Fitbit, Inc.2018年第2四半期決算カンファレンスコール（FIT (Fitbit, Inc. Earnings Conference Call Q2 2018 (FIT))

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Good day, and welcome to the Fitbit Second Quarter 2018 Earnings Call.
This call is being recorded.
At this time, I would like to turn the conference over to Tom Hudson.
Please go ahead, sir.
Good afternoon, and welcome.
Fitbit distributed a press release detailing its quarterly results earlier this afternoon.
It's posted on our website at www.fitbit.com and also available from normal financial news
sources.
This conference call is being webcast live on the Investor Relations page of our website
where a replay will be archived.
On this call, all financial measures are presented on a non-GAAP basis except for revenue, which
is a GAAP measure.
A reconciliation of GAAP to non-GAAP financial measures is provided in our posted earnings
release or in other earnings presentation materials posted on the Investor Relations
page of our website.
This conference call will contain forward-looking information, which is subject to risks and
uncertainties described in Fitbit's filings with the SEC and in today's press release.
Actual results or events may differ materially.
We will begin with a commentary from James and Ron and we'll then open the call to questions.
We are going to limit the call to about an hour, so we apologize in advance if we don't
get to all your questions.
Let me introduce Fitbit's Chairman and CEO, James Park.
James?
Thank you, Tom.
Thank you to everyone participating in today's call.
I'm pleased to report that for the sixth quarter in a row, we have delivered on our financial
commitments and are making progress in our multiyear transition, which include adapting
to the changing wearable device market, transforming the business from an episodic-driven model
centered around device sales to more non-device recurring revenue, deepening our reach into
health care and increasing our agility and optimizing our cost structure.
Revenue for the quarter was $299 million.
We saw continued momentum from our mass appeal smartwatch, Fitbit Versa, which sold out in
the quarter.
The introduction of Versa strengthened our brand and relevancy and highlights the opportunity
to regain market share as we progress the smartwatch category and continue to deliver
both hardware and software offerings that consumers find compelling.
Fitbit sold 2.7 million devices in the second quarter, up sequentially and with a year-over-year
rate of decline in devices sold dropping to 20% and hardware and software offering versus
27% in the first quarter.
The success of Versa has improved the company's positioning with retailers, fortified shelf
space with Fitbit brand and has provided a halo effect to our other product offerings.
Retailers have been looking for a counterbalance for Apple and Versa has delivered.
In the second quarter, Fitbit Versa outsold all Samsung, Garmin and Fossil smartwatches
in North America combined.
With the strong consumer receptivity for Versa, demand has outpaced supply and we have chosen
to add additional production lines.
Since launch, we have also seen a significant uplift in North America POS trends.
We also believe the channel reduction of trackers has on its course and have increased confidence
that Q2 will mark the trough in the year-over-year decline in Tracker sales.
Our confidence in the trough and the decline in Tracker sales is driven by clean Tracker
channel inventory levels, consumer feedback and our product pipeline.
As we look forward, we believe our improved forecasting and lower-risk approach in new
product introductions reduces the risk of an imbalance between sell-in and sell-through
and gives us confidence in the path ahead.
In the second quarter, 60% of activations came from new users while 40% came from repeat
buyers.
Of the repeat buyers, 51% were previously inactive for 90 days or more.
The percentage of repeat buyers coming from previously inactive customers has significantly
improved from 39% in the second quarter of 2017, demonstrating that our newest devices
can reengage inactive customers and bring them back to the Fitbit platform.
We have always emphasized there's no one-size-fits-all when it comes to health and fitness, and we
have always provided a choice for consumers across form factor, feature and price.
While smartwatches continue to grow at a rapid pace and present a strong opportunity for
future growth, there is still a large community of users who prefer the Tracker form factor
and who are looking for powerful health and fitness features at a more accessible price.
For example, we sold 50% more Alta HR devices in the U.S. during the 2018 Amazon Prime Day
than the prior year.
In addition, our Charge franchise has sold over 35 million devices and Charge 2 continues
to be our best-selling Tracker with over 15 million sold nearly 2 years after it launched.
