometric activity. We will leverage our incredible store biometric data to provide more advanced and personalized insight approaching guidance that we believe will keep consumers motivated and informed as they move along their health and fitness journey.

Increasing the value proposition of our software beyond just tracking is the key to bringing more consumers into Fitbit family and reigniting growth. For example, Fitbit users who use our personal goal setting feature and set a step goal are 55% more likely to achieve or exceed it than users who do not use the tool. Also after using the reminders to move feature on the Fitbit device for two months, Fitbit users who are least active throughout the day took nearly 500 additional daily steps adding up to over 1.5 extra miles a week.

The new Fitstar Personal Trainer app that was announced at CES is also a great example of these efforts. The new app features tailored adaptive workouts and recommendations based on the users Fitstar and Fitbit activities. This more robust guidance and coaching helps users workout smarter and get the most out of the Fitbit ecosystem. Consumers have loved these new features with Fitstar registering more than 1.2 million downloads since January; positive indicator that deeper insights and coaching have strong appeal.

In addition, we are starting to make investments in building a software and services revenue stream. Since relaunching the product, the Fitstar Personal Trainer app went from a low of number 50 in 2016 to number 9 in January of health and fitness apps in iTunes by dollars. We're also investing to capitalize on the current shift in consumer sentiment towards more full featured sophisticated devices and bring our unique strengths and experience into smart watch category.

Similar to when we launched our surge product and expanded the GPS enabled watch category, we can expand the smart watch category. Even today with a significantly higher average selling price, this adjacent market opportunity more than doubles our adjustable market. Our recent acquisitions of assets from Pebble, Vector Watch and Coin added software IP including a developer platform and STK and deep industry expertise which complement and accelerate this effort. In addition, we are looking at developing form factors beyond the risk, build a full ecosystem of products that support our consumer's health and fitness journey.

In health, we have continued to improve our group health and digital health offerings. Our announcements in the space include these examples that can potentially change the value proposition for this audience. First, Fitbit's activity tracking data can be automatically synced with Medtronic's glucose monitoring devices providing meaningful insights to how activity impacts glucose levels leading to better patient-physician communications and more effective diabetes care management.

Fitbit also announced an integration into one of the largest U.S. health plans to offer a custom feature or Fitbit Charge 2 where cash incentive-based employer-sponsored wellness program. While it's still early, these are powerful signals of where this industry is going.

We believe we are uniquely positioned to leverage our many assets capture these opportunities. Our brand and mission continue to resonate among consumers and our focus and expertise sets us apart from others in the category. Of those interested in the category, awareness of our brand has steadily marched higher from 30% in Q3 2014 to 76% in Q3 2016. Throughout 2016, our brand and product leadership have been recognized.

Fitbit ranked number 15 on IPG's D100 global brand list and was the largest gainer on the profit brand relevant index up 235 spots to number 29 scoring high on trust, dependability, and having a purpose consumers believe in. It is the strength of our brand and leadership in the category that gives us the ability to move into adjacent opportunities like software services, smart watches and health solutions.

Our community of users is also a large and growing asset. In the fourth quarter, we had 23.2 million active users on our platform, up 37% year-over-year and 50.2 million registered device users. The Fitbit app helps users find and engage with friends, family, and coworkers creating positive network effects that reinforce engagement and increase user attention. We know that social connections help provide the motivation and support that is fundamental to a successful health and fitness journey.

Over the past year, there has been a 98% increase in the number of users who have at least one friend on the Fitbit platform and Fitbit data shows that having support from friends and family helps you move more with users who have one of our friends making 700 more steps per day on average than users without friends in the platform. This highly engaged community of users provide us with a large base to which we can launch upgrades to existing devices and introduce new form factors. 26% of all activations in a year aim from repeat customers with 20% of these repeat purchases coming from customers who are reactivated or inactive for 90 days or greater.

While 2016 was not the year that we wanted, I feel we have taken steps to try to pass back the growth and profitability. We of course directed our spending to adjust for the slower growth reality for 2017 but we have maintained investment in key areas for the future.

First, in devices we expect to have a streamlined set of products across price points to address consumer's interested trackers, a full-featured smart watch, and different form factors taking us beyond the rest. Second, in software and services, we believe there is an opportunity to deal more with the data we collect, provide both free and premium offerings to further inspire, coach and guide users in their health and fitness journey in a more personalized way. Our goal is to create lifelong paying customers and to expand the addressable market of consumers interested in trackers.

