10-K 1 fitbit1231201810-k.htm 10-K Document

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
____________________________________________
FORM 10-K
____________________________________________
(Mark one)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
or
 
o
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.)
 
199 Fremont Street, 14th Floor
San Francisco, California 94105
(Address of principal executive offices) (Zip Code)

(415) 513-1000
(Registrant’s telephone number, including area code)
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class

Class A Common Stock, par value $0.0001
 
Name of each exchange on which registered

New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or 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
o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
o
 
 
 
Emerging growth company
o

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. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based on the closing sale price of the registrant's Class A common stock on June 30, 2018, the last business day of the registrant's most recently completed second fiscal quarter, as reported on the New York Stock Exchange, was approximately $1.4 billion.

As of February 20, 2019, there were 221,444,789 shares of the registrant’s Class A common stock outstanding and 31,281,638 shares of the registrant’s Class B common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Definitive Proxy Statement for the Annual Meeting of Stockholders are incorporated herein by reference in Part II and Part III of this Annual Report on Form 10-K to the extent stated herein. Such proxy statement will be filed with the Securities and Exchange Commission within 120 days of the registrant’s fiscal year ended December 31, 2018.





Fitbit, Inc.
Form 10-K
For the Fiscal Year Ended December 31, 2018

TABLE OF CONTENTS
 
 
Page 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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NOTE ABOUT FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K 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 Annual Report on Form 10-K 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 Annual Report on Form 10-K 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 revenue, cost of revenue, gross margin, 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 smartwatches and their market acceptance and future potential;
our ability to develop and introduce new products and services, including recurring non-device revenue offerings such as subscription-based premium services, and improve our existing products and services;
our ability to engage, expand and further monetize our user base;
the impact of tariffs or other restrictions placed on our products imported into the United States from China;
potential insurance recoveries;
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;
our ability to increase sales of devices and software services to employers, health plans and health systems through our Fitbit Health Solutions channel;
trends in our quarterly operating results and other operating metrics;
legal proceedings and the impact of such proceedings;
the impact of changes in tax law on our operating results;
the impact of our adoption of accounting pronouncements;
the effect of seasonality on our results of operations;
our ability to attract and retain highly skilled employees;
our expectations to derive the substantial majority of our revenue from sales of devices;
our expectations with respect to shifts in advertising and marketing spend;
the impact of our acquisitions in enhancing the features and functionality of our devices;
the impact of foreign currency exchange rates;
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, including potential changes in tariffs.

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

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Annual Report on Form 10-K 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 Annual Report on Form 10-K. 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 Annual Report on Form 10-K. 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.


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The forward-looking statements made in this Annual Report on Form 10-K 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 Annual Report on Form 10-K to reflect events or circumstances after the date of this Annual Report on Form 10-K 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 statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.


PART I

Item 1. Business
 
Our Vision
To make everyone in the world healthier.

Our Mission
 
To help people achieve positive health, wellness, and fitness outcomes by empowering them with intelligent insights, personalized guidance, and the motivation to reach their goals.
 
Overview
 
Fitbit is a technology company focused on delivering health solutions that impact health outcomes. The Fitbit platform combines wearable devices with software and services to give our users tools to help them reach their health and fitness goals, augmented by general purpose features that add further utility and drive user engagement. Our wearable devices, which include health and fitness trackers and smartwatches, enable our users to view data about their daily activity, exercise and sleep in real-time. Our software and services, which include an online dashboard and mobile app, provide our users with data analytics, motivational and social tools, and virtual coaching through customized fitness plans and interactive workouts. In addition, our software and services drive engagement and can be leveraged to provide personalized insights. Together, our devices, services, and software have helped millions of users on their health and fitness journeys be more active, sleep better, eat smarter, and manage their weight. Fitbit appeals to a wide spectrum of consumers by addressing key health and fitness needs with advanced technology embedded in simple-to-use products and services.
 
The core of our platform is our family of wearable devices. These devices automatically track users’ daily steps, calories burned, distance traveled, and active minutes, and display real-time feedback to encourage users to become more active in their daily lives. Most of our wearable devices also measure floors climbed, and sleep duration and quality, and our more advanced products track heart rate, and GPS-based information such as speed, distance, and exercise routes. Several of our devices also have more advanced features such as the ability to receive call and text notifications, and certain of our devices offer contactless payments, on-board music, notifications, and several apps. To accompany certain of our products, we offer accessories that include wireless headphones, interchangeable wrist bands and frames, colored clips, device charging cables, wireless sync dongles, band clasps, and Fitbit apparel. In addition, we offer a Wi-Fi connected scale that records weight, body fat, and BMI. We are able to enhance the functionality and features of our wearables through wireless updates.
 
Our platform also includes software that helps to encourage healthy behavior changes in three areas: activity, sleep, and nutrition. The software includes our online dashboard and mobile apps, which wirelessly and automatically sync with our devices. It enables users to see trends and achievements and, access motivational tools such as coaching and guidance, or connections to our community. We believe gamifying behaviors and providing virtual badges, real-time progress notifications, social support, and a competition dashboard helps drive engagement. Our direct connection with our users also enables us to provide personalized insights. In addition, we extend the value of our platform through our open API, which enables third-party developers to create health and fitness apps that interact with our platform. Through our open platform and our large community of users, we have established an ecosystem that includes thousands of third-party health and fitness apps that connect with our products and enhance the Fitbit experience.

Our platform enables a wide range of people to get fit their own way, whatever their interests and goals. Our users range from people interested in improving their health and fitness through everyday activities to endurance athletes seeking to maximize their performance. To address this wide range of needs, we design our devices, apps, and services to be easy to use so that they fit seamlessly into peoples’ daily lives and activities. Our users can sync their Fitbit devices with and view their dashboard on their

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computers and over 200 mobile devices, including iOS, Android, and Windows Phone products. This cross-platform capability coupled with broad global distribution have enabled us to attract what we believe is one of the largest community of wearable device users. The size of our user community increases the likelihood that our users will be able to find and engage with like-minded individuals, friends, and family, creating positive network effects that reinforce our growth. In addition, data from our large community enables us to enhance our product features, provide improved insights, and offer more valuable guidance for our users.

The Fitbit Platform
 
Our wearable platform is designed to enable our users to improve their health and fitness by:
 
Tracking activities through our wearable devices. We empower users to live healthier, more active lifestyles by both tracking the information that matters most to them and providing them with real-time feedback. Our wearable devices span multiple styles, form factors, and price points, and, as a result, address the needs of a wide range of people—from people simply looking to get fit by increasing their activity levels to endurance athletes seeking to maximize their performance. Our devices, which include both health and fitness trackers and smartwatches and our Wi-Fi connected scale, feature proprietary and advanced sensor technologies and algorithms and long battery lives. In addition, the ease of use and small, lightweight, and durable designs of our devices help them fit effortlessly into our users’ lifestyles.

Learning through our online dashboard and mobile apps. We offer our users a personalized online dashboard and mobile apps that sync automatically with and display data from our wearable devices. We provide our users with a wide range of information and analytics, such as charts and graphs of their progress and the ability to log caloric intake. Both our online dashboard and mobile apps are free and work with all of our wearable devices. Our internally-developed software is regularly updated and enhanced, increasing the utility of our platform.

Staying motivated through social features, notifications, challenges, and virtual badges. Our products help millions of users achieve their goals both individually and within the community that they choose. On an individual level, we motivate users by delivering real-time feedback, including notifications, leaderboard and challenge updates, and virtual badges. Our platform also offers users social features that allow them to view and participate in a social feed, receive and provide support through specific groups organized by activity or health, and engage in friendly competition. Users can securely share some or all of their health and fitness information on an opt-in basis with friends, family, and other parties and compete against each other on key statistics through leaderboards and daily or multi-day fitness challenges. In addition, users can choose to share their data with thousands of third-party apps and through social networks on an opt-in basis. As users create more connections on our network, they often benefit from higher levels of activity.

Improving health and fitness through goal-setting, personalized insights, premium services, and virtual coaching. Our primary goal is to help our users improve their health and fitness. We believe our platform assists users in changing their daily behavior, such as going for a run or walking more to reach a goal or win a challenge. We empower our users to set their own health and fitness goals and track their progress towards these goals. We also offer premium services on a subscription basis that provide personalized insights and virtual coaching through customized fitness plans and interactive video-based exercise experiences on mobile devices and computers. Our premium services feature in-depth data analysis and personalized reports, as well as benchmarking against peers.

Our Competitive Strengths
 
We believe our competitive strengths are brand, community, and data.

Brand

Fitbit is a leading global wearables brand. We stand for health and fitness and have a trusted relationship with our users. We have a singular focus on driving positive health outcomes by targeting activity, sleep, and nutrition.

Broad and differentiated go-to-market strategy. We have developed a broad go-to-market strategy that reaches individuals regardless of where they shop. We sell our products in over 39,000 retail stores and in 87 countries, through our retailers’ websites, through our online store at Fitbit.com, and through Fitbit Health Solutions. We believe the breadth and depth of our established selling channels and prominent presence in retail stores would be difficult for a competitor to replicate.

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Community

Broad range of wearable devices. We believe everyone’s approach to fitness is different, so we offer our users a range of wearable devices spanning multiple styles, form factors, and price points to allow people to find the devices that fit their lifestyles and goals. In addition to our wrist-based and clippable wearable health and fitness devices, we also offer a Wi-Fi connected scale that tracks weight, body fat, and BMI. We believe the breadth of our wearable devices provides us with a competitive advantage over our competitors, which often have a more limited line of products.

Large and growing community and powerful network effects. We believe the size of our community of users makes it more likely that users can connect with like-minded individuals, friends, and family and attracts many new users to our platform. Achieving meaningful health and fitness outcomes over the long-term is difficult. We believe that access to a network of users who provide support and motivation can increase a user’s engagement with and duration on the platform, especially when that network provides positive support as observed on our social feed. Each of our users adds value to our platform by making progress towards their goals and syncing their data with our platform, which we leverage to provide better insights for our users. As our community of users continues to grow, we will develop a deeper understanding of our users and expect to deliver additional value to them through more detailed insights and analysis. We believe the growth and scale of our user community allows users to become not only more engaged with personalized and relevant content, but also less likely to leave a community in which many of their friends and family are active members.

Direct relationship and continuous communication with our users. The connectivity of our devices allows us to better understand our users’ health and fitness goals. This connectivity also allows us to communicate the most relevant analysis, features, advice, and content to our users throughout the day with our online dashboard, mobile apps, emails, and notifications. It also allows us to focus on developing software that influences the behavior of our users to improve health outcomes, which can not only drive new forms of monetization, but also further engagement and duration of usage. We also utilize these communication channels to help our users become aware of our new products and services.

Data

Advanced, purpose-built hardware and software technologies. Our wearable devices leverage industry-standard technologies, such as Bluetooth low energy, as well as proprietary technologies, such as our PurePulse continuous heart rate tracking and our algorithms that measure and analyze user health and fitness metrics. We devote significant resources to ensure that our devices effortlessly fit into our users’ lifestyles. For example, we design our small, lightweight, durable, and fashionable products to be optimized for power efficiency, which enables automatic wireless data syncing without compromising battery life. We place a similarly strong emphasis on our online dashboard and mobile apps to provide users with visualization of their progress and personalized guidance. Our highly-scalable cloud infrastructure enables millions of users around the world to engage with our platform in real-time.

Broad mobile compatibility and open API. Our broad mobile compatibility and open API enable a large health and fitness ecosystem that provides additional value to our existing users and extends our reach to potential new users. Our users can sync their Fitbit devices with and view their online dashboard on their computers and over 200 mobile devices, including iOS, Android, and Windows Phone products. Additionally, we enable seamless integration with thousands of apps across iOS, Android, and Windows Phone through our open API, which allows our users to share data with third-party apps on an opt-in basis.

Our Devices and Accessories
 
Our line of devices includes Fitbit Charge 3™, Fitbit Surge®, Fitbit Blaze®, Fitbit Charge 2®, Alta HR™, Alta®, Fitbit Ace™, Fitbit Flex 2®, Fitbit One® and Fitbit Zip® activity trackers, as well as Fitbit Ionic™ and Fitbit Versa™ smartwatches, and Fitbit Aria 2™ Wi-Fi Smart Scales. We also offer a line of accessories including bands and frames for some of our devices, as well as Fitbit Flyer™, our wireless headphone designed for fitness.
 

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Our Software and Services

We believe our software and services offer the ability to engage the user and effect behavior change, representing an opportunity to diversify our revenue stream and deepen our relationship with our users. As we continue to work towards driving and influencing health outcomes, we believe there is an opportunity for our software to play a role in chronic disease management. We offer both enterprise software such as corporate challenges for Fitbit Health Solutions customers and coaching and guidance for our retail customers. Revenue from our software and services has historically represented less than one percent of our annual revenue.

Fitbit online dashboard and mobile apps. We offer our users a personalized online dashboard and mobile apps that sync automatically with, and display real-time data from, our wearable devices. Through these offerings, we provide users with charts and graphs of their progress, deeper analysis of their activities, and the ability to log caloric intake. Additionally, we motivate users through real-time feedback including notifications, leaderboard and challenge updates, and virtual badges. Our platform also offers users social features, such as access to an online community of users, leaderboards and challenges, that allow users to receive and provide support and engage in friendly competition. Our online dashboard and mobile apps are available for free through the iOS App Store, Google Play, Windows Store, and on Fitbit.com.
 
Fitbit Coach. In March 2015, we acquired FitStar, a provider of interactive video-based exercise experiences on mobile devices and computers that utilize proprietary algorithms to adjust and customize workouts for individual users based on data gathered during their workouts. We rebranded FitStar to Fitbit Coach beginning in October 2017. Through our Fitbit Coach offering, we provide exercise programs through personal trainer and yoga apps that continuously adjust to our users based on feedback throughout the workout.

Fitbit Care. In September 2018, we launched Fitbit Care, a connected health platform for health plans, employers, and health systems that combines health coaching and virtual care through the new Fitbit Plus™ app, Fitbit’s wearable devices and self-tracking and personalized digital interventions to help improve wellness, disease management and prevention. Fitbit Care combines our experience inspiring people to get healthy with the clinically-proven behavior change principles of Twine Health, which Fitbit acquired in March 2018 to improve care team collaboration and health outcomes across the spectrum of care. Fitbit Care is sold through our Fitbit Health Solutions channel.

Our Commitment to Privacy
 
We are committed to respecting our users’ privacy, letting our users decide how their information is used and shared, and keeping their data safe.
 
We have developed our data collection and use practices in accordance with the Fair Information Practice Principles, or FIPPs. We are committed to the following privacy principles as outlined in our privacy policy:
 
Transparent and Easy to Understand Policies. We are transparent about our data practices and explain them in clear language. Our data collection practices are designed to only collect data that is useful to improving our products, services, and user experience.

No Unexpected Uses. We never sell personally identifiable data or use it other than as described in our privacy policy.

Clear Notice and Consent. We only share personally identifiable data with third parties, including employers, when our users consent to the sharing and under the limited circumstances outlined in our privacy policy where users’ personally identifiable data can be shared without specific consent, such as our receipt of search warrants or subpoenas from law enforcement agencies or in response to a validly issued legal process in a civil litigation matter.

Prioritize Security. We take the security of our users’ data seriously. We use a combination of technical and administrative security controls to help ensure the security of user data.

Research and Development
 
We are passionate about developing innovative products and services that empower our users to reach their health and fitness goals. We believe our future success depends on our ability to develop new products and features that expand the versatility and performance of our existing platform, and we plan to continue to invest significant resources to enhance performance, functionality, convenience, and style for our users.


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Our global research and development team supports the design and development of our wearable devices, proprietary sensors, firmware, data algorithms, and online dashboard and mobile apps. Our team is also researching new advanced science to help deepen our penetration of wearable devices. The team is comprised of dedicated research employees, electrical engineers, mechanical engineers, firmware engineers, site operations engineers, and mobile app developers. Our research and development team is primarily based at our headquarters in San Francisco, California, as well as several other worldwide locations.
 
Manufacturing, Logistics and Fulfillment
 
We outsource the manufacturing of our products to several contract manufacturers. These contract manufacturers produce our products in their facilities, which are primarily located in Asia. The components used in our products are sourced either directly by us or on our behalf by our contract manufacturers from a variety of component suppliers selected by us and our contract manufacturers, and are located worldwide. Our operations employees coordinate our relationships with our contract manufacturers and component suppliers. We believe that using outsourced manufacturing enables greater scale and flexibility at lower costs than establishing our own manufacturing facilities. We evaluate our current contract manufacturers and component suppliers on an ongoing basis, including whether or not to utilize new or alternative contract manufacturers or component suppliers.
 
We work with third-party fulfillment partners that deliver our products from multiple locations worldwide, which allows us to reduce order fulfillment time, reduce shipping costs, and improve inventory flexibility.
 
Sales Channels and Customers
 
We sell our products through three primary channels:
 
Retail and distribution channel. We offer our products in over 39,000 retail stores and in 87 countries. We focus on building close relationships with our retailers, working with them to merchandise our products in a compelling manner both in-store and on their e-commerce sites, promoting our products through their marketing efforts, and educating their sales forces about our products. In addition, we sell to distributors who resell our products to retailers.
 
Consumer electronics and specialty retailers. Our products are sold by retailers with a large domestic and international presence such as Best Buy.
e-Commerce retailers. Our products are sold on Amazon.com, in addition to the e-commerce sites of our retailers.
Mass merchant, department store, and club retailers. Our products are sold by large retailers, including Target, Costco, Macy’s, Kohl’s, and Walmart.
Sporting goods and outdoors retailers. Our products are sold by sporting goods and outdoors retailers, including Dick’s Sporting Goods and REI.
Wireless carriers. Our products are sold by wireless carriers, including Verizon.
Distributors. Our products are sold by a network of distributors.

Consumer direct channel. We sell our full line of products directly to consumers in the United States and other countries through our online store at Fitbit.com, which represented 10% of our revenue in both 2018 and 2017. We drive consumers to our website through online and offline advertising as well as marketing promotions.
 
Fitbit Health Solutions channel. Fitbit Health Solutions delivers health and wellness solutions designed to increase engagement, improve health outcomes and drive positive returns for employers, health plans, and health systems. It leverages our consumer device technology to build a platform of hardware and software tools to motivate people to make sustained behavior change. We believe our strong brand recognition and success with consumers makes Fitbit a desirable partner for the healthcare and enterprise ecosystem. Fitbit Health Solutions partners and sells offerings to employer health and wellness plans, health plans, hospitals, and researchers through a direct sales team and indirectly through partners. In the fall, we launched Fitbit Care, a connected health platform for health plans, employers, and health systems that combines health coaching and virtual care, wearable devices, and personalized digital interventions to better support patients outside the walls of the clinical environment.
 
Backlog
 
There is a relatively short cycle between order and shipment of our sales. Therefore, we believe that backlog information is not material to the understanding of our business.

Marketing and Advertising
 
Our marketing and advertising programs are focused on building global brand awareness, increasing product adoption, including the launch of new product offerings, and driving sales. Our marketing and advertising efforts target a wide range of

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consumers and leverage traditional advertising methods (including television, cinema, and print magazines), sponsorships and public relations, digital marketing, channel marketing, and endorsements by professional athletes and celebrities.
 
Our in-store merchandising strategy focuses on our point of purchase, or POP displays. We install our freestanding, in-line, and endcap POP displays of varying sizes at our various retailers. These displays communicate our marketing messages, present our products and their features and, in many cases, allow consumers to try on our devices and view an interactive app that enables them to learn more about our products.
 
Intellectual Property
 
Intellectual property is an important aspect of our business, and we seek protection for our intellectual property as appropriate. We rely upon a combination of patent, copyright, trade secret, and trademark laws and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights.
 
We have developed a significant patent portfolio to protect certain elements of our proprietary technology. As of December 31, 2018, we had 480 issued patents. We continually review our development efforts to assess the existence and patentability of new intellectual property. We pursue the registration of our domain names and trademarks and service marks in the United States and in certain locations outside the United States.

Competition
 
The market for wearable devices is both evolving and competitive. The wearable devices category has a multitude of participants including specialized consumer electronics companies such as Garmin and Withings, and traditional watch companies such as Fossil. In addition, many large, broad-based consumer electronics companies either compete in our market or adjacent markets or have announced plans to do so, including Apple, Google, LG, and Samsung. For example, Apple sells the Apple Watch, which is a smartwatch with broad-based functionalities, including some health and fitness tracking capabilities, and Apple has sold a significant volume of its smartwatches since introduction. We also face competition from manufacturers of lower-cost devices, such as Xiaomi and its Mi Band device. In addition, we compete with a wide range of stand-alone health and fitness-related mobile apps that can be purchased or downloaded through mobile app stores.
 
The principal competitive factors in our market include:
 
brand awareness and focus;
breadth of product offerings;
battery life, sensor technology, and tracking features;
online and mobile app experience;
cross-platform capability (iOS, Android, and Windows Phone);
software algorithms;
partnerships;
strength of sales and marketing efforts; and
distribution strategy.

We believe we compete favorably with our competitors on the basis of these factors as a result of our community of users, leading global brand, and data. The size of our user community increases the likelihood that our users will be able to find and engage with like-minded individuals, friends, and family, creating positive network effects. We believe that our success with consumers, along with our focus on health and fitness, makes us an attractive wearables partner for the healthcare and enterprise ecosystem. Furthermore, our platform and open API have together enabled us to establish a large and growing health and fitness ecosystem that not only provides additional value to our existing users, but also extends our reach to potential new users.
 
Employees
 
As of December 31, 2018, we had 1,694 global employees. We have not experienced any work stoppages. We consider our relationship with our employees to be good.

Information about Geographic Revenue

Information about geographic revenue is described in Note 11, “Significant Customer Information and Other Information” in the notes to our consolidated financial statements.


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Corporate Information

We were incorporated in Delaware in March 2007 as Healthy Metrics Research, Inc. We changed our name to Fitbit, Inc. in October 2007. We completed our initial public offering, or IPO, in June 2015 and our Class A common stock is listed on The New York Stock Exchange under the symbol “FIT.” Our principal executive offices are located at 199 Fremont Street, 14th Floor, San Francisco, California 94105, and our telephone number is (415) 513-1000. Our website address is www.fitbit.com and our investor relations website address is http://investor.fitbit.com. The information on, or that can be accessed through, our website is not incorporated by reference into this Annual Report on Form 10-K. Fitbit, the Fitbit logo, Fitbit Versa, Fitbit Ionic, Fitbit Flyer, Fitbit Surge, Fitbit Blaze, Fitbit Charge 3, Fitbit Charge 2, Fitbit Charge HR, Alta, Fitbit Charge, Fitbit Flex 2, Fitbit Flex, Fitbit One, Fitbit Zip, Aria, PurePulse, SmartTrack, FitStar, and our other registered or common law trade names, trademarks, or service marks appearing in this Annual Report on Form 10-K are our intellectual property. This Annual Report on Form 10-K contains additional trade names, trademarks, and service marks of other companies that are the property of their respective owners.

