Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - FITBIT INCexhibit321q22017.htm
EX-31.2 - EXHIBIT 31.2 - FITBIT INCexhibit312q22017.htm
EX-31.1 - EXHIBIT 31.1 - FITBIT INCexhibit311q22017.htm

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
____________________________________________
FORM 10-Q
____________________________________________
(Mark one)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 1, 2017
or
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission file number: 001-37444
____________________________________________
FITBIT, INC.
(Exact name of registrant as specified in its charter)
____________________________________________
Delaware
(State or other jurisdiction of
 incorporation or organization)
 
20-8920744
(I.R.S. Employer Identification No.)
 
 
 
405 Howard Street
San Francisco, California
(Address of principal executive offices)
 
94105
(Zip Code)
(415) 513-1000
(Registrant’s telephone number, including area code)
____________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ
No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ
No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
þ


Accelerated filer
¨
Non-accelerated filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨
No þ


As of July 28, 2017, there were 196,384,332 shares of the registrant’s Class A common stock outstanding and 36,547,906 shares of the registrant’s Class B common stock outstanding.



TABLE OF CONTENTS

 
 
Page 
Number
 
 
 
 
  
 
  
  
 
Condensed Consolidated Balance Sheets—July 1, 2017 and December 31, 2016
 
  
  
 
Condensed Consolidated Statements of Operations—for the three and six months ended July 1, 2017 and July 2, 2016
 
  
  
 
Condensed Consolidated Statements of Comprehensive Income (Loss)—for the three and six months ended July 1, 2017 and July 2, 2016
 
  
  
 
Condensed Consolidated Statements of Cash Flows—for the six months ended July 1, 2017 and July 2, 2016
 
  
  
 
 
  
  
 
  
  
 
  
  
 
  
  
  
 
  
  
 
  
  
 
  
  
 
 
 
 
 




NOTE ABOUT FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

continued investments in research and development, sales and marketing and international expansion and the impact of those investments;
trends in our operating expenses, including personnel costs, research and development expense, sales and marketing expense and general and administrative expense;
competitors and competition in our markets;
our ability to anticipate and satisfy consumer preferences;
our smartwatch and timing of availability;
our ability to develop new products and services, improve our existing products and services, or engage or expand our user base;
our ability to accurately forecast consumer demand and adequately manage inventory;
our ability to deliver an adequate supply of product to meet demand;
our ability to maintain and promote our brand and expand brand awareness;
our ability to detect, prevent, or fix defects;
our reliance on third-party suppliers, contract manufacturers and logistics providers and our limited control over such parties;
trends in our quarterly operating results and other operating metrics;
trends in revenue, costs of revenue and gross margin;
legal proceedings and the impact of such proceedings;
the effect of seasonality on our results of operations;
our ability to attract and retain highly skilled employees;
our expectation to derive the substantial majority of our revenue from sales of devices;
growing our sales of subscription-based services;
the impact of our acquisitions in enhancing the features and functionality of our devices;
the impact of foreign currency exchange rates;
releasing and shipping new products and services, and the timing thereof;
the sufficiency of our existing cash and cash equivalent balances and cash flow from operations to meet our working capital and capital expenditure needs for at least the next 12 months; and
general market, political, economic and business conditions.

We caution you that the foregoing list does not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, operating results, and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.

The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking

3


statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

4


PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
FITBIT, INC.
Condensed Consolidated Balance Sheets
(In thousands)
(unaudited)
 
 
July 1, 2017
 
December 31, 2016
 
 
 
 
 
 
 
 
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
318,708

 
$
301,320

Marketable securities
 
357,090

 
404,693

Accounts receivable, net
 
216,346

 
477,825

Inventories
 
141,504

 
230,387

Prepaid expenses and other current assets
 
97,717

 
66,346

Total current assets
 
1,131,365

 
1,480,571

Property and equipment, net
 
80,135

 
76,553

Goodwill
 
51,036

 
51,036

Intangible assets, net
 
24,768

 
27,521

Deferred tax assets
 
162,899

 
174,097

Other assets
 
10,886

 
10,448

Total assets
 
$
1,461,089

 
$
1,820,226

Liabilities and Stockholders’ Equity
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
83,966

 
$
313,773

Accrued liabilities
 
347,517

 
390,561

Deferred revenue
 
44,427

 
49,904

Income taxes payable
 
599

 
7,694

Total current liabilities
 
476,509

 
761,932

Other liabilities
 
59,244

 
59,762

Total liabilities
 
535,753

 
821,694

Commitments and contingencies (Note 6)
 

 

Stockholders’ equity:
 
 
 
 
Class A and Class B common stock
 
23

 
23

Additional paid-in capital
 
911,057

 
859,345

Accumulated other comprehensive loss
 
(12,733
)
 
(978
)
Retained earnings
 
26,989

 
140,142

Total stockholders’ equity
 
925,336

 
998,532

Total liabilities and stockholders’ equity
 
$
1,461,089

 
$
1,820,226


The accompanying notes are an integral part of these condensed consolidated financial statements.

5


FITBIT, INC.
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
Revenue
$
353,299

 
$
586,528

 
$
652,241

 
$
1,091,884

Cost of revenue
204,054

 
341,559

 
384,697

 
613,160

Gross profit
149,245

 
244,969

 
267,544

 
478,724

Operating expenses:
 
 
 
 
 
 
 
   Research and development
80,543

 
79,909

 
168,301

 
152,157

   Sales and marketing
100,732

 
118,138

 
191,906

 
225,189

   General and administrative
31,379

 
37,262

 
62,125

 
72,964

Total operating expenses
212,654

 
235,309

 
422,332

 
450,310

Operating income (loss)
(63,409
)
 
9,660

 
(154,788
)
 
28,414

Interest income, net
193

 
839

 
1,289

 
1,421

Other income (expense), net
303

 
(463
)
 
836

 
1,105

Income (loss) before income taxes
(62,913
)
 
10,036

 
(152,663
)
 
30,940

Income tax expense (benefit)
(4,673
)
 
3,695

 
(34,344
)
 
13,564

Net income (loss)
$
(58,240
)
 
$
6,341

 
$
(118,319
)
 
$
17,376

Net income (loss) per share:
 
 
 
 
 
 
 
Basic
$
(0.25
)
 
$
0.03

 
$
(0.52
)
 
$
0.08

Diluted
$
(0.25
)
 
$
0.03

 
$
(0.52
)
 
$
0.07

Shares used to compute net income (loss) per share:
 
 
 
 
 
 
 
Basic
230,322

 
218,850

 
228,788

 
217,431

Diluted
230,322

 
242,328

 
228,788

 
242,153

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

6


FITBIT, INC.
Condensed Consolidated Statements of Comprehensive Income (Loss)
(In thousands)
(unaudited)
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
Net income (loss)
$
(58,240
)
 
$
6,341

 
$
(118,319
)
 
$
17,376

Other comprehensive income (loss):
 
 
 
 
 
 
 
   Cash flow hedges:
 
 
 
 
 
 
 
Change in unrealized gain (loss) on cash flow hedges, net of tax benefit (expense) of $404, $(245), $202 and $1,469, respectively
(12,629
)
 
5,538

 
(13,789
)
 
3,005

Less: reclassification for realized net gains included in net income, net of tax expense (benefit) of $(46), $(216), $(8) and $509, respectively
1,430

 
(407
)
 
1,647

 
(1,978
)
Net change, net of tax
(11,199
)
 
5,131

 
(12,142
)
 
1,027

   Change in foreign currency translation adjustment
585

 
(88
)
 
314

 
(160
)
   Change in unrealized loss on available-for-sale investments,
    net of tax
9

 
67

 
85

 
126

Less reclassification for realized net gains
(3
)
 

 
(12
)
 

Net change, net of tax

6

 
67

 
73

 
126

Comprehensive income (loss)
$
(68,848
)
 
$
11,451

 
$
(130,074
)
 
$
18,369


The accompanying notes are an integral part of these condensed consolidated financial statements.


