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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.

Good day, and welcome to the Fitbit Second Quarter 2018 Earnings Call.

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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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