Fitbit Q1'16 Earnings Conference Call: Full Transcript

Operator:

Good day and welcome to the Fitbit First Quarter 2016 Earnings Call. This call is being recorded. At this time, I would like to turn the conference over to Brad Samson. Please go ahead.

Brad Samson: Investor Relations:

Good afternoon and welcome. Fitbit distributed a press release detailing its quarterly results earlier this afternoon. It is posted on our website at fitbit.com and also available from normal financial news sources. This conference call is being webcast live on the Investor Relations page of our website where a replay will be archived. On this call we will refer to both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in our posted earnings release. This conference call will contain forward-looking information which is subject to risks and uncertainties described in Fitbit filings and with the Securities and Exchange Commission and in today's press release. Actual results or events may differ materially. We will begin with commentary from James and Bill and then we'll open the call to questions. We are going to limit the call to about an hour so we apologize in advance if we don't get to all questions.

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

James Park:Chief Executive Officer, President and Co-Founder:

Thanks Brad. Good afternoon, everyone. I am very proud of the company's first quarter 2016 results. The strong growth and defensibility of our business continues to be powered by product innovation, network effects our community, our ever expanding global distribution, and investment in our brand
I am excited to talk about each of these key strengths during the call. However to start, I want to share a few stories that remind us of our mission and keep us inspired every day. Fitbit devices are changing lives and in some cases saving lives to the power of data, inspiration and guidance.

Recently Fast Company Magazine highlighted the amazing transformation of an individual in one of our corporate wellness programs. Brett Broviak participated in the Indiana University Health Program shared with Fast Company how he was borderline diabetic with high cholesterol and blood sugar levels when he joined the wellness program in 2014. He quickly became the star of the program walking one million steps in a single month which is 30,000 steps a day, eventually loosing 30 pounds and lowering his cholesterol to normal levels after also changing his diet and becoming more active.

This last month a story was published in the medical journal Annals of Emergency Medicine, reviewing the case of a 42 year old man who presented to the emergency with newly diagnosed atrial fibrillation of unknown duration. The patient showed up at the ER after a grand mal seizure confused and unaware and his heart was in trouble or when trouble began. Doctors noticed he was wearing a Fitbit and with the patient's permission used heart rate data from the patient's Fitbit app. They quickly determined when the arrhythmia started that helped decide the best course of treatment needed to get his heartbeat under control.

While I would like to emphasize that Fitbit's current products are not medical devices and do not themselves diagnose or treat medical conditions, we hear these stories regularly. They show the potential and power of the devices and software and point the way to a future where Fitbit becomes an even more essential part of people's lives.

Creating the future starts with innovation. I believe Fitbit has had an incredible and consistent track record of creating and launching innovative devices and software that people love. I count eleven successful products that we have launched since we started the company over nine years ago. The original Fitbit tracker tractor which essentially created the entire category, the Fitbit Alta, Zip, One, Aria, Flex, Charge, Charge HR, Surge and most recently Blaze and Alta.

Over 9 years of creating and meeting this category we have gain that deep and proprietary understanding of market and our customers. This knowledge is allowed us to create a broad line of our product that address the wide range of user needs form factors and price points. Each product has a well sort out and highly incremental roll under linear. This explains out despite many observers casual skepticism, Fitbit Blaze that product shift over million units during its initial availability at the later part of the quarter with excellent reviews in Amazon and strong reorders from retailers -- similar trajectory.

Completing our product and market knowledge is our continued investment in R&D. The suites of R&D are not just about new sensors but also -- form factors, more power efficient electronics, more fashionable design included user interfaces and engaging social and community features. For example, our devices with -- technology lasts after five days depending on usage and other factors even when continuously sensing. Our investments in software have resulted in increasing attention of our users overtime.

We noted that of the $18 million new registered devices users added in 2015, 72% were still active users at year end.

Our R&D that powers this innovation is spread across hardware engineering, software engineering, firmware, interactive research and industrial design. Total R&D headcount comprising all those areas at the end of Q1 with 755 compared 295 in Q1 2015 certainly more than half our employees. At the end of Q1 2016, our patent portfolio consisted of 440 issued patents and 156 patent applications pending and 132 applications pending at the end of Q1 2015. We feel that it will be difficult for many of our competitors to match the breadth and piece of our R&D overtime.

Next I would like to highlight the network effects of our users community. Our community continues to be both an accelerate over growth and a powerful competitive note that makes it difficult for new companies to gain meaningful attraction. A significant portion of -- experience is the ability to compete and connect with friends and family across the variety of health and fitness metrics. Due to our breadth of users people are more likely to buy a Fitbit device because their friends and family are already likely to be Fitbit owners and less likely to be to competitor due to the same dynamics.

As a cooperating example of the power of that community the consumer technology association recently published results of the new survey of technology adoption in US homes. One of the key findings was that 44% of consumers that the friend or family member positively influence the decision to purchase a fitness tracker. You'll recall that at year end the average number of a friends are active users had increased 53% over the course of 2015 to 7.5 from 4.9 in 2014.

As I talk about sales, distribution, and marketing, I want to begin by highlighting the breadth of Fitbit's opportunity. Our users have a wide range of BMI and are spread relatively even the across wide range of age groups. You might think that what we do as a only amend for fitness phonetics, but in reality our static show that the our user base has incredibly brought with the users in many different stages of their fitness journey from catch to marathon and in many cases they're just starting out. Given the breadth and size of our user base in a first your product upgrade cycle you are starting to see some interesting statistics on VP purchasers.