7


FITBIT, INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(unaudited)
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
 
 
 
Cash Flows from Operating Activities
 
 
 
Net income (loss)
$
(118,319
)
 
$
17,376

Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
 
 
 
Provision for inventory obsolescence
8,409

 
665

Depreciation
19,199

 
13,121

Write-off of property and equipment
5,250

 
649

Amortization of intangible assets
2,753

 
1,066

Stock-based compensation
44,459

 
38,170

Deferred income taxes
16,137

 
(36,452
)
Other
1,428

 
(700
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
261,165

 
91,537

Inventories
81,486

 
(13,351
)
Prepaid expenses and other assets
(50,324
)
 
(16,085
)
Fitbit Force recall reserve
(500
)
 
(2,974
)
Accounts payable
(216,959
)
 
(39,425
)
Accrued liabilities and other liabilities
(43,963
)
 
54,000

Deferred revenue
(5,477
)
 
1,973

Income taxes payable
(1,516
)
 
14,857

Net cash provided by operating activities
3,228

 
124,427

Cash Flows from Investing Activities
 
 
 
Purchase of property and equipment
(39,817
)
 
(36,745
)
Purchases of marketable securities
(317,678
)
 
(392,738
)
Sales of marketable securities
13,806

 
38,814

Maturities of marketable securities
351,144

 
140,262

Acquisitions, net of cash acquired

 
(5,600
)
Net cash provided by (used in) investing activities
7,455

 
(256,007
)
Cash Flows from Financing Activities
 
 
 
Payments of offering costs

 
(1,236
)
Proceeds from issuance of common stock
11,407

 
14,467

Taxes paid related to net share settlement of restricted stock units
(5,234
)
 
(1,107
)
Net cash provided by financing activities
6,173

 
12,124

Net increase (decrease) in cash and cash equivalents
16,856

 
(119,456
)
Effect of exchange rate on cash and cash equivalents
532

 
(248
)
Cash and cash equivalents at beginning of period
301,320

 
535,846

Cash and cash equivalents at end of period
$
318,708

 
$
416,142


The accompanying notes are an integral part of these condensed consolidated financial statements.

8

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements


1.    Basis of Presentation and Summary of Significant Accounting Policies
 
The accompanying condensed consolidated financial statements of Fitbit, Inc. (the “Company”) are unaudited. The condensed consolidated balance sheet at December 31, 2016 has been derived from the audited financial statements of the Company. The accompanying condensed financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information, and in management’s opinion, includes all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the Company’s financial position, its results of operations, and cash flows for the interim periods presented. The results of operations for the three and six months ended July 1, 2017 are not necessarily indicative of the results to be expected for the full fiscal year or any other period.

The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed with the Securities and Exchange Commission (“SEC”) on March 1, 2017.

The Company’s fiscal year ends on December 31 of each year. The Company is on a 4-4-5 week quarterly calendar. There were 91 days in each of the three months ended July 1, 2017 and July 2, 2016, and 182 and 184 days in the six months ended July 1, 2017 and July 2, 2016, respectively.

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated.

Reclassifications of certain prior period amounts in the condensed consolidated financial statements have been made to conform to the current period presentation. 

Use of Estimates
 
The preparation of condensed consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the condensed consolidated financial statements and accompanying notes. The primary estimates and assumptions made by management are related to revenue recognition, reserves for sales returns and incentives, reserves for warranty, valuation of stock options, fair value of derivative assets and liabilities, allowance for doubtful accounts, inventory valuation, fair value of goodwill and acquired tangible and intangible assets and liabilities assumed during acquisitions, the number of reporting segments, the recoverability of intangible assets and their useful lives, contingencies, and the valuations of deferred income tax assets and uncertain tax positions. Actual results could differ from those estimates, and such differences may be material to the condensed consolidated financial statements.

Significant Accounting Policies

There have been no significant changes in the Company’s accounting policies from those disclosed in its Annual Report on Form 10-K, except for the policies described below and the adoption of Accounting Standards Update (“ASU”) 2016-09, Improvements to Employee Share-Based Payment Accounting, discussed below in the section titled “Accounting Pronouncements Recently Adopted.”

Rights of Return, Stock Rotation Rights, and Price Protection

The Company offers limited rights of return, stock rotation rights, and price protection under various policies and programs with its retailer and distributor customers and end-users. Below is a summary of the general provisions of such policies and programs:

Retailers and distributors are generally allowed to return products that were originally sold through to an end-user under provisions of their contracts, called “open-box” returns, and such returns may be made at any time after original sale.
All purchases through Fitbit.com are covered by a 45-day right of return.
Distributors are allowed stock rotation rights which are limited rights of return of products purchased during a prior period, generally one quarter.
Distributors and retailers are allowed return rights for defective products.
Certain distributors are offered price protection that allows for the right to a partial credit for unsold inventory held by the distributor if the Company reduces the selling price of a product.


9

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


The Company estimates reserves for these policies and programs based on historical experience and records the reserves as a reduction of revenue and accounts receivable. Through July 1, 2017, actual returns have primarily been open-box returns. In addition, through July 1, 2017, the Company has had minimal price protection claims. On a quarterly basis, the amount of revenue that is reserved for future returns is calculated based on historical trends and data specific to each reporting period. The historical trends consider product life cycles, new product introductions, market acceptance of products, product sell-through, the type of customer, seasonality, and other factors. Return rates can fluctuate over time, but have been sufficiently predictable to allow the Company to estimate expected future product returns. The Company reviews the actual returns evidenced in prior quarters as a percent of related revenue to determine the historical rate of returns. The Company then applies the historical rate of returns to the current period revenue as a basis for estimating future returns. When necessary, the Company also provides a specific reserve for products in the distribution channel in excess of estimated requirements. This estimate can be affected by the amount of a particular product in the channel, the rate of sell-through, product plans, and other factors. The Company also considers whether there are circumstances which may result in anticipated returns higher than the historical return rate from direct customers and records an additional specific reserve as necessary. The estimates and assumptions used to reserve for rights of return, stock rotation rights, and price protection have been accurate in all material respects and have not materially changed in the past.

Product Warranty

The Company offers a standard product warranty that its products will operate under normal use for a period of one-year from the date of original purchase, except in the European Union where the Company provides a two-year warranty. The Company has the obligation, at its option, to either repair or replace a defective product. At the time revenue is recognized, an estimate of future warranty costs is recorded as a component of cost of revenues. The estimate of future warranty costs is based on historical and projected warranty claim rates, historical and projected cost-per-claim and knowledge of specific product failures, if any, that are outside of the Company’s typical experience. The Company regularly review these estimates to assess the appropriateness of its recorded warranty liabilities and adjust the amounts as necessary. Factors that affect the warranty obligation include product failure rates, service delivery costs incurred in correcting the product failures, and warranty policies. The warranty obligation does not consider historical experience of the Fitbit Force product as a separate reserve has been established for the Fitbit Force recall. The Company’s products are manufactured by contract manufacturers, and in certain cases, the Company may have recourse against such contract manufacturers. Should actual product failure rates, use of materials or other costs differ from the Company’s estimates, additional warranty liabilities could be incurred, which could materially affect the Company’s results of operations. The estimates and assumptions used to reserve for product warranty have been accurate in all material respects and have not materially changed in the past.

Non-Monetary Transaction

The Company entered into an agreement with a third party during 2016 to exchange inventory for advertising credits and cash. The Company recorded the transaction based on the estimated fair value of the products exchanged. For the year ended December 31, 2016, the Company recorded $15.0 million of revenue and $7.0 million of associated cost of goods sold upon exchange of the products for advertising credits of $13.0 million and cash of $2.0 million. The $13.0 million of unused advertising credits remaining as of December 31, 2016 were recorded in prepaid expenses and other current assets, and other assets. Such credits are expected to be used over the contractual period of four years, and will be expensed as advertising services are received. During the three and six months ended July 1, 2017, $0.2 million and $0.3 million of credits were utilized, respectively. The Company’s prepaid and other assets related to unused advertising credits as of July 1, 2017 and December 31, 2016 were $12.7 million and $13.0 million, respectively.

Out-of-Period Adjustment

During the first quarter of 2016, the Company identified an error, which resulted in an understatement of income tax expense by $3.0 million for the year ended December 31, 2015. The Company recorded an out-of-period adjustment to correct the error in the quarter ended April 2, 2016. The Company assessed the materiality of this error and concluded the error was not material to the 2015 and 2016 consolidated financial statements, and therefore, recorded the correction in the first quarter of 2016.