Third, in health, we expect to integrate more deeply into the healthcare ecosystem. With also the powerful assets of our brand and community to take advantage of the opportunities available to us. All of these things make me excited and optimistic for the future.

With that, let me turn the call over to Bill to discuss the financials in more details.

Bill?

William Zerella

Thanks, James. My prepared remarks will be focused on a financial overview of the fourth quarter and full year 2016 results. I will then provide our guidance for the first quarter and fiscal year 2017. Before I go through the details, I would like to remind investors that the financial references are to non-GAAP measures except for revenue or unless I specify otherwise.

Fitbit sold 6.5 million units in the fourth quarter at an average selling price of $85 generating $574 million of revenue, down 19% year-over-year. Higher channel inventory coupled with weaker demand led to a contraction in unit growth of 21% in the quarter and flat pricing year-over-year. Revenue in the quarter was further impacted by $42 million in rebates and seller allowances which were booked as a contra revenue. Shipments late in Q3 had the effect of pulling forward revenue from the fourth quarter but in turn building our inventory in the channel.

With demand less than forecast, inventory built further leading to lower reorder rates and the subsequent dampening of revenue growth. Charges related to excessive inventory and the change in demand materially impacted gross margins. Gross margins in the quarter were 22.4%. We recorded a $78 million write-down of tooling equipment and a component inventory and a $41 million increase in return reserves due to higher channel inventory. In addition, we also increased our warranty reserves by $17 million for legacy products.

On a full year basis, gross margin declined 9 points year-over-year to 39% and was below our previous 46% target. 3.9 points of the decline can be attributed to the increase in warranty costs, primarily associated with our legacy products. 3.6 points of the reduction can be attributed to one-time charges, the write-down tooling equipment and component inventory. Promotions and rebates equate to 1.9 points of margin degradation partially offset by favorable contract negotiations with our contract manufacturers.

For the full year, gross profit declined 5%. Operating expenses in the quarter were 49.6% of revenue. Sales and marketing costs were the largest driver of operating expense growth at 32% of revenue, up 21% year-over-year. This was materially above our long-term target of 15%, primarily due to media commitments made prior to change in our sales forecast. Sales and marketing spend for the full year grew 47% representing 22% of revenue.

Research and development cost grew 54% in the quarter and represented 13% of revenue. For the full year, R&D cost advanced 107% representing 13% of revenue driven primarily by the growth in engineering resources including talent from our asset acquisitions Pebble, Vector Watch, and Coin. Our long-term target is 10%. Excluding job on legal costs G&A contracted 3% in the quarter and represented 5% of revenue. For the full year G&A costs grew 48% as we scale the business globally representing 5% of revenue over our long-term target of 3% to 4%.

Our operating margins reflect strategic investments we're making to support our product roadmap in 2017 and beyond . Our health strategy which includes both, our group health and digital health businesses, and the further build out of our back office infrastructure to support our increasing scale and global breadth including migrating our business systems to SAP . Much of this investment came in the form of additional headcount. Including acquisitions, headcount increased by 652 people in 2016.

Given these investments and the lower than anticipated revenue, we experienced significant deleveraging of our business. It was most acute in the fourth quarter resulting in an adjusted EBIT loss of $144 million on a non-back GAAP basic losses $0.56 per share. The full year adjusted EBITDA was $30 but we experienced the non-GAAP basic loss of $0.12 per share. The non-GAAP effective tax was a benefit of $30 million in the fourth quarter and liability of $23 million for the full year.

Despite the non-GAAP basic earnings, loss per share we had a tax liability to the geographic mix of income worldwide. Offshore losses and certain foreign jurisdictions cannot be utilized to lower taxes in other tax jurisdictions.

Turning to the balance sheet, we ended 2016 with $706 million of cash and short-term investments and no debt. This is an increase of $34 million from the end of Q3 despite the net loss per basic share due to the fact that a number of charges in the quarter were non-cash in nature. Reflecting the slower demand environment and timing of shipments, we ended the year with $478 million in accounts receivable, up $9 million year-over-year despite lower sales.

The net result will be greater cash collections in the first quarter; DSO increased to 85 days in the first quarter we exited the year with 230 million of inventory, up $52 million from sales year ago. Capital expenditures in the fourth quarter were $12 million totaling $79 million for the full year. To support the rollout of - for new product introductions, tooling equipment represented the largest portion of spend.

