FITBIT, INC. 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 over 100 countries worldwide through a variety of channels, including over 39,000 retail stores, retailer websites, Fitbit.com, and through Fitbit Health Solutions.
On
In 2019, we continued to focus on providing more choice and accessibility to
consumers in wearables to drive the acquisition of users. During the first
quarter of 2019, we introduced Fitbit Versa Lite Edition, an affordable everyday
smartwatch, Fitbit Inspire HR, our most affordable heart rate tracking device,
Fitbit Inspire, our even lower-cost tracker, and Fitbit Ace 2, our new tracker
for children ages 6 and older. During the third quarter of 2019, we introduced
Fitbit Versa 2, a premium, voice-enabled lifestyle smartwatch. During the fourth
quarter of 2019, we introduced
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 during 2019, we believe a growing community of active users provides us an opportunity to introduce or further develop software services for our community in the future.
In the third quarter of 2019, we launched Fitbit Premium, a paid subscription service that uses the unique data of users to deliver our most personalized experience yet, with actionable guidance and coaching to help users achieve their health and fitness goals. Fitbit Premium leverages insights from over 10 years of Fitbit data, as well as academic and medical expertise, to help users move more, sleep better, and eat well, with customized programs, advance sleep features, personal insights, thousands of workouts, new challengers, health reports, and more, all in the Fitbit app.
In addition, we continue to focus on growing our Fitbit 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. In the fall of 2018, 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. Revenue from the Fitbit Health Solutions channel was approximately 7% of total revenue in 2019.
Looking forward, we expect smartwatches to grow as a percentage of revenue,
along with anticipated growth in our higher margin Fitbit Premium and Fitbit
Health Solutions revenue streams. For the full year 2020 compared to the full
year 2019, we expect research and development expenses to increase as we grow
our investment into the expanding wearable device market, partially offset by a
projected decrease in sales and general administrative expenses, with the
exception of higher costs related to the Merger Agreement with
The following are financial highlights for 2019, 2018 and 2017:
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Year Ended December 31,
2019 2018 2017
(in thousands)
Revenue $ 1,434,788 $ 1,511,983 $ 1,615,519
Net loss $ (320,711) $ (185,829) $ (277,192)
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.
For the Year Ended or As of December 31,
2019 2018 2017
(in thousands)
Devices sold 15,988 13,939 15,343
Active users 29,566 27,627 25,367
Adjusted EBITDA $ (128,333) $ (31,361) $ (52,158)
Free cash flow $ (193,363) $ 60,327 $ (24,919)
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
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 user who, 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 users who joined the community during the past 90 days, existing users who have remained active, or previously active users who were inactive for 90 days or greater, if they meet the preceding definition of an active user. 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.
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Table of Contents 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 82.5% as of
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.
Activations - Repeat and Re-Activated Users
We define an "Activation" as the first instance of a Fitbit device (excluding the Aria family, 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 2019, 39.1% of Activations came from Repeat Users, with Re-Activated Users representing 54.3% of those Repeat Users. In 2018, 37.6% of Activations came from Repeat Users, with Re-Activated Users representing 52.0% 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 2019 and 2018. 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, intangible assets amortization,
acquisition-related costs (including costs associated with the pending Merger
with Google), litigation expense related to matters with
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Table of Contents 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
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 highly competitive. We
primarily compete in the wrist-based wearables market, which is comprised of
both smartwatches and trackers. Growth of the wearables market has been
primarily driven by the smartwatch category of the wearables market. The
wearable device market has a multitude of participants, including many large,
broad-based consumer electronics companies that either compete in our market or
adjacent markets or have announced plans to do so, such as Apple, Samsung, LG,
and Google. 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, with its
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 2019, 2018 and 2017, our fourth quarter represented 35%, 38% and 35% of our annual revenue, respectively. We also incur higher sales and marketing expenses during these periods.
Investing in Growth
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Table of Contents 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 to leverage the strength of our partners or make acquisitions where
necessary, to increase speed to market and our ability to scale our 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
Furthermore, we intend to increase our focus on the health ecosystem, building relationships with employers, wellness providers, and payers. The corporate wellness market for the 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 2019, 2018 and 2017, 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 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 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 revenue comes from the sale of wearable devices, which includes trackers, smartwatches, and accessories sold, 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 our revenue, primarily from our subscription-based Fitbit Premium services.
Cost of Revenue
Cost of revenue consists of product costs, including costs of contract manufacturers for production, shipping and handling; warranty replacement; packaging, fulfillment; manufacturing and tooling equipment depreciation, warehousing, hosting, write-downs of excess and obsolete inventory, and 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.
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Table of Contents 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 costs related to sales incentives, trade shows and events, sponsorship, consulting and contractors, travel, POP displays, and allocated overhead.