Through a link on our website, we make available the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission, or SEC: our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act. All such filings are available free of charge. The public may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that contains all reports that we file or furnish with the SEC electronically.

Item 1A. Risk Factors
 
An investment in our Class A common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, before making a decision to invest in our Class A common stock. Our business, operating results, financial condition, or prospects could be materially and adversely affected by any of these risks and uncertainties. If any of these risks actually occurs, the trading price of our Class A common stock could decline and you might lose all or part of your investment. Our business, operating results, financial performance, or prospects could also be harmed by risks and uncertainties not currently known to us or that we currently do not believe are material.
 
 
Risks Related to Our Business
 
We operate in a highly competitive market. If we do not compete effectively, our prospects, operating results, and financial condition could be adversely affected.

The wearable device market is highly competitive, with companies offering a variety of products and services. Wearables can be broadly defined as trackers, fitness watches, smartwatches and devices beyond the wrist. We expect competition in our market to intensify in the future as new and existing competitors introduce new or enhanced products and services that are potentially more competitive than our products and services. In terms of units sold, we have primarily operated in the health and fitness tracker and smartwatch segments of the wearables device market. The wearable device market has a multitude of participants, including specialized consumer electronics companies, such as Garmin and Withings, and traditional watch companies such as Fossil.

In addition, many large, broad-based consumer electronics companies either compete in our market or adjacent markets or have announced plans to do so, including Apple, Google, LG and Samsung. For example, Apple sells the Apple Watch, which is a smartwatch with broad-based functionalities, including some health and fitness tracking capabilities, and Apple has sold a significant volume of its smartwatches since introduction. Moreover, smartwatches with health and fitness functionalities may displace the market for traditional tracker devices. For example, Apple’s recently introduced Apple Watch includes ECG functionality and fall detection capability. We also face competition from manufacturers of lower-cost devices, such as Xiaomi and its Mi Band devices. In addition, we compete with a wide range of stand-alone health and fitness-related mobile apps that can be purchased or downloaded through mobile app stores.

We believe many of our competitors and potential competitors have significant advantages, including longer operating histories, ability to leverage their sales efforts and marketing expenditures across a broader portfolio of products and services, larger and broader customer bases, more established relationships with a larger number of suppliers, contract manufacturers, and channel partners, greater brand recognition, ability to leverage app stores which they may operate, experience manufacturing

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particular wearable devices, such as smartwatches, and greater financial, research and development, marketing, distribution, and other resources than we do.

Some of our competitors may aggressively discount their products and services in order to gain market share, which could result in pricing pressures, reduced profit margins, lost market share, or a failure to grow market share for us. In addition, new products may have lower selling prices or higher costs than legacy products, which could negatively impact our gross margins and operating results. Our competitors and potential competitors may also be able to develop products or services that are equal or superior to ours, achieve greater market acceptance of their products and services, and increase sales by utilizing different distribution channels than we do.

Furthermore, current or potential competitors may be acquired by third parties with greater available resources. As a result of such acquisitions, our current or potential competitors might be able to adapt more quickly to new technologies and consumer needs, devote greater resources to the promotion or sale of their products and services, initiate or withstand substantial price competition, take advantage of acquisition or other opportunities more readily or develop and expand their products and services more quickly than we do. If we are not able to compete effectively against our current or potential competitors, our prospects, operating results, and financial condition could be adversely affected.

If we are unable to anticipate and satisfy consumer preferences in a timely manner, our business may be adversely affected.

Our success depends on our ability to anticipate and satisfy consumer preferences in a timely manner. All of our products and services are subject to changing consumer preferences that cannot be predicted with certainty. In terms of units sold, we have primarily operated in the tracker segment of the wearables device market. However, consumer preference has increasingly shifted to the smartwatch segment of the wearables device market. Although we are building out our smartwatch offerings, consumers may ultimately decide not to purchase our products and services as their preferences could shift rapidly to different types of wearable devices or away from these types of products and services altogether. In addition, adoption of our products may vary by geographic region. Our future success depends in part on our ability to anticipate and respond to shifts in consumer preferences. If we do not anticipate such shifts in a timely manner, our reputation and business may be adversely affected.

Our newer products and services that have additional features or new product designs, such as Fitbit Versa, may also have higher prices than many of our earlier products and the products of some of our competitors, which may not appeal to consumers or only appeal to a smaller subset of consumers. It is also possible that competitors could introduce new products and services that negatively impact consumer preference for our wearable devices, which could result in decreased sales of our products and services and a loss in market share.

In addition, although we intend to build out our recurring non-device revenue offerings, such as with a premium experience that offers a variety of features, insights and programs, it is possible that consumers or enterprise customers may not be receptive to these new services or that revenue from these offerings may continue to be immaterial. For example, in the first quarter of 2018, we acquired Twine Health, Inc., or Twine Health, a health coaching platform and in the third quarter of 2018, we introduced Fitbit Care, a connected health platform for health plans and employers, and revenue from these offerings is an immaterial portion of our overall revenue. In addition, we have limited experience operating services outside of our core device business, and our ability to forecast revenue and other financial and operating results for any new service, such as Fitbit Care, is inherently uncertain, and our actual results may vary significantly from what we desire or predict or the estimates of analysts.

Accordingly, if we fail to anticipate and satisfy consumer preferences in a timely manner, or if it is perceived that our future products and services will not satisfy consumer preferences, our business may be adversely affected.

If we are unable to successfully develop, timely introduce, and effectively manage the introduction of new products and services or enhance existing products and services, our business may be adversely affected.

We must continually develop and introduce new products and services and improve and enhance our existing products and services to maintain or increase our sales. We believe that our future growth depends on continuing to engage and expand our user base by introducing new form factors, software services and other offerings. For example, in the first quarter of 2018, we started shipping Fitbit Versa, our second smartwatch; in the second quarter of 2018, we started shipping Fitbit Ace, our activity tracker designed for kids ages 8 and older; and in the third quarter of 2018, we started shipping Fitbit Charge 3, our newest activity tracker. In addition, in the first quarter of 2018, we acquired Twine Health, and in the third quarter of 2018, we introduced Fitbit Care. The success of new or enhanced products and services may depend on a number of factors including, among other things, anticipating and effectively addressing consumer preferences and demand, timely and successful research and development, the success of our

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sales and marketing efforts, effective forecasting and management of product demand, purchase commitments, and inventory levels, effective management of manufacturing and supply costs, and the quality of or defects in our products.

The development of our products and services is complex and costly, and we typically have several products and services in development at the same time. Given the complexity, we occasionally have experienced, and could experience in the future, delays in completing the development and introduction of new and enhanced products and services, product costs that are higher than planned, or lower than expected manufacturing yields of new and enhanced products, which may adversely affect our revenue and gross margins.

If revenues decline, we may be forced to reduce costs and may not be able to compete effectively. Unanticipated problems in developing products and services could also divert substantial research and development resources, which may impair our ability to develop new products and services and enhancements of existing products and services, and could substantially increase our costs. Problems in the design or quality of our products or services may also have an adverse effect on our brand, business, financial condition, and operating results.

We must also successfully manage introductions of new or enhanced products or services. Introductions of new or enhanced products or services could also adversely impact the sales of our existing products to retailers and consumers. For instance, retailers often purchase less of our existing products in advance of new product launches. Furthermore, we may experience greater returns from retailers or users of existing products, or retailers may be granted stock rotation rights and price protection. Moreover, consumers may decide to purchase new or enhanced products instead of existing products. We may face challenges managing the inventory of existing products, which could lead to excess inventory and discounting of our existing products. In addition, new products may have lower selling prices or higher costs than legacy products, which could negatively impact our gross margins and operating results. We have also historically incurred higher levels of sales and marketing expenses accompanying each product introduction. Accordingly, if we fail to effectively manage introductions of new or enhanced products, our operating results could be harmed.

Our operating results could be materially harmed if we are unable to accurately forecast consumer demand for our products and services and adequately manage our inventory.

If we fail to accurately forecast consumer demand, we may experience excess inventory levels or a shortage of products available for sale. Our ability to accurately forecast demand for our products and services could be affected by many factors, including an increase or decrease in consumer demand for our products and services or for the products and services of our competitors, product and service introductions by us and our competitors, channel inventory levels, sales promotions by us or our competitors, unanticipated changes in general market conditions, and the weakening of economic conditions or consumer confidence in future economic conditions. To ensure adequate inventory supply, we must forecast inventory needs and expenses and place orders sufficiently in advance with our suppliers and contract manufacturers based on our estimates of future demand for particular products. We have previously faced and may continue to face challenges acquiring adequate and timely supplies of our products to satisfy demand, particularly in connection with new product introductions, which we believe may negatively affect our revenue. For example, during the three months ended June 30, 2018, we were impacted by supply constraints associated with Fitbit Versa, which limited our ability to fully satisfy all of the current demand for this product. As we continue to introduce new products, we may face challenges managing the inventory of existing products. No assurance can be given that we will not incur additional charges in future periods related to our inventory management or that we will not underestimate or overestimate forecasted sales in a future period.

Inventory levels in excess of consumer demand may result in inventory write-downs or write-offs and the sale of inventory at discounted prices, which have caused and may continue to cause our gross margin to decline and could impair the strength of our brand. For example, during the fourth quarter of 2016, as a result of reduced demand, we recorded write-downs for excess and obsolete inventory, accelerated depreciation of manufacturing and tooling equipment, and recorded a liability to our contract manufacturers for unutilized manufacturing capacity and components. In addition, we offered, and recorded reserves for, additional rebates and promotions during the fourth quarter of 2016 to retailers and distributors. During 2017, we recorded additional write-downs for excess and obsolete inventory, accelerated depreciation of manufacturing and tooling equipment due to continued reduced demand, price protection on certain products, and rebates. Reserves and write-downs for rebates, promotions, excess inventory, tooling and manufacturing capacity are recorded based on our forecast of future demand. Actual future demand could be less than our forecast which may result in additional reserves and write-downs in the future or actual demand could be stronger than forecast which may result in a reduction to previously recorded reserves and write-downs in the future and increase the volatility of our operating results.


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Conversely, if we underestimate consumer demand for our products, we may in future periods be unable to meet customer, retailer or distributor demand for our products. We may also be required to incur higher costs to secure the necessary production capacity and components if we underestimate demand and our business and operating results could be adversely affected, including damage to our brand and customer relationships.

Our quarterly operating results or other operating metrics may fluctuate significantly, which could cause the trading price of our Class A common stock to decline.

Our quarterly operating results and other operating metrics have fluctuated in the past and may continue to fluctuate from quarter to quarter. We expect that this trend will continue as a result of a number of factors, many of which are outside of our control and may be difficult to predict, including:

the level of demand for our wearable devices and our ability to maintain or increase the size and engagement of our community of users;
the timing and success of new product and service introductions by us and the transition from legacy products;
the timing and success of new product and service introductions by our competitors or any other change in the competitive landscape of our market;
the mix of products sold in a quarter;
the continued market acceptance of, and the growth of the market for, wearable devices, and evolution of this market into smartwatches and other form factors;
pricing pressure as a result of competition or otherwise;
delays or disruptions in our supply, manufacturing, or distribution chain;
errors in our forecasting of the demand for our products, which could lead to lower revenue or increased costs, or both;
seasonal buying patterns of consumers;
increases in levels of channel inventory resulting from sales to our retailers and distributors in anticipation of future demand;
increases in and timing of sales and marketing and other operating expenses that we may incur to grow and expand our operations and to remain competitive;
impact of sales and marketing efforts and promotions by competitors, which are difficult to predict;
insolvency, credit, or other difficulties faced by our distributors and retailers, affecting their ability to purchase or pay for our products;
insolvency, credit, or other difficulties confronting our suppliers, contract manufacturers, or logistics providers leading to disruptions in our supply or distribution chain;
levels of product returns, stock rotation, and price protection rights;
levels of warranty claims or estimated costs of warranty claims;
adverse litigation judgments, settlements, or other litigation-related costs;
changes in the legislative or regulatory environment, such as with respect to privacy, information security, health and wellness devices, consumer product safety, advertising, and taxes;
product recalls, regulatory proceedings, or other adverse publicity about our products;
fluctuations in foreign exchange rates;
costs related to the acquisition of businesses, talent, technologies, or intellectual property, including potentially significant amortization costs and possible write-downs; and
general economic conditions in either domestic or international markets, including potential changes in tariffs.
Any one of the factors above or the cumulative effect of some of the factors above may result in significant fluctuations in our operating results.


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The variability and unpredictability of our quarterly operating results or other operating metrics could result in our failure to meet our expectations, those of any analysts that publish financial coverage of us, or investors with respect to revenue or other operating results for a particular period. If we fail to meet or exceed such expectations for these or any other reasons, the market price of our Class A common stock could fall substantially, and we could face costly lawsuits, including securities class action suits.

We may not be able to achieve revenue growth or profitability in the future.

Our historical revenue growth should not be considered indicative of our future performance. Our revenue has declined in recent periods, and we expect our revenue growth to be slower than in the past or to decline in future periods due to a number of factors which may include slowing demand for our products and services, increasing competition, a decrease in the growth of our overall market, our failure, for any reason, to capitalize on growth opportunities, or the maturation of our business.

From 2014 to 2016, our annual revenue grew rapidly from $745.4 million to $2.2 billion. However, in recent quarters, our revenue growth has declined, and our historical growth should not be considered as indicative of our future performance. Although our annual revenue in 2016 was up 17% compared to 2015, our annual revenue in 2017 declined 26% compared to 2016, and our revenue in 2018 declined 6% compared to 2017. In future periods, we could again experience a decline in revenue, or revenue could grow more slowly than we expect, which could have a material negative effect on our future operating results.

Because we have only a limited history operating our business at its current scale, it is difficult to evaluate our current business and future prospects, including our ability to plan for and model future growth. Our limited operating experience at this scale, combined with the rapidly evolving nature of the market in which we sell our products and services, substantial uncertainty concerning how these markets may develop, and other economic factors beyond our control, reduces our ability to accurately forecast quarterly or annual revenue. As such, any predictions about our future revenue and expenses may not be as accurate as they would be if we had a longer operating history or operated in a more developed and predictable market. Failure to manage our future growth effectively could have an adverse effect on our business, which, in turn, could have an adverse impact on our operating results and financial condition.

In addition, we have not consistently achieved profitability on a quarterly or annual basis. For example, we recorded a net loss of $185.8 million in 2018 and a net loss of $277.2 million in 2017. Lower levels of revenue and higher levels of operating expenses may result in limited profitability or losses in the future.

If we fail to manage our operating expenses effectively, our financial performance may be negatively impacted.
    
Our success also depends on our ability to manage our operating expenses effectively. Our employee headcount and the scope and complexity of our business have increased significantly during recent years and we had 1,694 employees as of December 31, 2018. We have incurred significant net losses of $185.8 million, $277.2 million and $102.8 million in 2018, 2017 and 2016, respectively.

In addition, we are also investing in areas we believe will grow revenue and our operating expenses might increase as a result of these investments. The development of our products and services is complex and costly, and we typically have several products and services in development at the same time. Our research and development efforts may require us to incur substantial expenses to support the development of our next generation devices and other new products and services. Our research and development expenses were $332.2 million, $343.0 million and $320.2 million, for 2018, 2017 and 2016, respectively.

We could also be required to continue to expand our sales and marketing, product development, and distribution functions, to upgrade our business information technology systems and other processes and technology, and to obtain more space for our expanding workforce. These efforts could increase the strain on our resources, and we could experience serious operating difficulties, including difficulties in hiring, training, and managing employees.

If our continued investments do not result in future revenue as expected, we may incur greater than expected losses and our liquidity position may be materially adversely affected.

Conversely, in the future, we may again need to strategically realign our resources, adjust our product line and/or enact price reductions in order to stimulate demand, implement additional restructuring and workforce reductions or downsize our facilities for our reduced workforce. Any such actions may result in the recording of special charges including inventory-related write-offs, workforce reductions, or other restructuring costs. Additionally, our estimates with respect to the useful life or ultimate recoverability of our assets, including purchased intangible assets and tooling, could also change and result in impairment charges.

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If we are unable to operate efficiently and manage our costs, we may continue to incur significant losses in the future and may not be able to achieve or maintain profitability.

Because some of the key components in our products come from a limited number or single source of supply, we are susceptible to supply shortages, long lead times for components, and supply changes, any of which could disrupt our supply chain.

Some of the key components used to manufacture our products come from a limited or single source of supply. Our contract manufacturers generally purchase these components on our behalf, subject to certain approved supplier lists. We are subject to the risk of shortages and long lead times in the supply of these components and the risk that our suppliers discontinue or modify components used in our products. In addition, the lead times associated with certain components are lengthy and preclude rapid changes in quantities and delivery schedules. We have in the past experienced and may in the future experience component shortages, and the predictability of the availability of these components may be limited. While component shortages have historically been immaterial, they could be material in the future. In the event of a component shortage or supply interruption from suppliers of these components, we may not be able to develop suitable alternate sources in a timely manner. In addition, some of our suppliers, contract manufacturers, and logistics providers may have more established relationships with our competitors, and as a result of such relationships, such suppliers may choose to limit or terminate their relationship with us. Developing suitable alternate sources of supply for these components may be time-consuming, difficult, and costly and we may not be able to source these components on terms that are acceptable to us, or at all, which may adversely affect our ability to meet our requirements or to fill our orders in a timely or cost-effective manner. Any interruption or delay in the supply of any of these parts or components, or the inability to obtain these parts or components from alternate sources at acceptable prices and within a reasonable amount of time, would harm our ability to meet our scheduled product deliveries to our customers and users. This could harm our relationships with our channel partners and users and could cause delays in shipment of our products and adversely affect our operating results. In addition, increased component costs could result in lower gross margins. If we are unable to buy these components in quantities sufficient to meet our requirements on a timely basis, we will not be able to deliver products and services to our customers and users, which could adversely impact our revenue, gross margins, and operating results.

Our future success depends on the continuing efforts of our key employees, including our founders, James Park and Eric N. Friedman, and on our ability to attract and retain highly skilled personnel and senior management.

Our future success depends, in part, on our ability to continue to attract and retain highly skilled personnel. In particular, we are highly dependent on the contributions of our co-founders, James Park and Eric N. Friedman, as well as other members of our management team. The loss of any key personnel could make it more difficult to manage our operations and research and development activities to deliver on our product road map, reduce our employee retention and revenue, and impair our ability to compete. Although we have generally entered into employment offer letters with our key personnel, these agreements have no specific duration and provide for at-will employment, which means they may terminate their employment relationship with us at any time.

Competition for highly skilled personnel is often intense, especially in the San Francisco Bay area where we are located, and we may incur significant costs to attract them. We may not be successful in attracting, integrating, or retaining qualified personnel to fulfill our current or future needs. We have, from time to time, experienced, and we expect to continue to experience, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. Job candidates and existing employees often consider the value of the equity awards they receive in connection with their employment, and the significant decline in the price of our Class A common stock since our initial public offering may adversely affect our ability to attract or retain highly skilled employees. Fluctuations in the price of our Class A common stock may also make it more difficult or costly to use equity awards to motivate, incentivize and retain our employees. Furthermore, there can be no assurances that the number of shares reserved for issuance under our equity incentive plans will be sufficient to grant equity awards adequate to recruit new employees and to compensate existing employees. Additionally, changes in immigration laws may make it harder to attract and retain highly skilled employees. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be severely harmed.

We spend significant amounts on advertising and other marketing campaigns to acquire new users, which may not be successful or cost effective.

We spend significant amounts on advertising and other marketing campaigns, such as television, cinema, print advertising, and social media, to acquire new users and we expect to continue to spend significant amounts marketing our products and services to acquire new users and increase awareness of our products and services. In 2018, 2017 and 2016, advertising expenses, excluding

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co-op advertising and rebates which are recorded as contra-revenue, were $161.5 million, $226.3 million and $316.8 million, respectively, representing approximately 11%, 14% and 15% of our revenue, respectively. Co-op advertising costs were $80.3 million, $45.0 million, and $52.9 million for 2018, 2017 and 2016, respectively. A significant portion of our advertising and marketing spend is typically incurred in the fourth quarter as part of our holiday promotions, as well as when new products are released. While we seek to structure our advertising campaigns in the manner that we believe is most likely to encourage people to buy our products and services, we may fail to identify advertising opportunities that satisfy our anticipated return on advertising spend as we scale our investments in marketing, accurately predict user acquisition, or fully understand or estimate the conditions and behaviors that drive user behavior. Particularly during the holiday season, there is significant competition for holiday spending; if competitors or other products offer more compelling promotions or products, we may not realize our expected sales or recover our advertising and promotional spend. If new products do not meet customer expectations, we may not recover our advertising and promotional spend for new product introductions. If for any reason any of our advertising campaigns prove less successful than anticipated in attracting new users, we may not be able to recover our advertising spend, and our rate of user acquisition may fail to meet market expectations, either of which could have an adverse effect on our business. There can be no assurance that our advertising and other marketing efforts will result in increased sales of our products and services. Further, promotional activity may adversely affect our gross margin.

Our current and future products and services may experience quality problems from time to time that can result in adverse publicity, product recalls, litigation, regulatory proceedings, and warranty claims resulting in significant direct or indirect costs, decreased revenue and operating margin, and harm to our brand.

We sell complex products and services that could contain design and manufacturing defects in their materials, hardware, and firmware. These defects could include defective materials or components, or “bugs,” that can unexpectedly interfere with the products’ intended operations or cause injuries to users or property. Although we extensively test new and enhanced products and services before their release, there can be no assurance we will be able to detect, prevent, or fix all defects. For example, our products may fail to provide accurate measurements and data to all users under all circumstances, or there may be reports or claims of inaccurate measurements under certain circumstances.