Term analyst posted data they -- from analyzing Amazon data to estimate repeat Fitbit purchasers. Our our internal data is very similar showing that of all the Blaze and Alta activations since launch, approximately 40% were by people who own or previously owned another Fitbit device. Just as important however is that approximately 20% of those buyers were reactivating, coming back to the Fitbit community after having been inactive for 90 days or more. Further, of the Blaze and Alta repeat buyers, the vast majority bought up from the less expensive prior device, less than 10% bought down.

Again this is early data but it is very encouraging. These strong results of Fitbit Blaze and Alta reinforce the overall trend in which are seeing order in lower price products declining in volume in favor of newer higher priced products, in fact Blaze and Alta comprised 47% of Q1 2016 revenue.

Throughout the US, we continued to be comfortable with our store count. Our biggest focus with US retailers right now is significant expansion of shelf space. In fact the expected top four retailers in the US will increase linear footage of our displays by over 50% to accommodate Blaze, Alta, and related accessories. As part of this expansion, this quarter we should observing retailers transitioning to more modular interactive display systems that will allow for easier changes for new products yet to come this year.

In Canada we grew store count modestly and we expect shelf space expansions as well. Our first quarter Canadian revenue increased 76% from Q1 2015. In AMEA, we continue to see very strong growth as Fitbit adoption accelerates driven by interest in our new products, from marketing activities, and strengthening the relationships with key retailers. The EMEA region comprised 15% of Q1 2016 revenue compared to 10% of Q1 2015 growing 113% year-over-year.

The UK continues to be a large our largest market in Europe and was up 54% in Q1 2016 year-over-year. We are especially pleased with our growth in Germany which increased 385% year-over-year. Other EMEA markets were strong as well.

Asia Pacific which comprise 11% of Q1 2016 revenue, grew 142% year-over-year. We continued this focus on expanding distribution and driving marketing activities in the other more nascent Asia Pacific countries.

In India for example while we have good distribution through Amazon and the Reliance Retail chain, Mom and Pop distribution is important in this market and we recently appointed a distributor to address this very large distribution opportunity.

On past calls we have talked about the language and localization customization we need to complete that we believe will help accelerate the Chinese, Japanese, and Korean markets. Some of these customizations are expected to launch in the second quarter.

On China specifically, last week we announced our intent to enter into a strategic partnership with Alibaba, the largest retailer in the world. We believe the opportunity for us in China is significant and we are excited about reaching millions of Chinese consumers with our partnership with Alibaba. Our brand and marketing engine is a key Fitbit asset and competitive advantage driving market development, increased awareness, and brand preference. Executing end market activities that incorporate top down and bottom up tactics including brand and product-focus campaigns, infiltration of popular culture through top television shows, select ambassadors and brand partnerships, making Fitbit a movement through positive media coverage, Fitbit local events and sponsorships.

All these programs are key elements driving our growth.

I hope by now you have seen our new fun Fitbit Blaze and Alta ads which demonstrate the brand values as well as product benefits. Our sales search and brand tracking results are proof points the collective success and continuation of our growth. for example in the U.S. Among those have considered our purchase to device in the activity tracker segment. Our unaided brand awareness is 65% up 10 points from our last research in Q3 2015.

We also spotted a number of unpaid top celebrities supporting our latest products such as Jennifer Aniston and ---- and Kerry Underwood, Kevin Spacey and Jordin Sparks --- further highlighting the popularity of our products. In Q1, fitbit marketing continue to infiltrate popular culture with the wide variety of events and sponsorships. For example we replicated the U.S. Auto launch with a similar fashion launch in India becoming a highlight of the --- fashion festival which we hope to be a catalyst for accelerating growth in region.

In the US we are the official tracker of the early marathon. Which generated 52,000 total app downloads with the Fitbit sponsored official rates weekend app.

In the UK we sponsored sports release a national attributable campaign for health. In Germany, we created a special insert --- news paper with -- a former soccer star now fitness celebrity. In France we sponsored the ---- the number one half marathon in Europe. These are just few examples of the many ways in which we are building the Fitbit brand worldwide.

I believe this kind of marketing power is not easy to create. It separates us from many aspiring competitors and puts us in a more eco footing to other big brand competitors.

Let me next provide a few highlights about corporate wellness and digital health. Corporate wellness continue to be strong in Q1 although it remained a small proportion of our total revenue because of the rapid growth at the retail side of our business. With healthcare cost continuing to rise for our employers and shares and consumers, no surprise that innovation and employee wellness programs continues to be increasingly important to both the private and public sector alike. Fitbit is helping to lead that front. In fact last month the ---- hit their wellness Amy Macdonald was invited to testify in front of Congress the health education and the workforce sub committee on health employment labor and pension theory around innovations in employees sponsored healthcare.

The momentum continued in Q1 2016 across our industry verticals. For example, we added a number of leading health systems in U.S. Including University hospitals --- , --- health in Michigan, the session health which has a footprint covering 23 states in Washington D C.

As one specific customer results example Amway healthcare and Amway University launched their move more challenge in September 2015 that utilized Fitbit devices and software. The Fitbit program had the highest participation of all of Amway's health involving programs with 92% reporting they are more active because of Fitbit and 96% believe that was a valuable benefit.

In the first quarter we also standard our reach into corporate wellness industry by leveraging a new channel of strategic partners and employee benefits base. We are currently working with over 10 of the top 100 benefits brokers in the U.S. Our corporate wellness business is also focused on building awareness and credibility within the corporate wellness industry driven by a strong track record with employers and continued investments in enterprise sales and marketing. For example, we are preparing for inaugural Captivate summit in June.

The Conference we are host for hundreds of HR leaders. The event includes three days of sessions led by independent health ----- experts and executives.

Last years Captivate road show created tremendous credibility for Fitbit wellness and we expect to see a flagship event will continue to create many opportunities for us. In digital health while we continue to ---- potential partnership and business opportunities Fitbit's popularity for used by the research community continues to grow. today Fitbit devices have been used in over 100 research projects and are used by major universities and research institutions.

