As discussed in the section titled "Note About Forward-Looking Statements," the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and in the section titled "Risk Factors" included under Part II, Item 1A below. Overview 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 engagements. Our wearable devices enable users to view data about their daily activity, exercise, and sleep in real time. Today, most of our revenue comes from the sale of wearable devices, including both trackers and smartwatches. Our products are available in over 100 countries worldwide through a variety of channels, including retail stores, retailer websites, and Fitbit.com, and through FitbitHealth Solutions . OnNovember 1, 2019 , we entered into an Agreement and Plan of Merger, or Merger Agreement, with Google LLC, or$7.35 per share in cash, valuing us at a fully diluted equity value of approximately$2.1 billion . Under the terms of, and subject to the conditions specified in, the Merger Agreement, we will become a wholly owned subsidiary ofJanuary 3, 2020 . The Merger is subject to customary closing conditions, including regulatory approvals. The duration of regulatory approvals cannot be foreseen with certainty. While the Merger is expected to close in 2020, the time frame may extend beyond that. The Merger Agreement may be terminated by mutual agreement of the parties or by either us or$80 million in certain circumstances, such as a material, uncured breach of our obligations under the Merger Agreement, and$250 million in certain circumstances related to a failure to obtain regulatory approvals or the existence of a restraint arising under the antitrust laws. Our business during the first three quarters of 2020 was negatively affected by the outbreak of the novel coronavirus COVID-19. As discussed further below, we expect the COVID-19 pandemic and associated mitigation efforts to continue to negatively impact our results in 2020, although the nature and extent will depend on future developments that are evolving and highly uncertain. We remain committed to our mission to empower and inspire people to live healthier, more active lives, while prioritizing the health and safety of our workforce. In the first three quarters of 2020, we focused on adding offerings for users looking to manage their overall health. In the third quarter of 2020, we introduced three new devices: Fitbit Sense, the world's first smartwatch with an electrodermal activity (EDA) sensor to help manage stress; Fitbit Versa 3, adding on-device GPS and a speaker to our most popular smartwatch family; and Fitbit Inspire 2, an enhanced version of our most affordable heart rate tracking device. With the purchase of Fitbit Sense and Fitbit Inspire 2, we offer a six-month and one-year free trial to Fitbit Premium, respectively, while certain other Fitbit devices offer a three-month free trial to Fitbit Premium. In the first quarter of 2020, we introduced Fitbit Charge 4, which innovates on our Charge family of trackers with built-in GPS. Additionally, we added more content to Fitbit Premium, our paid subscription service offering personalized health insights, guidance, advanced sleep tools, customized programs, mindfulness content, and over 200 workouts from various brands. To help support our users during the COVID-19 pandemic, in the first quarter of 2020, we announced a 90-day free trial for new Fitbit Premium users and, in the third quarter of 2020, Fitbit Premium reached over 500,000 paid subscribers during its first year since launch. During the third quarter of 2020, we also launched Fitbit Premium + Health Coaching, a virtual one-on-one coaching service matching users to a dedicated certified health professional to create personalized plans using their Fitbit data. Acquiring customers through the sale of our devices 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 continued to be immaterial in the first three quarters of 2020, we believe a growing community of active users provides an opportunity to introduce or further develop software services for our community in the future. We continue to focus on growing ourFitbit Health Solutions channel, which delivers health and wellness solutions for employers, health plans, and health systems and provides an opportunity to drive demand for our devices and software services. Revenue from the Fitbit Health Solutions channel was approximately 8% of total revenue in the first three quarters of 2020. 28
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For the full year 2020, we expect devices sold and revenue to decline compared to full year 2019 primarily as a result of the impact of the COVID-19 pandemic discussed further below, as well as due to the timing of our new product launches. We expect smartwatches to grow as a percentage of revenue compared to the prior year. We expect growth in our higher margin Fitbit Premium and FitbitHealth Solutions revenue streams in 2020 compared to 2019. We expect research and development expenses to increase for the full year 2020 over 2019 as we increase our investment into the expanding wearable device market, which we anticipate will be partially offset by a projected decrease in sales and marketing and general and administrative expenses, with the exception of higher costs related to the Merger Agreement.