Accounting Pronouncements Not Yet Adopted

In May 2014, the Financial Accounting Standards Board (the “FASB”), issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which affects any entity that either enters into contracts with customers to transfer goods and services or

10

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


enters into contracts for the transfer of nonfinancial assets. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under the currently effective guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 will become effective for the Company on January 1, 2018 and can be adopted either retrospectively to each prior reporting period presented or as a cumulative effect adjustment as of the date of adoption. In April 2016, the FASB issued ASU 2016-10, which clarifies guidance on identifying performance obligations and licensing implementation. The Company currently expects to adopt the new revenue recognition standard as of January 1, 2018, utilizing the modified retrospective transition method. The Company’s implementation team has made progress in its project plan, which includes evaluating customer contracts across the organization, developing policies, processes and tools to report financial results, and implementing and evaluating the Company’s internal controls over financial reporting that will be necessary under the new standard. Although the new standard may, in certain circumstances, impact the timing of when revenue is recognized for products shipped, and the timing and classification of certain sales incentives, which are expected to generally be recognized earlier than under existing guidance, the Company believes the new guidance is consistent with its current revenue recognition policy. Therefore, the Company does not currently expect adoption to have a material impact on its consolidated financial statements. The Company is continuing to make progress in evaluating the impact of the adoption and preliminary assessments are subject to change.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires lessees to recognize right-of-use assets and lease liabilities for operating leases, initially measured at the present value of the lease payments, on the balance sheet. ASU 2016-02 will become effective for the Company on January 1, 2019, and requires adoption using a modified retrospective approach. The Company is currently evaluating the impact of this guidance on its consolidated financial statements. The Company anticipates that the adoption will have a material impact on its consolidated balance sheets, as it will now include a right of use asset and a lease liability for the obligation to make lease payments related to substantially all operating lease arrangements; however, the Company does not expect the adoption to have a material impact on its consolidated statements of operations.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 provides for a new impairment model which requires measurement and recognition of expected credit losses for most financial assets and certain other instruments, including but not limited to accounts receivable and available for sale debt securities. ASU 2016-13 will become effective for the Company on January 1, 2020 and early adoption is permitted. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). ASU 2016-15 provides guidance intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. ASU 2016-15 will become effective for the Company on January 1, 2018 and early adoption is permitted. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating the second step of the goodwill impairment test. The second step measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Under ASU 2017-04, a company will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. ASU 2017-04 will be applied prospectively and is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. ASU 2017-09 was issued to clarify and reduce both (i) diversity in practice and (ii) cost and complexity when applying the guidance in Topic 718 to a change to the terms and conditions of a share-based payment award. ASU 2017-09 will become effective for the Company on January 1, 2018 with early adoption permitted. The amendments to ASU 2017-09 should be applied prospectively to an award modified on or after the adoption date. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.

Accounting Pronouncements Recently Adopted


11

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


In March 2016, the FASB issued ASU 2016-09, Compensation—Stock Compensation (Topic 718). ASU 2016-09 simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Upon adoption, ASU 2016-09 requires that excess tax benefits for share-based payments be recorded as a reduction of income tax expense and reflected within operating cash flows, rather than being recorded within equity and reflected within financing cash flows. ASU 2016-09 also permits the repurchase of more of an employee’s shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made on an employee’s behalf for withheld shares should be presented as a financing activity on the Company’s cash flows statement, and provides an accounting policy election to account for forfeitures as they occur. ASU 2016-09 became effective for the Company on January 1, 2017. The adoption of ASU 2016-09 resulted in a cumulative effect adjustment of $4.9 million to increase retained earnings as of January 1, 2017, related to the recognition of previously unrecognized excess tax benefits using the modified retrospective method. The Company elected to apply the change in presentation of excess tax benefits in the condensed consolidated statement of cash flows retrospectively, which resulted in an increase in net cash provided by operations and a decrease in net cash provided by financing activities of $16.3 million for the six months ended July 1, 2016.  The Company also elected to make an accounting policy change to recognize forfeitures starting on January 1, 2017 on a prospective basis.

 
2.    Fair Value Measurements
 
The carrying values of the Company’s accounts receivable, accounts payable, and accrued liabilities approximated their fair values due to the short period of time to maturity or repayment.
 
The following tables set forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy (in thousands):
 
 
July 1, 2017
 
Level 1
 
Level 2
 
Total
 
 
 
 
 
 
Assets:
 
 
 
 
 
Money market funds
$
161,762

 
$

 
$
161,762

U.S. government agencies

 
39,961

 
39,961

Corporate debt securities

 
353,046

 
353,046

Derivative assets

 
361

 
361

Total
$
161,762

 
$
393,368

 
$
555,130

Liabilities:
 
 
 
 
 
Derivative liabilities
$

 
$
13,869

 
$
13,869


 
December 31, 2016
 
Level 1
 
Level 2
 
Total
 
 
 
 
 
 
Assets:
 
 
 
 
 
Money market funds
$
50,125

 
$

 
$
50,125

U.S. government agencies

 
86,526

 
86,526

Corporate debt securities

 
390,286

 
390,286

Derivative assets

 
10,625

 
10,625

Total
$
50,125

 
$
487,437

 
$
537,562

Liabilities:
 
 
 
 
 
Derivative liabilities
$

 
$
3,780

 
$
3,780

 
The fair value of the Company’s Level 1 financial instruments is based on quoted market prices in active markets for identical instruments. The fair value of the Company’s Level 2 financial instruments is based on observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data.


12

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


In addition, Level 2 assets and liabilities include derivative financial instruments associated with hedging activity, which are further discussed in Note 3. Derivative financial instruments are initially measured at fair value on the contract date and are subsequently remeasured to fair value at each reporting date using inputs such as spot rates, forward rates, and discount rates. There is not an active market for each hedge contract, but the inputs used to calculate the value of the instruments are tied to active markets.

There were no Level 3 assets or liabilities as of July 1, 2017 and December 31, 2016. There have been no transfers between fair value measurement levels during the three and six months ended July 1, 2017 and July 2, 2016.
 

3.    Financial Instruments

Cash, Cash Equivalents and Marketable Securities

The Company’s marketable securities are classified as available-for-sale as of the balance sheet date and are reported at fair value with unrealized gains and losses reported, net of tax, as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity. Because the Company views marketable securities as available to support current operations as needed, it has classified all available-for-sale securities as current assets. Realized gains or losses and other-than-temporary impairments, if any, on available-for-sale securities are reported in other income (expense), net, as incurred.

Investments are reviewed periodically to identify potential other-than-temporary impairments. No impairment loss has been recorded on the securities included in the tables below because the Company believes that the decrease in fair value of these securities is temporary and expects to recover up to, or beyond, the initial cost of investment for these securities.

The following table sets forth cash, cash equivalents and marketable securities as of July 1, 2017 (in thousands):
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
Cash and Cash Equivalents
 
Marketable Securities
 
 
 
 
 
 
 
 
 
 
 
 
Cash
$
121,029

 
$

 
$

 
$
121,029

 
$
121,029

 
$

Money market funds
161,762

 

 

 
161,762

 
161,762

 

U.S. government agencies
39,974

 
1

 
(14
)
 
39,961

 
21,926

 
18,035

Corporate debt securities
353,108

 
64

 
(126
)
 
353,046

 
13,991

 
339,055

Total
$
675,873

 
$
65

 
$
(140
)
 
$
675,798

 
$
318,708

 
$
357,090


The following table sets forth cash, cash equivalents and marketable securities as of December 31, 2016 (in thousands):
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
Cash and Cash Equivalents
 
Marketable Securities
 
 
 
 
 
 
 
 
 
 
 
 
Cash
$
179,076

 
$

 
$

 
$
179,076

 
$
179,076

 
$

Money market funds
50,125

 

 

 
50,125

 
50,125

 

U.S. government agencies
86,533

 
8

 
(15
)
 
86,526

 

 
86,526

Corporate debt securities
390,466

 
24

 
(204
)
 
390,286

 
72,119

 
318,167

Total
$
706,200

 
$
32

 
$
(219
)
 
$
706,013

 
$
301,320

 
$
404,693


The gross unrealized gains or losses on marketable securities as of July 1, 2017 and December 31, 2016 were not material. There were no available-for-sale investments as of July 1, 2017 and December 31, 2016 that have been in a continuous unrealized loss position for greater than 12 months.

The following table classifies marketable securities by contractual maturities (in thousands):

13

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


 
July 1, 2017
 
December 31, 2016
 
 
 
 
Due in one year
$
340,293

 
$
355,152

Due in one to two years
16,797

 
49,541

Total
$
357,090

 
$
404,693


Derivative Financial Instruments

The Company operates in foreign countries, which exposes it to market risk associated with foreign currency exchange rate fluctuations between the U.S. dollar and various foreign currencies. In order to manage this risk, the Company may hedge a portion of its foreign currency exposures related to outstanding monetary assets and liabilities as well as forecasted revenues and expenses, using foreign currency exchange forward or option contracts. In general, the market risk related to these contracts is offset by corresponding gains and losses on the hedged transactions. The Company does not enter into derivative contracts for trading or speculative purposes.
 
Cash Flow Hedges
 
The Company has entered into foreign currency derivative contracts designated as cash flow hedges to hedge certain forecasted revenue and expense transactions denominated in currencies other than the U.S. dollar. The Company’s cash flow hedges consist of forward contracts with maturities of 12 months or less.

The Company periodically assesses the effectiveness of its cash flow hedges. Effectiveness represents a derivative instrument’s ability to generate offsetting changes in cash flows related to the hedged risk. The Company records the gains or losses, net of tax, related to the effective portion of its cash flow hedges as a component of accumulated other comprehensive income (loss) in stockholders’ equity and subsequently reclassifies the gains or losses into revenue and operating expenses when the underlying hedged transactions are recognized. The Company records the gains or losses related to the ineffective and excluded time value portion of the cash flow hedges, if any, immediately in other income (expense), net. If the hedged transaction becomes probable of not occurring, the corresponding amounts in accumulated other comprehensive income (loss) would immediately be reclassified to other income (expense), net. Cash flows related to the Company’s cash flow hedging program are recognized as cash flows from operating activities in its statements of cash flows.