Last week we announced potentially powerful research study with Dana-Farber Cancer Institute that is investigating the impact of weight loss on breast cancer recurrence. The breast cancer weight loss study will enroll nearly 3200 overweight and obese women with early stage breast cancer to test if weight loss can help prevent the disease from returning.

The study will begin in August 2016 and enroll women through oncology practices across the United States and Canada. Fitbit was selected to provide specific Fitbit products to help participants stay motivated and engaged while tracking their weight loss journeys and allowing their coaches to make sure participants meet their weight loss and fitness goals. The outcome of the study is the potential to make weight loss and physical activity standard part of treatment for millions of breast cancer patients around the world.

We're also learning that lack of consumer engagement is a critical missing element in many broad healthcare efforts such as population health and disease management. For example at the conference at the end of February, Accenture reveals a new research on different technologies' ability to impact health engagement. Highlight the current stage of engagement, we noted that despite two thirds of the 100 biggest hospital systems in the US providing mobile apps for patient, only 2% of patients actually use them. In contrast of that Accenture study noted that both consumers and physicians see wearables as the most effective tool for getting consumers engaged with their heart.

Since our devices and services are already engaging, Fitbit has an incredible opportunity to serve as the consumer healthcare engagement engine. I could argue that better than anyone else we can help people engage with their health, engage with their family's health, engage with their ensured employer, and engage with the healthcare system.

Before I turn call over to Bill I have one more brief topic that I want to cover. Hans Hartmann, our Chief Operations Officer who had responsibility to supply chain, customer service, and hardware engineering, announced he is leaving to pick a leadership position at Oculus owned by Facebook. Over his five years at Fitbit, Hans built a phenomenal team. Hans is an early stage builder and wants to do the same at Oculus.

With the strength of his team, we are not planning on a replacement and we do not expect this change to negatively affect Fitbit's operational or financial trajectories. Hans has been a great partner and we wish him well.

Let me now turn the call over to Bill for some financial highlights. Bill?

William Zerella: Chief Financial Officer:

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

The first quarter marks another quarter of outstanding results in which we significantly exceeded our previous guidance demonstrating the resiliency of our business model, success of new products in the Fitbit brand, and growth opportunities ahead. Q1 revenue of $505.4 million represents a 50% increase year-over-year from $336.8 million in the first quarter of 2015. We achieved this growth despite implementing planned reductions in channel inventory of certain products to facilitate a major product transition in which we shift Alta near the end of the quarter.

As James described, we have seen both of our new products Blaze and Alta get off to a very strong start demonstrating both selling to retailers and sell through to consumers. Geographically revenue from the United States accounted for 70% of our Q1 2016 revenue compared to 79% in Q1 2015 as we have accelerated our international business and the US growth rate is affected by the law of large numbers. . Looking at international regions, our total revenue outside the United States grew to $153.7 million in the first quarter of 2016 as compared to $71.4 million in Q1 of 2015 with 15% of total revenue coming from EMEA, 11% from Asia Pac and 4% from the Americas excluding the US. We are very excited by the progress we are seeing in international markets demonstrating we believe that there is tremendous multi-year runway both internationally ending the US.

First quarter 2016 revenue from the United States grew 33% year-over-year while revenue from Asia Pac grew 142% followed by EMEA growth of 113%. Americas, excluding the United States, grew 74% year-over-year.

Although we did build inventory levels in Asia Pac during the quarter, we believe these growth rates and the opportunities ahead justify our increased investment in sales and marketing to increase our presence in all regions. These investments are already there in fruit with significant progress for example in countries like the UK, Germany, and France.

Our first quarter year-on-year revenue growth was driven by continued growth in shipments of Charge HR, our leading product, augmented by the launch of our new products, Blaze and Alta. In fact although we started shipping both Blaze and Alta in the latter part of the quarter, they collectively represented 47% of total revenue and 50% including related accessories exceeding our expectations. This was driven by higher reorders than we anticipated to support sell-through by our channel partners. Blaze and Alta also drove an 18% increase in our ASP from $85 a year ago to $100.

This excludes the sale of accessories which if included, increases the average revenue per device to just over $104. We believe accessories provides another growth opportunity for us as we introduced new products with an accessories element. In the First Quarter 2016 the impact of currency FX was normal and based on the hedging activities we have put in place we do not expect material impacts going forward for the balance of the year. As a reminder in my remaining remarks of our financial performance all financial references are to non-GAAP financial measures unless I specify otherwise.

Gross margin in the first quarter of 2016 was 46.6% consistent with our guidance. This compares to 49.8% in the first quarter of 2015. The year-on-year change in gross margins is primarily due to cost associated with the launch of our new products ---- and standing up these production lines. Combined with the settlement benefit with one of our manufacturers in Q1 of last year.

Nevertheless these products launched at higher margins as they get and did a previous charge HR and search products. We expect these margins to improve going forward as we reflected in our updated dated outlook for the year that I will walk through shortly. Operating income for the first quarter 2016 was $37.1 million compared to $92.7 million in the first quarter of 2015. As discussed in our last call our OpEx levels reflect continued investments across all functional areas.

First quarter operating expenses were $198.4 million up 165% year-over-year but down 13% quarter-over-quarter. Specifically we ramp sales and marketing expenses associated with the global launch of Blaze and Alta. We consistently see a strong and direct sales impact and ROI associated with building our brand equity through media campaigns and see our strong topline performance as a reflection of that return.

Additionally, we have successfully attracted more engineering talent to support our future product development plans. We continue to invest in software and fitness tracker device development and see R&D as a key investment for maintaining a rapid pace of innovation that drives our differentiation not only in devices but also in other key aspects of the fitbit platform and user superior experience with fitbit. We also continue to invest in the back office infrastructure required to support our increasing scale and as mentioned on our last call, have launched the implementations of SAP which will be our new business systems backbone beginning in 2017.