Impact of COVID-19
The outbreak of the novel coronavirus COVID-19, which was declared a global pandemic by theWorld Health Organization inMarch 2020 , adversely impacted our business in the first three quarters of 2020. The pandemic and associated containment measures have caused disruptions in the development, manufacture, shipment, and sales of our products. Such disruptions have been due primarily to temporary closures of our facilities, those of our customers and retailerswho sell our products, and those of our contract manufacturers and other supply chain vendors; difficulties in transporting goods and materials; restrictions on travel; and quarantines, stay-at-home orders, and social distancing guidelines in effect in many of the regions in which we operate. In addition, the COVID-19 pandemic and related mitigation efforts have disrupted the economies ofthe United States and numerous other countries, which is impacting consumer sentiment and discretionary spending. We have temporarily closed our headquarters inSan Francisco, California and other facilities worldwide to protect the health of our employees. We have implemented a work-from-home policy for the majority of our global workforce and we are severely restricting business travel, in light of the recommendations or requirements of government authorities. The costs to implement our work-from-home policy during the first three quarters of 2020 were not material. We will continue to monitor the situation to determine suitable actions, which may vary by location. For example, we may adapt or extend our work-from-home policy beyond what is required by government authorities as we believe to be appropriate for the health and safety of our workforce or in our best interests, although such actions could adversely impact the efficiency and effectiveness of our organization. During the first three quarters of 2020, our operating results were negatively impacted by decreased retail activity and retail store closures due to COVID-19, which was partially offset by increased revenue from our direct channel, Fitbit.com. Operating results were also impacted by additional reserves for product returns, rebates and promotions, and price protection on certain products, primarily as a result of declining demand due to COVID-19. The current circumstances are dynamic and unprecedented, and the impacts of the COVID-19 pandemic on our business operations, including the duration and severity of the effect on overall consumer demand, are highly uncertain and cannot be predicted. However, these impacts have had, and we expect will continue to have, a significant adverse effect on our operations, revenue, liquidity, financial conditions, and financial results. The impact will depend largely on future developments, including the duration and severity of the pandemic; potential resurgence(s) of COVID-19 in the future; the effectiveness of actions taken by governments, businesses, and individuals in response to COVID-19; the stability of capital and financial markets; and how quickly and to what extent economic and operating conditions that pre-dated the pandemic can resume. We are focused on preserving our liquidity and managing our cash flow through the financial challenges presented by COVID-19 by reducing our discretionary spending, closely managing inventory levels, and reducing marketing spend. While we have been significantly impacted by the COVID-19 pandemic, we believe, based on our current forecasts, that we have sufficient liquidity to meet our working capital and capital expenditure needs through the anticipated closing of the Merger with
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Financial Highlights
The following are financial highlights for the three and nine months ended
Three Months Ended Nine Months Ended October 3, 2020 September 28, 2019 October 3, 2020 September 28, 2019 Revenue$ 363,932 $ 347,200$ 813,362 $ 932,646 Net loss$ (54,452) $ (51,893)$ (138,255) $ (199,876) Adjusted EBITDA $ (34) $ (19,439)$ (108,133) $ (93,455) Devices sold 3,303 3,540 7,943 9,999
See the section titled "Key Business Metrics" for additional information regarding devices sold and adjusted EBITDA, including a reconciliation of adjusted EBITDA to net income (loss).
Key Business Metrics
In addition to the measures presented in our condensed consolidated financial statements, we use the following key metrics to evaluate our business, measure our performance, develop financial forecasts, and make strategic decisions.
Devices Sold
Devices sold represents the number of wearable devices that are sold during a period, net of expected returns. 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 differingU.S. manufacturer's suggested retail prices, the effect of rebates and promotions, and sales of accessories and premium services.
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 userwho 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 Userwho 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 and nine months endedOctober 3, 2020 , 53.9% and 45.1%, respectively, of Activations came from Repeat Users, with Re-Activated Users representing 53.1% and 55.5%, respectively, of those Repeat Users. The number of Activations from Repeat Users and the number of Re-Activated Users for any period is measured promptly after the measurement period and is not updated. 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.