Failure to detect, prevent, or fix defects, or an increase in defects could result in a variety of consequences including a greater number of returns of products than expected from users and retailers, increases in warranty costs, regulatory proceedings, product recalls, and litigation, which could harm our revenue and operating results. For example, in 2016, we experienced an increase in actual and estimated warranty claims of $108.5 million as compared to 2015, which caused a 4% decline in gross margin in 2016 as compared to 2015. We generally provide a 45-day right of return for purchases through Fitbit.com and a 12-month limited warranty on all of our products, though warranty duration and scope may vary by jurisdiction in compliance with applicable local law. The occurrence of real or perceived quality problems or material defects in our current and future products could expose us to warranty claims in excess of our current reserves. Moreover, we may offer stock rotation rights and price protection to our distributors. If we experience greater returns from retailers or users, or greater warranty claims, in excess of our reserves, our business, revenue, gross margin, and operating results could be harmed. In addition, any negative publicity or lawsuits filed against us related to the perceived quality and safety of our products could also affect our brand and decrease demand for our products and services, adversely affecting our operating results and financial condition.

We rely on a limited number of suppliers, contract manufacturers, and logistics providers, and each of our products is manufactured by a single contract manufacturer.

We rely on a limited number of suppliers, contract manufacturers, and logistics providers. In particular, we use contract manufacturers located in Asia, and each of our products is manufactured by a single contract manufacturer. Our reliance on a sole contract manufacturer for each of our products increases the risk that in the event of an interruption from any one of these contract manufacturers, including, without limitation, due to a natural catastrophe, labor dispute or increased tariffs on goods produced in certain countries, we may not be able to develop an alternate source without incurring material additional costs and substantial delays. Accordingly, an interruption from any key supplier, contract manufacturer, or logistics provider could adversely impact our revenue, gross margins, and operating results.

If we experience a significant increase in demand, or if we need to replace an existing supplier, contract manufacturer, or logistics provider or move our contract manufacturing to a different country, we may be unable to supplement or replace such supply, contract manufacturing, or logistics capacity on terms that are acceptable to us, which may adversely impact our ability to deliver our products to customers in a timely manner. For example, for certain of our products, it may take a significant amount of time to onboard a contract manufacturer that has the capability and resources to build the product to our specifications in sufficient volume. Identifying suitable suppliers, contract manufacturers, and logistics providers is an extensive process that requires

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us to become satisfied with their quality control, technical capabilities, responsiveness and service, financial stability, regulatory compliance, and labor and other ethical practices. In addition, our contract manufacturers often make significant investments to build capacity based upon our forecasted production. If we experience a significant decrease in demand as compared to our forecast, our contract manufacturers may seek to renegotiate the terms of their commitments or choose to limit or terminate their relationship with us. Accordingly, a loss of any key supplier, contract manufacturer, or logistics provider could adversely impact our revenue, gross margins, and operating results.

We have limited control over our suppliers, contract manufacturers, and logistics providers, which subjects us to significant risks, including the potential inability to obtain or produce quality products on a timely basis or in sufficient quantity.

We have limited control over our suppliers, contract manufacturers, and logistics providers, including aspects of their specific manufacturing processes and their labor, environmental, or other practices, which subjects us to significant risks, including the following:

inability to satisfy demand for our products;
reduced control over delivery timing and product reliability;
reduced ability to oversee the manufacturing process and components used in our products;
reduced ability to monitor compliance with our product manufacturing specifications;
price increases;
insolvency, credit problems, or other financial difficulties confronting our suppliers, contract manufacturers, or logistic providers;
difficulties in establishing additional or alternative contract manufacturing relationships if we experience difficulties with our existing suppliers, contract manufacturers or logistic providers;
shortages of materials or components;
misappropriation of our intellectual property;
suppliers, contract manufacturers, and logistics providers may choose to limit or terminate their relationship with us;
exposure to natural catastrophes, political unrest, terrorism, labor disputes, and economic instability resulting in the disruption of trade from foreign countries in which our products are manufactured;
changes in local economic conditions in countries where our suppliers, contract manufacturers, or logistics providers are located;
the imposition of new laws and regulations, including those relating to labor conditions, quality and safety standards, imports, duties, taxes, and other charges on imports, as well as trade restrictions and restrictions on currency exchange or the transfer of funds and tariffs; and
insufficient warranties and indemnities on components supplied to our contract manufacturers.

If there are defects in the manufacture of our products, we may face negative publicity, government investigations, and litigation, and we may not be fully compensated by our contract manufacturers for any financial or other liability that we suffer as a result.

To date, we have derived substantially all of our revenue from sales of our wearable devices, and revenue from our Fitbit Health Solutions channel has historically accounted for less than 10% of our revenue
 
To date, substantially all of our revenue has been derived from sales of our wearable devices, and we expect to continue to derive the substantial majority of our revenue from sales of these devices for the foreseeable future. In 2018 and 2017, we derived less than 10% of our revenue from sales of devices and software services through our Fitbit Health Solutions channel. However, in the future we plan to increase sales of devices and software services to employers, health plans and health systems through our Fitbit Health Solutions channel. For example, in September 2018, we launched Fitbit Care, a connected health platform for health plans, employers, and health systems that combines health coaching and virtual care, wearable devices, and personalized digital interventions to better support patients outside the walls of the clinical environment. If reception from employers, health plans, health systems or end users is unfavorable, or if we are unable to successfully further develop, and market and sell our devices

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and software services through the Fitbit Health Solutions channel, we may be deprived of a potentially significant source of revenue in the future. 

To date, we have derived substantially all of our revenue from sales of our wearable devices, and sales of our subscription-based premium services to consumers have historically accounted for less than 1% of our revenue.

To date, substantially all of our revenue has been derived from sales of our wearable devices, and we expect to continue to derive the substantial majority of our revenue from sales of these devices for the foreseeable future. In 2018 and 2017, we derived less than 1% of our revenue from sales of our subscription-based premium services to consumers. However, in the future we plan to increase sales of subscriptions to these services. For example, in October 2017, we launched Fitbit Coach, our premium guidance and coaching paid offering, and we intend to further build out our recurring non-device revenue offerings, such as with a premium experience that offers additional features, insights and programs. If consumer reception is unfavorable or we are unable to successfully further develop, and market and sell our premium services, we may be deprived of a potentially significant source of revenue in the future. In addition, sales of our premium services may lead to additional sales of our wearable devices and user engagement with our platform. As a result, our future growth and financial performance may depend, in part, on our ability to sell more subscriptions to our premium services.

We are, and may in the future, be subject to claims and lawsuits alleging that our products fail to provide accurate measurements and data to our users.

Our products and services are used to track and display various information about users’ activities, such as daily steps taken, calories burned, distance traveled, floors climbed, active minutes, sleep duration and quality, and heart rate and GPS-based information such as speed, distance, and exercise routes. We anticipate new features and functionality in the future, as well. From time to time, there have been reports and claims made against us alleging that our products do not provide accurate measurements and data to users, including claims asserting that certain features of our products do not operate as advertised. Such reports and claims have resulted in negative publicity, and, in some cases, have required us to expend time and resources to defend litigation. For example, in the first quarter of 2016, class action lawsuits were filed against us based upon claims that the PurePulse heart rate tracking technology in the Fitbit Charge HR, Fitbit Surge, and Fitbit Blaze do not consistently and accurately record users’ heart rates during high-intensity exercise. If our products fail to provide accurate measurements and data to users, or if there are reports or claims of inaccurate measurements, claims of false advertisement, or claims of inaccuracy regarding the overall health benefits of our products and services in the future, we may become the subject of negative publicity, litigation, including class action litigation, regulatory proceedings, and warranty claims, and our brand, operating results, and business could be harmed.

Our gross margins have declined, and may continue to decline, and we have experienced operating losses as a result of decreased revenues, increasing product costs and operating expenses.

Our business is subject to significant pressure on pricing and costs caused by many factors, including intense competition, new product introductions, the cost of components used in our products, labor costs, constrained sourcing capacity, inflationary pressure, pressure from users to reduce the prices we charge for our products and services, warranty claims, and changes in consumer demand. Costs for the components used in the manufacture of our products are affected by, among other things, energy prices, consumer demand, fluctuations in commodity prices and currency, tariffs, and other factors that are generally unpredictable and beyond our control. Any change to pricing and costs could have an adverse effect on, among other things, our average selling price, the cost of our products, gross margins, operating results, financial condition, and cash flows. Moreover, if we are unable to offset any decreases in our average selling price by increasing our sales volumes or by adjusting our product mix, or if our sales volume declines and we are not able to reduce our costs, our operating results and financial condition may be harmed.

A substantial portion of our expenses are personnel related and include salaries, stock-based compensation and benefits, which are not seasonal in nature. Accordingly, in the event of revenue shortfalls, we are generally unable to mitigate a negative impact on operating margins in the short term. To the extent such revenue shortfalls recur in future periods, our operating results would be harmed.

Our success depends on our ability to maintain our brand. If events occur that damage our brand, our business and financial results may be harmed.

Our success depends on our ability to maintain the value of the “Fitbit” brand. The “Fitbit” name is integral to our business as well as to the implementation of our strategies for expanding our business. Maintaining, promoting, and positioning our brand will depend largely on the success of our marketing and merchandising efforts, our ability to provide consistent, high quality

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products and services, and our ability to successfully secure, maintain, and defend our rights to use the “Fitbit” mark and other trademarks important to our brand. Our brand could be harmed if we fail to achieve these objectives or if our public image or brand were to be tarnished by negative publicity. For example, there has been media coverage of some of the users of our products reporting skin irritation, as well as personal injury lawsuits filed against us relating to the Fitbit Zip, Fitbit One, Fitbit Flex, Fitbit Charge, Fitbit Charge HR, and Fitbit Surge products. We also believe that our reputation and brand may be harmed if we fail to maintain a consistently high level of customer service. In addition, we believe the popularity of the “Fitbit” brand makes it a target for counterfeiting or imitation, with third parties attempting to sell counterfeit and “knock-off” products that attempt to replicate our products and infringe on our intellectual property.

In addition, our products may be diverted from our authorized retailers, distributors, and other business partners and sold on the “gray market.” Gray market products result in shadow inventory that is not visible to us, thus making it difficult to forecast demand accurately. Also, when gray market products enter the market, we and our channel partners compete with often heavily discounted gray market products, which adversely affects demand for our products and negatively impacts our margins. In addition, our inability to control gray market activities could result in user satisfaction issues, which may have a negative impact on our brand. When products are purchased outside our authorized retailers and distributors, there is a risk that our customers are buying substandard products, including products that may have been designated for scrap, altered, mishandled, damaged, or used products represented as new.

Any occurrence of counterfeiting, imitation, or confusion with our brand could adversely affect our reputation, place negative pricing pressure on our products, reduce sales of our products, and impair the value of our brand. Additionally, counterfeit and unauthorized grey market sales may result in secondary warranty replacement and service costs. Maintaining, protecting, and enhancing our brand may require us to make substantial investments, and these investments may not be successful. If we fail to successfully maintain, promote, and position our brand and protect our reputation or if we incur significant expenses in this effort, our business, financial condition and operating results may be adversely affected.

If significant tariffs or other restrictions are placed on our goods imported into the United States from China or any related counter-measures are taken by China, our revenue, gross margin, and results of operations may be materially harmed.

If significant tariffs or other restrictions are placed on our goods imported into the United States from China or any related counter-measures are taken by China, our revenue and results of operations may be materially harmed. Between July and September 2018, the U.S. Trade Representative imposed additional duties, ranging from 10% to 25%, on a variety of goods imported from China. While these tariffs do not currently apply to our products, if additional tariffs that cover our products are imposed, the cost of our products may increase. In addition, any such additional tariffs may also make our products more expensive for consumers, which may reduce consumer demand. We may need to offset the financial impact by, among other things, moving our product manufacturing to other locations, modifying other business practices or raising prices. If we are not successful in offsetting the impact of any such tariffs, our revenue, gross margins, and operating results may be adversely affected.

Any insolvency, credit problems, or other financial difficulties impacting our retailers and distributors could expose us to financial risk.

Some of our retailers and distributors have experienced and may continue to experience financial difficulties. Insolvency, credit challenges, or other financial difficulties may impact our retailers and distributors and could expose us to significant financial risk. In addition, if the credit capacity of any retailer or distributor declines due to deterioration in their financial condition or increases in their outstanding payable balance to us, we may be subject to additional financial risk. Financial difficulties of our retailers and distributors could impede their effectiveness and also expose us to risks if they are unable to pay for the products they purchase from us. For example, Wynit Distribution, LLC, or Wynit, historically our largest customer, filed for bankruptcy protection in September 2017, which caused us to incur $7.6 million in net bad debt expenses and $1.4 million in net cost of revenues in 2017. Credit and financial difficulties of our retailers and distributors may also lead to a reduction in sales, price reductions, increased returns of our products, and adverse effects on our brand and operating results. We maintain credit insurance for the majority of our customer balances, perform ongoing credit evaluations of our customers, and maintain allowances for potential credit losses on customers’ accounts when deemed necessary. Credit and financial difficulties may lead to an increase in our credit insurance premiums and make it more difficult or impossible to obtain sufficient coverage, which could increase our exposure and result in increased bad debt expense or additional write-offs. We also may not have sufficient insurance coverage to cover losses resulting from the credit and financial difficulties of our retailers and distributors. Any reduction in sales by our current retailers or distributors, loss of large retailers or distributors, or decrease in revenue from our retailers or distributors could adversely affect our revenue, operating results, and financial condition.


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We depend on retailers and distributors to sell and market our products, and our failure to maintain and further develop our sales channels could harm our business.

We primarily sell our products through retailers and distributors and depend on these third-parties to sell and market our products to consumers. Any changes to our current mix of retailers and distributors could adversely affect our gross margin and could negatively affect both our brand image and our reputation. Our sales depend, in part, on retailers adequately displaying our products, including providing attractive space and point of purchase displays in their stores, and training their sales personnel to sell our products. Our retailers also often offer products and services of our competitors in their stores. If our retailers and distributors are not successful in selling our products or overestimate demand for our products or promote competing products and services more effectively than our products and services, our revenue would decrease and our gross margins could decline due to increased product returns or price protection claims. In addition, our success in expanding and entering into new markets internationally will depend on our ability to establish relationships with new retailers and distributors. We also sell and will need to continue to expand our sales through online retailers, such as Amazon.com, and through our direct channel, Fitbit.com, as consumers increasingly make purchases online. If we do not maintain our relationship with existing retailers and distributors or develop relationships with new retailers and distributors our ability to sell our products and services could be adversely affected and our business may be harmed.

In 2018 and 2017, our five largest retailers and distributors accounted for approximately 42% and 43%, respectively, of our revenue. Of these retailers and distributors, D&H Distribution Company and Amazon.com each accounted for approximately 10% of our revenue for 2018, and Amazon.com accounted for approximately 13% of our revenue for 2017. No other retailers or distributors accounted for 10% or more of our revenue during these periods. Accordingly, the loss of a small number of our large retailers and distributors, or the reduction in business with one or more of these retailers and distributors, could have a significant adverse impact on our operating results. For example, Wynit, historically our largest customer at the time, filed for bankruptcy protection in September 2017. While we have agreements with these large retailers and distributors, these agreements do not require them to purchase any meaningful amount of our products.

Consolidation of retailers or concentration of retail market share among a few retailers may increase and concentrate our credit risk and impair our ability to sell products.

The electronics retail and sporting goods markets in some countries, including the United States, our largest market, are dominated by a few large retailers with many stores. These retailers have in the past increased their market share and may continue to do so in the future by expanding through acquisitions and construction of additional stores. This can further concentrate our credit risk to a relatively small number of retailers, and, if any of these retailers were to experience credit or liquidity issues, it would increase the risk that our receivables from these customers may not be paid. In addition, increasing market share concentration among one or a few retailers in a particular country or region increases the risk that if any one of them substantially reduces their purchases of our wearable devices, we may be unable to find a sufficient number of other retail outlets for our products to sustain the same level of sales. These situations also may result in pricing pressure to us. Any reduction in sales by our retailers would adversely affect our revenue, operating results, and financial condition.

Our business is affected by seasonality and if our sales fall below our forecasts, our overall financial conditions and operating results could be adversely affected.

Our revenue and operating results are affected by general seasonal spending trends associated with holidays. For example, our fourth quarter has typically been our strongest quarter in terms of revenue and operating income, reflecting our historical strength in sales during the holiday season. We generated approximately 38%, 35% and 26% of our full year revenue during the fourth quarters of 2018, 2017 and 2016, respectively. Accordingly, any shortfall in expected fourth quarter revenue would adversely affect our annual operating results, as was the case in the fourth quarter of 2016. In addition, although we expect to achieve cash flow breakeven in 2019, we expect to incur net cash outflows in the first and second quarters of 2019, and positive cash flows in the third and fourth quarters of 2019.  Any shortfall in revenue, particularly in the fourth quarter of 2019, would negatively affect our ability to achieve cash flow breakeven in 2019, and may adversely affect our liquidity. We may also experience excess inventory levels or a shortage of products available for sale if we fail to accurately forecast consumer demand for the holiday season.

Furthermore, our growth rate in recent years may obscure the extent to which seasonality trends have affected our business and may continue to affect our business. Accordingly, yearly or quarterly comparisons of our operating results may not be useful and our results in any particular period will not necessarily be indicative of the results to be expected for any future period. Seasonality in our business can also be significantly impacted by introductions of new or enhanced products and services, including the costs associated with such introductions.


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We collect, store, process, and use personal information and other customer data, which subjects us to governmental regulation and other legal obligations related to privacy, information security, and data protection, and any security breaches or our actual or perceived failure to comply with such legal obligations could harm our business.

We collect, store, process, and use personal information and other user data, and we rely on third parties that are not directly under our control to do so. Our users’ exercise and activity-related data and other personal information may include, among other information, names, addresses, phone numbers, email addresses, payment account information, height, weight, and information such as heart rates, sleeping patterns, GPS-based location, and activity patterns.

Due to the volume of the personal information and data we manage and the nature of our products, the security features of our platform and information systems are critical. If our security measures, some of which we manage using third-party solutions, are breached or fail, unauthorized persons may be able to obtain access to or acquire our users’ data. Furthermore, if third-party service providers that host user data on our behalf experience security breaches or violate applicable laws, agreements, or our policies, such events may also put our users’ information at risk and could in turn have an adverse effect on our business. Additionally, if we or any third-party, including third-party applications, with which our users choose to share their Fitbit data were to experience a breach of systems compromising our users’ personal data, our brand and reputation could be adversely affected, use of our products and services could decrease, and we could be exposed to a risk of loss, litigation, and regulatory proceedings.

Depending on the nature of the information compromised, in the event of a data breach or other unauthorized access to or acquisition of our user data, we may also have obligations to notify users about the incident and we may need to provide some form of remedy, such as a subscription to a credit monitoring service, for the individuals affected by the incident. A growing number of legislative and regulatory bodies have adopted consumer notification requirements in the event of unauthorized access to or acquisition of certain types of personal data. Such breach notification laws continue to evolve and may be inconsistent from one jurisdiction to another. Complying with these obligations could cause us to incur substantial costs and could increase negative publicity surrounding any incident that compromises user data. Our users may also inadvertently disclose or lose control of their passwords, creating the perception that our systems are not secure against third-party access. While we maintain insurance coverage that, subject to policy terms and conditions and a significant self-insured retention, is designed to address certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses or all types of claims that may arise in the event we experience a security breach. In addition, any such security breaches may result in negative publicity, adversely affect our brand, decrease demand for our products and services, and adversely affect our operating results and financial condition.

Our failure to comply with U.S. and foreign laws related to privacy, data security, and data protection, such as the European Union’s General Data Protection Regulation, which has broad scope, raised standards, and substantial penalties, and requires an adequate legal mechanism for the transfer of personal data outside of Europe, could adversely affect our financial condition, operating results, and our brand.

We are or may become subject to a variety of laws and regulations in the United States and abroad regarding privacy, data protection, and data security. These laws and regulations are continuously evolving and developing. The scope and interpretation of the laws that are or may be applicable to us are often uncertain and may be conflicting, particularly with respect to foreign laws.

In particular, there are numerous U.S. federal, state, and local laws and regulations and foreign laws and regulations regarding privacy and the collection, sharing, use, processing, disclosure, and protection of personal data. Such laws and regulations often have changes in scope, may be subject to differing interpretations, and may be inconsistent among different jurisdictions. For example, the General Data Protection Regulation, or GDPR, became effective in May 2018. The GDPR includes operational requirements for companies that receive or process personal data of residents of the European Union that are more stringent than those previously in place in the European Union, and that will include significant penalties for non-compliance, including fines of up to €20 million or 4% of total worldwide revenue. Additionally, in June 2018, California passed the California Consumer Privacy Act, or CCPA, provides new data privacy rights for consumers and new operational requirements for companies, effective in 2020. Fines for noncompliance may be up to $7,500 per violation. The costs of compliance with, and other burdens imposed by, the GDPR and CCPA may limit the use and adoption of our products and services and could have an adverse impact on our business.

Additionally, we rely on various legal mechanisms for transferring certain personal data outside of the European Economic Area, or EEA, including the EU-US Privacy Shield Framework, or Privacy Shield, and EU Standard Contractual Clauses, or SCCs. In November 2016, the US Department of Commerce approved our Privacy Shield self-certification, which is available on the Department’s Privacy Shield website. Both Privacy Shield and the SCCs are the subject of ongoing legal challenges in European courts. If we fail or are perceived to fail to meet the Privacy Shield principles or our obligations under the SCCs, or if any of these

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legal mechanisms for transferring data from the EEA are invalidated by European courts or otherwise become defunct, EU data protection authorities or the Federal Trade Commission could bring enforcement actions seeking to prohibit or suspend our data transfers or alleging unfair or deceptive practices. In such cases, we could be required to make potentially expensive changes to our information technology infrastructure and business operations, and we could face legal liability, fines, negative publicity, and resulting loss of business.

Certain privacy laws and regulations also apply to the collection of personal information from children, including the Children’s Online Privacy Protection Act, or COPPA, and GDPR. In the first quarter of 2018, we introduced Fitbit Ace, our first activity tracker designed for kids ages 8 and up and Fitbit family accounts. If these products no not comply with any applicable laws or regulations, we could be subject to claims, legal liabilities, penalties, fines, and negative publicity, which could harm our operating results.

We strive to comply with all applicable laws, policies, legal obligations, and industry codes of conduct relating to privacy, data security, and data protection. However, given that the scope, interpretation, and application of these laws and regulations are often uncertain and may be conflicting, it is possible that these obligations may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another and may conflict with other rules or our practices. Any failure or perceived failure by us or third-party service-providers to comply with our privacy or security policies or privacy-related legal obligations, or the failure or perceived failure by third-party apps with which our users choose to share their Fitbit data to comply with their privacy policies or privacy-related legal obligations as they relate to the Fitbit data shared with them, or any compromise of security that results in the unauthorized release or transfer of personal data, may result in governmental enforcement actions, litigation, or negative publicity, and could have an adverse effect on our brand and operating results.