Industry analysts also note that Trackers will continue to be an important part of wearable
categories overall.
According to IDC, sales of Trackers are expected to reach 46 million units in 2018 compared
to 43 million smartwatches globally.
We see an opportunity to reinvigorate the category through innovation to successfully
serve the needs of this large consumer segment.
Fitbit Ace, our recently introduced kids' device as a great example.
With this product, we are introducing a wearable to a younger demographic while making fitness
fun and helping families connect and build healthy habits together.
In addition, we continue to invest in our social and software features.
We believe our active community of users provides a barrier to commoditization and a unique
value proposition.
56% of our active users viewed the Feed in the second quarter.
Our recently introduced female health tracking feature has also been well received with more
than 2.9 million sign-ups.
We know that wearable devices can help people get healthier.
The question now is how these devices will continue to evolve and what role they will
play in health care.
We have been working to lay the foundation for growth into the health care channel by
strengthening our relationships with key players in the health care ecosystem, building out
our direct sales team, adding capabilities at the human coach platform and collaborating
with developers to create health-focused apps and clock faces.
The strength of our consumer offerings and our ability to engage people and drive behavior
change directly supports our health care efforts.
We see ongoing evidence that health care use cases continue to grow and evolve.
Some examples include payers embracing wearables and providing financial incentives to motivate
behavior change, condition management, clinical research or connecting patients and care teams.
I'm proud to say that as of today, Fitbit Health Solutions has the ability to provide
solutions to over 100 health plans across the U.S., including Blue Cross Blue Shield
and Humana.
In terms of clinical research, we continue to help researchers pioneer new ways to use
our devices to drive better health outcomes.
In a new study, researchers from Cedars-Sinai Medical Center and Johns Hopkins University
found that a Fitbit device successfully gathered real-time objective data in patients with
cancer, helping clinicians predict outcomes.
We are also expanding the work we are doing with the University of Michigan's Intern Health
Study, which this year will follow 2,000 new doctors better understand how intense and
changing work schedules contribute to a resident's mental health.
When it comes to health, we want to leverage the investments we are making across both
our consumer and Health Solutions business.
As such, we are focused on chronic condition areas that have corollaries on the consumer
side: diabetes and weight management, heart health and fitness, sleep apnea and sleep
quality and mental health and stress.
Our ultimate goal is to help providers, health plans and clinical researchers better support
their patients outside the walls of the clinical environment and help our users better understand
their overall health and wellness.
We often receive testimonials from our customers telling us how their Fitbit devices either
raised awareness about a potential medical issue or changed their lives by changing their
behavior.
These examples include a young mother of 3 who identified that she had a serious condition
called postural orthostatic tachycardia syndrome or how a teenage girl discovered she was suffering
from supraventricular tachycardia, a defect that causes a faster-than-normal heart rate
due to an error in electrical impulses.
It is these types of testimonials that give us confidence that we have the building blocks
to create a device and software offering.
We also introduced a number of key health apps in Q2 that brings important health information
like blood glucose numbers to the wrist, helping to bridge the gap between consumer and health
care.
As part of this program, we introduced new health partner apps and clock faces, including
Walgreens, One Drop and Limeade.
Built using Fitbit's software development kit, the apps and clock faces will give Fitbit
smartwatch users new options to improve wellness and help manage conditions like diabetes.
Wearable devices are easy to use, unobtrusive and motivating while the benefits of increasing
activity and health awareness come with virtually no side effects.
Finally, before turning the call to Ron to discuss our financials in more detail, I wanted
to discuss our operating efficiency.
We continue to be on track, reduce operating costs 7% but made a conscious choice to pull
forward costs and increase our media and advertising spend to support the launch of Versa.
As I mentioned earlier, Versa's success strengthens channel partner relationships and we believe
provides momentum into the back half of the year.
Also, we continue to make progress transitioning our data infrastructure to Google's cloud
where we expect cost savings to begin in 2019.
I am also excited to announce that we have hired a new leader for engineering organization,
Koby Avital.
Koby joins us from Priceline.com where he was their Chief Technology Officer.