The Company had outstanding contracts with a total notional amount of $229.5 million and $0 million in cash flow hedges for forecasted revenue and expense transactions, respectively, as of July 1, 2017, and $20.0 million and $20.9 million in cash flow hedges for forecasted revenue and expense transactions, respectively, as of December 31, 2016.

Balance Sheet Hedges

The Company enters into foreign exchange contracts to hedge certain monetary assets and liabilities that are denominated in currencies other than the functional currency of its subsidiaries. These foreign exchange contracts are carried at fair value, do not qualify for hedge accounting treatment, and are not designated as hedging instruments. Changes in the value of the foreign exchange contracts are recognized in other income (expense), net, and offset the foreign currency gain or loss on the underlying net monetary assets or liabilities.

The Company had outstanding balance sheet hedges with a total notional amount of $59.8 million and $177.0 million as of July 1, 2017 and December 31, 2016, respectively.
 
Fair Value of Foreign Currency Derivatives

The foreign currency derivative contracts that were not settled at the end of the period are recorded at fair value, on a gross basis, in the condensed consolidated balance sheets. The following table presents the fair value of the Company’s foreign currency derivative contracts as of the periods presented (in thousands):

14

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


 
 
 
July 1, 2017
 
December 31, 2016
 
Balance Sheet Location
 
Fair Value Derivative
Assets
 
Fair Value Derivative Liabilities
 
Fair Value Derivative
Assets
 
Fair Value Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
Cash flow designated hedges
Prepaid expenses and other current assets
 
$

 
$

 
$
813

 
$

Cash flow designated hedges
Accrued liabilities
 

 
12,081

 

 
1,428

Hedges not designated
Prepaid expenses and other current assets
 
361

 

 
9,812

 

Hedges not designated
Accrued liabilities
 

 
1,788

 

 
2,352

Total fair value of derivative instruments
 
 
$
361

 
$
13,869

 
$
10,625

 
$
3,780


Financial Statement Effect of Foreign Currency Derivative Contracts

The following table presents the pre-tax impact of the Company’s foreign currency derivative contracts on other comprehensive income (“OCI”) and the condensed consolidated statements of operations for the periods presented (in thousands):
 
 
 
Three Months Ended
 
Six Months Ended
 
Income Statement Location
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
 
 
Foreign exchange cash flow hedges:
 
 
 
 
 
 
 
 
 
Gain (loss) recognized in OCI – effective portion
 
 
$
(13,029
)
 
$
5,783

 
$
(13,987
)
 
$
1,535

Loss reclassified from OCI into income – effective portion
Revenue
 
(1,035
)
 
(1,380
)
 
(280
)
 
(1,550
)
Gain (loss) reclassified from OCI into income – effective portion
Operating expenses
 
(440
)
 
1,393

 
(1,405
)
 
2,408

Gain (loss) recognized in income – ineffective portion
Other income (expense), net
 

 
(95
)
 
21

 
(185
)
 
 
 
 
 
 
 
 
 
 
Gain recognized in income – excluded time value portion
Other income (expense), net
 
660

 

 
843

 

 
 
 
 
 
 
 
 
 
 
Foreign exchange balance sheet hedges:
 
 
 
 
 
 
 
 
 
Loss recognized in income
Other income (expense), net
 
(3,547
)
 
(72
)
 
(6,776
)
 
(209
)

As of July 1, 2017, all net derivative gains related to the Company’s cash flow hedges will be reclassified from OCI into revenue and operating expense within the next 12 months.

Offsetting of Foreign Currency Derivative Contracts

The Company presents its derivative assets and derivative liabilities at gross fair values in the condensed consolidated balance sheets. The Company generally enters into master netting arrangements, which mitigate credit risk by permitting net settlement of transactions with the same counterparty. The Company is not required to pledge, and is not entitled to receive, cash collateral related to these derivative instruments.

The following tables set forth the available offsetting of net derivative assets under the master netting arrangements as of July 1, 2017 and December 31, 2016 (in thousands):



15

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Gross Amounts Not Offset in Condensed Consolidated Balance Sheets
July 1, 2017
Gross Amounts Recognized
 
Gross Amounts Offset
 
Net Amounts Presented
 
Financial Instruments
 
Cash Collateral Received
 
Net Amount
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts assets
$
361

 
$

 
$
361

 
$
361

 
$

 
$

Foreign exchange contracts liabilities
$
13,869

 
$

 
$
13,869

 
$
361

 
$

 
$
13,508

 
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Gross Amounts Not Offset in Condensed Consolidated Balance Sheets
December 31, 2016
Gross Amounts Recognized
 
Gross Amounts Offset
 
Net Amounts Presented
 
Financial Instruments
 
Cash Collateral Received
 
Net Amount
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts assets
$
10,625

 
$

 
$
10,625

 
$
3,780

 
$

 
$
6,845

Foreign exchange contracts liabilities
$
3,780

 
$

 
$
3,780

 
$
3,780

 
$

 
$






4.    Balance Sheet Components
 
Revenue Returns Reserve
 
Revenue returns reserve activities were as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
Beginning balances
$
68,317

 
$
55,875

 
$
98,851

 
$
74,045

Increases
48,285

 
85,335

 
89,911

 
119,550

Returns taken
(65,082
)
 
(60,933
)
 
(137,242
)
 
(113,318
)
Ending balances
$
51,520

 
$
80,277

 
$
51,520

 
$
80,277


Increases in the revenue returns reserve include provisions for open box returns and stock rotations.

Inventories
 
Inventories consisted of the following (in thousands):
 
July 1, 2017
 
December 31, 2016
  
 
 
 
 
 
Components
$
5,270

 
$
1,035

Finished goods
136,234

 
229,352

Total inventories
$
141,504

 
$
230,387

 

16

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


Prepaid Expenses and Other Current Assets
 
Prepaid expenses and other current assets consisted of the following (in thousands):
 
July 1, 2017
 
December 31, 2016
  
 
 
 
 
 
Prepaid income taxes
$
65,442

 
$
481

POP displays, net
5,436

 
22,804

Prepaid marketing
3,251

 
5,764

Derivative assets
361

 
10,625

Other
23,227

 
26,672

Total prepaid expenses and other current assets
$
97,717

 
$
66,346


Property and Equipment, Net
 
Property and equipment, net, consisted of the following (in thousands):
 
July 1, 2017
 
December 31, 2016
  
 
 
 
 
 
Tooling and manufacturing equipment
$
50,736

 
$
60,944

Furniture and office equipment
16,416

 
14,424

Purchased and internally-developed software
14,648

 
12,032

Leasehold improvements
37,107

 
28,489

Total property and equipment
118,907

 
115,889

Less: Accumulated depreciation and amortization
(38,772
)
 
(39,336
)
Property and equipment, net
$
80,135

 
$
76,553

 
Goodwill and Intangible Assets

The carrying amount of goodwill was $51.0 million as of July 1, 2017 and December 31, 2016. See Note 11 for additional information.

The carrying amounts of the intangible assets as of July 1, 2017 and December 31, 2016 were as follows (in thousands, except useful life). In-process research and development is not amortized until the completion or abandonment of the related development.
 
July 1, 2017
 
December 31, 2016
 
Weighted Average Remaining Useful Life
(years)
  
Gross
 
Accumulated Amortization
 
Net
 
Gross
 
Accumulated Amortization
 
Net
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed technology
$
26,092

 
$
(5,885
)
 
$
20,207

 
$
26,092

 
$
(3,247
)
 
$
22,845

 
4.2
Trademarks and other
1,150

 
(529
)
 
621

 
1,278

 
(542
)
 
736

 
2.8
Total finite-lived intangible assets subject to amortization, net
27,242

 
(6,414
)
 
20,828

 
27,370

 
(3,789
)
 
23,581

 
 
In-process research and development
3,940

 

 
3,940

 
3,940

 

 
3,940

 
 
Total intangible assets, net
$
31,182

 
$
(6,414
)
 
$
24,768

 
$
31,310

 
$
(3,789
)
 
$
27,521

 
 

Total amortization expense related to intangible assets was $1.4 million and $0.5 million for the three months ended July 1, 2017 and July 2, 2016, respectively, and $2.8 million and $1.1 million for the six months ended July 1, 2017 and July 2, 2016, respectively.