Active Users
We grow our community of users through device sales and investment in software to drive engagement. We define an active user as a registered Fitbit userwho , within the three months prior to the date of measurement, has (a) an active Fitbit Premium or 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 userswho joined the community during the past 90 days, existing userswho have remained active, or previously active userswho were inactive for 90 days or greater, if they meet the preceding definition of an active user. The active user number includes userswho have downloaded our mobile apps without purchasing any of our wearable devices for userswho have downloaded free versions of Fitbit Premium but are not subscribers to its paid premium offerings. 30
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Adjusted EBITDA
To supplement our condensed consolidated financial statements presented in accordance withU.S. GAAP, we monitor and consider adjusted EBITDA, which is a non-GAAP financial measure. This non-GAAP financial measure is not based on any standardized methodology prescribed byU.S. GAAP and is not necessarily comparable to similarly titled measures presented by other companies. We define adjusted EBITDA as net loss adjusted to exclude stock-based compensation expense, acquisition-related costs, the impact of restructuring, depreciation and intangible assets amortization, interest income (expense), net, and income tax expense (benefit). We use adjusted EBITDA to evaluate our operating performance and trends and make planning decisions. We believe that adjusted EBITDA helps identify underlying trends in our business that could otherwise be masked by the effect of the expenses and other items that we exclude in adjusted EBITDA. In particular, exclusion of the effect of stock-based compensation expense and certain other 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, enhances overall understanding of our past performance and future prospects, and allows 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 withU.S. GAAP, and should not be considered in isolation of, or as an alternative to, measures prepared in accordance withU.S. GAAP. There are a number of limitations related to the use of this non-GAAP financial measure rather than net loss, which is the nearestU.S. GAAP equivalent of adjusted EBITDA. For example, adjusted EBITDA excludes stock-based compensation expense, which has been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy. Accordingly, adjusted EBITDA should be considered along with other operating and financial performance measures presented in accordance withU.S. GAAP. The following table presents a reconciliation of net loss to adjusted EBITDA (in thousands): Three Months Ended Nine Months Ended October 3, 2020 September 28, 2019 October 3, 2020 September 28, 2019 Net loss (54,452) (51,893) (138,255) (199,876) Stock-based compensation expense 18,377 18,084 57,877 59,175 Acquisition-related costs 18,239 - 57,166 - Restructuring - - - 2,458 Depreciation and intangible assets amortization 13,563 15,089 41,683 49,314 Interest expense (income), net 268 (2,388) (1,038) (8,476) Income tax expense (benefit) 3,971 1,669 (125,566) 3,950 Adjusted EBITDA$ (34) $ (19,439)$ (108,133) $ (93,455) Non-GAAP Free Cash Flow We define non-GAAP 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 our balance sheet, but it is not intended to represent the residual cash flow available for discretionary expenditures. 31
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The following table presents a reconciliation of net cash used in operating activities to non-GAAP free cash flow (in thousands):
Nine Months
Ended
October 3, 2020
Net cash used in operating activities$ (62,608) $ (185,112) Purchase of property and equipment (22,419) (26,277) Non-GAAP free cash flow$ (85,027) $ (211,389) Net cash provided by investing activities$ 118,723 $ 7,277 Net cash used in financing activities$ (17,210) $ (8,690)
Components of our Operating Results
Revenue
We have three sources of revenue: consumer device revenue,Fitbit Health Solutions revenue, and consumer services 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 composed of devices, services, and software, with most of our revenue driven by device sales. Consumer services revenue includes revenue from our Premium subscription and extended warranty offerings.
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, platform fees associated with consumer services revenue, 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, and general and administrative expenses.
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, point-of-purchase 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. 32
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Other Income (Expense), Net
Other income (expense), net consists of foreign currency gains and losses.