As Executive Vice President of Engineering, Koby will focus on hardware, software and
firmware engineering.
Eric Friedman will maintain his role as CTO, focusing on data security and advanced research.
With that, let me turn the call over to Ron to discuss the quarter in more detail.
Ron?
Thanks, James.
My prepared remarks will be focused on the financial overview of the second quarter results.
I will then provide our guidance for the third quarter of 2018.
Before I go through the details, I would like to remind investors that all financial references
are to non-GAAP measures, except for revenue, unless I specify otherwise.
And all financial comparisons are on a year-over-year basis unless otherwise specified.
Fitbit sold 2.7 million devices and generated $299 million of revenue in the quarter, down
15%.
The 15% decline in revenue resulted from a 20% decline in devices sold, partially offset
by an average selling price increase of 6% to $106 per device.
The average price of Trackers sold declined year-over-year, driven primarily by a mix
of fewer Blaze units rather than competitive dynamics.
Versa's sales, at an average selling price higher than Blaze, more than made up for the
Tracker delta.
However, with Versa contributing the vast majority of smartwatch sales in the quarter,
having a sales price less than Fitbit Ionic, smartwatch ASPs declined from the prior quarter.
Accessory and other revenue added an additional $5.23 per device sold.
Accessory revenue was negatively impacted by fewer units sold while non-device paid
revenue grew 34% but remains immaterial to overall results.
U.S. revenue represented 61% of total revenue or $182 million, declining 8% in the quarter.
International revenue declined 24% to $117 million but growth varied significantly between
regions.
APAC revenue advanced 66% to $35 million while EMEA revenue declined 39% to $66 million,
driven by higher promotional activity and weakness in the U.K. market.
The U.K. market has lagged in its transition to smartwatches and thus was disproportionately
exposed to contraction in the Tracker market.
We expect a reversal of this trend in Q3 and a return to growth.
Americas, excluding the U.S., declined 35% to $16 million.
As James indicated, broadly speaking, retail channel inventory is relatively clean with
some Versa demand unable to be fulfilled, given supply constraints and Tracker inventory
now in line with expected consumer demand.
Our direct consumer business, Fitbit.com, represented 14% of revenue and declined 9%
to $43 million.
Gross margin declined 210 basis points to 40.9%.
Decline was expected, driven by the growing mix of smartwatch revenue, partially offset
by lower warranty costs and lower customer support contact rates.
Operating expenses increased 1% to $194 million.
Research and development cost increased 6% to $72 million.
Despite an objective to lower our operating cost, we are maintaining our investment and
innovation to transform the business.
Our goal is to drive efficiency in our device business while investing in software, services
and Fitbit Health Solutions.
Sales and marketing costs were flat year-over-year at $96 million.
We increased investment with higher media spend to support the launch of Versa but benefited
from the improved quality of our devices.
As DPPM has improved, case volume has shrunk, leading to lower customer support spend.
In addition, we spent less on point-of-purchase displays.
General and administrative expenses were $25 million.
In addition, we have reduced our real estate footprint in San Francisco.
This not only lowers our operating expense run rate but removes approximately $81 million
in lease obligations from our future commitments.
Operating loss was $71 million with other income of $4 million.
We recorded a tax benefit of $12 million, resulting in a net loss per share of $0.22
in the quarter.
Cash flow from operations was a negative $67 million, and capital expenditures in the quarter
were $16 million, resulting in a free cash flow loss of $83 million, better than our
expected free cash flow loss of $85 million.
We ended the quarter with $580 million in cash and short-term investments and no debt.
In addition, on July 3, we received a $72 million tax refund payment from the IRS.
We expect to receive approximately $8 million in additional tax refund payment but the timing
is uncertain.
Now let me turn and address our guidance.
We expect third quarter results to benefit from the lessening in year-over-year decline
of Tracker revenue and continued growth of our smartwatch franchise.
We expect revenue to decline approximately 3% on a year-over (sic) [ year-over-year ] basis
to a range of $370 million to $390 million and roughly flat gross margins in the second
quarter.