Q1, 2016 total headcount increased to 1,306 from 1,101 at the end of last year and 578 in Q1 2015. A predominant focus continues to be in the group that increase our capacity for developing new hardware, software experiences and our capacity to drive revenue growth. We expect to continue to higher aggressively as we enhance our existing product and services design and develop new products and services and expand internationally. First quarter of 2016 adjusted EBITDA was $45.1 million significantly exceeding our guidance due to stronger than expected top line growth.

Consistent with our views for the full year, we expect the result of our high investments will drive strong year-on-year growth in EBITDA as we get to the second half. Net income was $24.5 million for the first quarter 2016, resulting in earnings per diluted share of $0.10. Our effective tax rate in Q1 2016, was 37% on a non-GAAP basis and 47% on a GAAP basis. This rate is to stored due to a $3 million add of period adjustment to our tax liability.

While this was significant on a relative basis to pre tax earnings during the quarter is expected to have an immaterial impact on our full year effective tax rate. $242 million diluted shares were used to calculate the first quarter of 2016 diluted earnings per share.

Turning to the balance sheet; we ended the first quarter 2016 with $791.7 million of cash and short term investments and no debt. This is an increase of $127.2 million or 19% from the end of Q4 2015 as a result of $137.5 million of cash flow from operations. Year-over-year for Q1 2016 cash equivalents and short term investments increased 233%. Accounts receivable was $339.7 million a decrease of $129.6 million from December 31 2015 with DSOs of 56 in Q1 2016 assist with DSOs is 56 in Q4 2015 and a decrease from 58 in the first quarter 2015.

Inventory was $212.1 million an increased of $33.9 million from December 31 2015 reflecting the ramp up production of both Blaze and Alta. Inventory turns increased to $5.6 in Q1 2016 from 5.3 in Q1 2015 a decrease from 6.4 in Q4 2015. I

'll now turn to guidance of the second quarter and the full year 2016. Before I take you through the numbers I think it is important for investors to understand our views is that the opportunity ahead of us and how we plan to capitalize on. This perspective is important because it guides us in making investment decisions which we are consistently evaluated through the length of both return on investment and the deepening of our competitive mode, in fact as we continue our rapid rate of growth and better understand the growth drivers for our business is becoming increasingly clear that the desire of consumers globally to find ways to improve their health and well being is driving the purchase of our products further to the extend extent we can continue to maintain our leading market position we can further accelerate the network effect of our community making it increasingly difficult for competitive offerings to achieve critical mask. This is collaborated by the data James mentioned in that 44% of consumers purchase decisions of our -- products are influenced by products used by friends and family.

Our early success with Blaze and Alta further reinforce this view and we believe we have an opportunity to continue to drive strong growth with continued emphasis on building our brand equity and delivering innovative products to consumers. Therefore, in the second quarter we will maintain our investment in brand building by supporting the penetration of Blaze and Alta into the market. While investing more in international market development than in the US in front loading engineering cost to support future new product introductions. While this spending will be reflected in our guidance and results in lower operating leverage than what otherwise be the case in Q2 that positions us towards generate accelerated revenue and earnings growth in 2016 from what we have previously modeled as both Blaze and Alta reach their strives.

More importantly, these investments create a greater likelihood of future growth as we expand that Fitfit ecosystem of users. In fact in our current modeling, we expect sales and marketing spend for 2016 to be consistent with 2015 on a percent of revenue basis based on leverage in the second half of the year. Also I should note the investments we are making this year on the marketing side extend well beyond media campaigns with the significant portion of our expected year-on-year increase in spend due to upgrading our point of purchase displays in the 50,000 plus locations around the world. The allocation of additional marketing development funds working with our retail partners to putting new partnerships such as Alibaba in China, expanding our customer service capability globally to support our expanding user base and growing our sales and growing our sales and marketing teams to position us for longer term growth.

These dynamics will results in the linearity of earnings this year being at a different pace than prior years. First, due to normal seasonality we expect Q3 revenue to declined sequentially form Q2. While we have been able to overcome this seasonality in the past we are not assuming we will be able to do so this year due to the law of large numbers.

Second, based on the traction we are seeing with Blaze and Alta combined with other exciting new products we have planned heading into the holidays and the brand equity we will be building through the year, we expect to generate significant operating leverage in Q4, delivering approximately two-thirds of our projected full year earnings in that quarter.

Finally, investors should also recognized that because of our business model we do take a conservative approach to guiding top line revenue and the more visibility on sale through data. Also we are currently reserving in our guidance a high percentage of incremental gross profit for further investments so that we have flexibility if we believe we can generate a strong ROI.

With that is a backdrop for the full year of 2016, we are raising our expected revenue range by $100 million to $2.5 billion to $2.6 billion. While maintaining expected non-GAAP gross margins in the range of 48.5% to 49%. We expect this to result in higher non-GAAP diluted net income per share in the range of $1.12 to $1.24. Full year adjusted EBITDA is now expected to be in the range of $430 million to $490 million and stock based compensation expenses expected at $97 million to $106 million.

For the second quarter of 2016, we estimate revenue in the range of $565 million to $585 million. Non-GAAP gross margin is expected to be approximately 48%. We expect this to result in non-GAAP diluted net income per share in the range of $0.08 to $0.11. Second quarter adjusted EBITDA is projected to be in the range of $37 million to $47 million and stock-based compensation expense is estimated at $21 million to $23 million. Our guidance assumes an effective tax rate of approximately 30% for both the second quarter and for the year and a fully diluted share count of $247 million to $250 million for both the second quarter and the full year.