Certain health-related laws and regulations such as the Health Insurance Portability and Accountability Act of 1996, or HIPAA, and the Health Information Technology for Economic and Clinical Health Act, or HITECH, may have an impact on our business. For example, in September 2015 we announced that we intend to offer HIPAA compliant capabilities to certain customers of Fitbit Health Solutions who are “covered entities” under HIPAA, which may include our execution of Business Associate Agreements with such covered entities. In addition, changes in applicable laws and regulations may result in the user data we collect being deemed protected health information, or PHI, under HIPAA and HITECH. Furthermore, because we accept payment via credit cards, we are subject to payment card association operating rules and certification requirements, including the Payment Card Industry Data Security Standard, or PCI DSS. If we are unable to comply with the applicable privacy and security requirements under HIPAA, HITECH, or PCI DSS, or we fail to comply with Business Associate Agreements that we enter into with covered entities, we could be subject to claims, legal liabilities, penalties, fines, and negative publicity, which could harm our operating results.

Governments are continuing to focus on privacy and data security and it is possible that new privacy or data security laws will be passed or existing laws will be amended in a way that is material to our business. Any significant change to applicable laws, regulations, or industry practices regarding our users’ data could require us to modify our services and features, possibly in a material manner, and may limit our ability to develop new products, services, and features. Although we have made efforts to design our policies, procedures, and systems to comply with the current requirements of applicable state, federal, and foreign laws, changes to applicable laws and regulations in this area could subject us to additional regulation and oversight, any of which could significantly increase our operating costs.

Cybersecurity risks could adversely affect our business and disrupt our operations.

The threats to network and data security are increasingly diverse and sophisticated. Despite our efforts and processes to prevent breaches, our devices, as well as our servers, computer systems, and those of third parties that we use in our operations are vulnerable to cybersecurity risks, including cyber-attacks such as viruses and worms, phishing attacks, denial-of-service attacks, physical or electronic break-ins, employee theft or misuse, and similar disruptions from unauthorized tampering with our servers and computer systems or those of third parties that we use in our operations, which could lead to interruptions, delays, loss of critical data, unauthorized access to user data, and loss of consumer confidence. In addition, we may be the target of email scams that attempt to acquire personal information or company assets. Despite our efforts to create security barriers to such threats, we may not be able to entirely mitigate these risks. Any cyber-attack that attempts to obtain our or our users’ data and assets, disrupt our service, or otherwise access our systems, or those of third parties we use, if successful, could adversely affect our business, operating results, and financial condition, be expensive to remedy, and damage our reputation. In addition, any such breaches may result in negative publicity, adversely affect our brand, decrease demand for our products and services, and adversely affect our operating results and financial condition.


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Any material disruption of our information technology systems, or those of third-party partners and data center providers could materially damage user and business partner relationships, and subject us to significant reputational, financial, legal, and operational consequences.

We depend on our information technology systems, as well as those of third parties, to develop new products and services, operate our website, host and manage our services, store data, process transactions, respond to user inquiries, and manage inventory and our supply chain. Any material disruption or slowdown of our systems or those of third parties whom we depend upon, including a disruption or slowdown caused by our failure to successfully manage significant increases in user volume or successfully upgrade our or their systems, system failures, or other causes, could cause outages or delays in our services, which could harm our brand and adversely affect our operating results. In addition, such disruption could cause information, including data related to orders, to be lost or delayed which could---especially if the disruption or slowdown occurred during the holiday season---result in delays in the delivery of products to stores and users or lost sales, which could reduce demand for our merchandise, harm our brand and reputation, and cause our revenue to decline. Problems with our third-party data center service providers, the telecommunications network providers with whom they contract, or with the systems by which telecommunications providers allocate capacity among their users could adversely affect the experience of our users. Our third-party data center service providers could decide to close their facilities or cease providing us services without adequate notice. Any changes in third-party service levels at our data centers or any errors, defects, disruptions, or other performance problems with our platform could harm our brand and may damage the data of our users. If changes in technology cause our information systems, or those of third parties whom we depend upon, to become obsolete, or if our or their information systems are inadequate to handle our growth, we could lose users and our business and operating results could be adversely affected.

Our failure or inability to protect our intellectual property rights, or claims by others that we are infringing upon or unlawfully using their intellectual property could diminish the value of our brand and weaken our competitive position, and adversely affect our business, financial condition, operating results, and prospects.

We currently rely on a combination of patent, copyright, trademark, trade secret, and unfair competition laws, as well as confidentiality agreements and procedures and licensing arrangements, to establish and protect our intellectual property rights. We have devoted substantial resources to the development of our proprietary technologies and related processes. In order to protect our proprietary technologies and processes, we rely in part on trade secret laws and confidentiality agreements with our employees, licensees, independent contractors, commercial partners, and other advisors. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. We cannot be certain that the steps taken by us to protect our intellectual property rights will be adequate to prevent infringement of such rights by others, including imitation of our products and misappropriation of our brand. Additionally, the process of obtaining patent or trademark protection is expensive and time-consuming, and we may not be able to file, apply for or prosecute all necessary or desirable patent applications or trademark applications at a reasonable cost or in a timely manner. We have obtained and applied for U.S. and foreign trademark registrations for the “Fitbit” brand and a variety of our product names, and will continue to evaluate the registration of additional trademarks as appropriate. However, we cannot guarantee that any of our pending trademark or patent applications will be approved by the applicable governmental authorities. Moreover, intellectual property protection may be unavailable or limited in some foreign countries where laws or law enforcement practices may not protect our intellectual property rights as fully as in the United States, and it may be more difficult for us to successfully challenge the use of our intellectual property rights by other parties in these countries. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and our failure or inability to obtain or maintain trade secret protection or otherwise protect our proprietary rights could adversely affect our business.

We are and may in the future be subject to patent infringement and trademark claims and lawsuits in various jurisdictions, and we cannot be certain that our products or activities do not violate the patents, trademarks, or other intellectual property rights of third-party claimants. Companies in the technology industry and other patent, copyright, and trademark holders seeking to profit from royalties in connection with grants of licenses own large numbers of patents, copyrights, trademarks, domain names, and trade secrets and frequently commence litigation based on allegations of infringement, misappropriation, or other violations of intellectual property or other rights. Companies and individuals may also be subject to criminal prosecution for trade secret theft under 18 U.S.C. section 1832. As we face increasing competition, the intellectual property rights claims against us and asserted by us have grown and will likely continue to grow. For example, we have been involved in litigation with Jawbone, as well as in a related federal criminal investigation concerning alleged theft of Jawbone’s trade secrets, which is described in Note 7 of the “Notes to Consolidated Financial Statements” included elsewhere in this Annual Report on Form 10-K. In addition, on June 14, 2018, the six former Jawbone employees who were named as individual defendants in the state trade secret case were charged in a federal indictment with being in possession of certain Jawbone trade secrets.


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We intend to vigorously defend and prosecute litigation matters against us. However, litigation is inherently uncertain, and any judgment or injunctive relief entered against us or any adverse settlement could materially and adversely impact our business, financial condition, operating results, and prospects. In addition, litigation can involve significant management time and attention and can be expensive, regardless of outcome. During the course of these litigation matters, there may be announcements of the results of hearings and motions, and other interim developments related to the litigation matters. If securities analysts or investors regard these announcements as material and negative, the market price of our Class A common stock may decline.

Further, from time to time, we have received and may continue to receive letters from third parties alleging that we are infringing upon their intellectual property rights. Successful infringement claims against us could result in significant monetary liability, prevent us from selling some of our products and services, or require us to change our branding. In addition, resolution of claims may require us to redesign our products, license rights from third parties at a significant expense, or cease using those rights altogether. We have also in the past and may in the future bring claims against third parties for infringing our intellectual property rights. Costs of supporting such litigation and disputes may be considerable, and there can be no assurances that a favorable outcome will be obtained. Patent infringement, trademark infringement, trade secret misappropriation, and other intellectual property claims and proceedings brought against us or brought by us, whether successful or not, could require significant attention of our management and resources and have in the past and could further result in substantial costs, harm to our brand, and have an adverse effect on our business.

We are regularly subject to general litigation, regulatory disputes, and government inquiries.

We are regularly subject to claims, lawsuits, including potential class actions, government investigations, and other proceedings involving competition and antitrust, intellectual property, privacy, consumer protection, accessibility claims, securities, tax, labor and employment, commercial disputes, and other matters. The number and significance of these disputes and inquiries have increased as our company has grown larger, our business has expanded in scope and geographic reach, and our products and services have increased in complexity.

The outcome and impact of such claims, lawsuits, government investigations, and proceedings cannot be predicted with certainty. Regardless of the outcome, such investigations and proceedings can have an adverse impact on us because of legal costs, diversion of management resources, and other factors. Determining reserves for our pending litigation is a complex, fact-intensive process that is subject to judgment calls. It is possible that a resolution of one or more such proceedings could require us to make substantial payments to satisfy judgments, fines, or penalties or to settle claims or proceedings, any of which could harm our business. These proceedings could also result in reputational harm, criminal sanctions, or orders preventing us from offering certain products, or services, or requiring a change in our business practices in costly ways, or requiring development of non-infringing or otherwise altered products or technologies. Any of these consequences could harm our business.

We may experience difficulties managing our cloud infrastructure migration.

We recently announced our move to the Google Cloud Platform. Cloud infrastructure migrations are complex, time-consuming, and can involve substantial expenditures. Our cloud service is critical to developing and providing products and services to our customers, scaling our business for future growth, accurately maintaining data and otherwise operating our business; any such implementation involves risks inherent in the conversion to a new system, including loss of information and potential disruption to our normal operations. We may discover deficiencies in our design or implementation or maintenance of the new cloud system that could adversely affect our business.

The market for wearable devices is still evolving and if it does not continue to grow, grows more slowly than we expect, or fails to grow as large as we expect, our business and operating results would be harmed.

The market for wearable devices, which includes both health and fitness trackers and smartwatches, is still evolving and it is uncertain whether wearable devices will sustain high levels of demand and wide market acceptance. Our success will depend to a substantial extent on the willingness of people to widely adopt these products and services. In part, adoption of our products and services will depend on the increasing prevalence of wearable devices driven by the introduction of new form factors, related software services and other offerings. However, it is not certain whether consumers will respond to these new form factors, software services and other offerings, and if our offerings fail to satisfy consumer preferences, our business may be adversely affected.

Furthermore, some individuals may be reluctant or unwilling to use wearable devices because they have concerns regarding the risks associated with data privacy and security. If the wider public does not perceive the benefits of our wearable devices or chooses not to adopt them as a result of concerns regarding privacy or data security or for other reasons, then the market for these products and services may not further develop, it may develop more slowly than we expect, or it may not achieve the growth

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potential we expect it to, any of which would adversely affect our operating results. The development and growth of this market may not be sustained.

Our active user metric is only an indicator of potential repeat behavior. Therefore, you should not rely on the active user metric as a guarantee of repeat purchasing behavior.

Our active user metric tracks the first instance of a Fitbit device (excluding Aria, Aria 2, Flyer and other accessories) pairing to a user account during the three months ending on the date of measurement, as well as a Fitbit user who previously activated another Fitbit device to his or her account.

The active user metric is only an indicator of potential repeat behavior. Actual repeat purchase behavior may depend on a number of factors, including but not limited to our ability to anticipate and satisfy consumer preferences. Therefore, you should not rely on our active user metric as a guarantee of repeat purchase behavior. Further, we do not believe that the active user metric has a direct effect on our revenue and operating results since substantially all of our revenue to date has been derived from sales of our wearable devices. However, we believe the size of our active user population is a potential indicator of future demand from repeat buyers for our devices and for other future monetization opportunities such as software services or coaching revenue.

See the sections titled, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Key Business Metrics-Activations,” in this Annual Report on Form 10-K for additional information.

Our business and products are subject to a variety of additional U.S. and foreign laws and regulations that are central to our business; our failure to comply with these laws and regulations could harm our business or our operating results.

We are or may become subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including laws and regulations regarding consumer protection, advertising, privacy, intellectual property, manufacturing, anti-bribery and anti-corruption, and economic or other trade prohibitions or sanctions.

The manufacturing, labeling, distribution, importation, marketing, and sale of our products are subject to extensive regulation by various U.S. state and federal and foreign agencies, including the U.S. Consumer Product Safety Commission, or CPSC, FTC, FDA, Federal Communications Commission, and state attorneys general, as well as by various other federal, state, provincial, local, and international regulatory authorities in the countries in which our products and services are manufactured, distributed marketed or sold. If we fail to comply with any of these regulations, we could become subject to enforcement actions or the imposition of significant monetary fines, other penalties, or claims, which could harm our operating results or our ability to conduct our business.

 The global nature of our business operations also create various domestic and foreign regulatory challenges and subject us to laws and regulations such as the U.S. Foreign Corrupt Practices Act, or FCPA, the U.K. Bribery Act, and similar anti-bribery and anti-corruption laws in other jurisdictions, and our products are also subject to U.S. export controls, including the U.S. Department of Commerce’s Export Administration Regulations and various economic and trade sanctions regulations established by the Treasury Department’s Office of Foreign Assets Controls. If we become liable under these laws or regulations, we may be forced to implement new measures to reduce our exposure to this liability. This may require us to expend substantial resources or to discontinue certain products or services, which would negatively affect our business, financial condition, and operating results. In addition, the increased attention focused upon liability issues as a result of lawsuits, regulatory proceedings, and legislative proposals could harm our brand or otherwise impact the growth of our business. Any costs incurred as a result of compliance or other liabilities under these laws or regulations could harm our business and operating results.

Our international operations subject us to additional costs and risks, and our continued expansion internationally may not be successful.

We have entered into many international markets in a relatively short time and may enter into additional markets in the future. Outside of the United States, we currently have operations in Australia and a number of countries in Asia and Europe. There are significant costs and risks inherent in conducting business in international markets, including:

establishing and maintaining effective controls at foreign locations and the associated increased costs;
adapting our technologies, products, and services to non-U.S. consumers’ preferences and customs;
variations in margins by geography;

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increased competition from local providers of similar products;
longer sales or collection cycles in some countries;
compliance with foreign laws and regulations;
compliance with the laws of numerous taxing jurisdictions where we conduct business, potential double taxation of our international earnings, and potentially adverse tax consequences due to U.S. and foreign tax laws as they relate to our international operations;
compliance with anti-bribery laws, such as the FCPA and the U.K. Bribery Act, by us, our employees, and our business partners;
complexity and other risks associated with current and future foreign legal requirements, including legal requirements related to consumer protection, consumer product safety, and data privacy frameworks, such as the GDPR, and any applicable privacy and data protection laws in foreign jurisdictions where we currently conduct business or intend to conduct business in the future;
currency exchange rate fluctuations and related effects on our operating results;
economic and political instability in some countries, particularly those in China where we have expanded;
the uncertainty of protection for intellectual property rights in some countries and practical difficulties of enforcing rights abroad;
tariffs and customs duties and the classification of our products by applicable governmental bodies; and
other costs of doing business internationally.

Our products are manufactured overseas and imported into the United States, the European Union, and other countries and may be subject to duties, tariffs and anti-dumping penalties imposed by applicable customs authorities. Those duties and tariffs are based on the classification of each of our products and is routinely subject to review by the applicable customs authorities. We are unable to predict whether those authorities will agree with our classifications and if those authorities do not agree with our classifications additional duties, tariffs or other trade restrictions may be imposed on the importation of our products. Such actions could result in increases in the cost of our products generally and might adversely affect our sales and profitability.

These factors and other factors could harm our international operations and, consequently, materially impact our business, operating results, and financial condition. Further, we may incur significant operating expenses as a result of our international expansion, and it may not be successful. We have limited experience with regulatory environments and market practices internationally, and we may not be able to penetrate or successfully operate in new markets. We may also encounter difficulty expanding into new international markets because of limited brand recognition in certain parts of the world, leading to delayed acceptance of our products and services by users in these new international markets. If we are unable to continue to expand internationally and manage the complexity of our global operations successfully, our financial condition and operating results could be adversely affected.

Our Aria scales are subject to FDA and corresponding regulations, and sales of this product or future regulated products could be adversely affected if we fail to comply with the applicable requirements.

Medical devices, including our Aria scales, are regulated by the FDA and corresponding state regulatory agencies in the United States and separate governmental authorities outside of the United States, and we may have future software features or hardware products that are regulated as medical devices by the FDA. In the United States, the medical device industry is regulated by governmental authorities, principally the FDA and corresponding state regulatory agencies. Before we can market or sell a new regulated product or make a significant modification to an existing medical device in the United States, we must comply with FDA Quality Management System regulations, and must obtain regulatory clearance or approval from the FDA, unless an exemption from pre-market review applies. In addition, certain future software functionality, whether standalone or embedded in existing or future devices, may be regulated as a medical device and require pre-market review and clearance or approval by the FDA. The process of obtaining regulatory clearances or approvals to market a medical device can be costly and time consuming, and we may not be able to obtain these clearances or approvals on a timely basis, or at all, for future products. Any delay in, or failure to receive or maintain, clearance or approval for any medical device products under development could prevent us from generating revenue from these products.

Medical devices are also subject to numerous ongoing compliance requirements under the regulations of the FDA and corresponding state regulatory agencies, which can be costly and time consuming. For example, under FDA regulations medical

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device manufacturers are required to, among other things, (i) establish a quality management system to help ensure that their products consistently meet applicable requirements and specifications, (ii) establish and maintain procedures for receiving, reviewing, and evaluating complaints, (iii) establish and maintain a corrective and preventive action procedure, (iv) report certain device-related adverse events and product problems to the FDA, and (v) report to the FDA the removal or correction of a distributed product. If we experience any product problems requiring reporting to the FDA or if we otherwise fail to comply with applicable FDA regulations or the regulations of corresponding state regulatory agencies, with respect to our Aria scales or future regulated products, we could jeopardize our ability to sell our products and could be subject to enforcement actions such as fines, civil penalties, injunctions, recalls of products, delays in the introduction of products into the market, and refusal of the FDA or other regulators to grant future clearances or approvals, which could harm our reputation, business, operating results, and financial condition.

In addition, in the United States, the FDA has taken the position that device manufacturers are prohibited from promoting their products other than for the uses and indications set forth in the approved product labeling, and any failure to comply could subject us to significant civil or criminal exposure, administrative obligations and costs, and/or other potential penalties from, and/or agreements with, the federal government.

Government regulations outside the United States have, and may continue to, become increasingly stringent and common. In the European Union, for example, a new Medical Device Regulation was published in 2017 which, when it enters into full force in 2020, will include significant additional premarket and post-market requirements. Penalties for regulatory non-compliance could be severe, including fines and revocation or suspension of a company’s business license, mandatory price reductions, and criminal sanctions. Future laws and regulations may have a material adverse effect on us.

An economic downturn or economic uncertainty may adversely affect consumer discretionary spending and demand for our products and services.

Our products and services may be considered discretionary items for consumers. Factors affecting the level of consumer spending for such discretionary items include general economic conditions, and other factors, such as consumer confidence in future economic conditions, fears of recession, the availability and cost of consumer credit, levels of unemployment, and tax rates. As global economic conditions continue to be volatile or economic uncertainty remains, including economic conditions resulting from recent volatility in European markets, trends in consumer discretionary spending also remain unpredictable and subject to reductions. Unfavorable economic conditions may lead consumers to delay or reduce purchases of our products and services and consumer demand for our products and services may not grow as we expect. Our sensitivity to economic cycles and any related fluctuation in consumer demand for our products and services may have an adverse effect on our operating results and financial condition.

Our financial performance is subject to risks associated with changes in the value of the U.S. dollar versus local currencies.

Our primary exposure to movements in foreign currency exchange rates relates to non-U.S. dollar denominated sales and operating expenses worldwide. Weakening of foreign currencies relative to the U.S. dollar, while beneficial to our operating expenses, adversely affects the U.S. dollar value of our foreign currency-denominated sales and earnings, and generally leads us to raise international pricing, potentially reducing demand for our products. In some circumstances, for competitive or other reasons, we may decide not to raise local prices to fully offset the strengthening of the U.S. dollar, or at all, which would adversely affect the U.S. dollar value of our foreign currency denominated sales and earnings. Conversely, a strengthening of foreign currencies relative to the U.S. dollar, while generally beneficial to our foreign currency-denominated sales and earnings, could cause us to reduce international pricing, incur losses on our foreign currency derivative instruments, and incur increased operating expenses, thereby limiting any benefit. Additionally, strengthening of foreign currencies may also increase our cost of product components denominated in those currencies, thus adversely affecting gross margins.

We use derivative instruments, such as foreign currency forward contracts, to hedge certain exposures to fluctuations in foreign currency exchange rates. The use of such hedging activities may not offset any, or more than a portion, of the adverse financial effects of unfavorable movements in foreign exchange rates over the limited time the hedges are in place. In addition, our counterparties may be unable to meet the terms of the agreements. We seek to mitigate this risk by limiting counterparties to major financial institutions and by spreading the risk across several major financial institutions.

Changes in our tax rates or exposure to additional tax liabilities could adversely affect our earnings and financial condition.

We are subject to income taxes in the United States and foreign jurisdictions in which we do business. These foreign jurisdictions have statutory tax rates different from those in the United States. Accordingly, our provision for income taxes is

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subject to volatility and could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, by changes in foreign currency exchange rates, or by changes in the relevant tax, accounting, and other laws, regulations, principles, and interpretations, or by changes in the valuation of our deferred tax assets and liabilities. As we operate in numerous taxing jurisdictions, the application of tax laws can be subject to diverging and sometimes conflicting interpretations by tax authorities of these jurisdictions.

Uncertainties in the interpretation and application of the 2017 Tax Cuts and Jobs Act could materially affect our tax obligations and effective tax rate.

On December 22, 2017, the U.S. Tax Cuts and Jobs Act of 2017, or the “2017 Tax Act,” was signed into law and includes several key tax provisions that affected us, including a reduction of the statutory corporate tax rate from 35% to 21% effective for tax years beginning after December 31, 2017, elimination of certain deductions, and changes to how the United States imposes income tax on multinational corporations, among others. The 2017 Tax Act requires complex computations to be performed that were not previously required in U.S. tax law, significant judgments to be made in interpretation of the provisions of the 2017 Tax Act, significant estimates in calculations, and the preparation and analysis of information not previously relevant or regularly produced. The U.S. Treasury Department, the IRS, and other standard-setting bodies will continue to interpret or issue guidance on how provisions of the U.S. Tax Act will be applied or otherwise administered. As future guidance is issued, we may make adjustments to amounts that we have previously recorded that may materially impact our financial statements in the period in which the adjustments are made.