As a percentage of revenue, we expect Q3 operating costs to trend materially lower.
We expect free cash flow of approximately negative $30 million in Q3 and net income
per share between a $0.02 loss and a $0.01 profit.
Our tax rate will vary on our ability to achieve profitability and the geography of income.
We expect tax to shift from a benefit to an expense of approximately 2% and a basic share
count for approximately 247 million shares.
Stock-based compensation is expected to be approximately $26 million.
We are reiterating our full year 2018 guidance.
We have increased confidence that Q2 market trough and the year-over-year decline in Tracker
sales anticipate continued strength in smartwatch growth.
Similar to Q3, we anticipate gross margins to be roughly flat to Q2's at approximately
41%.
The device mix shift will also benefit average selling price on a year-over-year basis but
will not offset the decline in Tracker devices sold, and as such, we are forecasting an overall
year-over-year decline in devices sold.
Relative to Q2, average selling price is expected to be roughly flat.
We expect to continue to grow our Fitbit Health Solutions business and increase our premium
subscribers, but this growth will be relatively immaterial to our wearable device revenue.
The net result is that we are maintaining our revenue expectations of approximately
$1.5 billion.
We are on track to reduce operating expenses by approximately $60 million from 2017 levels
to $740 million, consistent with our previously stated commitment.
Our intent is to continue to drive efficiencies into the business and redeploy capital to
growing our software, services, Fitbit Health Solutions and international sales footprint.
Given the strength of demand for Versa, we have increased our capital expenditure cost
to increase production capacity and now anticipate CapEx to increase as a percent of revenue
to 5% from the previously forecasted 4% level.
We expect this spend to negatively impact free cash flow.
As such, we are revising our fiscal 2018 free cash flow guidance to a loss of approximately
$20 million from breakeven.
Moving to taxes.
We are forecasting fiscal 2018 tax of approximately 25% but anticipate the tax rate to fluctuate
substantially, depending on the geographic distribution of our earnings.
With respect to liquidity, given the shifting demand patterns, continued investments to
transform our business from an episodic one to more durable sources of revenue, our primary
focus in 2018 is to adapt the changing wearable device market while creating the foundation
to grow Fitbit Health Solutions and software services in 2019 and beyond.
Our balance sheet remains robust with $580 million in cash and marketable securities
as of the end of Q2.
In addition, as I noted earlier, we received $72 million in a tax refund in early July.
We will continue to augment organic investment with targeted M&A.
Similar to the acquisition of Twine Health, we expect M&A to continue to play an important
role at Fitbit and are targeting businesses that will help transform our business towards
digital health and recurring revenues.
Before turning the call over to the operator, I wanted to take a minute to discuss the tariff
situation.
Fitbit utilizes contract manufacturers located in China to produce its devices.
These devices, with the exception of our scale and headphone, are included in the tariff
code identified by the U.S. trade representative's recent proposal.
As such, a 10% tariff, if implemented, would apply to the bill of material cost on goods
imported into the U.S.
We are navigating a number of different paths to reduce or eliminate the impact of the tariff.
It is important to note that it is unclear if the tariff will ultimately go into effect,
if wearable devices can qualify for an exemption or how much, if any, of the potential increase
in cost can be mitigated.
Thus, our full year guidance excludes the potential impact.
We support open markets and free trade where everyone plays by the rules.
With that, let me turn the call back to the operator and answer questions.
Operator?
We'll go first to Alex Fuhrman with Craig-Hallum.
Wanted to ask about, where do you kind of envision the role for the legacy wearable
Trackers in your portfolio over the next couple of years?
It's encouraging to hear that it sounds like you're continuing to think that Q2 was the
trough in terms of the negative growth rate.
Can you give us a little bit of a sense of where that optimism comes from?
I imagine some of that comes from the fact that the inventory in the channel appears
to be pretty clean.
But going forward on a more sustainable basis, can you give us a sense of where you see the
role of the Trackers in your portfolio?
And specifically, I'd be interested to hear where you envision the distribution of these
products.
I think you mentioned that the success of the Versa really helped to strengthen the
relationship with some of your channel partners.