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

James Park:

Before we start taking questions, let me reiterate the key highlights from the quarter. We successfully launched Blaze and Alta, ASP again moved higher, international growth was strong reflecting the increasingly global nature of our business. We are confident in our continued execution and as a result to our raising guidance for the year.

Operator we are ready to open up the lines for questions.

Question & Answer

Operator:

Ladies and gentlemen if you would like to ask a question over the phone please signal by pressing star, one on your telephone keypad. Once again that's star, one. And we will take our first question from Robert Peck with SunTrust.

Robert Peck:SunTrust:

Two quick questions. The first is Will I was wondering if you can give us a little more color here on the sale through during the quarter so obviously your models sale in was any sort of feedback from your partner as far as inventory levels were punishment orders things of that nature and I has a follow up question.

Brad Samson:

Yes, hey, Bob. The sale through for Blaze and Alta were very strong and that's obviously what helped us over performed and that's lot of reorders for the quarter even though we shift those products in the last month. So, channel inventory levels in North America were basically flat there were lot of puts and takes charge inventories meter down in a very big way during the quarter as we expected. Also even some of the other products, legacy products that we have down metered down in terms of inventory levels in their channel while the new products Blaze and Alta metered up.

So that's probably the best way to describe what happened during the quarter.

Robert Peck:

Okay great and you had this favorable ruling during the quarter on the jaw bone litigation. Could you just give us an update to where that stands and how we should expect that to play out through the year?

James Park:

Yes the case between Jawbone and Fitbit started Jawbone serving six patents against us. We've knocked out all six of those patents which is pretty phenomenal. The case is still going forward on the trade secrets portion alone but it's pretty safe to say to we're optimistic with the direction of the case.

Robert Peck:

Thank you so much

Operator:

We'll take our next question from Ross Sandler with Deutsche Bank.

Ross Sandler: Deutsche Bank:

Greta. Bill, Just a couple of questions on the full year guidance same as previous quarters I guess. So if we look at the current run rate in the first quarter 50%, 44% for the guidance at the midpoint second quarter we drop off to kind of the low 30s for backhalf so is that what you expect to happen or is that conservatism? Any commentary I now you guys don't add new products into the guidance but any commentary on the trajectory and backhalf. And then just ran through a bunch of the cost items that are front end loaded.

Other than sales and marketing I guess it seem like most of those were structural so can you just give us a little bit more color on the confidence that two thirds of the EBITDA will show up in the fourth quarter and I guess how you get to that number and then the last question is just I know you guys have been targeting Blaze and Alta to come in closer to the 50% gross margin level that use as company goal and why you hit the gross margin in first quarter think we're still like 48 or so from second quarter so can you just talk about the gross margin that you're seeing from those new products and I guess what's dragging it below the average of trying to hit 50 company wide what's coming in below that. Thank you.

William Zerella:

Okay. Hi Ross. So, first let's talk about revenue. So, to your point if you use the mid point of our guidance for Q2 our six months year to date growth in the first half is just a little under 47% and then if you back into the mid point of the guidance for the second half, it was up to 31% growth.

So that is entirely a function of the way that we model revenue which is to take conservative perspective. I think we already established a track record of doing that. The trends would certainly point to a higher growth rates for the full year but frankly we were not going to extrapolate that until we get further through the year and see more sell through data especially on Blaze and Alta and see how our marketing campaigns progress around the world.

So, I think the best way to describe it is we're being consistent with how we projected and guided revenue in the past and that's taking a pretty conservative approach until we see data otherwise. So that's on the revenue side. In terms of the bank has ended nature of earnings this year so the short answer is that we yes we do so confident which is why we are actually raising guidance slightly for the year. So again -- is a lot different this year than we've had in the past then a lot of its due to the timing of one we introduce new products .

Since we are putting a lot of marketing muscles behind those introduction as we discussed on the last earnings call we are doing in on a global basis. So its a much heavier lift but we believe that will give us a lot of momentum heading into the holidays especially with other new products that we're bringing to market to really drive a lot of leverage that quarter.

So obviously we wouldn't be guiding to them unless we felt confident. So that's what's driving that side of the business. I mean the other side is funneling engineering spend. Just to reiterate, our revenue growth is very much driven by new product introductions.

The fact that we introduced Blaze and Alta in the last month of the quarter and that they drove almost 50% of our revenue is pretty remarkable and it demonstrates how important it is to bring new products to market on a timely basis and products that are innovative and of interest to consumers.

Lastly in terms of gross margins, good question. Blaze and Alta do have better margin profiles. In Q2 we are reserving some additional costs to cover some trends we are seeing on the warranty side for some of our legacy products. We are being pretty conservative on that side as well so we are reserving for those costs and we'll see how those play out but we track all those trends pretty closely and we are taking that into account which is why the gross margins in Q2 are a little lower than you might expect but again we are maintaining the full year guidance which kind those tells you that we're going to be driving 50% as we exit the year and that's looking pretty good based on the profile that we are seeing in terms of Blaze and Alta and the other products we are going to introduce towards the holidays.

Ross Sandler:

Great. Thank you. That's very helpful.

Operator:

We'll take our next question come Matthew McClintock with Barclays.

Marjorie Lopez: Barclays:

Hi this is Marjorie Lopez on for Matt McClintock he is in a plane. Thank you for taking our question. You have seen a lot of encouraging signs from your new products yet it seems there is a lot of skepticism within the investment community. What do you think is been missed in truns of the underlying opportunities that these new products address and what do you think is the most miss understood part of your story today

James Park:

I think the same that most of ---- don't understand the better product strategy is that one, the other a broad line of a products that more each product addresses a specific need whether it's consumer need, price point, foreign factor, battery life accessories et cetera and so in other reason that Blaze succeeded with that a targeted specifically are high end active user base we segment our users into everyday active and performance users. I know the great product for active users with 5 days battery life with continues heartrate $199 price point and a reach set of accessories. So we're fairly confident that Blaze with the incredible well which is done as we've mentioned it shipped over million devices towards the later end of the quarter it continues to be really along the market as ---- and Amazon. So if anything we're pretty surprise by outsiders initial the action the product but internally we've been always confident.