The estimated future amortization expense of acquired finite-lived intangible assets to be charged to cost of revenue and operating expenses after July 1, 2017 is as follows (in thousands):

17

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


  
Cost of Revenue
 
Operating Expenses
 
Total
 
 
 
 
 
 
Remaining 2017
$
2,638

 
$
115

 
$
2,753

2018
5,276

 
230

 
5,506

2019
4,496

 
230

 
4,726

2020
3,716

 
46

 
3,762

2021
3,716

 

 
3,716

Thereafter
365

 

 
365

Total finite-lived intangible assets, net
$
20,207

 
$
621

 
$
20,828


Accrued Liabilities
 
Accrued liabilities consisted of the following (in thousands):
 
July 1, 2017
 
December 31, 2016
  
 
Product warranty
$
72,761

 
$
99,923

Accrued manufacturing expense and freight
60,826

 
75,579

Accrued sales incentives
64,281

 
74,181

Accrued sales and marketing
24,495

 
41,948

Accrued co-op advertising and marketing development funds
17,992

 
40,002

Sales taxes and VAT payable
20,263

 
8,891

Employee related liabilities
19,716

 
13,934

Inventory received but not billed
13,981

 
7,363

Accrued legal fees
10,336

 
3,963

Derivative liabilities
13,869

 
3,780

Other
28,997

 
20,997

Accrued liabilities
$
347,517

 
$
390,561


Product warranty reserve activities were as follows (in thousands)(1):
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
Beginning balances
$
90,459

 
$
50,669

 
$
99,923

 
$
40,212

Charged to cost of revenue
(1,595
)
 
64,211

 
17,342

 
101,452

Changes related to pre-existing warranties
4,913

 
(487
)
 
2,473

 
(487
)
Settlement of claims
(21,016
)
 
(37,552
)
 
(46,977
)
 
(64,336
)
Ending balances
$
72,761

 
$
76,841

 
$
72,761

 
$
76,841

 

(1) 
Does not include reserves established as a result of the recall of the Fitbit Force. See the section titled “Fitbit Force Recall Reserve” in the Company’s Annual Report on Form 10-K for additional information regarding such reserves.

In the first quarter of 2017, the Company corrected the allocation of customer support costs and freight and fulfillment to the amounts reported in “Charged to cost of revenue” and “Settlement of claims.” Those costs are included in the beginning and ending balances. Further, the Company does not consider this adjustment to be material and there was no impact to its condensed consolidated balance sheets and statements of operations.


18

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


Restructuring

In January 2017, the Company announced cost-efficiency measures to be implemented in 2017 that include realigning sales and marketing spend and improved optimization of research and development investments. In addition, the Company announced a reorganization, including a reduction in workforce. This reorganization impacted approximately 110 employees, or approximately 6% of the Company’s global workforce. The Company recorded $6.4 million in total restructuring expenses, substantially all of which were severance and related costs, in the first quarter of 2017. The Company anticipates that it will substantially complete the reorganization by the end of the third quarter of 2017.

The restructuring reserve activities were as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
Beginning balance
$
2,352

 
$

 
$

 
$

  Restructuring charges

 

 
6,375

 

  Cash paid
(1,330
)
 

 
(4,625
)
 

  Other - noncash

 

 
(728
)
 

Ending balance
$
1,022

 
$

 
$
1,022

 
$


Accumulated Other Comprehensive Income (Loss)

The components and activity of accumulated other comprehensive income (“AOCI”), net of tax, were as follows (in thousands):

 
Unrealized Gains (Losses) on Cash Flow Hedges
 
Currency Translation Adjustments
 
Unrealized Gains (Losses) on Available-for-Sale Investments
 
Total
 
 
 
 
 
 
 
 
Balance at December 31, 2016
$
(477
)
 
$
(314
)
 
$
(187
)
 
$
(978
)
Other comprehensive income (loss) before reclassifications
(13,789
)
 
314

 
85

 
(13,390
)
Amounts reclassified from AOCI
1,647

 

 
(12
)
 
1,635

Other comprehensive income (loss)
(12,142
)
 
314

 
73

 
(11,755
)
Balance at July 1, 2017
$
(12,619
)
 
$

 
$
(114
)
 
$
(12,733
)


5.    Long-Term Debt
 

2015 Credit Agreement
 
In December 2015, the Company entered into a second amended and restated credit agreement (the “Senior Facility”) that allowed the Company to borrow up to $250.0 million, including up to $50.0 million for the issuance of letters of credit and up to $25.0 million for swing line loans. As of July 1, 2017, there were no outstanding borrowings under the Senior Facility. As of July 1, 2017, the Company had outstanding letters of credit totaling $38.0 million, issued to cover various security deposits on its facility leases.

On May 3, 2017, the Company entered into a first amendment to the Senior Facility (the “First Amendment”), pursuant to which the aggregate amount the Company can borrow under the Senior Facility was reduced from $250.0 million to $100.0 million, with up to $50.0 million available for the issuance of letters of credit and up to $25.0 million available for swing line loans. In addition, pursuant to the First Amendment, the applicable margin in respect of the interest rates under the Senior Facility were amended to be based on the Company’s level of liquidity (defined as the sum of the Company’s aggregate cash holdings and the amount available under its revolving commitments) and range from, with respect to Alternate Base Rate loans, 0.5% to 1.0%, and, with respect to LIBOR loans, 1.5% to 2.0%. Among other changes, the First Amendment also removed the fixed charge coverage ratio covenant and the consolidated leverage ratio covenant, and added a general liquidity covenant requiring the Company to

19

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


maintain liquidity of at least $200.0 million in unrestricted cash, of which $100.0 million in cash or cash equivalents must be held in accounts subject to control agreements with, and maintained by, Silicon Valley Bank or its affiliates. The Company was in compliance with the financial covenants under the Senior Facility as of July 1, 2017.

Letters of Credit
 
As of July 1, 2017 and December 31, 2016, the Company had outstanding letters of credit totaling $38.0 million issued to cover various security deposits on the Company’s facility leases.
 

6.    Commitments and Contingencies
 
Leases
 
The Company’s principal facility is located in San Francisco, California. The Company also leases office space in various locations with expiration dates between 2017 and 2024. The lease agreements often include leasehold improvement incentives, escalating lease payments, renewal provisions and other provisions which require the Company to pay taxes, insurance, maintenance costs or defined rent increases. All of Company’s leases are accounted for as operating leases. Future minimum payments under the Company’s noncancelable lease agreements as of July 1, 2017 were $281.0 million.
 
Legal Proceedings

Jawbone. On May 27, 2015, Aliphcom, Inc. d/b/a Jawbone (“Jawbone”) filed a lawsuit in the Superior Court of California in the County of San Francisco against the Company and certain of its employees who were formerly employed by Jawbone, alleging trade secret misappropriation and unfair and unlawful business practices against all defendants, and alleging breach of contract and breach of implied covenant of good faith and fair dealing against the employee defendants. The complaint seeks unspecified damages, including punitive damages and injunctive relief. On June 23, 2016, Jawbone filed a Second Amended Complaint, adding an additional employee defendant and related allegations. The trial is currently scheduled for April 30, 2018.
On June 10, 2015, Jawbone and BodyMedia, Inc., a wholly-owned subsidiary of Jawbone (“BodyMedia”), filed a lawsuit against the Company in the U.S. District Court for the Northern District of California alleging that the Company infringes certain U.S. patents. The complaint seeks unspecified compensatory damages and attorneys’ fees from the Company and to permanently enjoin the Company from making, manufacturing, using, selling, importing, or offering the Company’s products for sale. The lawsuit has been stayed pending resolution of the investigation in the U.S. International Trade Commission (the “ITC”).
On July 7, 2015, Jawbone and BodyMedia filed a complaint with the ITC requesting an investigation into purported violations of the Tariff Act of 1930 by the Company and Flextronics International Ltd. and Flextronics Sales and Marketing (A-P) Ltd. The complaint makes the same patent infringement and trade secret misappropriation claims as the two earlier cases. The complaint seeks a limited exclusion order and a cease and desist order halting the importation and sale of the infringing products. The ITC instituted the investigation on August 17, 2015. As a result of motions, all of the patent infringement claims were dismissed from the case. A trial on the trade secrets allegations took place from May 9 to May 17, 2016. On August 23, 2016, the administrative law judge concluded that the Company did not misappropriate any Jawbone trade secrets. On October 20, 2016, the ITC terminated the investigation in the ITC. Jawbone has appealed the dismissal of the patent infringement claims to the Federal Circuit. Oral argument has not yet been scheduled.
On September 3, 2015, the Company filed a complaint for patent infringement against Jawbone in the U.S. District Court for the District of Delaware, asserting that Jawbone’s activity trackers infringe certain U.S. patents. This case has been transferred to the U.S. District Court for the Northern District of California. The trial is currently scheduled for July 13, 2020. On September 8, 2015, the Company filed a complaint for patent infringement against Jawbone in the U.S. District Court for the Northern District of California, asserting that Jawbone’s activity trackers infringe certain U.S. patents. No trial date has been set. On October 29, 2015, the Company filed a complaint for patent infringement against Jawbone in the U.S. District Court for the District of Delaware, asserting that Jawbone’s activity trackers infringe certain U.S. patents. That case has also been transferred to the U.S. District Court for the Northern District of California. No trial date has been set.
On November 2, 2015, the Company filed a complaint with the ITC requesting an investigation into violations of the Tariff Act of 1930 by Jawbone and Body Media. The complaint asserts that Jawbone’s products infringe certain U.S. patents. The complaint seeks a limited exclusion order and a cease and desist order halting the importation and sale of infringing products. The