What are the channel partners most interested in carrying?
Are they -- do you envision them likely carrying the legacy products over time?
Or do you see them more carrying the newer products and then selling more the legacy
devices on Fitbit.com?
Just curious how we should expect to see that process unfold over the next couple of years.
Yes.
So we continue to be excited about the Tracker category, and we expect Trackers to be an
important part of our portfolio for many years ahead.
And the reason for that is several: one, there's no one-size-fits-all in the wearables category.
There's a lot of nuance in consumer preference in choice between form factor, feature set
and price.
And there's actually a large community of users, based on our market research, who still
prefer Trackers and actually specifically Trackers and not smartwatches.
And it's a good thing that we lead that category.
So we're going to continue to invest and innovate in Trackers, and I'm pretty excited about
our product pipeline in that category.
And to give you some context, we have had a huge franchise since we've launched the
original Tracker.
35 million devices for Charge, 15 million in Charge 2 since launching 2 years ago.
So it's going to continue to be important.
Not only that, we're taking opportunities to increase where Trackers can be sold.
One is the kids' demographic.
Fitbit Ace continues to get positive momentum and reception.
And then health care is going to be a big channel for us for Trackers.
The health care channel is more price-sensitive.
And our Tracker lineup is perfect for distribution into our health plans.
For retailers, because we feel pretty strongly that the year-over-year decline in Trackers
has hit a trough, they're going to continue to carry the Tracker lineup along with smartwatches.
Great.
That's really helpful.
And then if I could just add one follow-up.
It seems like you have a very strong and growing community of users that are really engaging
with the app using the Feed.
Is there any discernible difference in behavior from those core engaged users that are using
the Feed?
Are they more likely to gravitate towards the smartwatches or the Trackers or more likely
to purchase on Fitbit.com versus a retailer?
Just curious if that subset of users is behaving differently than the other users.
Yes, they do behave differently.
Where we see it is actually in terms of retention and engagement.
Being involved in the community and being involved with your friends and family on Fitbit
helps both of those metrics pretty materially.
And where that's going to really manifest itself in terms of our future strategy is
as we roll out more services that are paid and attached to the core product, we obviously
want very healthy engagement and retention numbers.
And a great statistic for us on the paid premium front is inclusive of our Twine acquisition,
our paid premium services actually grew 34% year-over-year.
So that's a positive trend.
We'll go next to Sherri Scribner with Deutsche Bank.
I guess, just thinking over the next couple of years and the transition in the smartwatch
business from Trackers, I guess, how are you thinking about potential unit growth as we
move into '19 and '20 as we've sort of stabilized some of the declines in Tracker business or
at least the smartwatch business has become a bigger piece of the overall business?
Yes, I think -- this is Ron.
I think if you look at the kind of the mix we saw in Q2 with Trackers being -- or excuse
me, smartwatches being 55% so a little over half, I think as you look certainly to the
second half of this year and probably into early next year, I would expect that we would
still see Trackers comprising a significant portion of those sales, and that the smartwatches
would still be probably in that 50% range, maybe a little bit -- increasing a little
bit as part of mix going forward.
But Trackers, as James indicated, there's a large community of users who prefer Trackers.
I think as you look at the innovation, you're going to see more of a blending some of the
features and form factors between the 2.
And in addition, particularly in health care and in the kids' space, you're going to continue
to see sort of demand in new products and increased unit sales into the health care.
And I mentioned in my prior comment, we need both of those products to be successful in
executing our strategy.
And they're a foundational element of, I think, a huge milestone, which is one, for us to
break even in Q3 and actually return to growth and profitability in the second half, which
is what we're expecting.
Okay, great.
And then thinking about all of the new initiatives you have on the health side with sleep apnea
and tracking women's health, I guess, I'm trying to -- I guess, I'm asking is there
a way for you guys to monetize those opportunities beyond just selling a hardware device?
Is there some way that you guys have been thinking about where there's some sort of
services or some sort of the other way that you guys can generate some type of recurring
revenue stream maybe on top of the hardware sales?