These whole improvements to build out our global footprint and acquisition of lab test equipment also were uses of cash.

Now let me turn to guidance. We expect 2017 revenue in the range of $1.5 billion $1.7 billion with gross margin ranging from 42.5% to 44%. Operating margins are forecasted to trough in the first half and improve in the back half as we roll out additional product offerings. All things being equal, cash typically peaks on our balance sheet in the first quarter post the holiday collections. This is particular through this year with many of our fourth quarter shipments coming late in the period. However, we expect the change in working capital to become a headwind as we move through the year. This primarily a result of dollars being converted to inventory ahead of the important Q4 selling season.

In addition, we plan to continue to invest in lab and testing equipment utilized by our R&D teams to drive innovation and leasehold improvements. With this in mind, we expect 2017 free cash flow of approximately negative $50 million to negative $100 million. We expect basic net loss per share of $0.22 to $0.44. Our guidance reflects an effective rate of approximately 50% which will vary depending upon the mix of domestic and international revenue and basic share count of approximately 233 million shares. Stock-based compensation is expected to be in the range of $100 million to $110 million.

Turning to the first quarter; we expect several dynamics will drive our results due to new products introduced in the first quarter of 2016 and exiting year with a higher operating expense run rate as driven by our 550 plus heads. We expect revenues to be in the range of $270 million to $290 million than represent below for the year. However, given higher accounts receivables entering the quarter, we expect free cash will trend in opposite direction as receivables turning to cash receipts unless overhead is required to support the growth in inventory.

We expect basic net loss per share of $0.18 to $0.20. Our guidance reflects an effective tax rate of approximately 50% which will vary depending upon the mix of domestic and international revenue on a basic share count of approximately 226 million shares. Stock-based compensation is expected to be in the range of $23 million to $25 million.

With that let me turn the call back to the operator to answer questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Okay, and we'll take our first question from Joe Wittine with Longbow Research.

Joseph Wittine

I wanted to ask about the United Health deal taking on charge to - James you said it's one of the country's largest health plans, so that sounds alluring. So are units already shipping or is that for the '17 plan year? And if there are any insights you can provide on employee's willingness to adopt - I think that would be interesting.

James Park

Yes. We don't have detail to share yet on how many units are shipping or will ship but what we can say is that United Healthcare has done a lot of research on this program to prove out the ROI benefits, and they have worked with at least one other partner in the past than the reception with those employees has been incredibly positive from what we gather and have seen from the data and that engagement is really high. So we're very optimistic about this program.

Joseph Wittine

And because that's a potentially really nice reference customer, can you help us handicap the potential that you will have further announcements like that one in other plans latter throughout the year?

James Park

Yes. We can't give any guidance on that but as you know, growing our health business both in digital and group health is critical to the future growth of the company. And so clearly, we've been talking to insurance partners for quite a while now almost since the bear inception of the company. But it's been really rewarding to see that in the past few months there has been a market increase interaction reception amongst insurance plans.

Joseph Wittine

Okay. And finally for me, of the $40 million to $80 million additional potential adopters; what is the geographic mix there? Thanks.

James Park

I don't know if we have an opinion on the geographic mix but we do know that $40 million to $80 million as I mentioned the call represents the early and late majority segment of technology adoption. And the way we do plan on capturing these users, you know, most of them are going to be in the U.S. is with much more powerful software, especially in terms of providing guidance and coaching and giving people solutions out-of-the-box to meet a variety of health goals rather than just give them tracking capability and biometric data capture. So we think that's going to be key to capturing the segment and it's part of our strategy for reigniting growth for trackers.

Joseph Wittine

Thank you.

Operator

And we'll go next to Travis McCourt with Raymond James.

Travis McCourt

Thanks for taking my question. First Bill, just a housekeeping one; if you have a number for cash flow from operations in the fourth quarter that would be helpful. And James, you went through kind of some of the product introductions that we should expect; and you mentioned the surge earlier in the call but I guess I'm trying to get some clarification, when you say a smart watch would you consider a Surge of smart watch or the smart watch in your opinion specifically means watch with an operating system they you can download third-party apps too?

William Zerella

Travis, it's Bill. So first on the question marketing cash flow from operations, so we haven't finalized the cash flow statement yet but it's going to come in at around $65 million to $70 million or so of cash flow from operating activities.