Marjorie Lopez:

great Thank you

Operator:

Next go Katy Huberty with Morgan Stanley.

Analyst:

Hi it's Sherry here for Katy. So maybe first we can talk about this churn opportunity with Alibaba and ---- do you expect this to drive growth acceleration in the country this quarter or the second half of this year or is this opportunity kind of further out in the future I mean North America remains over 70% of the company. So wondering if you think the other regions can start becoming a bigger portion of revenues and then I have a follow up.?

James Park:

Hey Jerry. So I mean right now we are modeling to the full year that 70% of our revenue will be in the U.S. and 30% outside the U.S. that's versus a 75, 25 mixed last year.

That's based on your growth internationally in all markets outside the US with China specifically we've been pretty conservative in terms of our existing modeling until we see how our potential partnership with Alibaba plays out I mean we frankly a very excited and we think the opportunity in China is very significant and if we do get a lot traction in that market than could potentially move our numbers in a bigger way but right now we're being pretty conservative until we see how that place out.

Analyst:

Got it and then may be just couple of things on gross margins in the second quarter the improvement from the first quarter are similar to that has to do with non ---- overtime and et cetera from manufacturing. But then the further improvement into the second half is that just the warranties you spoke about or could our future products also coming in at this kind of 48 or higher margin level or should we how should we think about the impact of new products.?

James Park:

Yes its really two factors, so first its continued cost down for Blaze and Alta that similar to other products that we've introduced in the past every quarter. We improved the margin profile by driving the cost efficiencies in value engineering. So those products will just continue to improve each quarter that's number one and then number two if we look at the margin profile of the other products that we are planning later in the year those margins are looking very attractive.

On average being even potentially stronger or as certainly as strong as Blaze and Alta when we model all that out that combine with Q4 leverage right because extent that we are driving significant revenue in Q4 we get a lot of benefits in terms of scale which go down to gross margin. So all those factors combined allow us to we believe gets it to those kinds of margins in the second half.

Analyst:

Got it. Thanks a lot.

James Park:

Okay.

Operator:

We will next go to Matt Schindler - Bank of America with Bank of America.

Matt Schindler:Bank of America:

Yes. Hi guy's. So doing on the modeling questions I think have been coming up but I thought it ask like a longer term strategy issue. You guy's have been making your brand and your software to your larger your major competitive differentiator.

Yet I am seeing lot of watch companies like Movado and like integrate step counters and thus have to build software on their own as well. Have you guy's spoken with any of these companies and perhaps what the partnerships become in Fitbit inside.

James Park:

Yes I think long-terms we're always open to partnerships in fact we have had pretty successful partnerships particularly in ----- in the past and as it relates to fashion brands I think that's a template for how we most likely partner with those types of brands in the future. For us I think there is just a lot of value and having the hardware and software incredibly tightly integrated and I think having outside brands would be part of that process whether its merchant a hardware side I think they tracts from the level of integration that's needed to have a really success for consumer product.

Matt Schindler:

Great. Thank you.

Operator:

We'll next go to Tavis McCourt with Raymond James.

Tavis McCourt:Raymond James:

hey guys thanks for taking my questions. Bill there are couple of modeling questions and then a follow up for James. So you mentioned cash flow from operations in the quarter can you give us the CapEx and then also if I run through the guidance it looks like non-GAAP operating costs would be flat to maybe even slightly down in the second half of the year versus the first half of my doing the algebra correctly.

William Zerella:

Yes. So let me take your second question first. So yes we see a lot of optimization in the second half and that would be primarily on the sales on marketing line. In connection with Q3 having being seasonally low quarter, we would have minimal marketing efforts during that quarter and even though in Q4 that's the holidays we think our brand equity and awareness gives us the ability to not spend at the levels that we have historically during the quarter.

So that's where most of the leverage of happens on the OpEx side as we get into second half. In terms of CapEx, CapEx for the quarter was $17 million a big part of that was production tooling for our new products primarily for Blaze and Alta.

Tavis McCourt:

Alright and then first I want to confirm whether or not you have in your guidance any new products in the second quarter and then also if I think about your product portfolio today and compared to some of your competitors it would see most of your wholes in the portfolio or opportunities would be higher ASP. So is there reason why we shouldn't be building financial models with higher ASPs than today. Thanks.

William Zerella:

So I'll take the first question now James takes the second. So, Q2 yes, the new products that we are assuming in Q2 are Blaze and Alta. In Q4, heading into holidays as I mentioned there will be other new products and we've baked that into our guidance for Q4. As I mentioned earlier we take a pretty conservative stands. In terms of ASPs our I will let James.

James Park:

Yes, I mean in terms of our product line up going forward I think you still have to look at the entire line up ranging from entry level devices to more advanced form factors. Overtime across the board some products are going to be phased out, they are going to be replaced possibly at difference price points. So I don't think there is a one guiding principal that you can point to at this point. I mean for us we're going to be continuously launching newer versions with existing products, phasing our products and introducing new products when we think the user fit is there.

Tavis McCourt:

Great, and the follow up James you mentioned in your prepared remarks about 50% or so increased shelf space across some of the bigger retailers this holiday season. Do you think that's a larger commitment for the category or do you think that's Fitbit's specific and I mentioning it because there is been a couple of acquisitions in a last six months it seems like some of the smaller folks are struggling so any commentary around your share of shelf space?