20

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


ITC instituted the investigation on December 1, 2015. On December 23, 2016, the Company filed a motion to terminate the investigation, and the ITC terminated the investigation on February 1, 2017.
On August 12, 2016, the Company was notified by Jawbone that Jawbone had received a confidential subpoena from the U.S. Attorney’s Office for the Northern District of California requesting certain of the Company’s confidential business information that appeared to be related to Jawbone’s allegations of trade secret misappropriation. On February 17, 2017, the Company received a subpoena from the same office. The Company is cooperating with the U.S. Attorney’s Office.
The Company intends to vigorously defend and prosecute each of the Jawbone litigation matters and, based on its review, the Company believes it has valid defenses and claims with respect to each of these matters. However, litigation is inherently uncertain, and any judgment or injunctive relief entered against the Company or any adverse settlement could materially and adversely impact its business, financial condition, operating results, and prospects. Regarding the Jawbone-related legal proceedings, because the outstanding matters are still in the early stages of litigation, the Company is unable to estimate a reasonably possible loss or range of loss, if any, that may result from these matters. In addition, these litigation matters are complex, likely to involve significant management time and attention, and the cost of defending and prosecuting these matters is likely to be expensive, regardless of outcome.
Sleep Tracking. On May 8, 2015, a purported class action lawsuit was filed against the Company in the U.S. District Court for the Northern District of California, alleging that the sleep tracking function available in certain trackers does not perform as advertised. Plaintiffs seek class certification, restitution, an award of unspecified compensatory and punitive damages, an award of reasonable costs and expenses, including attorneys’ fees, and other further relief as the Court may deem just and proper. On January 31, 2017, plaintiffs filed a motion for class certification. A ruling on this matter has not yet issued. On April 20, 2017, the Company filed a motion for summary judgment. The hearing on this motion is scheduled for August 31, 2017. All other dates, including the prior trial date of July 10, 2017, have been vacated.

The Company believes that the plaintiffs’ allegations are without merit, and intends to vigorously defend against the claims. Because the Company is in the early stages of this litigation matter, the Company is unable to estimate a reasonably possible loss or range of loss, if any, that may result from this matter.

Heart Rate Tracking. On January 6, 2016 and February 16, 2016, two purported class action lawsuits were filed against the Company in the U.S. District Court for the Northern District of California, alleging that the PurePulse® heart rate tracking technology does not consistently and accurately record users’ heart rates. Plaintiffs allege common law claims as well as violations of various states’ false advertising and unfair competition statutes, and seek class certification, injunctive and declaratory relief, restitution, an award of unspecified compensatory damages, exemplary damages, punitive damages, and statutory penalties and damages, an award of reasonable costs and expenses, including attorneys’ fees, and other further relief as the Court may deem just and proper. On April 15, 2016, the plaintiffs filed a Consolidated Master Class Action Complaint and, on May 19, 2016, filed an Amended Consolidated Master Class Action Complaint. On January 9, 2017, the Company filed a motion to compel arbitration, and is currently awaiting a ruling from the Court.
The Company believes that the plaintiffs’ allegations are without merit, and intends to vigorously defend against the claims. Because the Company is in the early stages of this litigation matter, the Company is unable to estimate a reasonably possible loss or range of loss, if any, that may result from this matter.
Securities Litigation. On January 11, 2016, a putative securities class action was filed in the U.S. District Court for the Northern District of California naming as defendants the Company, certain of its officers and directors, and the underwriters of the Company’s initial public offering (the “IPO”). On May 10, 2016, the Court appointed the Fitbit Investor Group (consisting of five individual investors) as lead plaintiff, and an Amended Complaint was filed on July 1, 2016. Plaintiffs allege violations of the Securities Act of 1933, as amended (the “Securities Act”), and the Securities Exchange Act of 1934, as amended, based on alleged materially false and misleading statements about the Company’s products between October 27, 2014 and November 23, 2015. Plaintiffs seek to represent a class of persons who purchased or otherwise acquired the Company’s securities (i) on the open market between June 18, 2015 and May 19, 2016; and/or (ii) pursuant to or traceable to the IPO. Plaintiffs seek class certification, an award of unspecified compensatory damages, an award of reasonable costs and expenses, including attorneys’ fees, and other further relief as the Court may deem just and proper.
On April 28, 2016, a putative class action lawsuit alleging violations of the Securities Act was filed in the Superior Court of California, County of San Mateo, naming as defendants the Company, certain of its officers and directors, the underwriters of the IPO, and a number of its investors. Plaintiffs allege that the IPO registration statement contained material misstatements about the

21

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


Company’s products. Plaintiffs seek to represent a class of persons who purchased the Company’s common stock in and/or traceable to the IPO and/or the November 2015 follow-on public offering (the “Secondary Offering”). Plaintiffs seek class certification, an award of unspecified compensatory damages, an award of reasonable costs and expenses, including attorneys’ fees, and other further relief as the Court may deem just and proper. On May 17, 2016, a similar class action lawsuit was filed in the Superior Court of California, County of San Francisco. The cases have now been consolidated in the County of San Francisco. On April 7, 2017, the Court granted a motion to dismiss the Section 11 claim based on the Secondary Offering and stayed the cases.
On November 11, 2016, a derivative lawsuit was filed in the U.S. District Court for the Northern District of California derivatively on behalf of the Company naming as defendants certain of its officers and directors and as a nominal defendant the Company. Plaintiffs allege breach of fiduciary duty based on the same set of alleged facts in the federal and state securities class action litigation. On February 3, 2017, a second derivative lawsuit was filed in the U.S. District Court for the District of Delaware on the same allegations. Both Courts have ordered a stay in these two cases.
On June 1, 2017 and June 9, 2017, two additional derivative complaints were filed in the Delaware Court of Chancery. Plaintiffs allege breach of fiduciary duty misappropriation of information against certain defendants who sold shares in the IPO and/or the Secondary Offering. On June 27, 2017, a fifth derivative lawsuit was filed in the U.S. District Court for the Northern District of California on the same allegations.
On June 27, 2017, an individual investor lawsuit alleging violations of the Securities Act and state law claims for statutory fraud and unfair business practice was filed in the Superior Court of California, County of Alameda, naming as defendants the Company and certain of its officers. The allegations are based on the same set of alleged facts in the federal and state securities class action litigation.
The Company believes that the plaintiffs’ allegations in these actions are without merit, and intends to vigorously defend against the claims. Because the Company is in the early stages of these litigation matters, the Company is unable to estimate a reasonably possible loss or range of loss, if any, that may result from these matters.
Other. The Company is and, from time to time, may in the future become, involved in other legal proceedings in the ordinary course of business. The Company currently believes that the outcome of any of these existing legal proceedings, including the aforementioned cases, either individually or in the aggregate, will not have a material impact on the operating results, financial condition or cash flows of the Company. With respect to existing legal proceedings, the Company has either determined that the existence of a material loss is not reasonably possible or that it is unable to estimate a reasonably possible loss or range of loss. The Company may incur substantial legal fees, which are expensed as incurred, in defending against these legal proceedings.
Indemnifications

In the ordinary course of business, the Company enters into agreements that may include indemnification provisions. Pursuant to such agreements, the Company may indemnify, hold harmless and defend an indemnified party for losses suffered or incurred by the indemnified party. Some of the provisions will limit losses to those arising from third-party actions. In some cases, the indemnification will continue after the termination of the agreement. The maximum potential amount of future payments the Company could be required to make under these provisions is not determinable. To date, the Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. The Company has also entered into indemnification agreements with its directors and officers that may require the Company to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers to the fullest extent permitted by Delaware corporate law. The Company also currently has directors’ and officers’ insurance.
 
7.    Stock Plan
 

22

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


Stock Option Exchange

On April 13, 2017, the Company filed its definitive proxy statement, submitting to stockholders a proposal for a stock option exchange program (the “Program”). The Program would allow the Company employees, including its executive officers other than its President, Chief Executive Officer, and Chairman, Chief Technology Officer, and Chief Financial Officer (“Eligible Employees”), to exchange out-of-the-money or “underwater” options to purchase shares of the Company’s Class A common stock or Class B common stock currently held by such Eligible Employees for a lesser number of restricted stock units (“RSUs”) that may be settled for shares of its Class A common stock, (“New RSUs”), under the Company’s 2015 Equity Incentive Plan (the “2015 Plan”). Each New RSU represents an unfunded right to receive one share of the Company’s Class A common stock on a date in the future, which generally is the date on which the New RSU will vest. Eligible Employees participating in the Program would receive one New RSU for every two “out-of-the-money” options that they exchange. The New RSUs would generally vest over the remaining vesting period of the exchanged option (subject to a one-year minimum vesting period). None of the members of the Company’s board of directors were eligible to participate in the Program. On May 25, 2017, the Company’s stockholders approved the Program at the 2017 Annual Meeting of Stockholders. The Company subsequently commenced the Program by filing a tender offer statement on Schedule TO with the SEC on June 21, 2017. The Program expired on July 19, 2017, additional details of which are discussed in Note 12.