Income Tax Expense (Benefit)
We are subject to income taxes inthe United States and foreign jurisdictions in which we do business. These foreign jurisdictions have statutory tax rates different from those inthe United States . Accordingly, our effective tax rates will vary depending on the relative proportion of foreign toU.S. income and changes in tax laws. OnMarch 27, 2020 , the CARES Act was signed into law. The CARES Act includes, among other items, provisions relating to refundable payroll tax credits, deferment of the employer portion of certain payroll taxes, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. The CARES Act allows losses incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding tax years and to offset 100% of regular taxable income in such years. We anticipate that, as a result of the CARES Act, some of the net operating losses generated in 2020, and all of the net operating losses generated in 2018 and 2019, will be carried back to prior taxable years resulting in material cash benefits to us. We will continue to evaluate the potential impact of the CARES Act.The U.S. Treasury Department has adopted regulations requiring related parties in an intercompany cost-sharing arrangement to share expenses related to share-based compensation in proportion to the economic activity of the related parties. OnJune 7, 2019 , theU.S. Court of Appeals for the Ninth Circuit issued an opinion inAltera Corp. v. Commissioner upholding these regulations, which reversed the prior decision of theU.S. Tax Court. OnNovember 12, 2019 , theNinth Circuit Court of Appeals denied the plaintiff's request for an en banc rehearing. The plaintiff filed a petition for a writ of certiorari in theU.S. Supreme Court onFebruary 10, 2020 . OnJune 22, 2020 , theU.S. Supreme Court declined to issue a writ of certiorari in the Altera v. Commissioner case. The actions of theU.S. Supreme Court did not have a material impact on our consolidated financial statements.
Operating Results
The following tables set forth the components of our condensed consolidated statements of operations for each of the periods presented and as a percentage of our revenue for those periods (in thousands, except percentages). The period-to-period comparison of operating results is not necessarily indicative of results for future periods. Three Months Ended Nine Months Ended October 3, 2020 September 28, 2019 October 3, 2020 September 28, 2019 Consolidated Statements of Operations Data: Revenue$ 363,932 $ 347,200$ 813,362 $ 932,646 Cost of revenue(1) 228,120 239,248 529,586 627,027 Gross profit 135,812 107,952 283,776 305,619 Operating expenses: Research and development(1) 90,771 65,693 256,093 213,651 Sales and marketing(1) 60,726 71,296 183,157 222,972 General and administrative(1) 35,493 23,083 112,583 74,640 Total operating expenses 186,990 160,072 551,833 511,263 Operating loss (51,178) (52,120) (268,057) (205,644) Interest income (expense), net (268) 2,388 1,038 8,476 Other income (expense), net 965 (492) 3,198 1,242 Loss before income taxes (50,481) (50,224) (263,821) (195,926) Income tax expense (benefit) 3,971 1,669 (125,566) 3,950 Net loss$ (54,452) $ (51,893)$ (138,255) $ (199,876) 33
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(1)Includes stock-based compensation expense as follows (in thousands):
Three Months Ended Nine Months Ended October 3, 2020 September 28, 2019 October 3, 2020 September 28, 2019 Stock-Based Compensation Expense: Cost of revenue $ 1,846 $ 1,446 $ 6,059 $ 4,397 Research and development 10,633 10,557 33,194 34,437 Sales and marketing 2,701 2,587 8,376 8,900 General and administrative 3,197 3,494 10,248 11,441
Total stock-based compensation expense
18,084 $ 57,877 $ 59,175 Three Months Ended Nine Months Ended October 3, 2020 September 28, 2019 October 3, 2020 September 28, 2019 (as a percentage of revenue) Consolidated Statements of Operations Data: Revenue 100 % 100 % 100 % 100 % Cost of revenue 63 69 65 67 Gross profit 37 31 35 33 Operating expenses: Research and development 24 19 30 23 Sales and marketing 17 21 23 24 General and administrative 10 7 14 8 Total operating expenses 51 46 67 55 Operating loss (14) (15) (32) (22) Interest income (expense), net - 1 - 1 Other income (expense), net - - - - Loss before income taxes (14) (14) (32) (21) Income tax expense (benefit) 1 - (15) - Net loss (15) % (15) % (17) % (21) % Revenue Three Months Ended Change Nine Months Ended Change October 3, October 3, (dollars in thousands) 2020 September 28, 2019 $ % 2020 September 28, 2019 $ % Revenue$ 363,932 $ 347,200$ 16,732 5 %$ 813,362 $ 932,646$ (119,284) (13) % Revenue increased$16.7 million , or 5%, to$363.9 million for the three months endedOctober 3, 2020 , from$347.2 million for the three months endedSeptember 28, 2019 , primarily as a result of a higher smartwatch mix due to the