If we are unable to protect our domain names, our brand, business, and operating results could be adversely affected.

We have registered domain names for websites, or URLs, that we use in our business, such as Fitbit.com. If we are unable to maintain our rights in these domain names, our competitors or other third parties could capitalize on our brand recognition by using these domain names for their own benefit. In addition, although we own the “Fitbit” domain name under various global top level domains such as .com and .net, as well as under various country-specific domains, we might not be able to, or may choose not to, acquire or maintain other country-specific versions of the “Fitbit” domain name or other potentially similar URLs. The regulation of domain names in the United States and elsewhere is generally conducted by Internet regulatory bodies and is subject to change. If we lose the ability to use a domain name in a particular country, we may be forced to either incur significant additional expenses to market our solutions within that country, including the development of a new brand and the creation of new promotional materials, or elect not to sell our solutions in that country. Either result could substantially harm our business and operating results. Regulatory bodies could establish additional top-level domains, appoint additional domain name registrars, or modify the requirements for holding domain names. As a result, we may not be able to acquire or maintain the domain names that utilize the name “Fitbit” in all of the countries in which we currently conduct or intend to conduct business. Further, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights varies among jurisdictions and is unclear in some jurisdictions. Domain names similar to ours have already been registered in the United States and elsewhere, and we may be unable to prevent third parties from acquiring and using domain names that infringe, are similar to, or otherwise decrease the value of, our brand or our trademarks. Protecting and enforcing our rights in our domain names and determining the rights of others may require litigation, which could result in substantial costs, divert management attention, and not be decided favorably to us.

Our use of “open source” software could negatively affect our ability to sell our products and subject us to possible litigation.

A portion of the technologies we use incorporates “open source” software, and we may incorporate open source software in the future. From time to time, companies that incorporate open source software into their products have faced claims challenging the ownership of open source software or compliance with open source license terms. Therefore, we could be subject to suits by parties claiming ownership of what we believe to be open source software or noncompliance with open source licensing terms. Some open source licenses may subject us to certain unfavorable conditions, including requirements that we offer our products and services that incorporate the open source software for no cost or that we make publicly available all or part of the source code for modifications or derivative works. Additionally, if a third-party software provider has incorporated open source software into software that we license or obtain from such provider, we could be required to disclose or provide at no cost all or part of our source code that incorporates such licensed software. If a copyright holder that distributes open source software that we use or license or other third party were to allege that we had not complied with the conditions of the applicable license, we could be required to incur significant legal expenses defending against such allegations and may be required to release portions of our proprietary source code, subject to significant damages, re-engineer our products and services, enjoined from the sale of our products and services that contained the open source software if re-engineering our products or services cannot be accomplished on a timely basis, or take other remedial action that may divert resources away from our development efforts. Any of the foregoing could disrupt the distribution and sale of our products and services and harm our business.

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We may engage in merger and acquisition activities, which could require significant management attention, disrupt our business, dilute stockholder value, and adversely affect our operating results.

As part of our business strategy, we may make investments in other companies, products, or technologies. For example, in 2016, we acquired assets from Coin, Inc., Pebble Industries, Inc., and Vector Watch S.R.L and in 2018 we acquired Twine Health, Inc. We may not be able to find suitable acquisition candidates and we may not be able to complete acquisitions on favorable terms, if at all. If we do complete acquisitions, we may not ultimately strengthen our competitive position or achieve our goals, and any acquisitions we complete could be viewed negatively by users or investors. In addition, if we fail to successfully integrate such acquisitions, or the technologies associated with such acquisitions, into our company, the revenue and operating results of the combined company could be adversely affected.

Acquisitions may disrupt our ongoing operations, divert management from their primary responsibilities, subject us to additional liabilities, increase our expenses, and adversely impact our business, financial condition, operating results, and cash flows. We may not successfully evaluate or utilize the acquired technology and accurately forecast the financial impact of an acquisition transaction, including accounting charges. We would have to pay cash, incur debt, or issue equity securities to pay for any such acquisition, each of which may affect our financial condition or the value of our capital stock and could result in dilution to our stockholders. If we incur more debt it would result in increased fixed obligations and could also subject us to covenants or other restrictions that would impede our ability to manage our operations. Additionally, we may receive indications of interest from other parties interested in acquiring some or all of our business. The time required to evaluate such indications of interest could require significant attention from management, disrupt the ordinary functioning of our business, and adversely affect our operating results.

There have been reports that some users of certain of our devices have experienced skin irritations, which could result in additional negative publicity or otherwise harm our business. In addition, some of our users have filed personal injury lawsuits against us relating to certain of our devices, which could divert management’s attention from our operations and result in substantial legal fees and other costs.

Due to the nature of some of our wearable devices, some users have had in the past and may in the future experience skin irritations or other biocompatibility issues not uncommon with jewelry or other wearable products that stay in contact with skin for extended periods of time. There have been reports of some users of certain of our devices experiencing skin irritations. This negative publicity could harm sales of our products and also adversely affect our relationships with retailers that sell our products, including causing them to be reluctant to continue to sell our products. In addition, in the past, some of our users have filed personal injury lawsuits against us arising out of such claims relating to certain of our devices. While we do not believe that these lawsuits are material, due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of any proceedings arising from such claims, and these actions or other third-party claims against us may result in the diversion of our management’s time and attention from other aspects of our business and may cause us to incur substantial litigation or settlement costs. If large numbers of users experience these problems, we could be subject to enforcement actions or the imposition of significant monetary fines, other penalties, or proceedings by the CPSC or other U.S. or foreign regulatory agencies and face additional personal injury or class action litigation, any of which could have a material adverse impact on our business, financial condition, and operating results.

We may be subject to CPSC recalls, regulatory proceedings and litigation in various jurisdictions, including multi-jurisdiction federal and state class action and personal injury claims, which may require significant management attention and disrupt our business operations, and adversely affect our financial condition, operating results, and our brand.
    
We face product liability, product safety and product compliance risks relating to the marketing, sale, use, and performance of our products. The products we sell must be designed and manufactured to be safe for their intended purposes. Certain of our products must comply with certain federal and state laws and regulations. For example, all of our products are subject to the Consumer Product Safety Act and the Consumer Product Safety Improvement Act, which empower the CPSC. The CPSC is empowered to take action against hazards presented by consumer products, up to and including product recalls. We are required to report certain incidents related to the safety and compliance of our products to the CPSC, and failure to do so could result in a civil penalty.

Our products may, from time to time, be subject to recall for product safety and compliance reasons. For example, in March 2014, we recalled one of our products, the Fitbit Force, after some of our users experienced allergic reactions to adhesives in the wristband. These reactions included skin irritation, rashes, and blistering. The recall had a negative impact on our operating results,

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primarily in our fourth quarter of 2013, the first quarter of 2014, and the fourth quarter of 2015. We have provided and are continuing to provide full refunds to consumers who return the Fitbit Force. If returns of the Fitbit Force or other costs related to the recall are higher than anticipated, we will be required to increase our reserves related to the recall which would negatively impact our operating results in the future.

The recall was conducted in conjunction with the CPSC, which monitored recall effectiveness and compliance. In addition to the financial impacts discussed elsewhere in this Annual Report on Form 10-K, this recall required us to collect a significant amount of information for the CPSC, which takes significant time and internal and external resources.

A large number of lawsuits, including multi-jurisdiction complex federal and state class action and personal injury claims, were filed against us relating to the Fitbit Force. These litigation matters required significant attention of our management and resources and disrupted the ordinary course of our business operations. We have settled all of the class action lawsuits and related individual personal injury claims. In the fourth quarter of 2015, we received proceeds from the insurance policies that apply to these claims and related legal fees, and we recorded an accrual for liabilities arising under these claims that was immaterial and falls within the amount of the insurance proceeds received.

In addition, the CPSC has conducted investigations into several of our products. Although the CPSC did not find a substantial product hazard, there can be no assurances that investigations will not be conducted in the future or that product hazards or other defects will not be found in the future with respect to our products. The Fitbit Force product recall, regulatory proceedings, and litigation have had and may continue to have, and any future recalls, regulatory proceedings, and litigation could have an adverse impact on our financial condition, operating results, and brand. Furthermore, because of the global nature of our product sales, in the event we experience defects with respect to products sold outside the United States, we could become subject to recalls, regulatory proceedings, and litigation by foreign governmental agencies and private litigants, which could significantly increase the costs of managing any product issues. Any ongoing and future regulatory proceedings or litigation, regardless of their merits, could further divert management’s attention from our operations and result in substantial legal fees and other costs.

If we fail to maintain an effective system of disclosure controls and internal control over financial reporting, our ability to produce timely and accurate financial statements or comply with applicable regulations could be impaired.

We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the rules and regulations of the applicable listing standards of the New York Stock Exchange. We expect that the requirements of these rules and regulations will continue to increase our legal, accounting, and financial compliance costs, make some activities more difficult, time-consuming, and costly, and place strain on our personnel, systems, and resources.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. We are also required to make a formal assessment and provide an annual management report on the effectiveness of our internal control over financial reporting, which must be attested to by our independent registered public accounting firm. In order to maintain the effectiveness of our disclosure controls and procedures and internal control over financial reporting, we have expended, and anticipate that we will continue to expend, resources, including accounting-related costs and management oversight.

As disclosed in Item 9A of this Annual Report on Form 10-K, we did not maintain effective controls over the accuracy of invoicing gross revenue. This represented a material weakness that did not result in the identification of any adjustments to our annual or interim consolidated financial statements. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. As a result of the material weakness identified, our management concluded that our internal control over financial reporting was not effective as of December 31, 2018, which was previously reported in Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. Management has identified and implemented changes to our internal control over financial reporting to remediate the control deficiencies that led to this material weakness. However, we cannot assure you that remediation efforts will be effective, and the enhanced controls and procedures could require increased management time and attention and resources.

Additional current controls and any new controls that we develop may become inadequate because of changes in conditions in our business. Further, additional weaknesses in our disclosure controls and internal control over financial reporting may be discovered in the future. Any failure to maintain or develop effective controls or any difficulties encountered in their implementation or improvement could harm our operating results or cause us to fail to meet our reporting obligations and may result in a restatement of our financial statements for prior periods. Any failure to maintain effective internal control over financial reporting also could adversely affect the results of periodic management evaluations and annual independent registered public accounting firm attestation

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reports regarding the effectiveness of our internal control over financial reporting. Ineffective disclosure controls and procedures and internal control over financial reporting could also cause investors to lose confidence in our reported financial and other information, which would likely have a negative effect on the trading price of our Class A common stock. In addition, if we are unable to continue to meet these requirements, we may not be able to remain listed on the New York Stock Exchange.

Our business is subject to the risk of political events, war, terrorism, other business interruptions, earthquakes, fire, power outages, floods, and other catastrophic events.

War, terrorism, geopolitical uncertainties, trade restrictions, public health issues, natural disasters and other business interruptions have caused and may cause damage or disruption to the economy and commerce on a global, regional or country-specific basis, which could have a material adverse effect on our business, our customers, and companies with which we do business. For example, the Trump Administration recently signaled that it may alter trade terms between China and the United States, including limiting trade with China and/or imposing tariffs on imports from China. Political uncertainty surrounding these trade terms could have a negative effect on consumer confidence and spending, which could adversely affect our business.

Our business is also vulnerable to damage or interruption from earthquakes, fires, floods, power losses, telecommunications failures, human errors, break-ins, and similar events. The third-party systems and operations and contract manufacturers we rely on, such as the data centers we lease, are subject to similar risks. For example, a significant natural disaster, such as an earthquake, fire, or flood, could have an adverse effect on our business, operating results, and financial condition, and our insurance coverage may be insufficient to compensate us for losses that may occur. Our corporate offices and one of our data center facilities are located in California, a state that frequently experiences earthquakes. In addition, the facilities at which our contract manufacturers manufacture our products are located in parts of Asia that frequently endure typhoons and earthquakes. Acts of terrorism, which may be targeted at metropolitan areas that have higher population density than rural areas, could also cause disruptions in our or our suppliers’, contract manufacturers’, and logistics providers’ businesses or the economy as a whole. We may not have sufficient protection or recovery plans in some circumstances, such as natural disasters affecting California or other locations where we have data centers or store significant inventory of our products. As we rely heavily on our data center facilities, computer and communications systems, and the Internet to conduct our business and provide high-quality customer service, these disruptions could negatively impact our ability to run our business and either directly or indirectly disrupt suppliers’ businesses, which could have an adverse effect on our business, operating results, and financial condition.

If our estimates or judgments relating to our critical accounting policies prove to be incorrect, our operating results could be adversely affected.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, as provided in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K. The results of these estimates form the basis for making judgments about the carrying values of assets, liabilities, and equity, and the amount of revenue and expenses that are not readily apparent from other sources. Significant assumptions and estimates used in preparing our consolidated financial statements include those related to revenue recognition, inventories, product warranty reserves, business combinations, accounting for income taxes, and stock-based compensation expense. Our operating results may be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our operating results to fall below the expectations of securities analysts and investors, resulting in a decline in the price of our Class A common stock.

We are exposed to fluctuations in the market values of our investments.

Credit ratings and pricing of our investments can be negatively affected by liquidity, credit deterioration, financial results, economic risk, political risk, sovereign risk, changes in interest rates, or other factors. As a result, the value and liquidity of our cash, cash equivalents, and marketable securities may fluctuate substantially. Therefore, although we have not realized any significant losses on our cash, cash equivalents, and marketable securities, future fluctuations in their value could result in a significant realized loss, which could materially adversely affect our financial condition and operating results.

Regulations related to conflict minerals may cause us to incur additional expenses and could limit the supply and increase the costs of certain metals used in the manufacturing of our products.


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We are subject to requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which will require us to conduct due diligence on and disclose whether or not our products contain conflict minerals. The implementation of these requirements could adversely affect the sourcing, availability, and pricing of the materials used in the manufacture of components used in our products. In addition, we will incur additional costs to comply with the disclosure requirements, including costs related to conducting diligence procedures to determine the sources of minerals that may be used or necessary to the production of our products and, if applicable, potential changes to products, processes, or sources of supply as a consequence of such due diligence activities. It is also possible that we may face reputational harm if we determine that certain of our products contain minerals not determined to be conflict free or if we are unable to alter our products, processes, or sources of supply to avoid such materials.

Risks Related to Ownership of Our Class A Common Stock

The market price of our Class A common stock has been and will likely continue to be volatile, and you could lose all or part of your investment.

The market price of our Class A common stock has been, and will likely continue to be, volatile. Since shares of our Class A common stock were sold in our IPO in June 2015 at a price of $20.00 per share, our stock price has ranged from $4.23 to $51.90 through December 31, 2018. In addition, the trading prices of the securities of technology companies in general have been highly volatile.

The market price of our Class A common stock may continue to fluctuate significantly in response to numerous factors, many of which are beyond our control, including:

overall performance of the equity markets;
actual or anticipated fluctuations in our revenue and other operating results;
changes in the financial projections we may provide to the public or our failure to meet these projections;
failure of securities analysts to initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors;
recruitment or departure of key personnel;
the economy as a whole and market conditions in our industry;
negative publicity related to problems in our manufacturing or the real or perceived quality of our products, as well as the failure to timely launch new products that gain market acceptance;
rumors and market speculation involving us or other companies in our industry;
announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments;
new laws or regulations or new interpretations of existing laws or regulations applicable to our business;
lawsuits threatened or filed against us;
other events or factors, including those resulting from war, incidents of terrorism, or responses to these events; and
sales of shares of our Class A common stock by us or our stockholders.

In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. Stock prices of many companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. We are currently subject to securities litigation, which is described in Note 7 of the “Notes to Consolidated Financial Statements” included elsewhere in this Annual Report on Form 10-K. This or any future securities litigation could subject us to substantial costs, divert resources and the attention of management from our business, and adversely affect our business.

Sales of substantial amounts of our Class A common stock in the public markets, or the perception that they might occur, could cause the market price of our Class A common stock to decline.


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Sales of a substantial number of shares of our Class A common stock into the public market, particularly sales by our directors, executive officers, and principal stockholders, or the perception that these sales might occur, could cause the market price of our Class A common stock to decline.

As of December 31, 2018, there were 252.4 million shares of Class A and Class B common stock outstanding. All shares of our common stock are available for sale in the public market, subject in certain cases to volume limitations under Rule 144 under the Securities Act of 1933, as amended, or the Securities Act, various vesting agreements, as well as our insider trading policy.

In addition, as of December 31, 2018, we had stock options outstanding that, if fully exercised, would result in the issuance of 1.3 million shares of Class A common stock and 14.9 million shares of Class B common stock (which shares of Class B common stock generally convert to Class A common stock upon their sale or transfer). We also had restricted stock units, or RSUs, outstanding as of December 31, 2018 that may be settled for 18.4 million shares of Class A common stock and 0.1 million shares of Class B common stock. As of December 31, 2018, all of the shares issuable upon the exercise of stock options or settlement of RSUs and the shares reserved for future issuance under our equity incentive plans, are registered for public resale under the Securities Act. Accordingly, these shares may be freely sold in the public market upon issuance subject to applicable vesting requirements.

In addition, certain holders of our capital stock have rights, subject to some conditions, to require us to file registration statements for the public resale of their shares or to include such shares in registration statements that we may file for us or other stockholders.

The dual class structure of our common stock has the effect of concentrating voting control with our founders and certain other holders of our Class B common stock, including our directors, executive officers, and significant stockholders. This will limit or preclude your ability to influence corporate matters, including the election of directors, amendments of our organizational documents, and any merger, consolidation, sale of all or substantially all of our assets, or other major corporate transaction requiring stockholder approval.

Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. As of December 31, 2018, our directors, executive officers, and holders of more than 5% of our common stock, and their respective affiliates, held a substantial majority of the voting power of our capital stock. Because of the ten-to-one voting ratio between our Class B and Class A common stock, our co-founders, who currently serve as our chief executive officer and chief technology officer, control a majority of the combined voting power of our common stock and therefore are able to control all matters submitted to our stockholders for approval until the earlier of June 17, 2027 or the date the holders of a majority of our Class B common stock choose to convert their shares. This concentrated control will limit or preclude your ability to influence corporate matters for the foreseeable future, including the election of directors, amendments of our organizational documents, and any merger, consolidation, sale of all or substantially all of our assets, or other major corporate transaction requiring stockholder approval. In addition, this may prevent or discourage unsolicited acquisition proposals or offers for our capital stock that you may feel are in your best interest as one of our stockholders.

Transfers by holders of Class B common stock will generally result in those shares converting to Class A common stock, subject to limited exceptions, such as certain transfers effected for estate planning purposes. The conversion of Class B common stock to Class A common stock will have the effect, over time, of increasing the relative voting power of those holders of Class B common stock who retain their shares in the long term.

If securities or industry analysts do not publish research, or publish inaccurate or unfavorable research, about our business, the price of our Class A common stock and trading volume could decline.

The trading market for our Class A common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. We do not have any control over these analysts. If industry analysts cease coverage of us, the trading price for our common stock would be negatively affected. If one or more of the analysts who cover us downgrade our Class A common stock or publish inaccurate or unfavorable research about our business, our common stock price would likely decline. If one or more of these analysts’ cease coverage of us or fail to publish reports on us regularly, demand for our Class A common stock could decrease, which might cause our Class A common stock price and trading volume to decline.

We do not intend to pay dividends for the foreseeable future.

We have never declared or paid any cash dividends on our common stock and do not intend to pay any cash dividends in the foreseeable future. We anticipate that we will retain all of our future earnings for use in the development of our business and for general corporate purposes. Any determination to pay dividends in the future will be at the discretion of our board of directors.

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Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments.

Provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management, limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, or employees, and limit the market price of our common stock.

Provisions in our restated certificate of incorporation and restated bylaws may have the effect of delaying or preventing a change of control or changes in our management. Our restated certificate of incorporation and restated bylaws include provisions that:

provide that our board of directors will be classified into three classes of directors with staggered three-year terms at such time as the outstanding shares of our Class B common stock represent less than a majority of the combined voting power of our common stock;
permit the board of directors to establish the number of directors and fill any vacancies and newly created directorships;
require super-majority voting to amend some provisions in our restated certificate of incorporation and restated bylaws;
authorize the issuance of “blank check” preferred stock that our board of directors could use to implement a stockholder rights plan;
provide that only the chairman of our board of directors, our chief executive officer, or a majority of our board of directors will be authorized to call a special meeting of stockholders;
provide for a dual class common stock structure in which holders of our Class B common stock have the ability to control the outcome of matters requiring stockholder approval, even if they own significantly less than a majority of the outstanding shares of our Class A and Class B common stock, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or its assets;
prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
provide that the board of directors is expressly authorized to make, alter, or repeal our bylaws; and
establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by stockholders at annual stockholder meetings.

In addition, our restated certificate of incorporation provides that the Court of Chancery of the State of Delaware will be the exclusive forum for: any derivative action or proceeding brought on our behalf; any action asserting a breach of fiduciary duty; any action asserting a claim against us arising pursuant to the Delaware General Corporation Law, our restated certificate of incorporation, or our restated bylaws; or any action asserting a claim against us that is governed by the internal affairs doctrine. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or any of our directors, officers, or other employees, which may discourage lawsuits with respect to such claims. Alternatively, if a court were to find the choice of forum provision contained in our restated certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could harm our business, operating results, and financial condition.

Moreover, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of our company. Section 203 imposes certain restrictions on mergers, business combinations, and other transactions between us and holders of 15% or more of our common stock.

Item 1B. Unresolved Staff Comments
 
None.

Item 2. Properties
 
We are a global company with our corporate headquarters located in San Francisco, California. Our headquarters facilities in San Francisco comprise approximately 324,000 square feet of space pursuant to several leases that expire at various dates through June 2024. Our corporate headquarters serve as the principal facilities for our administrative, sales, marketing, product

32


development, and customer support groups. We also lease additional office space in San Francisco and around the world for various product development, operational and support purposes. We believe our existing facilities are adequate to meet our current requirements. If we were to require additional space, we believe we will be able to obtain such space on acceptable and commercially reasonable terms.

Item 3. Legal Proceedings

For a discussion of legal proceedings, see Note 7 in the “Notes to Consolidated Financial Statements” included in Part II, Item 8 of this Annual Report on Form 10-K, which is incorporated herein by reference.

Further, we are and, from time to time, we may become, involved in legal proceedings or be subject to claims arising in the ordinary course of our business. We are not presently a party to any other legal proceedings that in the opinion of our management, if determined adversely to us, would individually or taken together have a material adverse effect on our business, operating results, financial condition, or cash flows.