James Park

Yes. And in terms of the question it surges smart watch and what is our idea of what the future of smart watch is, look like - no, I wouldn't characterize Surge as a smart watch. I think it was our first foray into the watch category, in general, in particular, GPS watches. And I'd like to point out again that it was a pretty successful introduction. We went into category that hadn't seen a lot of innovation and we definitely made a huge impact in terms of expanding that category. And as you can see it from our acquisitions of Coin, Pebble and Vector Watch, that we're going to bring some unique assets to table with our own set of smart watch products. So what characterizes a Fitbit smart watch? I would say definitely a focus on health and fitness, a focus on long battery life, broad platform compatibility, and I think our existing brand and large community of users. And given the Pebble acquisition, there is going to be a large emphasis on developer SDK and the developer ecosystem; and if you had looked at the Pebble tools before, they are definitely world-class in terms of developer productivity. So excited to see that come out in the product at some point.

Travis McCourt

Great. And can you give us any sense of how long this had been under development at Fitbit versus how much you're going to be using the underlying software code from the two acquisitions?

James Park

Yes, we can't breakout the contribution of each but definitely a driver of the Pebble acquisition was to help accelerate our efforts in developing our third-party ecosystem. And not only that, to really improve the productivity of our own internal teams as they develop applications. One great example of how this is going to really foster creativity for us in the future is if you look at the United Healthcare deal, and the UHC app basically that was running on Charge 2, things like that are going to be a lot easier going forward with things like Pebble.

Travis McCourt

Great. Thanks a lot.

Operator

We'll go next to Jerry Liu with Morgan Stanley.

Jerry Liu

Thank you. First, James, again on this topic of the smart watch; can you talk a little bit more about whether you have all the pieces you need that you mentioned the three acquisitions - but are there other acquisitions or talent you need to hire because often times it takes several quarters if not longer after some of these assets are acquired in order to even put product together. So trying to get a sense of how soon can we see something come to market?

James Park

Yes. I mean we acquired Coin - I think since the acquisition of Coin and Pebble, there has been sufficient time for us to access where they were in their state of technology and I can definitively say that they have helped accelerate our efforts. I don't know if I can go into much more detail beyond that. As to whether we need future acquisitions to complete our smart watch story, we're always on the lookout for really innovative technologies that are going to make our devices incredibly compelling. But I think the three acquisitions that we made give us a very good foundation for creating a really compelling smart watch product.

Jerry Liu

Understood. And for Bill, if I look at the guidance for the March quarter some of the comments suggest; last year there was a product launch and this year there wouldn't be. So I guess the question is should we expect a different product launch cadence this year versus last year; it was a spring launch and then a fall launch, could this year maybe see the spring launch push back or even wanted two launches in the year?

William Zerella

Yes. I mean last year we had four launches, they didn't exactly coincide to a spring-fall cadence. We've been talking for quite some time now in terms of trying to get to a predictable cadence if we can every year so that comparability is easier as we look at our performance. So that's where you're trying to do this year. We're are not specific in terms of what you're introducing when other than to say that we are hoping this year that we can kind of get on a track of spring-fall and then just continue that on a go-forward basis. So I really can't comment beyond that at this point, Jerry.

Jerry Liu

Yes. Thank you.

Operator

And we'll go next to Sherri Scribner with Deutsche Bank.

Unidentified Analyst

Hi, it's Colby [ph] for Sherri Scribner. Thanks for taking the question. One of the factors weighing on gross margins for the past few quarters have been increased warranty reserves for legacy products. I'm just wondering if we should be reading this to mean that return rates are going up; and also if you could comment on how much legacy inventory is in the channel at this point?

William Zerella

Yes, this is Bill. So what happened in Q4 was our projected return rates did not change actually but what did change was since our volume and our volume projections changed materially, it had an impact on the replacement costs associated with devices that we would use to fulfill our warranty obligations. So we needed to bake in that higher unit cost into our liability calculations which resulted in us getting to increase the reserve. So what we've observed now is basically the warranty return rate has stabilized. We will continue to evaluate it every quarter but at this point we feel pretty comfortable that we've got the right return rates in place. And now we've captured the change in unit cost.