introduction of our two new smartwatches in the third quarter of 2020, as well as an increase in average selling price. Sales of smartwatches increased to 60% of revenue for the third quarter of 2020 from 59% of revenue for the same period in 2019, while demand for trackers decreased to 36% of revenue from 40% of revenue in the same period in 2019. As a result of new product launches in the third quarter of 2020 with innovative features at higher price points, average selling price increased by 8% to$104 for the third quarter of 2020, from$96 in the third quarter of 2019. As a result of fewer new product introductions, or NPIs, of smartwatches and trackers in 2020 compared to 2019, revenue from NPIs decreased to$187.9 million , or 52% of revenue, in the third quarter of 2020, from$211.7 million , or 61% of revenue, during the third quarter of 2019. Total devices sold decreased 7% year over year, to 3.3 million devices sold in the third quarter of 2020, from 3.5 million devices sold during the same period in 2019. Revenue from our direct channel, Fitbit.com, increased 54% to$42.0 million , or 12% of revenue, in the three months endedOctober 3, 2020 , compared to$27.2 million , or 8% of revenue, in the same period in 2019. 34
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Revenue decreased$119.3 million or 13%, to$813.4 million for the nine months endedOctober 3, 2020 , from$932.6 million for the nine months endedSeptember 28, 2019 , primarily as a result of decreased retail activity and retail store closures due to COVID-19 during the first half of 2020. The decrease in retail revenue was partially offset by an increase in revenue from our direct channel, Fitbit.com, which increased 47% to$131.0 million , or 16% of revenue, in the nine months endedOctober 3, 2020 , compared to$88.8 million , or 10% of revenue, in the same period in 2019. As a result of the increased revenue from our direct channel, which experiences fewer discounts and returns, our recent new product launches with innovative features at higher price points, and fewer promotions compared to the prior year, average selling price increased by 5% to$96 for the first three quarters of 2020, from$91 for the first three quarters of 2019. As a result of fewer product introductions of smartwatches and trackers in 2020 compared to 2019, revenue from NPIs decreased to$482.9 million , or 59% of revenue, during the first three quarters of 2020, from$606.8 million , or 65% of revenue, during the first three quarters of 2019. Total devices sold decreased 21% year over year, to 7.9 million devices sold in the first three quarters of 2020, from 10.0 million devices sold during the same period in 2019. Sales of our smartwatches increased to 53% of revenue for the first three quarters of 2020 from 47% of revenue for the same period in 2019, while demand for our trackers decreased to 43% of revenue for the first three quarters of 2020, from 52% of our revenue in the same period in 2019.U.S. revenue, based on ship-to destinations, decreased$11.7 million , or 6%, to$195.0 million for the three months endedOctober 3, 2020 , from$206.7 million for the three months endedSeptember 28, 2019 . International revenue, based on ship-to destinations, increased$28.4 million , or 20%, to$168.9 million for the three months endedOctober 3, 2020 , from$140.5 million for the three months endedSeptember 28, 2019 , primarily due to an increase of 23% in theEurope ,Middle East , andAfrica region.U.S. revenue decreased$60.8 million , or 12%, to$461.8 million for the nine months endedOctober 3, 2020 , from$522.6 million for the nine months endedSeptember 28, 2019 . International revenue decreased$58.4 million , or 14%, to$351.6 million for the nine months endedOctober 3, 2020 , from$410.0 million for the nine months endedSeptember 28, 2019 , primarily due to a decrease of 28% in theAsia Pacific region. The increase in revenue from our direct channel, Fitbit.com, was primarily inthe United States for the nine months endedOctober 3, 2020 . Cost of Revenue Three Months Ended Change Nine Months Ended Change
(dollars in thousands)
$ % October 3, 2020 September 28, 2019 $ % Cost of revenue$ 228,120 $ 239,248$ (11,128) (5) %$ 529,586 $ 627,027$ (97,441) (16) % Gross profit 135,812 107,952 27,860 26 % 283,776 305,619 (21,843) (7) % Gross margin 37 % 31 % 35 % 33 % Cost of revenue decreased to$228.1 million for the three months endedOctober 3, 2020 , from$239.2 million for the three months endedSeptember 28, 2019 . The decrease in cost of revenue was due to a$13.5 million reduction in product costs and a$7.6 million reduction in warranty expense, both associated with the decreases in devices sold compared to the same period in 2019, as well as a$4.5 million decrease in excess and obsolete inventory write-downs compared to the prior period. The reduction in warranty