Item 4. Mine Safety Disclosures
 
None.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
 

Market Information

Our Class A common stock has been listed on the New York Stock Exchange under the symbol “FIT” since June 18, 2015. Prior to that date, there was no public trading market for our Class A common stock. Our Class B common stock is neither listed nor traded.     

Holders of Record

As of December 31, 2018, we had 32 holders of record of our Class A common stock. Because many of our shares of Class A common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. As of December 31, 2018, we had 25 holders of record of our Class B common stock.

Dividends

We have never declared or paid any cash dividends on our capital stock. We currently intend to retain any future earnings and do not expect to pay any cash dividends on our common stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors, subject to applicable laws, and will depend on our financial condition, operating results, capital requirements, general business conditions, and other factors that our board of directors considers relevant.

Securities Authorized for Issuance under Equity Compensation Plans

The information required by this item with respect to our equity compensation plans is incorporated by reference to our Proxy Statement for the 2018 Annual Meeting of Stockholders to be filed with the SEC within 120 days of the fiscal year ended December 31, 2018.

Stock Performance Graph

The following graph compares the cumulative total return on our Class A common stock with that of the S&P 500 Index and the Nasdaq Composite Index. The period shown commences on June 18, 2015, our initial public offering date, and ends on December 31, 2018, the end of our last fiscal year.  The graph assumes $100 was invested at the close of market on June 18, 2015 in our Class A common stock, the S&P 500 Index and the Nasdaq Composite Index, and assumes the reinvestment of any dividends. The stock price performance on the following graph is not intended to forecast or be indicative of future stock price performance of our Class A common stock.

33



a2018stockgraphv1.jpg

This performance graph shall not be deemed incorporated by reference into any of our other filings under the Exchange Act, or the Securities Act, except to the extent we specifically incorporate it by reference into such filing.

Recent Sales of Unregistered Securities.
 
None.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

None.

34


Item 6. Selected Financial Data
 
We derived the selected consolidated statements of operations data for 2018, 2017 and 2016 and the selected consolidated balance sheet data as of December 31, 2018 and 2017 from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The consolidated statements of operations data for 2015 and 2014, and the consolidated balance sheet data as of December 31, 2016, 2015 and 2014 are derived from consolidated financial statements that are not included in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results that may be expected in the future. You should read this data together with our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
 
For the Year Ended December 31,
 
2018
 
2017
 
2016
 
2015(1)
 
2014(1)
 
(in thousands, except per share data)
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
 
 
Revenue
$
1,511,983

 
$
1,615,519

 
$
2,169,461

 
$
1,857,998

 
$
745,433

Cost of revenue (2)
908,404

 
924,618

 
1,323,577

 
956,935

 
387,776

Gross profit
603,579

 
690,901

 
845,884

 
901,063

 
357,657

Operating expenses:
 
 
 
 
 
 
 
 
 
Research and development (2)
332,169

 
343,012

 
320,191

 
150,035

 
54,167

Sales and marketing (2)
344,091

 
415,042

 
491,255

 
332,741

 
112,005

General and administrative (2)
116,627

 
133,934

 
146,903

 
77,793

 
33,556

Change in contingent consideration

 

 

 
(7,704
)
 

Total operating expenses
792,887

 
891,988

 
958,349

 
552,865

 
199,728

Operating income (loss)
(189,308
)
 
(201,087
)
 
(112,465
)
 
348,198

 
157,929

Interest income (expense), net
7,808

 
3,647

 
3,156

 
(1,019
)
 
(2,222
)
Other income (expense), net
(2,642
)
 
2,796

 
14

 
(59,230
)
 
(15,934
)
Income (loss) before income taxes
(184,142
)
 
(194,644
)
 
(109,295
)
 
287,949

 
139,773

Income tax expense (benefit) (3)
1,687

 
82,548

 
(6,518
)
 
112,272

 
7,996

Net income (loss)
$
(185,829
)
 
$
(277,192
)
 
$
(102,777
)
 
$
175,677

 
$
131,777

Net income (loss) per share attributable to common stockholders (4):
 
 
 
 
 
 
 
 
 
Basic
$
(0.76
)
 
$
(1.19
)
 
$
(0.47
)
 
$
0.88

 
$
0.70

Diluted
$
(0.76
)
 
$
(1.19
)
 
$
(0.47
)
 
$
0.75

 
$
0.63

Other Data:
 
 
 
 
 
 
 
 
 
Devices sold (5)
13,939

 
15,343

 
22,295

 
21,355

 
10,904

Active users (6)
27,627

 
25,367

 
23,238

 
16,903

 
6,700

Adjusted EBITDA (7)
$
(31,361
)
 
$
(52,158
)
 
$
29,985

 
$
389,879

 
$
191,042

Free cash flow (8)
$
60,327

 
$
(24,919
)
 
$
60,080

 
$
110,691

 
$
(7,708
)

(1)
In March 2014, we recalled Fitbit Force. The recall, which primarily affected our results for the first quarter of 2014 and the fourth quarter of 2015, had the following effect on our income (loss) before income taxes in 2015 and 2014. The recall had a negligible effect on our loss before income taxes in 2016.
 
Year Ended December 31,
 
2015
 
2014
 
(in thousands)
Reduction of revenue
$

 
$
(8,112
)
Incremental (benefit to) cost of revenue
(5,755
)
 
11,339

Impact on gross profit
(5,755
)
 
(19,451
)
Incremental general and administrative expenses (benefit)
(4,416
)
 
3,389

Impact on income (loss) before income taxes
$
10,171

 
$
(22,840
)


35



(2)
Includes stock-based compensation expense as follows:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(in thousands)
Cost of revenue
$
7,312

 
$
5,312

 
$
4,797

 
$
4,739

 
$
890

Research and development
57,188

 
54,123

 
47,207

 
18,251

 
2,350

Sales and marketing
14,726

 
14,959

 
11,575

 
7,419

 
1,295

General and administrative
17,783

 
17,187

 
15,853

 
10,615

 
2,269

Total
$
97,009

 
$
91,581

 
$
79,432

 
$
41,024

 
$
6,804

 
(3)
In 2017, we established a valuation allowance of $99.6 million against our U.S. deferred tax assets. See Note 9 of the “Notes to Consolidated Financial Statements” included elsewhere in this Annual Report on Form 10-K for further details.
(4)
See Notes 2 and 10 of the “Notes to Consolidated Financial Statements” included elsewhere in this Annual Report on Form 10-K for an explanation of the calculations of our net income (loss) per share attributable to common stockholders, basic and diluted.
(5)
See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Business Metrics—Devices Sold” for more information.
(6)
See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Business Metrics—Active Users” for more information.
(7)
Adjusted EBITDA is a financial measure that is not calculated in accordance with U.S. GAAP. See the section below titled “Non-GAAP Financial Measures—Adjusted EBITDA” for information regarding our use of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income (loss).
(8)
Free cash flow is a financial measure that is not calculated in accordance with U.S. GAAP. See the section below titled “Non-GAAP Financial Measures—Free cash flow” for information regarding our use of free cash flow and a reconciliation to net cash provided by (used in) operating activities.
 
As of December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(in thousands)
Consolidated Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash, cash equivalents, and marketable securities
$
723,449

 
$
679,300

 
$
706,013

 
$
664,478

 
$
195,626

Working capital
592,428

 
683,065

 
724,231

 
847,157

 
101,860

Total assets
1,515,547

 
1,582,075

 
1,821,926

 
1,519,066

 
633,051

Total long-term debt

 

 

 

 
132,589

Retained earnings (accumulated deficit)
(319,067
)
 
(132,112
)
 
140,142

 
242,919

 
67,242

Total stockholders’ equity
735,938

 
823,963

 
998,532

 
981,451

 
75,262

 

Non-GAAP Financial Measures
 
To supplement our consolidated financial statements presented in accordance with U.S. GAAP, we monitor and consider adjusted EBITDA and free cash flow, which are non-GAAP financial measures. These non-GAAP financial measures are not based on any standardized methodology prescribed by U.S. GAAP and are not necessarily comparable to similarly-titled measures presented by other companies.

Adjusted EBITDA
 
We define adjusted EBITDA as net income (loss) adjusted to exclude stock-based compensation expense, depreciation and intangible assets amortization, litigation expense (credit) related to matters with Aliphcom, Inc. d/b/a Jawbone, or Jawbone, the impact of our restructuring in 2017, the impact of the Fitbit Force recall, impairment of equity investment, the revaluation of our redeemable convertible preferred stock warrant liability prior to our initial public offering, or IPO, change in contingent consideration, interest income (expense), net, and income tax expense (benefit). We began excluding Jawbone related litigation expense in the second quarter of 2016 because we do not believe these expenses 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

36


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 (loss), which is the nearest U.S. GAAP equivalent of adjusted EBITDA. Some of these limitations are:
 
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;
adjusted EBITDA excludes depreciation and intangible assets amortization expense and, although these are non-cash expenses, the assets being depreciated and amortized may have to be replaced in the future;
adjusted EBITDA excludes external litigation expenses to support our legal proceedings with Jawbone, which is no longer a recurring expense;
adjusted EBITDA excludes the Fitbit Force recall, which primarily impacted our results for the fourth quarter of 2013, first quarter of 2014, and the fourth quarter of 2015;
adjusted EBITDA excludes the impact of our restructuring in 2017, which has not been a recurring expense;
adjusted EBITDA excludes the revaluation of our redeemable convertible preferred stock warrant liability, which was a historically recurring non-cash charge prior to our initial public offering, but will not recur in the periods following the completion of our initial public offering;
adjusted EBITDA excludes change in contingent consideration, a non-recurring benefit received for the reversal of a contingent liability incurred in connection with the acquisition of FitStar;
adjusted EBITDA excludes impairment charge to reflect the write-down of an equity investment in 2018;
adjusted EBITDA excludes interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces cash available to us;
adjusted EBITDA excludes income tax expense (benefit); and
the expenses and other items that we exclude in our calculation of adjusted EBITDA may differ from the expenses and other items, if any, that other companies may exclude from adjusted EBITDA when they report their operating results.

Because of these limitations, adjusted EBITDA should be considered along with other operating and financial performance measures presented in accordance with U.S. GAAP.


37


The following table presents a reconciliation of net income (loss) to adjusted EBITDA:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(in thousands)
Net income (loss)
$
(185,829
)
 
$
(277,192
)
 
$
(102,777
)
 
$
175,677

 
$
131,777

Stock-based compensation expense*
97,009

 
90,853

 
79,432

 
41,024

 
6,804

Depreciation and amortization
56,815

 
45,693

 
38,133

 
21,107

 
6,131

Litigation expense, net — Jawbone
765

 
3,212

 
24,845

 

 

Impact of restructuring

 
6,375

 

 

 

Impact of Fitbit Force recall

 

 
26

 
(10,171
)
 
22,840

Impairment of equity investment
6,000

 

 

 

 

Revaluation of redeemable convertible preferred stock warrant liability

 

 

 
56,655

 
13,272

Change in contingent consideration

 

 

 
(7,704
)
 

Interest (income) expense, net
(7,808
)
 
(3,647
)
 
(3,156
)
 
1,019

 
2,222

Income tax expense (benefit)
1,687

 
82,548

 
(6,518
)
 
112,272

 
7,996

Adjusted EBITDA
$
(31,361
)
 
$
(52,158
)
 
$
29,985

 
$
389,879

 
$
191,042

 
 
 
 
 
 
 
 
 
 
* A portion of stock-based compensation expense for the year ended December 31, 2017 was allocated to and included in "Impact of restructuring," thus explaining the difference between the total by function presented in this table compared to the amounts presented in the above tables.

Free cash flow

We define free cash flow as net cash provided by (used in) operating activities less purchase of property and equipment. We consider free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that can possibly be used for investing in our business and strengthening ​the​balance sheet, but it is not intended to represent the residual cash flow available for discretionary expenditures.  Free cash flow 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.

The following table presents a reconciliation of net cash provided by (used in) operating activities to free cash flow:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
 
(in thousands)
Net cash provided by operating activities (9)
$
113,207

 
$
64,241

 
$
138,720

 
$
141,257

 
$
18,787

Purchase of property and equipment 
(52,880
)
 
(89,160
)
 
(78,640
)
 
(30,566
)
 
(26,495
)
Free cash flow
$
60,327

 
$
(24,919
)
 
$
60,080

 
$
110,691

 
$
(7,708
)
Net cash provided by (used in) investing activities
$
17,496

 
$
(28,718
)
 
$
(392,666
)
 
$
(170,027
)
 
$
(24,185
)
Net cash provided by financing activities (9)
$
1,287

 
$
4,635

 
$
19,794

 
$
368,953

 
$
119,251


(9)
Our adoption of ASU 2016-09 on January 1, 2017 resulted in excess tax benefits for share-based payments recorded as a reduction of income tax expense and reflected within operating cash flows, rather than recorded within equity and reflected within financing cash flows. We elected to adopt this new standard retrospectively, which impacted the presentation for all periods prior to the adoption date. See Note 1 of the “Notes to Consolidated Financial Statements - Recent Accounting Pronouncements” included elsewhere in this Annual Report on Form 10-K for additional information.


38


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the section titled “Selected Financial Data” and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from such forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those identified below and those discussed above in the section titled “Risk Factors” included elsewhere in this Annual Report on Form 10-K.
 
Overview
 
Today, most of our revenue comes from the sale of wearable devices, including both trackers and smartwatches. Our products are available in 87 countries worldwide through a variety of channels, including 39,000 retail stores, retailer websites, Fitbit.com and through Fitbit Health Solutions. 

In 2018, we focused on providing more choice and accessibility to consumers in wearables to drive acquisition of users. We introduced Fitbit Versa, our first mass appeal smartwatch in the second quarter, resulting in increased smartwatch revenue over the course of 2018.  Smartwatch revenue increased to 44% of revenue in 2018, from 8% in 2017. We also launched Fitbit Charge 3, which innovates on our Charge family of trackers, and which has sold more than 38 million devices. It gives people health and fitness features in a slim, premium tracker design, with smart functionality, and long battery life at an affordable price. The introduction of Fitbit Ace, a tracker designed for kids ages 8 and up and Fitbit family accounts, also expanded our addressable market.
 
The mix shift towards smartwatches favorably impacted the average selling price of our devices, but negatively impact our gross margin. This was partially mitigated by improvement in operating efficiency.  Operating efficiencies were driven by four key areas: returns, warranty claims, product quality and customer support costs. 
 
Acquiring customers through the sale of a device increases the size of our community of users and also increases the potential for future demand for devices and other monetization opportunities, such as software services or coaching revenue. While software revenue was immaterial in 2018, a growing community of active users provides us an opportunity to introduce or further develop software services for the community in the future.

In addition, we focused on growing our Fitbit Health Solutions channel, which delivers health and wellness solutions for employers, health plans and health systems. In the fall, we launched Fitbit Care, a connected health platform that combines health coaching and virtual care, wearable devices, and personalized digital interventions to better support patients outside the walls of the clinical environment. While revenue from the Fitbit Health Solutions channel was immaterial in 2018, growth of the channel provides us an opportunity to drive demand for devices and software services.
 
The following are financial highlights for 2018, 2017 and 2016:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(in thousands)
Revenue
$
1,511,983

 
$
1,615,519

 
$
2,169,461

Net loss
$
(185,829
)
 
$
(277,192
)
 
$
(102,777
)

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

39


 
For the Year Ended and As Of December 31,
 
2018
 
2017
 
2016
 
(in thousands)
Devices sold
13,939

 
15,343

 
22,295

Active users
27,627

 
25,367

 
23,238

Adjusted EBITDA
$
(31,361
)
 
$
(52,158
)
 
$
29,985

Free cash flow
$
60,327

 
$
(24,919
)
 
$
60,080

 
Devices Sold
 
Devices sold represents the number of wearable devices that are sold during a period, net of expected returns. 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, the introduction of new product offerings with differing U.S. manufacturer’s suggested retail prices, or MSRPs, and sales of accessories and premium services.
 
Active Users

Fitbit builds its community of users through device sales and investment in its software to drive engagement. We define an active user as a registered Fitbit user who, within the three months prior to the date of measurement, has (a) an active Fitbit Coach subscription, (b) paired a wearable device or Aria scale with his or her Fitbit account, or (c) logged at least 100 steps with a wearable device or a weight measurement using an Aria scale. Active users can be new users who joined the community during the past ninety days, existing users who have remained active and met our definition of an active user, or previously active users who were inactive for 90 days or greater. The active user number excludes users who have downloaded our mobile apps without purchasing any of our wearable devices and users who have downloaded free versions of Fitbit Coach but are not subscribers to its paid premium offerings.

The active user metric is intended to provide a snapshot of the potential size and growth of our engaged user community. We believe interest in health and fitness ebbs and flows and as such, the active user metric is not designed to be a measure of the levels of continuous engagement of our individual users and does not track the number of individual users that have become inactive on our platform in a period. Accordingly, this metric does not take into account the extent to which inactive users are offset by new active users or how long an individual user remains active.

The number of active users is based on activity associated with each Fitbit user account. A user establishes an account with us by registering his or her email with us at Fitbit.com or through our app. As such, the active user metric reflects the number of Fitbit users who meet our definition of an active user during the measurement period; it is not associated with the particular device(s) owned by a user. Accordingly, a user with multiple devices synced to his or her account would only be counted as one active user. As a percentage of the active user metric, users who logged at least 100 steps with a health and fitness tracker or a weight measurement using an Aria scale but had an existing user account in a prior quarter increased from 79% as of December 31, 2017 to 82% percent as of December 31, 2018.

However, it is also possible to have multiple active users associated with a single device at different points in time, such as with users who acquired a refurbished device and with users who acquired a device directly from another user. In such cases, particularly the latter instance, it is also possible that the prior owner and new owner of a single device could each be counted as unique active users during the same measurement period. However, we believe it is appropriate to include both new and prior owners of a particular device in the active user metric because the metric is intended to provide a snapshot of the potential size and growth of our engaged user community during the measurement period. Since both the new and prior owners meet the active user metric, we believe both users would be appropriately included in the active user metric as both users independently have demonstrated a level of engagement with our devices and platform.
  
In addition, the active user metric is not intended to be an indicator of device sales in any period, as device sales are reported as a separate metric. We do not believe that the active user metric has a direct effect on our revenue and operating results since substantially all of our revenue to date has been derived from sales of our wearable devices. However, we believe the size of our active user population is a potential indicator of future demand from repeat buyers for our devices and for other future monetization opportunities such as software services or coaching revenue. We aim to increase the active user metric by developing products, services and content that are compelling for new, existing, and prior users.


40


Activations - Repeat and Re-Activated Users

We define an “Activation” as the first instance of a Fitbit device (excluding Aria, Aria 2, Flyer and other accessories) pairing to a user account during the three months prior to the date of measurement. A “Repeat User” is defined as a Fitbit user who activated a Fitbit device to his or her account during the measurement period and activated a different Fitbit device to his or her account during a prior period. A “Re-Activated User” is defined as Repeat User who has not synced his or her prior device and taken at least 100 steps for 90 days or more prior to the measurement period with such device. 

In the three months ended December 31, 2018, 35.1% of Activations came from Repeat Users, with Re-Activated Users representing 56.5% of those Repeat Users. In the three months ended December 31, 2017, 32.6% of Activations came from Repeat Users, with Re-Activated Users representing 47.1% of those Repeat Users. In the twelve months ended December 31, 2018, 37.6% of Activations came from Repeat Users, with Re-Activated Users representing 52.0% of those Repeat Users. In the twelve months ended December 31, 2017, 36.9% of Activations came from Repeat Users, with Re-Activated Users representing 41.3% of those Repeat Users. We calculated the full year Activation metric by summing the Activations from Repeat Users and Re-Activated Users in each of the four quarters in 2018 and 2017. As such, a user who activated more than one Fitbit device to his or her account during the year and had activated a different Fitbit device in a prior year would count as a Repeat User more than once.

We believe that the Activations metric is a potential indicator of repeat purchase behavior but not a guarantee of repeat purchase behavior.  Actual repeat purchase behavior may depend on a number of factors, including but not limited to our ability to anticipate and satisfy consumer preferences. 

Adjusted EBITDA

We define adjusted EBITDA as net income (loss) adjusted to exclude stock-based compensation expense, depreciation and intangible assets amortization, litigation expense related to matters with Aliphcom, Inc. d/b/a Jawbone, or Jawbone, the impact of our restructuring in 2017, the impact of the Fitbit Force recall, impairment of equity investment, the revaluation of our redeemable convertible preferred stock warrant liability prior to our initial public offering, or IPO, change in contingent consideration, interest income (expense), net, and income tax expense (benefit). See the section titled “Selected Financial Data-Non-GAAP Financial Measures-Adjusted EBITDA” in this Annual Report on Form 10-K for information regarding our use of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income (loss).

Free cash flow

We define free cash flow as net cash provided by (used in) operating activities less purchase of property and equipment. See the section titled “Selected Financial Data—Non-GAAP Financial Measures— Free cash flow” in this Annual Report on Form 10-K for information regarding our use of free cash flow and a reconciliation of free cash flow to net cash provided by (used in) operating activities.
 
Factors Affecting Our Future Performance
 
Product Introductions
 
To date, product introductions have often had a significant, positive impact on our operating results due primarily to increases in revenue associated with sales of the new products in the quarters following their introduction. Furthermore, new product introductions, or NPI, which we define as new products shipped in the past 12 months, could also adversely impact the sales of our existing products to retailers and users. New products may also have higher costs associated with them, which could adversely affect our margins. In addition, we have incurred higher levels of sales and marketing expenses accompanying each product introduction. In the future, we intend to continue to release new products and enhance our existing products, and we expect that our operating results will be impacted by these releases.
 
International Expansion
 
Our revenue, based on ship-to destinations, from sales outside of the United States represented 42% of our revenue in both 2017 and 2018. We believe our global opportunity is significant, and to address this opportunity, we intend to continue to invest in sales and marketing efforts, distribution channels, and infrastructure and personnel to support our international expansion, including establishing additional sales offices globally. Our growth will depend in part on the adoption and sales of our products and services in international markets. Moreover, our international expansion efforts have resulted and will continue to result in increased costs and are subject to a variety of risks, including increased competition, uncertain enforcement of our intellectual property rights, more complex distribution logistics, and the complexity of compliance with foreign laws and regulations.
 

41


Category Adoption, Expansion of our Total Addressable Market, and Market Growth
 
As a pioneer of the wearable device market, we believe we have contributed significantly to the market’s growth. However, our future growth depends in part on the continued consumer adoption of wearable devices as a means to improve health and fitness and the growth of this market. In addition, our long-term growth depends in part on our ability to expand into adjacent markets in the future.