James Park:

Yes. So I think it reflects the fact that the channel realized at that this point that Fitbit is almost essentially the category. We come from lot of its growth if you look at MPD in Q1 or dollar share was 87%. So when the channel partner look that which company is there starting to carrying their stores and I think they preferred the deal of fewer rather than more and we've obviously demonstrated to the buyer that these key retailers that we have been incredibly successful with selling whatever product that we launch.

Tavis McCourt:

Okay. Thanks a lot.

Operator:

We'll next go to Erinn Murphy with Piper Jaffray.

Erinn Murphy:Piper Jaffray:

Great. Thanks, good afternoon. Maybe just going back to some of the comments you had on the strength of Alta and Blaze during the quarter I know is only a partial quarter. So could you just maybe speak about your expectations of what that could contribute from just an overall percent of the mix when you have them in for a full quarter and then how does that impact ASP should we kind of think about that $100 ASP continuing or should actually be higher once its kind of a bigger piece of mix and then I have a couple of follow ups.

William Zerella:

Okay, hey Erinn. So first in terms of ASP right now our internal modeling is basically in ASP of roughly a $100 which is pretty consistent with where work for Q1 and there might be little bit of an flow there ASPs can change a little bit during the holidays due to promotions on Black Friday which we do participate in. So if you look at the full year, we should roughly around $100 maybe $99 at least that's we are modeling today. The other variable here is accessories which we are little early on to you making too many assumptions there next quarter we will have little more visibility maybe longer term attach rates and how that can yield move the needle when we take into account accessories.

In terms of the contribution of the Blaze and Alta, so here we would certainly assuming Q2 would be higher than Q1, because we have full quarter. I am not going to be that specific frankly because there is too many of the puts and takes and Charge HR they were still our best selling products. So it's hard for us to predict exactly how that's going to play out especially with mothers day and fathers day we think Blaze and Alta are going to be really good products for mothers day and fathers day. For the full year though as we think about other new products well that is certainly drive a high percentage of our total revenue for the year and we would expect to be pretty similar to last year when we when the full year is set and done.

So last year about 77% of our product of our revenue was from new products charge HR and surge. We wouldn't be surprise if we're in a similar range that ---- it's just again linearity is little different.

Erinn Murphy:

Got it, that super helpful and then maybe just consumer insight perspective one of their metrics you highlighted earlier on well that 20% of the Blaze and Alta consumers actually reactivated having been --- for a bit higher 90 days. How did that reactivation compared to other launches maybe Charge HR search from last year and then if I can just sneak in one clarification on Q4 guidance you talk about a being two thirds of the contribution is that earnings or EPS of is that of EBITDA? Thanks.

James Park:

Yes so first question in terms of we see purchase behaviors this is the first time we have published that metric frankly we will interacted price now because we didn't really have any true upgrades like the Alta so it hasn't been a focus for us. So there is no other data that compare to and I am not sure would be comparable anyway since we didn't you know have a clear upgrade path for consumers. So that's the way we look at behavior we're just looking at for the first time.

William Zerella:

I think those numbers are really encouraging we don't know how those percentages will play out overtime but I think there is three things one there is quarter we demonstrated ability to one ad new users. We demonstrated the ability to upgrade existing users and we demonstrated the ability to reactive to reactivate in active users. So I think those are three positive things for the business overall.

James Park:

Yes, then in terms of

Erinn Murphy:

The Q4 guidance.

James Park:

Q4 yes. So both our EBIT, EPS and EBITDA we those would all be pretty consistently aligned is being about two thirds of the full year guidance.

Analyst:

Okay and sorry, if I can just sneak in one more just on the linear footage comment you made in the US what kind of growing by 50% you guys being effectively ---- of the category. I think the US growth in Q1 was about 33% so should we anticipate that run rate to accelerate once you have the full linear footage expansion that accommodates for the new product? Thank you.

William Zerella:

I guess best way I would answer that question is I think the potential is there. Again we tend to be we tend to lean on a conservative side once all these new point of sales displays are in place it certainly gives us some much bigger presence in the stores it also displays all of out accessories in a very big way. Yes so it's kind of great multiple opportunities for us. We are excited about it, it certainly represents increased commitment by our retail partners.

So I would say it does create some potential of upside for us we'll see how it plays out there.

Erinn Murphy:

Great. Thank you guys and best of luck.

Operator:

Our next question comes from Joe Wittine with Longbow Research.

Joe Wittine: Longbow Research:

Hi thanks, nice sales number and nice to your confirmation of the repeat wise. First question on OpEx is Bill a you put as front ending the engineering spend with headcount here, is that simply what's necessary to kind of continue your current pace of a consumer product innovation or do you think you could be more active with this new headcount overtime on hardware, software updates I mean really what I am trying to understand if we take a step back you think you'll ultimately view '16 as kind of a excessive investment year.

James Park:

Yes so as Bill mentioned we are front loading lot of the R&D. So that's driving newer products that are going to launch in the second half of this year and we are also making some investments for products even beyond that. So our hope is to really accelerate the pace of development that we have on the product side and also to lower the timeframe in which we launch products as well. So all that R&D is going into those efforts.

Joe Wittine:

Got it and then James I am glad to have with that sees your --- story that was in the press are you giving consideration eventually towards kind of expanding your media campaign beyond solely that the current fitness up push towards highlighting somebody is more serious help anecdotes or for some reason is that potentially slippery slow from a legal perspective.

James Park:

I think it is pretty massive opportunity I think these advices are going to get increasingly more sophisticated over time but there is obviously a lot of legal and regulatory challenges that we are going to have to navigate. I think the great thing is that due to our leadership position we are very visible in Washington and I think we are going to have a big sit at the table in driving those discussions. So its going to be a pretty big opportunity for us.