So in terms of legacy product that's out there, we don't really break that out other than to say that if you look at the legacy products here that - this pertains to, it's Charge, HR, and Surge. And Charge and Charge HR are no longer being sold, so we expect that we're going to be approaching the tail-end of those warranty obligations as we get through the first quarter and the first half of 2017. Obviously Charge, we end up like that at the beginning of 2016 rather and Charge HR we end up like in the early Q4. So we think this exposure is going to be predominantly behind us and what we're seeing is certainly improved warranty rates and improved quality with all of our new products.

Unidentified Analyst

Thank you.

Operator

And we'll go next to Matt McClintock with Barclays.

Unidentified Analyst

Hi, this is Lopez [ph] on for Matt McClintock, thank you for taking our question. My first question is, so one of your competitors today posted strong growth in the wearable's business. Are you seeing more competitive pressures now than in the past?

James Park

Yes, this is James. So I think one context is that we still have 81% market share in the category, so it's tough to comment on the impact of other competitors. I don't think we're seeing any material impact. For us the challenge is because our numbers are so large in the category, you know, how do we reignite growth ourselves? And I think in the earnings call, I laid out a few approaches that we're going to take around streamlining our tracker roadmap, investing more in coaching and guidance software, we're already seeing some good results, especially with the launch of Fitstar at CES. So I think our destiny is in our own hands to try to grow to market.

Unidentified Analyst

Great. Thanks for that color.

Operator

And we'll go next to Betty Chen with Mizuho Securities.

Betty Chen

Thank you. Good afternoon and thanks for taking our question. I was wondering Bill, sorry if I missed it earlier but in terms of the $200 of expense reduction, can you give us some help around - you know, how that's spread out between R&D, sales and marketing or G&A and any sort of cadence related to that? And then I guess my second question is, when we think about James your comments regarding streamlining the portfolio, anymore color on how we should think about that because I think currently it's already sort of tiered by price and feature, you know, what should we expect on that front and how should we think about the smart watch margin profile relative to the current core business? Thanks.

James Park

Yes; so the way to think about the expense reductions is that roughly half of those reductions are on the marketing side, primarily related to marketing programs spend. What we're doing obviously is resizing that spend to be more commensurate with what the expected revenue streams - that we've forecasted for 2017. About most of the rest of the half is related to headcount and the headcount related and that's pretty much spread across the organization. I mean obviously we've got a lot more focus on our R&D and engineering side, so in terms of sheer numbers of people it's a little bit heavier on that side but we also talked about changing our business model for accessories and we had pretty big team on board to support that approach or the prior approach so we made some pretty significant reductions there as well. So those would be the areas of focus.

Betty Chen

Okay.

James Park

And in terms of - go ahead.

Betty Chen

I was just to ask Bill, should we expect those cuts to begin in the first quarter or since they are completed?

William Zerella

Well, all the headcount reductions have been made. And we already have a very detailed operating plan this year that rolls up to support the $200 million reduction. So all those actions have already been taken and we're executing on all of those as we speak.

Betty Chen

Okay, thank you. Sorry, James.

James Park

So in terms of streamlining a road map, you know, the thinking behind that is as we move beyond the innovator and early adopter segments, the market, we feel that the more simple fight portfolio that's easier to understand for consumers is going to be one of the keys to unlocking the later adopters in this category. And it will allow us to invest more of our internal resources into more advanced devices and other form factors such as smart watches and we've already seen from our Flex 2 results that we believe that consumer sentiment is shifting to more advanced devices, so this all works together.

Betty Chen

Okay. And just in terms of the smart watch margin profile, should we expect that to vary much from the core wearable's targets in the past?

William Zerella

It's Bill. So we would expect that our smart watch margins will be somewhat less than our tracker margins and we've baked that into our adjusted long-term gross margin target. So these are obviously much more complex devices and we want to ensure that it's competitively priced in the market so that we can be successful.

Betty Chen

Okay, great. Thank you so much. I'll let something else get in the queue. Thanks.

Operator

And we'll go next to Erinn Murphy with Piper Jaffray.

Erinn Murphy

Great, thanks, good afternoon. Just a couple of questions for me; I guess first just from an inventory perspective, if you try to right-size inventories align with some of your sell-throughs that you're seeing; how should we be thinking about the promotional activity that you have planned in 2017? And then how does that kind of accordingly impact your ASP projections for the year?

James Park

So we - I mean we're clearly going to be supporting more in-store promotions to ensure that we clear out the channel, alright. And we've made an accrual at the end of Q4 to account for that. So you'll see us being pretty active working with all of our retail partners. That will serve to reduce ASP's, I mean we have it specifically guided on ASP's. But obviously, if we're supporting those activities in the channels, it's going to have an impact.