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)
We are subject to income taxes in
On
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Table of Contents 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,
2019 2018 2017
(in thousands)
Consolidated Statements of Operations Data:
Revenue $ 1,434,788 $ 1,511,983 $ 1,615,519
Cost of revenue (1) 1,007,116 908,404 924,618
Gross profit 427,672 603,579 690,901
Operating expenses:
Research and development (1) 300,354 332,169 343,012
Sales and marketing (1) 329,800 344,091 415,042
General and administrative (1) 118,231 116,627 133,934
Total operating expenses 748,385 792,887 891,988
Operating loss (320,713) (189,308) (201,087)
Interest income, net 10,291 7,808 3,647
Other income (expense), net 1,357 (2,642) 2,796
Loss before income taxes (309,065) (184,142) (194,644)
Income tax expense 11,646 1,687 82,548
Net loss $ (320,711) $ (185,829) $ (277,192) (1)Includes stock-based compensation expense as follows:
Year Ended December 31,
2019 2018 2017
(in thousands)
Cost of revenue $ 6,403 $ 7,312 $ 5,312
Research and development 44,855 57,188 54,123
Sales and marketing 11,585 14,726 14,959
General and administrative 14,896 17,783 17,187
Total $ 77,739 $ 97,009 $ 91,581
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Year Ended December 31,
2019 2018 2017
(as a percentage of revenue)
Consolidated Statements of Operations Data:
Revenue 100 % 100 % 100 %
Cost of revenue 70 60 57
Gross profit 30 40 43
Operating expenses:
Research and development 21 22 21
Sales and marketing 23 23 26
General and administrative 8 8 8
Total operating expenses 52 53 55
Operating loss (22) (13) (12)
Interest income, net 1 1 -
Other income (expense), net - - -
Loss before income taxes (21) (12) (12)
Income tax expense (benefit) 1 - 5
Net loss (22) % (12) % (17) %
A discussion regarding our results of operations for 2019 compared to 2018 is
presented below. A discussion regarding our financial condition and results of
operations for 2018 compared to 2017 can be found in Part II, Item 7 of our
Annual Report on Form 10-K for the year ended
Revenue
Year Ended December 31, Change
(dollars in thousands) 2019 2018 $ %
Revenue $ 1,434,788 $ 1,511,983 $ (77,195) (5) %
Revenue decreased
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Cost of Revenue
Year Ended December 31, Change
(dollars in thousands) 2019 2018 $ %
Cost of revenue $ 1,007,116 $ 908,404 $ 98,712 11 %
Gross profit 427,672 603,579 (175,907) (29) %
Gross margin 30 % 40 %
Cost of revenue increased
Research and Development
Year Ended December 31, Change
(dollars in thousands) 2019 2018 $ %
Research and development $ 300,354 $ 332,169 $ (31,815) (10) %
Research and development expenses decreased
Sales and Marketing
Year Ended December 31, Change
(dollars in thousands) 2019 2018 $ %
Sales and marketing $ 329,800 $ 344,091 $ (14,291) (4) %
Sales and marketing expenses decreased
General and Administrative
Year Ended December 31, Change
(dollars in thousands) 2019 2018 $ %
General and administrative $ 118,231 $ 116,627 $ 1,604 1 %
General and administrative expenses increased
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Interest and Other Income (Expense), Net
Year Ended December 31, Change
(dollars in thousands) 2019 2018 $ %
Interest income, net $ 10,291 $ 7,808 $ 2,483 32 %
Other income (expense), net 1,357 (2,642) 3,999 (151) %
Interest income, net increased
Income Tax Expense
Year Ended December 31, Change
(dollars in thousands) 2019 2018 $ %
Income tax expense $ 11,646 $ 1,687 $ 9,959 590 %
Effective tax rate (3.8) % (0.9) %
Income tax expense increased
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
Of our total cash, cash equivalents, and marketable securities,
We believe our existing cash, cash equivalents, 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 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.
Letters of Credit
As of
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Table of Contents Cash Flows
The following table summarizes our cash flows for the periods indicated:
Year Ended December 31,
2019 2018 2017
(in thousands)
Net cash provided by (used in):
Operating activities $ (156,832) $ 113,207 $ 64,241
Investing activities 25,761 17,496 (28,718)
Financing activities (8,406) 1,287 4,635
Net change in cash and cash equivalents
Cash Flows from Operating Activities
Net cash used in operating activities of
Net cash used in operating activities was
Cash Flows from Investing Activities
Net cash provided by investing activities for 2019 of
Net cash provided by investing activities for 2018 of
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 used in financing activities for 2019 of
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Net cash provided by financing activities for 2018 of
Contractual Obligations and Other Commitments
Our future minimum lease payments under finance and operating leases as of
The aggregate amount of open purchase orders for the purchase of certain goods
and services as of
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
We have recorded a liability for uncertain tax positions of
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
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.
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Table of Contents 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 Premium and Fitbit Coach offerings.
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
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 customized programs, advanced sleep features, personal insights, 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 2% 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 2% 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
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reduction of revenue and an accrued liability. Through
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 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
Leases
We determine if an arrangement is a lease at inception. Operating lease right-of-use assets ("ROU assets") and short-term and long-term lease liabilities are included on the face of the consolidated balance sheet. Finance lease ROU assets are presented within other assets, and finance lease liabilities are presented within accrued liabilities.
ROU assets represent the right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use an incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease ROU asset also excludes lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are accounted for as a single lease component. For lease agreements with terms less than 12 months, we have elected the short-term lease measurement and recognition exemption, and it recognizes such lease payments on a straight-line basis over the lease term.
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Table of Contents 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
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.
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.
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Table of Contents 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
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.
Risk-Free Rate. The risk-free interest rate is the estimated average interest
rate based on
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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