Joe Wittine:

Thank you.

Operator:

We will take our next question from Charlie Anderson with Dougherty and Company.

Charlie Anderson:Dougherty and Co.

Yes thanks for squeezing me and congrats on the results. Bill I want to ask how much ---- you are on the OpEx as a percent of revenue and then the sales and marketing I guess specifically as a percent of revenue if you outperformed on revenue is that marketing spend go up or do you get leverage and then I have question for James I am wondering what the success of the Blaze and the Alta you didn't add any new sensor technology and effort you talked in the past about new sensor technology to the change your view point on in terms of adding new sensors to expand the market. Thanks.

William Zerella:

Hey Charlie so on sensor marketing as I said in my prepared remarks so we take a very ROI focused approach especially on media campaign and we have been very successful in the past and really getting a good return in driving that awareness and driving our market position and therefore driving revenue. So what I would tell you is the guidance represents our baseline model right now.

If we see an opportunity to drive higher revenue growth and we think there are others select investments that we should consider making then we are going lean towards making those investments if we think it drives again the network effect of our community and drives the competitive mode.

So we still think we are in a position to drive good earnings for the full year again the linearity is different, but we are most focused on just continuing to really drive our leading market position. Because we think that's what creates really long term value and sustainability of this business. So we always think about those investments in those terms obviously with that said, we are always sensitive to driving earnings and so far we have been pretty successful in driving pretty significant performance versus our guidance that's not guarantee, but obviously we seek to do that as possible.

James Park:

Yes. In terms of innovation around center technology an algorithm as you said in the prepared remarks in addition for us is in just about those two things they involve much better battery life mini transform factors, accessories, cost reductions, and a lot of investment in the software side those are in the user experience and the community aspect. That said look there is lot of R&D that we're doing in both sensors and algorithms and you can expect future products to add some of those accordingly overtime. But the key thing is the success our products is demonstrated by Blaze is going to be the right blend of all those characteristics.

Charlie Anderson:

Thanks so much.

Operator:

Our next question comes from Betty Chen with Mizuho Securities.

Betty Chen:Mizuho Securities:

Thank you. Good afternoon. Congratulation on a nice quarter. I was wondering if you can talk about the international opportunity little bit more very strong growth in the first quarter.

Can you just remind us on the number of language customizations that will be launching in the second quarter and just thinking longer term what are you seeing the international customers prefer in terms of device and ASP and what is that mean for the longer term margin profile for international business. Thanks.

James Park:

Yes. So some of the major languages have launching going forward are CJK, Chinese, Japanese and Korean. Our products have already launched with the Europe languages and so in terms of consumer preferences I thing the great thing as I noted before is that demand and desire for products seems to be fairly global. If there is any new launches is probably in some of the Asian markets particularly China where I think we are going to be we feel that we are going to be incredibly successful with our higher ASP devices.

And so in that budget with our announced memorandum of understanding with Alibaba makes China pretty interesting region for us.

William Zerella:

In terms of the gross margins we really seek to have similar gross margins regardless of where we selling around the world. We are not perfect to that I mean obviously exchange rates can come into place to a degree especially over the course of the last year or so. But directionally we seek to get similar margins on our products rather where we sale them.

Betty Chen:

And then can I clarify earlier will you referring to in terms of revenue growth in the back half will you referring to that the third quarter could be growth closer the low 30s or will you seeing in the back half total growth rate of 30s range.

James Park:

yes if you back if you look at our guidance we use the midpoint backing to the numbers then the second half growth rate and total is 31% the we taking into account the sequential decline in Q3 from seasonality and then the balance of course in Q4.

Betty Chen:

Okay, great. Thanks so much

James Park:

Okay.

Operator:

We'll take our next question from John Kernan with Cowen.

John Kernan:Cowen:

hey congrats guys thank you for taking my question. Just one of my question has been answered by just to be one thing clear is the long term margin expansion of the model really based on the gross margin getting towards that 50% level within the next just for our models within the next couple of years is it safe to assume that your going to be aggressively reinvesting in the mode that you talked about earlier in some of these higher ROI projects you talked about to.

William Zerella:

hey John. So good question so in terms of gross margin I mean obviously we're inching we're getting closer to getting back to our target which we've achieved in the past. Right, so we're feeling pretty good about that side of the equation. The OpEx side is where we are investing pretty heavily I mean we're not in a position obviously to provide guidance here for next year of course.

I mean we would certainly look to get closer to our target model. It all depends upon the maturity of the market and the opportunities we see for future growth right. So you always balancing that investment with driving your short-term profitability versus your longer term your position in the market. So I think its really dependent upon the opportunities that we see and the competitive environment and what we think makes the most sense for the business.

So maybe that's not an answer today or I can tell you is we are sensitive to the need to get back to our target model and the appropriate time we will do that but we certainly don't want to sacrifice the long-term just to hit some short term target. That's the way we think about it.

John Kernan:

That makes a lot of sense and then just on the SAP implementation that you talked about it -- for 2017 can you talk about the cost and benefits of that program? Thanks.

James Park:

Yes so right now the target go live for SAP the spring of 2017. This year we are projecting about $10 million in CapEx to support that implementation. In terms of the benefits of any ERP system its the core backbone to run the business and we were scaling the Company at a rapid rate and we need the right systems in place to effectively run this business as we continue to grow. That's basically the value proposition our current systems are not going to scale and SAP certainly will meet our requirements as we continue to grow.

John Kernan:

Okay. Thank you best of luck.

James Park:

Thanks.

Operator:

Ladies and gentlemen this does concludes both the question and answer session and the Fitbit's first quarter 2016 earnings conference call. Thank you for your participation. You may now disconnect.