expense was also associated with lower customer support contact rates due to the improved quality of our products. The decrease in cost of revenue was partially offset by a$6.1 million increase in platform fees associated with an increase in consumer services revenue. Cost of revenue decreased to$529.6 million for the nine months endedOctober 3, 2020 , from$627.0 million for the nine months endedSeptember 28, 2019 . In the first quarter of 2020, we were granted an exclusion from tariffs on our products manufactured inChina , resulting in a$21.3 million benefit during the period for tariff costs incurred in 2019. The decrease in cost of revenue for the nine months endedOctober 3, 2020 was also due to a$76.8 million reduction in product costs and a$13.7 million reduction in warranty expense, both associated with the decreases in devices sold compared to the same period in 2019, as well as an$8.6 million decrease in excess and obsolete inventory write-downs compared to the prior period. The reduction in warranty expense was also associated with lower customer support contact rates due to the improved quality of our products. The decrease in cost of revenue was partially offset by a$11.1 million increase in platform fees associated with an increase in consumer services revenue and a$4.0 million increase in shipping and handling costs due to the increase in shipments in our direct channel, Fitbit.com. Gross margin increased to 37% for the three months endedOctober 3, 2020 , from 31% for the three months endedSeptember 28, 2019 , primarily due to a decrease in discounts, rebates and promotions, an increase in consumer services revenue, and an increase in revenue from our direct channel, Fitbit.com. 35
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Gross margin increased to 35% for the nine months endedOctober 3, 2020 , from 33% for the nine months endedSeptember 28, 2019 , primarily due to a decrease in discounts, rebates and promotions, lower warranty costs, an increase in consumer services revenue, and an increase in revenue from our direct channel, Fitbit.com. The increase in gross margin was also driven by the benefit of the tariffs exclusion during the first three quarters of 2020. Research and Development Three Months Ended Change Nine Months Ended Change October 3, (dollars in thousands) October 3, 2020 September 28, 2019 $ % 2020 September 28, 2019 $ % Research and development$ 90,771 $ 65,693$ 25,078 38 %$ 256,093 $ 213,651$ 42,442 20 % Research and development expenses increased$25.1 million , or 38%, to$90.8 million for the three months endedOctober 3, 2020 , from$65.7 million for the three months endedSeptember 28, 2019 . The increase was primarily due to a$21.4 million increase in personnel-related expenses, including bonuses connected with the Merger, and a$3.3 million increase in tooling expenses, offset by a$1.7 million decrease in travel expenses. Headcount increased 13% for the three months endedOctober 3, 2020 compared to the prior year period. Research and development expenses increased$42.4 million , or 20%, to$256.1 million for the nine months endedOctober 3, 2020 , from$213.7 million for the nine months endedSeptember 28, 2019 . The increase was primarily due to a$39.0 million increase in personnel-related expenses, including bonuses connected with the Merger, and a$3.9 million increase in tooling expenses, offset by a$3.8 million decrease in travel expenses. Headcount increased 4% for the nine months endedOctober 3, 2020 compared to the prior year period. Sales and Marketing Three Months Ended Change Nine Months Ended Change October 3, (dollars in thousands) October 3, 2020 September 28, 2019 $ % 2020 September 28, 2019 $ % Sales and marketing$ 60,726 $ 71,296$ (10,570) (15) %$ 183,157 $ 222,972$ (39,815) (18) % Sales and marketing expenses decreased$10.6 million , or 15%, to$60.7 million for the three months endedOctober 3, 2020 , from$71.3 million for the three months endedSeptember 28, 2019 . The decrease was primarily due to a$15.2 million reduction in marketing expenses due to timing of media spend to support product launches and a$1.7 million decrease in customer support costs due to the improved quality and reduced case volume of our products, offset by an increase of$5.2 million in personnel-related expenses, including bonuses connected with the Merger. Headcount decreased 1% for the three months endedOctober 3, 2020 compared to the prior year period. Sales and marketing expenses decreased$39.8 million , or 18%, to$183.2 million for the nine months endedOctober 3, 2020 , from$223.0 million for the nine months endedSeptember 28, 2019 . The decrease was primarily due to a$43.9 million reduction in marketing expenses due to timing of media spend to support product launches, an$8.1 million decrease in customer support costs due to the improved quality