Competition

The market for wearable devices is both evolving and competitive. The wearable devices category has a multitude of participants, including specialized consumer electronics companies such as Garmin and Withings, and traditional watch companies such as Fossil. In addition, many large, broad-based consumer electronics companies either compete in our market or adjacent markets or have announced plans to do so, including Apple, Google, LG, and Samsung. For example, Apple sells the Apple Watch, which is a smartwatch with broad-based functionalities, including some health and fitness tracking capabilities, and has sold a significant volume of its smartwatches since introduction. Moreover, smartwatches with health and fitness functionalities may displace the market for traditional tracker devices. For example, Apple’s recently introduced Apple Watch includes ECG functionality and fall detection capability. We also face competition from manufacturers of lower-cost devices, such as Xiaomi and its Mi Band device. In addition, we compete with a wide range of stand-alone health and fitness-related mobile apps that can be purchased or downloaded through mobile app stores.
 
Seasonality
 
Historically, we have experienced higher revenue in the fourth quarter compared to other quarters due in large part to seasonal holiday demand. For example, in 2018, 2017 and 2016, our fourth quarter represented 38%, 35% and 26% of our annual revenue, respectively. We also incur higher sales and marketing expenses during these periods.
 
Investing in Growth
 
Our business is in a multi-year transition process where we expect to leverage our core assets of brand, community, and data to focus on four key areas: adapting to the changing wearable device market; deepening our reach within healthcare; increasing our agility and optimizing our cost structure; and transforming our business from an episodic driven model centered around device sales to more life time value and recurring revenue. We expect our device mix to continue to shift towards smartwatches in 2019.  This will benefit average selling price, but will not offset the decline in our tracker unit growth. We expect the device mix shift to negatively impact gross margins, partially offset by operating efficiencies. For the full year 2019, operating expenses are expected to decline in absolute dollars as compared to the full year 2018.  We intend to drive incremental margin on the device side of the business and redeploy capital to grow international sales, Fitbit Health Solutions and recurring revenue opportunities.

We also expect to leverage the strength of our partners or acquire where necessary to increase speed to market and our ability to scale the business more effectively. For example, in 2016 we acquired assets from Coin, Pebble and Vector Watch to enhance the features and functionality of our devices, accelerate the expansion of our platform and ecosystem, and grow our capabilities in lower cost regions of the world. In 2018 we acquired Twine Health to further extend our reach into healthcare and to lay the foundation to expand our offerings to health plans, health systems and self-insured employers, including the introduction of Fitbit Care, a connected health platform for health plans and employers, in the third quarter of 2018, while creating opportunities to increase our subscription-based revenue.

Furthermore, we intend to increase our focus on the health ecosystem, building relationships with employers, wellness providers, and payers. The corporate wellness market for wearable devices market is new and is subject to a variety of challenges, including whether employers, health systems, and payers will continue to invest in such programs, long sales cycles, and substantial upfront sales costs. In each of 2018, 2017 and 2016, we derived less than 10% of our revenue from our Fitbit Health Solutions offerings. However, we believe that as healthcare costs continue to rise and as the healthcare ecosystem continues to seek ways to manage their costs, this represents an opportunity to grow revenue. In order to grow our Fitbit Health Solutions presence, we intend to enhance our offerings as well as expand our sales team focused on this market.

Product Quality

We sell complex products and services that could contain design and manufacturing defects in their materials, hardware, and firmware. These defects could include defective materials or components, or “bugs,” that can unexpectedly interfere with the products’ intended operations or cause injuries to users or property. Although we extensively and rigorously test new and enhanced products and services before their release, there can be no assurance we will be able to detect, prevent, or fix all defects. In addition, we utilize products and services provided by third-parties, such as vendors and contract manufacturers, and we rely on their

42


representations and do not have full control over their processes. Failure to detect, prevent, or fix defects, or an increase in defects could result in a variety of consequences including a greater number of returns of products than expected from users and retailers, increases in warranty costs, regulatory proceedings, product recalls, and litigation, which could harm our revenue and operating results.

Components of our Operating Results
 
Revenue
 
We have three sources of revenue: consumer device revenue, Fitbit Health Solutions revenue, and consumer non-device revenue. The vast majority of our total revenue comes from the sale of wearable devices through the retail, direct, and Fitbit Health Solutions channels. Within the Fitbit Health Solutions channel, revenue is comprised of devices, services, and software with most of it driven by device sales. Consumer non-device revenue represents a small portion of total revenue, primarily from our subscription-based Fitbit Coach services.

We generate substantially all of our revenue from the sale of our wearable devices, which includes both trackers and accessories and smartwatches sold both directly to consumers as well as through our Fitbit Health Solutions channel. We also generate a small portion of our revenue from our subscription-based Fitbit Coach services and from software services sold through our Fitbit Health Solutions channel.
 
Cost of Revenue
 
Cost of revenue consists of product costs, including costs of contract manufacturers for production, shipping and handling costs, warranty replacement costs, packaging, fulfillment costs, manufacturing and tooling equipment depreciation, warehousing costs, hosting costs, write-downs of excess and obsolete inventory, amortization of developed technology intangible assets acquired, and certain allocated costs related to management, facilities, and personnel-related expenses and other expenses associated with supply chain logistics. Personnel-related expenses include salaries, bonuses, benefits, and stock-based compensation.

Operating Expenses
 
Operating expenses consist of research and development, sales and marketing, general and administrative expenses, and change in contingent consideration.
 
Research and Development. Research and development expenses consist primarily of personnel-related expenses, consulting and contractor expenses, tooling and prototype materials, and allocated overhead costs.
 
Substantially all of our research and development expenses are related to developing new products and services and improving our existing products and services. To date, research and development expenses have been expensed as incurred, because the release of products and services for sale has been short and development costs qualifying for capitalization have been insignificant.
 
Sales and Marketing. Sales and marketing expenses represent a significant component of our operating expenses and consist primarily of advertising and marketing promotions of our products and services and personnel-related expenses, as well as sales incentives, trade show and event costs, sponsorship costs, consulting and contractor expenses, travel, POP display expenses and related amortization, and allocated overhead costs.
 
General and Administrative. General and administrative expenses consist of personnel-related expenses for our finance, legal, human resources, and administrative personnel, as well as the costs of professional services, allocated overhead, information technology, bad debt expense, amortization of intangible assets acquired, and other administrative expenses.

Interest Income (Expense), Net
 
Interest income (expense), net consists of interest expense associated with our debt financing arrangements, amortization of debt issuance costs, and interest income earned on our cash, cash equivalents, and marketable securities.
 
Other Income (Expense), Net
 
Other income (expense), net consists of foreign currency gains and losses, and impairment loss from an equity investment.
 
Income Tax Expense (Benefit)
 

43


We are subject to income taxes in the United States and foreign jurisdictions in which we do business. These foreign jurisdictions have statutory tax rates different from those in the United States. Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to U.S. income, the utilization of foreign tax credits, and changes in tax laws.

On July 24, 2018, the Ninth Circuit Court of Appeals issued an opinion in Altera Corp. v. Commissioner requiring related parties in an intercompany cost-sharing arrangement to share expenses related to share-based compensation. This opinion reversed the prior decision of the United States Tax Court. On August 7, 2018, the Court withdrew the opinion issued on July 24, 2018 to allow time for a reconstituted panel of judges to confer. We will continue to monitor the case.

On December 22, 2017, the U.S. Tax Cuts and Jobs Act of 2017, or the 2017 Tax Act, was signed into law and includes several key tax provisions that affected us, including a reduction of statutory corporate tax rate from 35% to 21% effective for tax years beginning after December 31, 2017, elimination of certain deductions, and changes to how the U.S. imposes income tax on multinational corporations, among others. We are required to recognize the effect of tax law changes in the period of enactment, such as re-measuring our U.S. deferred tax assets and liabilities, as well as re-assessing the net realizability of our deferred tax assets. As of December 31, 2018, we finalized all provisional amounts related to the 2017 Tax Act. Finalizing provisional adjustments related to the 2017 Tax Act did not have a material impact on our consolidated financial statements for the year ended December 31, 2018.
 
Operating Results
 
The following tables set forth the components of our consolidated statements of operations for each of the periods presented and as a percentage of our revenue for those periods. The period-to-period comparison of operating results is not necessarily indicative of results for future periods.
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(in thousands)
Consolidated Statements of Operations Data:
 
 
 
 
 
Revenue
$
1,511,983

 
$
1,615,519

 
$
2,169,461

Cost of revenue (1)
908,404

 
924,618

 
1,323,577

Gross profit
603,579

 
690,901

 
845,884

Operating expenses:
 
 
 
 
 
Research and development (1)
332,169

 
343,012

 
320,191

Sales and marketing (1)
344,091

 
415,042

 
491,255

General and administrative (1)
116,627

 
133,934

 
146,903

Total operating expenses
792,887

 
891,988

 
958,349

Operating loss
(189,308
)
 
(201,087
)
 
(112,465
)
Interest income, net
7,808

 
3,647

 
3,156

Other income (expense), net
(2,642
)
 
2,796

 
14

Loss before income taxes
(184,142
)
 
(194,644
)
 
(109,295
)
Income tax expense (benefit)
1,687

 
82,548

 
(6,518
)
Net loss
$
(185,829
)
 
$
(277,192
)
 
$
(102,777
)
 
(1)
Includes stock-based compensation expense as follows:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(in thousands)
Cost of revenue 
$
7,312

 
$
5,312

 
$
4,797

Research and development
57,188

 
54,123

 
47,207

Sales and marketing
14,726

 
14,959

 
11,575

General and administrative
17,783

 
17,187

 
15,853

Total
$
97,009

 
$
91,581

 
$
79,432


44


 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(as a percentage of revenue)
Consolidated Statements of Operations Data:
 
 
 
 
 
Revenue
100
 %
 
100
 %
 
100
 %
Cost of revenue
60

 
57

 
61

Gross profit
40

 
43

 
39

Operating expenses:
 
 
 
 
 
Research and development
22

 
21

 
15

Sales and marketing
23

 
26

 
22

General and administrative
8

 
8

 
7

Total operating expenses
53

 
55

 
44

Operating loss
(13
)
 
(12
)
 
(5
)
Interest income, net
1

 

 

Other income (expense), net

 

 

Loss before income taxes
(12
)
 
(12
)
 
(5
)
Income tax expense (benefit)

 
5

 

Net loss
(12
)%
 
(17
)%
 
(5
)%
 
 
Revenue
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2018 vs. 2017
 
2017 vs. 2016
 
 
 
 
 
 
 
$ Change
 
% Change
 
$ Change
 
% Change
 
(in thousands)
Revenue
$
1,511,983

 
$
1,615,519

 
$
2,169,461

 
$
(103,536
)
 
(6
)%
 
$
(553,942
)
 
(26
)%

Revenue decreased $103.5 million, or 6%, from $1.6 billion for 2017 to $1.5 billion for 2018. The decrease was primarily from a 9% reduction in devices sold driven by a decline in the demand for our trackers as the wearable market shifted from trackers to smartwatches. This shift adversely impacted us since trackers represented the majority of our revenue in 2017. Our tracker decline was partially offset by the growth in sales of our smartwatches, primarily from our introduction of Fitbit Versa in 2018, our first mass appeal smartwatch, which has enabled us to participate in the faster growing portion of the wearables device market. As a result, our smartwatch revenue grew by 437%, from 8% of our revenue in 2017 to 44% of our revenue in 2018, and our tracker revenue declined by 44%, from 88% of our revenue in 2017 to 53% of our revenue in 2018, compared to the prior fiscal year. The product mix shift towards higher end smartwatches favorably impacted the ASP of our devices. ASP increased by 4%, from $101 in 2017 to $105 in 2018. During 2018, we benefited from an improved lower rate of product returns and from $12.4 million in revenue from the release of outstanding product return and rebate reserves related to Wynit, as we believe the possibility of future claims associated with these reserves is remote. Revenue from NPI increased by 74%, from $498.3 million, or 31% of revenue, in 2017, to $869.4 million, or 57% of revenue, in 2018. NPI revenue for 2018 was primarily from Fitbit Versa, Fitbit Charge 3 and Fitbit Ace. Revenue from our direct channel, Fitbit.com, decreased by 8% to $154.7 million, or 10% of revenue in 2018, compared to the prior fiscal year. The decrease in our direct channel revenue was primarily due to a decline in discounted sales derived from customer claims. In response to customer complaints about out of warranty devices, we offer certain customers discounts on new products in lieu of providing replacements. These discounts are generally redeemed through our direct channel. The improved quality of our products has resulted in fewer customer complaints and, as a result, the issuance of fewer discount offers, therefore driving a decrease in direct channel revenue. Revenue from accessories declined by 32% and software services increased by 29%, compared to the prior fiscal year.

Revenue decreased $553.9 million, or 26%, from $2.2 billion for 2016 to $1.6 billion for 2017. Our 2017 results reflect lower demand for our trackers as consumers started migrating towards higher-end smartwatches, compared to the same period in 2016, primarily in the United States. A substantial majority of the decrease was due to a 31% decline in the number of devices sold, from 22.3 million in 2016 to 15.3 million in 2017. The decrease was offset in part by an 8% increase in the average selling price of our devices, from $94 for 2016 to $101 for 2017, due to favorable product mix primarily from our special edition devices. Revenue from NPI decreased by 67%, from $1.5 billion, or 70% of revenue, in 2016, to $498.3 million, or 31% of revenue, in

45


2017. NPI revenue for 2017 included Fitbit Ionic, Fitbit Alta HR, Fitbit Aria 2 and Fitbit Flyer. Revenue from our direct channel, Fitbit.com, increased by 11% to $167.9 million, or 10% of revenue, in 2017, compared to the same period in the prior fiscal year.

U.S. revenue, based on ship-to destinations, decreased $63.5 million, or 7%, from $944.1 million for 2017 to $880.5 million for 2018. International revenue decreased $40.0 million, or 6%, from $671.5 million for 2017 to $631.4 million for 2018, primarily due to decreases of 13% in the EMEA region, and 13% in the Americas excluding the United States region, offset in part by a 27% increase in the APAC region. The decline in EMEA was driven primarily by revenue declines in the United Kingdom region due to an increased competitive environment.

U.S. revenue, based on ship-to destinations, decreased $595.5 million, or 39%, from $1.5 billion for 2016 to $944.1 million for 2017. International revenue increased $41.6 million, or 7%, from $629.9 million for 2016 to $671.5 million for 2017, due to increases in revenue of 13% in the EMEA region and 6% in the Americas excluding the United States region, partially offset by a decrease in revenue of 12% in the APAC region.

For the full year 2019, we expect revenue to increase modestly as compared to the full year 2018.
 
Cost of Revenue
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2018 vs. 2017
 
2017 vs. 2016
 
 
 
 
 
 
 
$ Change
 
% Change
 
$ Change
 
% Change
 
(in thousands)
Cost of revenue
$
908,404

 
$
924,618

 
$
1,323,577

 
$
(16,214
)
 
(2
)%
 
$
(398,959
)
 
(30
)%
Gross profit
603,579

 
690,901

 
845,884

 
(87,322
)
 
(13
)%
 
(154,983
)
 
(18
)%
Gross margin
40
%
 
43
%
 
39
%
 
 
 
 
 
 
 
 

Cost of revenue decreased $16.2 million, or 2%, from $924.6 million for 2017 to $908.4 million for 2018. The decrease was due to a 9% decline in the number of devices sold during 2018 and lower warranty costs and lower customer support contact rates due to improved quality of our products, offset in part by product mix shift towards higher cost smartwatches, which increased from 8% of revenue for 2017 to 44% of revenue for 2018. Gross margin decreased to 40% for 2018 from 43% for 2017 primarily due to our product mix shift towards higher cost smartwatches which have lower gross margins than our health and fitness trackers, offset in part by lower warranty costs and lower customer support contact rates due to improved quality of our products, and the recognition of revenue due to the release of outstanding product return and rebate reserves related to Wynit described above.

Cost of revenue decreased $399.0 million, or 30%, from $1.3 billion for 2016 to $924.6 million for 2017. The decrease was primarily due to the 31% decline in the number of devices sold during 2017, a decrease in excess manufacturing capacity costs, a decrease in excess and obsolete inventory write-downs for certain legacy products, a decrease in accelerated depreciation of manufacturing and tooling equipment, and lower warranty costs. Gross margin increased to 43% for 2017 from 39% for 2016 primarily due to the significant drop in demand that occurred in the fourth quarter of 2016, causing us to incur significant excess manufacturing capacity costs, excess and obsolete inventory write-downs for certain legacy products, and accelerated depreciation of manufacturing and tooling equipment in 2016, combined with lower warranty costs in 2017. In 2017, we also benefited from an initiative to improve our forecasting accuracy that reduced our exposure to the above described significant costs that we experienced during the fourth quarter of 2016.

We expect our gross margin to decrease in 2019 compared to 2018 primarily due to the continued mix shift towards lower margin smartwatches and the introduction of lower priced devices. We expect these to be partially offset by lower warranty costs and customer contact rates, and improved manufacturing processes.
 
Research and Development
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2018 vs. 2017
 
2017 vs. 2016
 
 
 
 
 
 
 
$ Change
 
% Change
 
$ Change
 
% Change
 
(in thousands)
Research and development
$
332,169

 
$
343,012

 
$
320,191

 
$
(10,843
)
 
(3
)%
 
$
22,821

 
7
%
 
Research and development expenses decreased $10.8 million, or 3%, from $343.0 million for 2017 to $332.2 million for 2018. The decrease was due to a $9.0 million decrease in tooling and prototype material costs and a $4.6 million decrease in

46


consulting and contractor expenses, offset in part by a $1.9 million increase in personnel-related expenses primarily from an average headcount increase of 2% in 2018, compared to the same period in the prior fiscal year.

Research and development expenses increased $22.8 million, or 7%, from $320.2 million for 2016 to $343.0 million for 2017. The increase was primarily due to an increase of $27.3 million in personnel-related expenses due to an average headcount increase of 7% in 2017, a $8.1 million increase in allocated overhead, and a $3.6 million increase in third-party hosting costs, partially offset by a decrease of $13.8 million in consulting and contractor expenses and a $1.1 million decrease in tooling and prototype material costs.

For the full year 2019, we expect research and development expenses to decrease in absolute dollars and decrease as a percentage of revenue as compared to the full year 2018.
 
Sales and Marketing
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2018 vs. 2017
 
2017 vs. 2016
 
 
 
 
 
 
 
$ Change
 
% Change
 
$ Change
 
% Change
 
(in thousands)
Sales and marketing
$
344,091

 
$
415,042

 
$
491,255

 
$
(70,951
)
 
(17
)%
 
$
(76,213
)
 
(16
)%

Sales and marketing expenses decreased $71.0 million, or 17%, from $415.0 million for 2017 to $344.1 million for 2018. The decrease was primarily due to a $33.8 million decrease in marketing activities accounted for as a reduction to revenue instead of sales and marketing expense in prior periods due to a shift towards direct promotion programs from marketing incentives. Additionally, we further reduced our sales and marketing expenses by $17.9 million due to a shift in focus from traditional television marketing to digital media, by $14.9 million in lower customer support costs due to lower contact rates resulting from improved quality of our products, and by $12.0 million in POP display costs due to a reduced number of new displays, offset in part by a $7.3 million increase in personnel-related expenses primarily due to an average headcount increase of 4% in 2018, compared to the same period in the prior fiscal year.

Sales and marketing expenses decreased $76.2 million, or 16%, from $491.3 million for 2016 to $415.0 million for 2017. The decrease was primarily due to a $103.9 million decrease in advertising and marketing expense and a $8.5 million decrease in consulting and contractor expenses, partially offset by a $16.9 million increase in personnel-related expenses due to an average headcount increase of 11% in 2017, a $9.7 million increase in allocated overhead, a $7.2 million increase in sales transaction expenses, and a $3.6 million increase in expenses for purchased software.

For the full year 2019, we expect sales and marketing expenses to decrease in absolute dollars and decrease as a percentage of revenue as compared to the full year 2018.
 
General and Administrative
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2018 vs. 2017
 
2017 vs. 2016
 
 
 
 
 
 
 
$ Change
 
% Change
 
$ Change
 
% Change
 
(in thousands)
General and administrative
$
116,627

 
$
133,934

 
$
146,903

 
$
(17,307
)
 
(13
)%
 
$
(12,969
)
 
(9
)%

General and administrative expenses decreased $17.3 million, or 13%, from $133.9 million for 2017 to $116.6 million for 2018. The decrease was primarily due to a $7.6 million decrease in bad debt expense resulting from Wynit’s bankruptcy filing in 2017, a $5.1 million decrease in legal fees, a $2.9 million decrease in allocated overhead, and a $2.0 million decrease in consulting and contractor expense, offset in part by a $3.3 million increase in personnel-related expenses primarily due to an average headcount increase of 5% in 2018, compared to the same period in the prior fiscal year.

General and administrative expenses decreased $13.0 million, or 9%, from $146.9 million for 2016 to $133.9 million for 2017. The decrease was primarily due to a $23.9 million decrease in legal fees primarily due to decreased litigation expense as a result of our global settlement of all outstanding civil litigation with Jawbone, and a $4.1 million decrease in consulting and contractor expense, partially offset by a $11.0 million increase in personnel-related expenses due to an average headcount increase of 8% in 2017, and a $7.6 million increase in bad debt expense resulting from Wynit’s bankruptcy filing.


47


For the full year 2019, we expect general and administrative expenses to remain relatively consistent in absolute dollars and as a percentage of revenue as compared to the full year 2018.

Interest and Other Income (Expense), Net
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2018 vs. 2017
 
2017 vs. 2016
 
 
 
 
 
 
 
$ Change
 
% Change
 
$ Change
 
% Change
 
(in thousands)
Interest income, net
$
7,808

 
$
3,647

 
$
3,156

 
$
4,161

 
114
 %
 
$
491

 
16
%
Other income (expense), net
(2,642
)
 
2,796

 
14

 
(5,438
)
 
(194
)%
 
2,782

 
19,871
%
 
Interest income, net increased $4.2 million, or 114%, from $3.6 million for 2017 to $7.8 million for 2018, primarily due to higher interest rates earned on cash, cash equivalents and marketable securities. Other income (expense), net decreased primarily due to an impairment loss of $6.0 million on an equity investment.

Interest income, net increased $0.5 million, or 16%, from $3.2 million for 2016 to $3.6 million for 2017, primarily due to higher interest earned on cash, cash equivalents, and marketable securities, offset in part by the net write-down of deferred financing costs resulting from the May 2017 amendment of our Senior Facility that reduced our borrowing capacity from $250.0 million to $100.0 million. Other income, net increased $2.8 million primarily due to an increase in foreign currency gains.