Erinn Murphy

Okay. Is it fair to assume though just like first half would be under a lot more pressure and then maybe potentially there is ability for stabilization in the back half of you - maybe get some flow-through of the new products and maybe some potential stabilization there, just directionally for models?

James Park

Yes, that's - actually that's exactly the case. We're going to be pretty aggressive working with our channel partners and so hopefully by the time we get through the first half, we've got everything rebalanced and that is behind us.

Erinn Murphy

Okay. And then I know you're not speaking to specifics on timing of your - kind of new products, I know you want to get into a spring-fall cadence going forward longer term. But in terms of again, the inventory that you have - the got excess inventory, is that changing kind of the timing of launches? I mean, because I would imagine you want to have very clean complexion of inventory; so you're not duplicating efforts in the market when you launched new products on top of potentially stale or promotional product?

James Park

Do you mean for product transitions, is that what you're asking?

Erinn Murphy

Yes. Because I mean if there is excess product now, let's just say you're kind of products last year; and then you're launching a new product on top, it could be confusing for the consumer if you're not pleased with the complexion of your inventory before you launch. I'm just curious on if that has been taken into consideration on the timing of launches?

James Park

You know, I can't speak with respect to the timing of smart watch but I can just tell you directionally, we are assuming we'll work with our channel partners to clear out any inventory related to any products that we would subsequently end of life and replace with a new product. So that would be in the normal course and we'd bake that into our assumptions in terms of our models.

Erinn Murphy

Okay. And then just last question, Bill for you on the sales guidance for the year. For the full year, I think the range is kind of down 32% to down 22% or somewhere around there. How can you think about the regional build kind of underneath that? I guess the U.S. is probably the region we're most interested in just given the size of it. And then APAC given the pressure there, when should we start to see it fairly stabilizing? Thanks.

William Zerella

Sure. So obviously the U.S. is where we'll see the biggest downdraft in terms of sell in. EMEA has continued to be a really strong growth market for us and we would expect our business there to continue to grow in 2017 as well. And on the Asia Pac side, we're mostly looking just for stability there. I mean obviously it was a tough year in 2016; so the way to think about Asia Pac is kind of just getting to stability and being somewhere in the neighborhood of flat year-on-year.

Erinn Murphy

Okay, that's helpful. Thanks so much.

Operator

We will go next to Ben Bollin with Cleveland Research.

Ben Bollin

The first one I wanted to look at the ratio of active users to registered users, by your figures active users was 58% of registered users last year and exiting '15 and then exiting '16 it dropped to 46%. What do you think is kind of the driver to that, the engagement overall and how do you stem that trajectory going forward and then I had a follow-up.

James Park

Yes. So one, I think we are investing pretty heavily in software and services and I mentioned our focus and rolling out more coaching and guidance features that will help us unlock more segments to market and also improve things like engagement and retention over time. And I think my only comment on that is we are starting to see the early proof points of that so if you look at Fitstar, we mentioned on the earnings call, we relaunched Fitstar at CES since January we saw over 1.2 million downloads, it also ended up moving from number 50 to number nine on top apps by revenue. So I think those results tell us that clearly more advanced coaching guidance features are resonating with the market and that's going to be a large part of R&D efforts going forward.

Ben Bollin

Okay. And Bill, looking at the inventory, sorry to dig into this again, I am trying to understand, like you think sell in, sell-through normalized maybe midyear but I'm curious how you think about partner commitments kind of an absolute or per SKU basis, do you have any thoughts on whether or not they are changing their commitment levels based on the trajectory of the category, maybe they don’t commit quite as much in the future per individual SKU, what do you think is the way to think about partner commitments for product into the future based on kind of what we have seen here over the last one or two quarter? Thank you.

William Zerella

Yes. So what I would say is all of our partners are frankly very supportive of where we are headed and they are excited about the future roadmap and things that we have talked about in terms of new categories that we will enter into in the future. So we are seeing continued strong commitment across all of our channel partners. We continue to maintain a 80%, 81% share in the market in the U.S. So I would not say that there is any change in sentiment. I mean, obviously our channel partners like us are disappointed with the Q4 results but frankly they are in alignment with us in terms of our plans to reignite growth and will be very supportive in the future.