and reduced case volume of our products, and a$2.0 million decrease in travel expenses, offset by an increase of$8.3 million in personnel-related expenses, including bonuses connected with the Merger. Headcount increased 1% for the nine months endedOctober 3, 2020 compared to the prior year period. General and Administrative Three Months Ended Change Nine Months Ended Change October 3, (dollars in thousands) October 3, 2020 September 28, 2019 $ % 2020 September 28, 2019 $ % General and administrative$ 35,493 $ 23,083$ 12,410 54 %$ 112,583 $ 74,640$ 37,943 51 % General and administrative expenses increased$12.4 million , or 54%, to$35.5 million for the three months endedOctober 3, 2020 , from$23.1 million for the three months endedSeptember 28, 2019 . The increase was primarily due to an$8.9 million increase in personnel-related expenses, including bonuses connected with the Merger, a$7.2 million increase in legal fees primarily related to litigation, and a$4.3 million increase in consulting and legal fees related to the Merger Agreement with 36
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$5.6 million decrease in credit loss allowances. Headcount decreased 3% for the three months endedOctober 3, 2020 compared to the prior year period. General and administrative expenses increased$37.9 million , or 51%, to$112.6 million for the nine months endedOctober 3, 2020 , from$74.6 million for the nine months endedSeptember 28, 2019 . The increase was primarily due to$16.9 million in consulting and legal fees related to the Merger Agreement with$16.1 million increase in legal fees primarily related to litigation, and a$10.7 million increase in personnel-related expenses, including bonuses connected with the Merger, offset by a$4.0 million decrease in allocated overhead. Headcount decreased 1% for the nine months endedOctober 3, 2020 compared to the prior year period.
Interest and Other Income (Expense), Net
Three Months Ended Change Nine Months Ended Change (dollars in thousands) October 3, 2020 September 28, 2019 $ % October 3, 2020 September 28, 2019 $ % Interest income (expense), net$ (268) $ 2,388$ (2,656) (111) % $ 1,038 $ 8,476$ (7,438) (88) % Other income (expense), net 965 (492) 1,457 (296) % 3,198 1,242 1,956 157 % Interest income (expense), net decreased$2.7 million , to an expense of$0.3 million for the three months endedOctober 3, 2020 , from income of$2.4 million for the three months endedSeptember 28, 2019 , primarily due to decreases in cash, cash equivalents, and marketable securities balances, as well as lower interest rates earned. Other income (expense), net increased primarily due to an increase in foreign currency gains. Interest income (expense), net decreased$7.4 million , to$1.0 million for the nine months endedOctober 3, 2020 , from$8.5 million for the nine months endedSeptember 28, 2019 , primarily due to decreases in cash, cash equivalents, and marketable securities balances, as well as lower interest rates earned. Other income (expense), net increased primarily due to an increase in foreign currency gains. Income Tax Expense (Benefit) Three Months Ended Change Nine Months Ended Change (dollars in thousands) October 3, 2020 September 28, 2019 $ % October 3, 2020 September 28, 2019 $ % Income tax expense (benefit)$ 3,971 $ 1,669$ 2,302 138 %$ (125,566) $ 3,950$ (129,516) (3,279) % Effective tax rate (7.9) % (3.3) % 47.6 % (2.0) % Income tax expense increased$2.3 million , to an income tax expense of$4.0 million for the three months endedOctober 3, 2020 , from an income tax expense of$1.7 million for the three months endedSeptember 28, 2019 . Our effective tax rate was (7.9)% and (3.3)% for the three months endedOctober 3, 2020 andSeptember 28, 2019 , respectively. The change in our effective tax rate for the three months endedOctober 3, 2020 was primarily due to the impact of carrying back current year, 2018 and 2019 net operating losses into prior taxable periods under the provisions adopted under the CARES Act. The tax expense for the three months endedOctober 3, 2020 includes a true-up to the tax benefit recorded through the second quarter of 2020 for the carryback of net operating losses due to changes in the mix of income/losses between our jurisdictions in the third quarter of 2020. Income tax expense decreased$129.5 million , to an income tax benefit of$125.6 million for the nine months endedOctober 3, 2020 , from an income tax expense of$4.0 million for the nine months endedSeptember 28, 2019 . Our effective tax rate was 47.6% and (2.0)% for the nine months endedOctober 3, 2020 andSeptember 28, 2019 , respectively. The change in our effective tax rate for the nine months endedOctober 3, 2020 was primarily due to the impact of carrying back current year, 2018 and 2019 net operating losses into prior taxable periods under the provisions adopted under the CARES Act. 37