Yes, absolutely.
We're very focused on building a recurring revenue stream so that's going to happen on
both the consumer side and on the health care side.
So on the consumer side, we are investing and thinking about creating a membership model
for devices and having services that consumers pay for.
And then on the health care side, the way that we monetize beyond the device will be
one, selling our services include diagnostics and coaching on a per member per month basis
or possibly even sharing in some of the cost savings that our products and services deliver.
I think one of the positive proof points is that our health care business actually grew
at a double-digit rate in Q2.
Okay, great.
And then just quickly, Ron and clarification.
The change in the free cash flow to be down into as opposed to flat, does that include
the $72 million cash you got from the tax refund or does it not include that?
No, our free cash flow guidance excludes the tax refund of $72 million.
We'll now take a question from Jeff Garro with William Blair.
I want to ask a little bit more about the deepening in health care and maybe get you
guys to talk a little bit more about the channel strategy and specifically, how you view the
health plan channel versus the direct employer opportunity or maybe any other channel within
health care.
Yes.
So our 2 primary go-to-markets for health care business is our employers and health
plans, and we're continuously adding to the breadth in both.
I think one of the big proof points for us in Q2 was that the number of health plans
that we worked with now exceed over 100, including Blue Cross Blue Shield and Humana.
And one of the things that we're trying to work with all these partners is adding revenue
streams beyond the initial device sale.
So again, either on a per member per month basis, PMPM, or shared savings.
And that's a big focus of the company.
Great, that's helpful.
And maybe to follow up, I was hoping to get an update on the Twine acquisition, the integration
of that and how we can get health care stakeholders to engage more deeply in the health of their
end users and the ability to produce tangible results like the cost savings that you say
you might be able to share in and generate revenue.
Yes.
So the Twine acquisition has been going really well.
We've gotten positive reception again from our employers and our health plan customers.
And just to repeat the step that I had before, inclusive of Twine, our paid premium or recurring
software model -- business model grew 34% year-over-year.
So we feel the integration is going well.
We'll now go to Scott McConnell with D.A. Davidson.
So you talked a little bit about the difficulties in the U.K.
How did growth in EMEA outside of the U.K. look?
And maybe can you discuss what exactly the hurdles are in the U.K. with users to switch
to smartwatches from Trackers and how you're addressing these challenges?
This is Ron.
So across the -- EMEA, we don't typically break out each country individually.
What I can say is that the decline we saw in Europe was driven primarily by declines
in the U.K., which is one of our largest markets in the U.K.
And what we saw there is in the quarter, they were impacted by their relatively high exposure
to Trackers.
That was a predominant portion of what they were purchasing and so when we saw the reduction
in the Tracker category, they were disproportionately impacted.
I think the one positive thing that we're seeing is unlike when Australia and the U.S.
went through this category correction, we have this alternative with the smartwatch
product that is (sic) [has] been well received.
And so we expect the decline that we saw in the region to be less.
And we expect the rebound to be much faster than what we saw in other regions.
And as a result, we're expecting to see a return to growth in Q3 in the region.
Our next question will come from Jim Suva with Citi.
This is Josh Kehoe on for Jim.
What are your expectations for non-wrist-worn device sales?
For example, your headphones and scale and when can we see that coming maybe at 5% or
more percent of revenue?
I think as we look at those, I think at this juncture, those non-wrist sales, we would
expect to see those continue to be pretty minimal in terms of our sales and in the foreseeable
future to continue to be in that under 5% level.
We'll go to our next question with Joe Wittine with Longbow Research.
Ionic is going on a year since announcement.
By all accounts, the reception has been pretty mixed.
So when you look at that, combined with the obvious success of Versa, I'm wondering how
your strategy is evolving, if at all, in serving that high-end GPS running market, where there's
some long-standing entrenched competition with high-end features?
Like, I guess, do you think you're getting the ROI and the resources you're directing
to GPS-enabled?
Or could the niche down by the Versa mass-market smartwatch area be enough for Fitbit to carve
out more ground?
Yes.
So I'll say Ionic didn't meet our initial expectations.