Equity Incentive Plans

In May 2015, the Company’s board of directors and stockholders adopted and approved the 2015 Plan. The 2015 Plan became effective on June 16, 2015 and serves as the successor to the Amended and Restated 2007 Stock Plan (the “2007 Plan”). The Company ceased granting awards under the 2007 Plan, and any outstanding stock options and RSUs granted under the 2007 Plan would remain subject to the terms of the 2007 Plan. As of July 1, 2017, 14.3 million shares of Class A common stock were reserved and available for future issuance under the 2015 Plan.

Employee Stock Purchase Plan

In May 2015, the Company’s board of directors adopted the 2015 Employee Stock Purchase Plan (the “2015 ESPP”), which became effective on June 17, 2015. A total of 3.8 million shares of Class A common stock were initially reserved for issuance under the 2015 ESPP. The 2015 ESPP allows eligible employees to purchase shares of the Company’s Class A common stock through payroll deductions at a price per share equal to 85% of the lesser of the fair market value of the Company’s Class A common stock (i) on the first trading day of the applicable offering period and (2) the last trading day of each purchase period in the applicable offering period. Except for the initial offering period, the 2015 ESPP provides for 6-month offering periods beginning in May and November of each year. The initial offering period began June 17, 2015 and ended in May 2016.

Stock Options
 
Stock option activity under the equity incentive plans was as follows:
 
Stock Options Outstanding
 
Number of
Shares Subject
to
Stock Options
 
Weighted–
Average
Exercise
Price
 
Aggregate
Intrinsic
Value (1)
 
(in thousands)
 
 
 
(in thousands)
Balance—December 31, 2016
34,454

 
$
3.85

 
 
Granted

 


 
 
Exercised
(3,850
)
 
$
1.32

 


Forfeited or canceled
(2,562
)
 
$
7.26

 
 
Balance—July 1, 2017
28,042

 
$
3.88

 
$
85,564

 
 
 
 
 
 
Stock options exercisable—July 1, 2017
20,405

 
$
3.08

 
$
72,752

Stock options vested and expected to vest—July 1, 2017
27,831

 
$
3.87

 
$
85,240

 
(1) The aggregate intrinsic values of stock options outstanding, exercisable, vested and expected to vest as of July 1, 2017 were calculated as the difference between the exercise price of the stock options and the fair value of the Class A common stock of $5.31 as of June 30, 2017.


23

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


 Restricted Stock Units
 
RSU activity under the equity incentive plans was as follows:
 
RSUs
Outstanding
 
Weighted-
Average
Grant Date
Fair Value
 
(in thousands)
 
 
Unvested balance—December 31, 2016
11,578

 
$
16.85

Granted
9,929

 
5.75

Vested
(2,354
)
 
15.69

Forfeited or canceled
(2,712
)
 
13.86

Unvested balance—July 1, 2017
16,441

 
10.81

 
Stock-Based Compensation Expense
 
Total stock-based compensation expense recognized was as follows (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
Cost of revenue
$
1,492

 
$
1,084

 
$
1,510

 
$
2,393

Research and development
12,648

 
11,725

 
27,333

 
22,118

Sales and marketing
3,987

 
2,927

 
7,622

 
5,462

General and administrative
3,839

 
4,664

 
7,994

 
8,197

Total stock-based compensation expense
$
21,966

 
$
20,400

 
$
44,459

 
$
38,170

 
As of July 1, 2017, the total unrecognized stock-based compensation expense related to unvested stock options and RSUs was $267.9 million, which the Company expects to recognize over an estimated weighted average period of 2.3 years.
 
8.     Income Taxes
  
The Company is subject to income tax in the United States as well as other tax jurisdictions in which it conducts business. Earnings from non-U.S. activities are subject to local country income tax.

For the three and six months ended July 1, 2017, the Company recorded a benefit for income taxes of $(4.7) million and $(34.3) million, respectively, for an effective tax rate of 7.4% and 22.5%, respectively. The effective tax rate for the six months ended July 1, 2017 was different than the statutory federal tax rate, primarily due to research and development credits, non-deductible stock-based compensation expense, unrecognized tax benefits, the reduction in the domestic production activities deduction in prior periods on account of current year operating losses carried back to refund prior period taxes, the impact of a valuation allowance of approximately $10.5 million recorded against certain of the Company’s deferred tax assets, and the mix of income between U.S. and foreign jurisdictions.

The Company regularly assesses whether it is more likely than not that it will realize its deferred tax assets in each jurisdiction in which it operates. In performing this assessment, the Company reviews all available evidence, including recent cumulative earnings experience and expectations of future earnings, the carryforward periods available to it for tax reporting purposes, and other relevant factors.

As of July 1, 2017, the Company has net deferred tax assets of $163 million. At this time, the Company believes it is more likely than not that it will realize these deferred tax assets; however, if the Company is not able to generate sufficient taxable income from its operations, a substantial valuation allowance to reduce its deferred tax assets may be required, which would materially affect its operating results. Specifically, unless the Company is able to generate sufficient taxable income from its U.S. operations, a substantial valuation allowance to reduce its U.S. deferred tax assets may be required, which would materially increase its tax expense in the period the allowance is recognized and materially adversely affect its results of operations and statement of financial condition. The Company’s judgment regarding future profitability may change due to future market conditions, changes

24

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


in U.S. or international tax laws and other factors. These changes, if any, may require possible material adjustments to these deferred tax assets, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made. The actual amount of any valuation allowance will depend on the value of the Company’s deferred tax assets at that time, and its ability to monetize these assets through loss carry-back claims or other strategies.

For the three and six months ended July 2, 2016, the Company recorded an expense for income taxes of $3.7 million and $13.6 million, respectively, for an effective tax rate of 36.8% and 43.8%, respectively. The effective tax rate for the six months ended July 2, 2016 was higher than the statutory federal tax rate due to the effect of an out-of-period adjustment recorded in the three months ended April 2, 2016, a change in mix of income between U.S. and foreign jurisdictions, and unrecognized tax benefits.

As of July 1, 2017, the total amount of gross unrecognized tax benefits was $37.3 million, of which $32.3 million would affect the effective tax rate if recognized. The Company does not have any tax positions as of July 1, 2017 for which it is reasonably possible that the total amount of gross unrecognized tax benefits will increase or decrease within the following 12 months.

The Company adopted ASU 2016-09 effective January 1, 2017. Adoption of ASU 2016-09 resulted in the recognition of net stock compensation shortfalls in the Company’s provision for income taxes rather than paid-in capital of $1.2 million and $4.0 million for the three and six months ended July 1, 2017, respectively. These expenses are recorded discretely in the quarter.  The Company’s effective tax rate will fluctuate based upon its stock price and the amount of stock options exercised and equity awards vested in a particular quarter.

9.    Net Income (Loss) per Share
 
The following table sets forth the computation of the Company’s basic and diluted net income (loss) per share (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
Numerator:
 
 
 
 
 
 
 
Net income (loss)
$
(58,240
)
 
$
6,341

 
$
(118,319
)
 
$
17,376

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted-average shares of common stock—basic for Class A and Class B
230,322

 
218,850

 
228,788

 
217,431

Effect of dilutive securities

 
23,478

 

 
24,722

Weighted-average shares of common stock—diluted for Class A and Class B
230,322

 
242,328

 
228,788

 
242,153

Net income (loss) per share:
 
 
 
 
 
 
 
Basic
$
(0.25
)
 
$
0.03

 
$
(0.52
)
 
$
0.08

Diluted
$
(0.25
)
 
$
0.03

 
$
(0.52
)
 
$
0.07


The following potentially dilutive common shares were excluded from the computation of diluted net income (loss) per share for the periods presented because including them would have been anti-dilutive (in thousands):
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
Stock options to purchase common stock
19,074

 
3,861

 
20,924

 
3,548

RSUs
9,929

 
4,256

 
10,066

 
3,884

Diluted impact of ESPP
70

 

 
152

 

Diluted common stock subject to vesting
110

 

 
120

 

Total
29,183

 
8,117

 
31,262

 
7,432

 
10.    Significant Customer Information and Other Information
 

25

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


Retailer and Distributor Concentration
 
Retailers and distributors with revenue equal to or greater than 10% of total revenue for the three and six months ended July 1, 2017 and July 2, 2016 were as follows:
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
A
11
%
 
16
%
 
11
%
 
17
%
B
*

 
14

 
*

 
12

C
14

 
14

 
12

 
13

* Represents less than 10%.