Income Tax Expense (Benefit)
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
2018 vs. 2017
 
2017 vs. 2016
 
 
 
 
 
 
 
$ Change
 
% Change
 
$ Change
 
% Change
 
(in thousands)
Income tax expense (benefit)
$
1,687

 
$
82,548

 
$
(6,518
)
 
$
(80,861
)
 
(98
)%
 
$
89,066

 
(1,366
)%
Effective tax rate
(0.9
)%
 
(42.4
)%
 
6.0
%
 
 
 
 
 
 
 
 
 
Income tax expense decreased $80.9 million, from an expense of $82.5 million for 2017 to an expense of $1.7 million for 2018. Our effective tax rate was (0.9)% and (42.4)% for 2018 and 2017, respectively. The decrease in income tax expense for 2018 was primarily due to the establishment of a full valuation allowance on our U.S. deferred tax assets in 2017, the mix of income or losses between our foreign jurisdictions, and pretax losses in jurisdictions for which no tax benefit will be recognized.

Income tax expense increased $89.1 million, from a benefit of $6.5 million for 2016 to an expense of $82.5 million for 2017. Our effective tax rate was (42.4)% and 6.0% for 2017 and 2016, respectively. The increase in income tax expense for 2017 was primarily due to establishment of a full valuation allowance on our U.S. deferred tax assets, partially offset by an anticipated carryback of losses incurred in 2017.
 
Liquidity and Capital Resources
 
Our operations have been financed primarily through cash flow from operating activities and net proceeds from the sale of our equity securities. As of December 31, 2018, we had cash and cash equivalents of $474.0 million and marketable securities of $249.5 million, approximately 85% of which are held on-shore by a U.S. legal entity.
 
Of our total cash, cash equivalents, and marketable securities, $111.3 million is held by our foreign subsidiaries. Our intent is to indefinitely reinvest our earnings from foreign operations and current plans do not anticipate that we will require funds generated from foreign operations to fund our domestic operations. In the event funds from foreign operations are needed to fund operations in the United States in the future, we may be required to accrue and pay additional taxes on repatriated funds at that time.

We believe our existing cash, cash equivalent, and marketable securities balances, and cash flow from operations will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our levels of revenue, the timing and extent of spending on research and development efforts and other business initiatives, the expansion of sales and marketing activities, the timing of new product introductions, market acceptance of our products, acquisitions, and overall economic conditions. To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in

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additional dilution to our stockholders. The incurrence of debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations.
 
Credit Facility

On November 21, 2018, we voluntarily terminated our Senior Facility. As of the date of termination, we did not have any outstanding borrowings under the Senior Facility but did have outstanding letters of credit totaling $36.6 million, issued to cover various security deposits on our facility leases. In connection with this termination, all outstanding letters of credit issued under the Senior Facility are being held with SVB on an unsecured basis. We did not incur any early termination penalties in connection with the termination of the Senior Facility. See Note 6 of the “Notes to Consolidated Financial Statements” included elsewhere in this Annual Report on Form 10-K for further details.

As of December 31, 2018, we had outstanding letters of credit of $36.6 million issued to cover various security deposits on our facility leases.

Cash Flows
 
The following table summarizes our cash flows for the periods indicated:
 
Year Ended December 31,
 
2018
 
2017
 
2016
 
(in thousands)
Net cash provided by (used in):
 
 
 
 
 
Operating activities
$
113,207

 
$
64,241

 
$
138,720

Investing activities
17,496

 
(28,718
)
 
(392,666
)
Financing activities
1,287

 
4,635

 
19,794

Net change in cash and cash equivalents
$
131,990

 
$
40,158

 
$
(234,152
)
 
Cash Flows from Operating Activities

Net cash provided by operating activities of $113.2 million for 2018 was primarily due to a decrease in net change in operating assets and liabilities of $122.8 million, which consisted of a decrease in prepaid expenses and other assets primarily due to the receipt of a $72 million income tax refund, and an increase in accounts payables, offset in part by an increase in inventory primarily related to Fitbit Charge 3 and Fitbit Versa, a decrease in accrued liabilities as a result of lower operating activity during the current period, and an increase in accounts receivables. The net change in operating assets and liabilities was also impacted by non-cash adjustments of $176.3 million, primarily resulting from stock-based compensation expense of $97.0 million, depreciation and amortization expense of $56.8 million, provision for inventory obsolescence of $11.8 million, write-off of property and equipment of $7.7 million and impairment loss from an equity investment of $6.0 million, partially offset by a net loss of $(185.8) million. Our days sales outstanding in accounts receivable, calculated as the number of days represented by the accounts receivable balance as of period end, decreased from 76 days as of December 31, 2017 to 70 days as of December 31, 2018 due to higher collections during the fourth quarter of 2018 compared to the fourth quarter of 2017.

Net cash provided by operating activities of $64.2 million for 2017 was primarily due to a decrease in net change in operating assets and liabilities of $1.1 million, which consisted of a decrease in inventory as a result of lower inventory purchases which decreased accounts payable and decreased accrued manufacturing expense and freight (included in accrued liabilities) as a result of lower operating activity during 2017, a decrease in account receivables resulting from higher collections and from taking a full reserve on Wynit’s outstanding account receivables, offset by an increase in prepaid expenses and other assets primarily from an increase in income tax receivable due to expected refunds from prior tax years and from an insurance receivable due to a litigation settlement. The net change in operating assets and liabilities was also impacted by non-cash adjustments of $340.3 million, primarily resulting from a valuation allowance recorded against our U.S. deferred tax assets of $173.8 million, stock-based compensation expense of $91.6 million, depreciation and amortization expense of $45.7 million, provision for inventory obsolescence of $14.8 million, and provision for doubtful accounts of $7.9 million, partially offset by a net loss of $277.2 million. Our days sales outstanding in accounts receivable, calculated as the number of days represented by the accounts receivable balance as of period end, decreased from 85 days as of December 31, 2016 to 76 days as of December 31, 2017 due to higher collections during the fourth quarter of 2017 compared to the fourth quarter of 2016.

Net cash provided by operating activities of $138.7 million for 2016 was primarily due to an increase in net change in operating assets and liabilities of $199.2 million and non-cash adjustments of $42.3 million, partially offset by a net loss of $102.8

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million. The increase in net change in operating assets and liabilities was primarily due to a $259.0 million increase in accounts payable and accrued liabilities, largely driven by increases in the product warranty reserve, sales rebates accruals, and reserves for excess components, partially offset by a $62.0 million increase in inventories, a $37.9 million increase in prepaid expenses and other assets, and an $8.7 million increase in accounts receivable. Non-cash adjustments primarily consisted of stock-based compensation expense, depreciation and amortization, and the abandonment of property and equipment, partially offset by deferred taxes. Our days sales outstanding in accounts receivable increased from 56 days as of December 31, 2015 to 85 days as of December 31, 2016 due to slower collections in the fourth quarter of 2016 as compared to the fourth quarter of 2015.
 
Cash Flows from Investing Activities
 
Net cash provided by investing activities for 2018 of $17.5 million was primarily due to maturities and sales of marketable securities of $443.6 million, partially offset by purchases of marketable securities of $353.9 million, purchases of property and equipment of $52.9 million, the cash portion of an acquisition of $13.6 million, net of cash acquired, and acquisition-related holdback payments of $5.6 million.

Net cash used in investing activities for 2017 of $28.7 million was primarily due to maturities and sales of marketable securities of $664.9 million, partially offset by purchases of marketable securities of $597.9 million, purchases of property and equipment of $89.2 million, an equity investment of $6.0 million, and an asset purchase of $0.6 million.

Net cash used in investing activities for 2016 of $392.7 million was due to the purchases of marketable securities of $638.1 million, partially offset by the sale and maturities of marketable securities of $362.3 million, purchases of property and equipment of $78.6 million, and the cash portion of acquisitions of $38.3 million, net of cash acquired.
 
We may continue to use cash in the future to acquire businesses and technologies that enhance and expand our product offerings. Due to the nature of these transactions, it is difficult to predict the amount and timing of such cash requirements to complete such transactions. We may be required to raise additional funds to complete future acquisitions.
 
Cash Flows from Financing Activities
 
Net cash provided by financing activities for 2018 of $1.3 million was primarily due to $21.5 million of proceeds from the exercise of stock options and stock purchases made through our 2015 Employee Stock Purchase Plan, or the 2015 ESPP, offset in part by $19.4 million in net cash used for payment of taxes on common stock issued under our employee equity incentive plans.

Net cash provided by financing activities for 2017 of $4.6 million was primarily due to $19.0 million of proceeds from the exercise of stock options and stock purchases made through our 2015 ESPP, offset in part by $14.4 million in net cash used for payment of taxes on common stock issued under our employee equity incentive plans.

Net cash provided by financing activities for 2016 of $19.8 million was primarily related to net proceeds from the issuance of common stock related to employee equity incentive plans of $21.0 million.

Contractual Obligations and Other Commitments
 
The following table summarizes our non-cancelable contractual obligations as of December 31, 2018:
 
Payments Due By Period
 
Total
 
Less than
1 Year
 
1-3
Years
 
3-5
Years
 
More than
5 Years
 
(in thousands)
Operating leases (1)
$
146,405

 
$
27,473

 
$
54,586

 
$
52,237

 
$
12,109

Capital leases
2,700

 
2,700

 

 

 

Total
$
149,105

 
$
30,173

 
$
54,586

 
$
52,237

 
$
12,109

(1)
Represents expected future minimum lease payments, net of minimum sublease rental income, under noncancellable operating leases for our facilities. See Note 7 of the “Notes to Consolidated Financial Statements” included elsewhere in this Annual Report on Form 10-K for further details.

Purchase orders or contracts for the purchase of certain goods and services are not included in the above table. The aggregate amount of open purchase orders as of December 31, 2018 was approximately $517.6 million, of which $185.0 million related to our transition to a third-party hosting provider and $2.9 million was accrued for as of December 31, 2018. We cannot determine the aggregate amount of such purchase orders that represent contractual obligations because purchase orders may represent authorizations to purchase rather than binding agreements. Our purchase orders are based on our current needs and are fulfilled

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by our suppliers, contract manufacturers, and logistics providers within short periods of time. We subcontract with other companies to manufacture our products.

During the normal course of business, we and our contract manufacturers procure components based upon a forecasted production plan. If we cancel all or part of the orders, or materially reduce forecasted orders, we may be liable to our suppliers and contract manufacturers for the cost of the excess components purchased by our contract manufacturers. As of December 31, 2018, approximately $10.8 million was accrued for such liabilities to contract manufacturers.
 
The table above excludes the liability for uncertain tax positions of $27.7 million as of December 31, 2018, due to the uncertainty of when the related tax settlements will become due.
 
Off-Balance Sheet Arrangements
 
We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.
 
Critical Accounting Polices and Estimates
 
Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s estimates, assumptions, and judgments.
 
Revenue Recognition
 
We recognize revenue upon transfer of control of promised goods or services to customers at transaction price, an amount that reflects the consideration we expect to receive in exchange for those goods or services. Transaction price is calculated as selling price net of variable consideration which may include estimates for future returns and sales incentives related to current period product revenue.

Products and Services

We derive substantially all of our revenue from sales of our wearable devices, which includes trackers, smartwatches and accessories. We also generate a small portion of revenue from our subscription-based services. We consider delivery of our products to have occurred once control has transferred and delivery of services to have occurred as control is transferred. We recognize revenue, net of estimated sales returns, sales incentives, discounts, and sales tax.

Arrangements with Multiple Performance Obligations

We enter into contracts that have multiple performance obligations that include hardware, software, and services. The first performance obligation is the hardware and firmware essential to the functionality of the tracker or smartwatch delivered at the time of sale. The second performance obligation is the software services included with the products, which are provided free of charge and enable users to sync, view, and access real-time data on our online dashboard and mobile apps. The third performance obligation is the embedded right included with the purchase of the device to receive, on a when-and-if-available basis, future unspecified firmware upgrades and features relating to the product’s essential firmware. In addition, we occasionally offer a fourth performance obligation in bundled arrangements that allows access to subscription-based services related to our Fitbit Coach offering.

We allocate revenue to all performance obligations based on their relative standalone selling prices (“SSP”). Our process for determining SSP considers multiple factors including consumer behaviors, our internal pricing model, and cost-plus margin, and may vary depending upon the facts and circumstances related to each deliverable. SSP for the trackers and smartwatches reflect our best estimate of the selling prices if they were sold regularly on a stand-alone basis and comprise the majority of the arrangement consideration. SSP for upgrade rights currently ranges from $1.00 to $3.00. SSP for the online dashboard and mobile apps is currently estimated at $0.99. SSP for access to Fitbit Coach subscription-based services is based on the price charged when sold separately.

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Amounts allocated to the delivered wearable devices are recognized at the time of delivery, provided the other conditions for revenue recognition have been met. Amounts allocated to the online dashboard and mobile apps and unspecified upgrade rights are deferred and recognized on a straight-line basis over the estimated usage period.

We offer our users the ability to purchase subscription-based services, through which the users receive incremental features, including access to a digital personal trainer, in-depth analytics regarding the user’s personal metrics, or video-based customized workouts. Amounts paid for subscriptions are deferred and recognized ratably over the service period, which is typically one year. Revenue from subscription-based services was less than 1% of revenue for all periods presented.

In addition, we offer subscription-based software and services to certain customers in Fitness Health Solutions, which includes a real-time dashboard, and the ability to create corporate challenges. SSP for the Fitness Health Solutions subscription is determined based on our internal pricing model for anticipated renewals for existing customers and pricing for new customers. Revenue allocated to the Fitness Health Solutions subscription is deferred and recognized on a straight-line basis over the estimated access period of one year, which is the typical service period. Revenue for Fitness Health Solutions software and services was less than 1% of revenue for all periods presented.

We apply a practical expedient to expense costs to obtain a contract with a customer as incurred when the amortization period would be one year or less. We apply a practical expedient to not consider the effect of a significant financing component as we expect that the period between transfer of control and payment from customer to be one year or less.

We account for shipping and handling fees billed to customers as revenue. Sales taxes and value added taxes, or VAT, collected from customers which are remitted to governmental authorities are not included in revenue, and are reflected as a liability on the consolidated balance sheets.
 
Rights of Return, Stock Rotation Rights, and Price Protection
 
We offer limited rights of return, stock rotation rights, and price protection under various policies and programs with our 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 the original sale.
All purchases through Fitbit.com are covered by a 45-day right of return.
Certain distributors are allowed stock rotation rights which are limited rights of return of products purchased during a prior period, generally one quarter.
Certain distributors are offered price protection that allows for the right to a partial credit for unsold inventory held by the distributor if we reduce the selling price of a product.
    
We estimate reserves for these policies and programs based on historical experience, and record the reserve as a reduction of revenue and an accrued liability. Through December 31, 2018, actual returns have primarily been open-box returns. 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 us to estimate expected future product returns. We review the actual returns evidenced in prior quarters as a percent of related revenue to determine the historical rate of returns. We then apply the historical rate of returns to the current period revenue as a basis for estimating future returns. When necessary, we also provide 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. We also consider whether there are circumstances which may result in anticipated returns higher than the historical return rate from direct customers and record 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.

Sales Incentives

We offer sales incentives through various programs, consisting primarily of cooperative advertising and pricing promotions to retailers and distributors. We record advertising with customers as a reduction to revenue unless we receive a distinct benefit in exchange for credits claimed by the customer and can reasonably estimate the fair value of the distinct benefit received, in

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which case we record it as a marketing expense. We recognize a liability and reduce revenue for rebates or other incentives based on the estimated amount of rebates or credits that will be claimed by customers.
 
Inventories
 
Inventories consist of finished goods and component parts, which are purchased from contract manufacturers and component suppliers. Inventories are stated at the lower of cost or net realizable value. We assess the valuation of inventory and periodically write down the value for estimated excess and obsolete inventory based upon estimates of future demand and market conditions.
 
Product Warranty
 
We offer a standard product warranty that our products will operate under normal use for a period of one-year from the date of original purchase, except in the European Union and certain Asia Pacific countries where we provide a two-year warranty. We have the obligation, at our 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 our typical experience. We regularly review these estimates to assess the appropriateness of our 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. Our products are manufactured by contract manufacturers, and in certain cases, we may have recourse against such contract manufacturers. Should actual product failure rates, use of materials or other costs differ from our estimates, additional warranty liabilities could be incurred, which could materially affect our 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.
 
Business Combinations, Goodwill, and Intangible Assets
 
We allocate the fair value of purchase consideration to tangible assets, liabilities assumed, and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is allocated to goodwill. The allocation of the purchase consideration requires management to make significant estimates and assumptions, especially with respect to intangible assets. These estimates can include, but are not limited to, future expected cash flows of acquired customers, acquired technology, and trade names from a market participant perspective, and estimates of useful lives, and discount rates. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is up to one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.
 
We assess goodwill for impairment at least annually during the fourth quarter and whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. Consistent with our determination that we have one operating segment, we have determined that there is one reporting unit and test goodwill for impairment at the entity level. We test goodwill using the two-step process in accordance with ASC 350, Intangibles—Goodwill and Other. In the first step, we compare the carrying amount of the reporting unit to the fair value based on the fair value of our common stock. If the fair value of the reporting unit exceeds the carrying value, goodwill is not considered impaired and no further testing is required. If the carrying value of the reporting unit exceeds the fair value, goodwill is potentially impaired and the second step of the impairment test must be performed. In the second step, we would compare the implied fair value of the goodwill, as defined by ASC 350, to our carrying amount to determine the amount of impairment loss, if any. We tested goodwill for impairment as of October 31, 2018 and 2017, and the fair value of our reporting unit exceeded the carrying value. We considered other factors in the performance of the annual goodwill impairment test in the fourth quarter of 2018, including assumptions about expected future revenue forecasts, changes in the overall economy, trends in our stock price, and other operating conditions. It is reasonably possible that we could perform significantly below our expectations or a deterioration of market and economic conditions could occur. This would adversely impact our ability to meet our projected results, which could cause our goodwill to become impaired. If we determine that our goodwill is impaired, we would be required to record a non-cash charge that could have a material adverse effect on our results of operations and financial position.
 
Acquired finite-lived intangible assets are amortized over their estimated useful lives. We evaluate the recoverability of our intangible assets for possible impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. We have not recorded any such impairment charge during the years presented.

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Income Taxes
 
We utilize the asset and liability method of accounting for income taxes, which requires the recognition of deferred tax assets and liabilities for expected future consequences of temporary differences between the financial reporting and income tax bases of assets and liabilities using enacted tax rates. We make estimates, assumptions, and judgments to determine our expense (benefit) for income taxes and also for deferred tax assets and liabilities and any valuation allowances recorded against our deferred tax assets. We assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we establish a valuation allowance.
 
The calculation of our income tax expense involves the use of estimates, assumptions, and judgments while taking into account current tax laws, our interpretation of current tax laws, and possible outcomes of future tax audits. We have established reserves to address potential exposures related to tax positions that could be challenged by tax authorities. Although we believe our estimates, assumptions, and judgments to be reasonable, any changes in tax law or our interpretation of tax laws and the resolutions of potential tax audits could significantly impact the amounts provided for income taxes in our consolidated financial statements.

The calculation of our deferred tax asset balance involves the use of estimates, assumptions, and judgments while taking into account estimates of the amounts and type of future taxable income. Actual future operating results and the underlying amount and type of income could differ materially from our estimates, assumptions and judgments, thereby impacting our financial position and operating results.
 
We include interest and penalties related to unrecognized tax benefits within income tax expense. Interest and penalties related to unrecognized tax benefits have been recognized in the appropriate periods presented.
 
Stock-Based Compensation
 
Stock-based compensation is measured at the grant date based on the fair value of the award and is recognized as expense, over the requisite service period, which is generally the vesting period of the applicable award.
 
Determining the fair value of stock-based awards at the grant date requires judgment.

The fair value of restricted stock units, or RSUs, without market conditions is the fair value of our common stock on the grant date. We estimate the fair value of RSUs subject to market conditions using a Monte Carlo simulation model. The determination of the fair value is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables including our expected stock price volatility over the expected term of the awards, and risk-free interest rates.

We use the Black-Scholes option-pricing model to determine the fair value of stock options and warrants and shares issued under our 2015 ESPP. The determination of the grant date fair value of stock options and warrants and shares issued under our 2015 ESPP using an option-pricing model is affected by our estimated common stock fair value as well as assumptions regarding a number of variables. These variables include the fair value of our common stock, our expected common stock price volatility over the expected life of the stock options and warrants, the expected term of the stock option and warrants, risk-free interest rates, and the expected dividends, which are estimated as follows:
 
Fair Value of Our Common Stock. The fair value of our stock options, warrants and RSUs are based on the closing price of our Class A common stock as reported on the New York Stock Exchange on the date of grant.
 
Expected Term. The expected term represents the period over which we anticipate stock-based awards to be outstanding. We do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time stock-based awards have been exercisable. As a result, for stock options and warrants, we used the simplified method to calculate the expected term estimate based on the vesting and contractual terms of the stock option. Under the simplified method, the expected term is equal to the average of the stock-based award’s weighted average vesting period and its contractual term. The expected term of equity awards issued under our 2015 ESPP is the contractual term.

Volatility. Expected volatility is a measure of the amount by which the stock price is expected to fluctuate. Prior to 2018, we estimated the expected volatility of the common stock underlying our stock options, warrants and equity awards issued under our 2015 ESPP at the grant date by taking the average historical volatility of the common stock of a group of comparable publicly traded companies over a period equal to the expected life. We used this method because we had limited information on the volatility of our Class A common stock because of our short trading history. Beginning in 2018, we now use a combination of historical volatility from our Class A common stock along with historical volatility from the group of comparable publicly traded companies.
 

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Risk-Free Rate. The risk-free interest rate is the estimated average interest rate based on U.S. Treasury zero-coupon notes with terms consistent with the expected term of the awards.
 
Dividend Yield. We have never declared or paid any cash dividends and do not presently plan to pay cash dividends in the foreseeable future. Consequently, we used an expected dividend yield of zero.
 
The assumptions used in calculating the fair value of the stock-based awards represent management judgment. As a result, if factors change and different assumptions are used, the stock-based compensation expense could be materially different in the future.
 

Recent Accounting Pronouncements

See Note 2, “Significant Accounting Policies,” in the notes to our consolidated financial statements for a full description of recent accounting pronouncements, including expected dates of adoption and estimated effects on results of operations and financial condition.


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