Operator

We will go next to Jim Duffy with Stifel.

Jim Duffy

I had a big picture line a question for you. We can appreciate that 2017 is a transition year as you characterized it. We are trying to get a better sense of what's on the other side of that transition to build an investment case. As you think about top priority market facing objectives for the company as we look out to 2018 and beyond, is it about simply breathing new life into the market you have already defined or is it about creating and penetrating entirely new markets?

James Park

Yes. It is a little bit of both. So there's three areas that we're going to be focusing on, one, our devices business and software services and then health. So in a devices side, there's a couple of things we are doing as I mentioned before, you want to reinvigorate the tracker category and we feel we can do that by one streamlining our tracker roadmap to make it simpler for people to understand, and then with more coaching and guidance features, I think that will help us unlock the early and latent majority adapter segments to market which again we feel in the U.S. represent about 40 to 80 million people and then we also plan on expanding with the smart watches as well which you look at any industry data of the market in terms of actual sell-through, you feel entering this category will double our addressable market.

So pretty excited about that and our acquisitions of [indiscernible] really have accelerated our efforts to create a world-class product in that category. In software and services again a lot of emphasis on coaching guidance. As I mentioned before Fitstar, we already have been seeing early impact from that and we see the market moving from just basic tracking to more advanced coaching and guidance and our third area is going to be around health. I think both the UHC deal and Medtronic integration demonstrate that we do have a very important role to play within healthcare. These are still the early days but these are really positive indicators.

Jim Duffy

You have dabbled some in healthcare, I am sorry, in M&A, as you look to the healthcare opportunities, do you expect M&A to play a larger role?

James Park

It will definitely play a role. I mean we see a lot of opportunities both in consumer and in health and wherever it makes sense, we will definitely be looking at M&A to accelerate our efforts there.

Operator

And we will to John Kernan with Cowen.

John Kernan

Sure. Can you talk about what you're most excited about in terms of just embedding yourself in the healthcare ecosystem and the digital health efforts you have?

James Park

Yes. I think what makes the most excited is that people know Fitbit as a consumer company and consumer brand and people might perceive us as kind of a nice to have. I think what I most excited about is really transforming Fitbit in its products into a must-have and I think that's going to come with more features and other form factors that we develop, it's also going to come from deeper integration into the healthcare ecosystem. I mean you already see all these stories out there about how Fitbit has literally saved people's lives. I mean there is almost an article every day about someone seeing irregularities in their heart rate, they have gone and seen their doctor who has put them on some course of treatment whether its s medication or surgical interventions, I think that shows the promise of connected health and fitness devices have a really profound impacts on people's lives. So that itself is what makes me excited about the future of the company.

John Kernan

What technology advancements is giving you confidence that you can really embed yourself into this ecosystem with the insurance committee and healthcare providers can find and use this data?

James Park

Yes. I think what gives me confidence is really the history and the breadth of R&D that we have put into incredibly power efficient and miniaturized sensors for tracking people's health and I think the UHC integration and the Medtronic integration are great examples of really credible and tested companies in healthcare relying on what we do as a key part of their strategy. So I can point to all the data in the world but I think the quality of our partners speaks for itself.

Operator

We will now go to Kunal Madhukar with SunTrust.

Kunal Madhukar

Bill, quick one on the shipments and inventory versus what's in the store. One of the things that you said was many of the 4Q shipments came late in the fourth quarter and at the same time you already have a lot of channel inventory. Can you help reconcile these two statements please?

William Zerella

Sure. So I mean there were already committed orders from retailers to replenish that we shipped against based upon anticipated sell through which did materialize to the level that our retail partners anticipated. So therein, the result was, we exited the year with a lot more inventory in the channel than either us or our retail partners had expected.

Kunal Madhukar

And a quick follow-up on the services side, are there adjacent opportunities I mean in addition, submarkets or niche markets within health and care where you could expand into as far as sources are concerned? Things like the geriatric care and things like that where Fitbit could be an essential device but it also gives you a lot of subscription revenues on an ongoing basis.

James Park

Yes, I mean clearly as you pointed out there is a lot of opportunities in health and healthcare some of which are lower hanging fruit given the device and software that we already have in place. So we're looking at a lot of different opportunities and we will be able to share more of that as our health strategy becomes much more into play.

Operator

And that concludes our question-and-answer session as well as today's conference call. You may now disconnect. Thank you for your participation.

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