Retailers and distributors that accounted for equal to or greater than 10% of accounts receivable at July 1, 2017 and December 31, 2016 were as follows:
 
July 1,
2017
 
December 31,
2016
 
 
 
 
 
 
C
19
%
 
19
%
A
19

 
16

D
*

 
12

B
12

 
*

 
* Represents less than 10%.

Geographic and Other Information
 
Revenue by geographic region, based on ship-to destinations, was as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 
 
 
 
 
 
 
United States
$
199,201

 
$
445,192

 
$
369,621

 
$
796,877

Americas excluding United States
24,412

 
27,375

 
44,380

 
50,769

Europe, Middle East, and Africa
108,601

 
99,471

 
196,373

 
174,195

APAC
21,085

 
14,490

 
41,867

 
70,043

Total
$
353,299

 
$
586,528

 
$
652,241

 
$
1,091,884

 
As of July 1, 2017 and December 31, 2016, long-lived assets, which represent property and equipment, located outside the United States were $25.0 million and $30.1 million, respectively.
 
11.   Acquisitions

2016 Acquisitions

In December 2016, the Company completed a purchase of certain assets from Pebble Industries, Inc., a privately-held company (“Pebble”), which was accounted for as a business combination, for total cash consideration of $23.4 million, of which $9.6 million was allocated to developed technology intangible assets, $14.4 million to goodwill, and $0.6 million to assumed liabilities. Approximately $3.5 million of the consideration payable to Pebble was held as partial security for certain indemnification obligations, and will be held back for payment until March 2018. The acquisition is expected to enhance the features and functionality of the Company’s devices. The amortization period of the acquired developed technology is approximately 5 years. Goodwill is deductible for tax purposes.

In December 2016, the Company completed a purchase of certain assets from Vector Watch S.R.L., a privately-held company (“Vector Watch”), which was accounted for as a business combination, for total cash consideration of $15.0 million, of which $3.9

26

FITBIT, INC.
Notes to Condensed Consolidated Financial Statements (Continued)


million was allocated to developed technology intangible assets, $11.4 million to goodwill, and $0.3 million to assumed liabilities. Approximately $2.3 million of the consideration payable to Vector Watch was held as partial security for certain indemnification obligations, and will be held back for payment until December 2018. The acquisition is expected to enhance the features and functionality of the Company’s devices. The amortization period of the acquired developed technology is approximately 2.5 years. Goodwill is deductible for tax purposes.

In May 2016, the Company completed a purchase of certain assets from Coin, Inc., a privately-held company, which was accounted for as a business combination, for total cash consideration of $7.0 million, of which $3.9 million was allocated to in-process research and development intangible assets, and $3.1 million to goodwill. The acquisition is expected to enhance the features and functionality of the Company’s devices. In-process research and development is not amortized until the completion or abandonment of the related development. Goodwill is deductible for tax purposes.


12.   Subsequent Event

Stock Option Exchange

As discussed in Note 7. Stock Plan, the Program expired on July 19, 2017. A total of 3.7 million “underwater” stock options were tendered by the Eligible Employees, representing approximately 85% of the stock options eligible for exchange. On July 20, 2017, the Company granted an aggregate of 1.8 million New RSUs under the 2015 Plan in exchange for the “underwater” stock options tendered. The completion of the Program resulted in total incremental unrecognized stock-based compensation expense of approximately $9.5 million, to be recognized over the greater of one year or the remaining vesting service period of the tendered stock options.









27


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 
As discussed in the section titled “Note About Forward-Looking Statements,” the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included under Part II, Item 1A below.


Overview
 
Our mission is to help people lead healthier, more active lives by empowering them with data, inspiration, and guidance to reach their goals.

Fitbit is transforming the way millions of people around the world achieve their health and fitness goals. The Fitbit platform combines wearable devices with connected health solutions via software and services, including an online dashboard and mobile apps, data analytics, motivational and social tools, personalized insights, and virtual coaching through customized fitness plans and interactive workouts. Our platform helps people become more active, exercise more, sleep better, eat smarter, and manage their weight. Fitbit appeals to a large, mainstream health and fitness market by addressing these key needs with advanced technology embedded in simple-to-use products and services. We pioneered the wearable device market starting in 2007, and since then, we have grown into a leading global health and fitness brand.
 
We generate substantially all of our revenue from sales of wearable devices. We sell our products in over 55,000 retail stores and in 65 countries, through our retailers’ websites, through our online store at Fitbit.com, and as part of our corporate wellness offering. We seek to continue to build global brand awareness, increase product adoption, and drive sales through our sales and marketing efforts. We intend to continue to significantly invest in these sales and marketing efforts in the future.

The following are financial highlights for the three and six months ended July 1, 2017 and July 2, 2016:
 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
 
 (in thousands)
 
 
 
 
Revenue
$
353,299

 
$
586,528

 
$
652,241

 
$
1,091,884

Net income (loss)
$
(58,240
)
 
$
6,341

 
$
(118,319
)
 
$
17,376

Adjusted EBITDA
$
(28,172
)
 
$
48,322

 
$
(80,475
)
 
$
93,433

Devices sold
3,373

 
5,673

 
6,329

 
10,515


See the section titled “—Key Business Metrics” for additional information regarding devices sold and adjusted EBITDA, including a reconciliation of adjusted EBITDA to net income.

In January 2017, we announced cost-efficiency measures to be implemented in 2017 that include realigning sales and marketing spend and improved optimization of research and development investments. In addition, we announced a reorganization, including a reduction in workforce. This reorganization impacted approximately 110 employees, or approximately 6% of our global workforce. We recorded $6.4 million in total restructuring expenses in the first quarter of 2017. We anticipate that we will substantially complete the reorganization by the end of the third quarter of 2017.

Key Business Metrics
 
In addition to the measures presented in our condensed consolidated financial statements, we use the following key metrics to evaluate our business, measure our performance, develop financial forecasts, and make strategic decisions.

Devices Sold
 
Devices sold represents the number of wearable devices that are sold during a period, net of expected returns and provisions for the Fitbit Force recall. Devices sold does not include sales of accessories. Growth rates between devices sold and revenue are not necessarily correlated because our revenue is affected by other variables, such as the types of products sold during the period,

28


the introduction of new product offerings that have different U.S. manufacturer’s suggested retail prices, and sales of accessories and premium services.
 
Adjusted EBITDA
 
To supplement our condensed consolidated financial statements presented in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”), we monitor and consider adjusted EBITDA, which is a non-GAAP financial measure. This non-GAAP financial measure is not based on any standardized methodology prescribed by U.S. GAAP and is not necessarily comparable to similarly titled measures presented by other companies.

We define adjusted EBITDA as net income (loss) adjusted to exclude stock-based compensation expense, depreciation and intangible assets amortization, restructuring expense, litigation expense (credit) related to the litigation matters with Aliphcom, Inc. d/b/a Jawbone (“Jawbone”), the impact of the Fitbit Force recall, interest income, net, and income tax expense (benefit). We began excluding Jawbone-related litigation expense (credit) in the second quarter of 2016 because we do not believe these expenses (credits) have a direct correlation to the operations of our business and because of the singular nature of the claims underlying the Jawbone litigation matters.

We use adjusted EBITDA to evaluate our operating performance and trends and make planning decisions. We believe that adjusted EBITDA helps identify underlying trends in our business that could otherwise be masked by the effect of the expenses and other items that we exclude in adjusted EBITDA. In particular, the exclusion of the effect of stock-based compensation expense and certain expenses in calculating adjusted EBITDA can provide a useful measure for period-to-period comparisons of our business. Accordingly, we believe that adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects, and allowing for greater transparency with respect to a key financial metric used by our management in its financial and operational decision-making.

Adjusted EBITDA is not prepared in accordance with U.S. GAAP, and should not be considered in isolation of, or as an alternative to, measures prepared in accordance with U.S. GAAP. There are a number of limitations related to the use of this non-GAAP financial measure rather than net income, which is the nearest U.S. GAAP equivalent of adjusted EBITDA. For example, adjusted EBITDA excludes stock-based compensation expense, which has been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy. Accordingly, adjusted EBITDA should be considered along with other operating and financial performance measures presented in accordance with U.S. GAAP.

The following table presents a reconciliation of net income (loss) to adjusted EBITDA (in thousands):


 
Three Months Ended
 
Six Months Ended
 
July 1, 2017
 
July 2, 2016
 
July 1, 2017
 
July 2, 2016
Net income (loss)
$
(58,240
)
 
$
6,341

 
$
(118,319
)
 
$
17,376

Stock-based compensation expense