But over the course of its lifetime so far, it is playing a very important role in our
portfolio, and it's not something that we would get rid of.
So when we talk about smartwatches being 55% of our revenue, that's a combination of both
Ionic and Versa.
Ionic is targeting the performance segment of the category really effectively, and Versa
is targeting the mainstream portion of the category.
So I feel that we still need both of those products in the mix.
Great.
And then on OpEx, James, you referenced the move to Google's public cloud which will carry
some cost savings.
And Ron, you mentioned the office square footage decline.
I know you won't quantify '19 OpEx but can you give us some directional comment on if
these initiatives are enough to keep the OpEx dollars flat or continually declining next
year?
I think for -- in general, we're looking to drive efficiency and leverage into the business.
And I think a number of things such as the Google cloud transition, the office space
reductions that we did are very focused at driving efficiencies, particularly into 2019.
Driving that efficiency is we're going to continue to invest in software, our Fitbit
health services as well as international sales.
So I think we look at kind of a balance of those 2.
And we don't have specific guidance for 2019 at this point other than continuing to drive
efficiency in the business.
Okay.
And then finally, you may have answered a little bit of this in the U.K. question earlier.
But how do we interpret EMEA returning to growth?
Because I think in your tracker-only days, the company used to view EMEA as lagging the
U.S. by a couple of quarters.
I think it's an interesting data point, and I don't know if, is it may be an easier comp
or a quicker smartwatch adoption in EMEA versus the U.S. today?
Yes.
So as Ron mentioned before and as you just mentioned, EMEA does lag the U.S. markets.
I think the positive thing is as it goes to this shift in the wearables market from Trackers
to smartwatches, we do have a great product and product lineup in both Ionic and Versa
to help mitigate that.
And while we don't break it out specifically, we are seeing very positive momentum for our
smartwatches outside of the U.S., EMEA and APAC.
So that's what's giving us confidence in our statement that we feel that the region is
going to return back to growth in Q3.
Is EMEA where smartwatches have the largest portion of your unit mix, geographically speaking?
No.
A large portion of our smartwatch unit mix is in the U.S.
We'll go now to Ryan Goodman with Bank of America Merrill Lynch.
I have 2.
First one, really nice job in the quarter.
But I did have a question.
So you beat the quarter versus expectations.
The outlook was also pretty good but you reiterated the fiscal year guidance.
I'm just curious, this seems to imply more of a conservative posture just in 4Q versus
where you would have been a quarter ago.
So first, just any thoughts on that?
And then second question, just on the gross margin guidance for the year to hold flat
with Q2 levels.
Is -- previously, that was expected to decline over the course of the year, so is the implication
that smartwatches kind of stabilize at this 55% of revenue level?
Or is there anything else pointing it back to there?
Okay.
I think on the guidance, I think a couple of things.
Part of it is to derisk the year in terms of looking at guidance.
The majority of our sales still occur in the second half, so I think it's prudent not to
be raising guidance.
But we have increased confidence around our revenue guidance of $1.5 billion.
And I think particularly given the positive momentum in Q2, it significantly reduces our
risk around our 2018 commitment.
I think in terms of gross margin, if you kind of go back to the beginning of the year, Q1
margins were higher.
Part of it was due to reserve adjustments associated with WYNIT, and so we [ did ] expect
that the rest of the year coming off in Q1 would be lower.
I think based on the gross margin levels that we saw in Q2, at right around 40%, 41%, are
where we would expect for the rest of the year.
So we expect them now to run flat for the remainder of the year.
I think the -- we also saw Trackers in Q2 was kind of the trough in terms of their demand,
which also impacted margins in the second quarter.
We'll go next to Yuuji Anderson with Morgan Stanley.
On the Q3 guide, appreciate that you mentioned that the Versa had a sellout in Q2.
Is there additional channel stocking activity built into the Q3 guide versus perhaps additional
product launch?
Yes, I think in Q3 as we indicated, we were sold out in Q2 on Versa, so there would be
some amount of additional stocking.