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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 ofOctober 3, 2020 , we had cash and cash equivalents of$373.4 million and marketable securities of$43.1 million , approximately 72% of which are held by aU.S. legal entity inthe United States . Of our total cash, cash equivalents, and marketable securities,$117.2 million is held by our foreign subsidiaries. Our intent is to indefinitely reinvest our earnings from foreign operations, and based on our current plans, we do not anticipate that we will require funds generated from foreign operations to fund our domestic operations. In the event funds from foreign operations are needed to fund operations inthe United States in the future, we may be required to accrue and pay additional taxes on repatriated funds at that time. While we have been significantly impacted by the COVID-19 pandemic, we believe, based on our current forecasts, that we have sufficient liquidity to meet our working capital and capital expenditure needs through the anticipated closing of the Merger with
Letters of Credit
As of
Cash Flows
The following table summarizes our cash flows for the periods indicated (in thousands):
Nine Months Ended October 3, 2020 September 28, 2019 Net cash provided by (used in): Operating activities$ (62,608) $ (185,112) Investing activities 118,723 7,277 Financing activities (17,210) (8,690)
Net change in cash and cash equivalents $ 38,905 $ (186,525)
Cash Flows from Operating Activities
Net cash used in operating activities of$62.6 million for the nine months endedOctober 3, 2020 was primarily due to our net loss of$138.3 million , partially offset by total non-cash adjustments of$115.3 million and a decrease in net operating assets and liabilities of$39.7 million . The decrease in net operating assets and liabilities compared to the first three quarters of 2019 included a decrease in accounts receivable of$76.4 million and a decrease in inventory of$21.4 million , offset by a decrease in accounts payable and accrued liabilities of$89.8 million , and an increase in prepaid expenses and other assets of$9.1 million . The$115.3 million total non-cash adjustments for the first three quarters of 2020 included stock-based compensation expense of$57.9 million , depreciation expense of$33.3 million , provision for inventory obsolescence of$14.2 million , non-cash lease expense of$11.1 million , and intangible assets amortization of$8.4 million . Our days sales outstanding in accounts receivable, calculated as the number of days represented by the accounts receivable balance as of period end, increased from 74 days as ofDecember 31, 2019 , to 78 days as ofOctober 3, 2020 , due to slower collections during the third quarter of 2020 compared to the fourth quarter of 2019. 38
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Cash Flows from Investing Activities
Net cash provided by investing activities for the nine months endedOctober 3, 2020 of$118.7 million was due to maturities and sales of marketable securities of$200.9 million , offset by purchases of marketable securities of$59.7 million and purchases of property and equipment of$22.4 million .
Cash Flows from Financing Activities
Net cash used in financing activities for the nine months endedOctober 3, 2020 was due to$18.8 million in net cash used for payment of taxes on Class A common stock issued under our employee equity incentive plans and$1.4 million paid for financing leases, offset by$3.0 million in proceeds from the exercise of stock options.
Contractual Obligations and Other Commitments
Our future minimum lease payments under our operating leases as of
The aggregate amount of open purchase orders as ofOctober 3, 2020 was approximately$430.5 million . Of the aggregate amount,$156.9 million related to our migration to a third-party hosting provider, of which$17.3 million was accrued for as ofOctober 3, 2020 . 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 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, in certain circumstances we may be liable to our suppliers and contract manufacturers for the cost of the excess components purchased by our contract manufactures. As ofOctober 3, 2020 ,$7.9 million was accrued for such liabilities to contract manufacturers.
We have recorded a liability for uncertain tax positions of
Off-Balance Sheet Arrangements
As of
Critical Accounting Polices and Estimates
Our management's discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance withU.S. GAAP. The preparation of these condensed 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.
There have been no material changes to our critical accounting policies and
estimates from those disclosed in our Annual Report on Form 10-K for the fiscal
year ended
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