Twofold: one is as the additional supply comes online and secondly, as we get toward the
late part of the year and we get closer to the holiday season, then we'll continue to
add and build inventory back to what we believe is a healthy level in the channel.
Got it.
And then a quick question on Twine and the continued investment in direct sales there.
As we model out OpEx, should we be expecting some incremental hires to close out the year?
And related to that, how should we think about leverage off of those investments?
This is Ron.
I think first thought in terms of just looking at overall headcount, I think broadly speaking,
we're focused less on the level of headcount and driving OpEx efficiency while we redeploy
resources in growth areas of investment such as health services, Twine, international.
And broadly speaking, as we indicated, we do expect to continue to achieve our $60 million
reduction in OpEx versus the prior year and come in and hit our $740 million operating
expense commitment for 2018.
We'll go next to Scott Searle with Roth Capital.
Nice quarter, nice outlook.
I apologize, I'm late to the call so I apologize again if this was already covered.
But in terms of the outlook for the second half of this year, I think you had spoken
previously about 50% of the mix coming from smartwatches.
And in the context of 55% in the second quarter, have your thoughts on that changed at all?
And in particular, you had some -- I heard the positive commentary talking about Trackers
and returning more to a growth mode in playing an important role.
So I'm kind of wondering how you think that sequentially progressing both into the third
quarter and fourth quarter with some seasonality but also from the product portfolio standpoint
on the smartwatch front.
How much do you have to broaden it to start to hit all the different buckets out there?
You certainly have high performance and Versa has been a huge success in terms of the middle
market.
But other areas such as cellular connectivity and otherwise, which is that put into the
overall thought process for the portfolio?
Yes, so I'll take the first part of the question in terms of the mix.
I think we still expect the smartwatch mix in the second half to be around 50%, around
what we saw in Q2.
I think part of that's driven by, as we noted, Q2 was -- marked the trough in year-over-year
declines in Trackers.
So we would expect the Trackers to improve in the second half over what we saw in Q2.
And so given the improvement in Trackers, we expect it to remain basically flat in line
with that 50%.
Yes.
And in terms of the overall smartwatch portfolio, we have Versa and Ionic today, which target
2 very different segments in the category.
But we do feel that there is opportunity to expand the lineup at some point and address
additional needs.
And we feel that those will be incremental to the overall lineup.
And we'll take our last question from Charlie Anderson of Dougherty.
I wonder on smartwatch gross margins if you can maybe address sort of the long-term trajectory
that you see there.
Are there opportunities to increase ASP over time or is it going to be situation where
your ASP goes down to broaden the appeal?
And then on the cost side, what do you see happening there that's maybe identifiable
to help gross margins there?
And then I've got a follow-up.
Yes.
So on the ASP side, it kind of relates to my prior comment.
We're looking at different opportunities and additional opportunities in the smartwatch
portfolio, so that's clearly going to affect the ASP.
It's a little too early to comment how it's going to be affected but it most likely will.
And then on the cost side?
I think on the cost side, I think there's a couple of things.
Certainly, as we expand our production, yield improvement -- we'll yield some improvement
in gross margins.
I think at this point, we have clear visibility for the remainder of this year.
But -- in terms of seeing flat, but I think through yield improvements, product mix, some
of the new products that James was talking about, I think there's an opportunity to drive
efficiencies there.
Great.
And for my follow-up question, you mentioned how you've, with Versa, really allowed yourself
to be sort of that second brand next to Apple.
And I wonder over time, do you feel like you just leverage off advertising here?
Kind of incremental margins on the smartwatch business, get better over time, will you need
less advertising to support it maybe than we've seen in some prior launches?
Yes, that's definitely a possibility.
I think one of the things that we did in Q2 to support the launch was invest more heavily
in sales and marketing.
And we do expect that investment in brand awareness to have benefits as we enter the
second half of the year.
So I'd say overall, it's a very positive story.
The success of Versa creates a positive feedback loop between ourselves, our customers and
the channel.
And it's providing an overall halo effect and lift in brand awareness and product strength
across the board.
And this concludes today's call.
Thank you for your participation.
You may now disconnect.