FITBIT INC, S-1/A filed on 11/9/2015
Securities Registration Statement
Document and Entity Information
9 Months Ended
Sep. 30, 2015
Document And Entity Information [Abstract]
 
Document Type
S-1/A 
Amendment Flag
false 
Document Period End Date
Sep. 30, 2015 
Trading Symbol
FIT 
Entity Registrant Name
FITBIT INC 
Entity Central Index Key
0001447599 
Entity Filer Category
Non-accelerated Filer 
Condensed Consolidated Balance Sheets (USD $)
In Thousands, unless otherwise specified
Sep. 30, 2015
Dec. 31, 2014
Dec. 31, 2013
Current assets:
 
 
 
Cash and cash equivalents
$ 462,280 
$ 195,626 
$ 81,728 
Marketable securities
113,198 
Restricted cash
2,310 
Accounts receivable, net
244,921 
238,859 
80,624 
Inventories
276,083 
115,072 
56,441 
Deferred tax assets
56,846 
33,555 
Prepaid expenses and other current assets
21,199 
13,614 
3,185 
Total current assets
1,174,527 
596,726 
224,288 
Property and equipment, net
35,728 
26,435 
6,486 
Goodwill
22,157 
Intangible assets, net
12,749 
Other assets
17,296 
9,890 
Total assets
1,262,457 
633,051 
230,774 
Current liabilities:
 
 
 
Fitbit Force recall reserve
11,659 
22,476 
82,938 
Accounts payable
320,195 
195,666 
70,896 
Accrued liabilities
98,258 
70,940 
28,565 
Deferred revenue
27,077 
9,009 
5,606 
Income taxes payable
2,472 
30,631 
17,841 
Long-term debt, current portion
132,589 
3,985 
Total current liabilities
459,661 
461,311 
209,831 
Long-term debt, less current portion
6,725 
Redeemable convertible preferred stock warrant liability
15,797 
4,028 
Other liabilities
18,624 
12,867 
7,420 
Total liabilities
478,285 
489,975 
228,004 
Commitments and contingencies (Note 8)
   
   
   
Redeemable convertible preferred stock, $0.0001 par value: 144,528,912 shares authorized as of December 31, 2013 and 2014, and September 30, 2015 (unaudited); 139,503,915, 139,851,483 and no shares issued and outstanding as of December 31, 2013 and 2014, and September 30, 2015 (unaudited), respectively; aggregate liquidation preference of $0 as of September 30, 2015 (unaudited)
67,814 
66,236 
Stockholders' equity (deficit):
 
 
 
Common stock
Additional paid-in capital
604,323 
7,979 
1,065 
Accumulated other comprehensive income
1,074 
37 
Retained earnings (accumulated deficit)
178,754 
67,242 
(64,535)
Total stockholders' equity (deficit)
784,172 
75,262 
(63,466)
Total liabilities, redeemable convertible preferred stock and stockholders' equity (deficit)
1,262,457 
633,051 
230,774 
Common Class A [Member]
 
 
 
Stockholders' equity (deficit):
 
 
 
Common stock
Common Class B [Member]
 
 
 
Stockholders' equity (deficit):
 
 
 
Common stock
$ 17 
$ 0 
$ 0 
Condensed Consolidated Balance Sheets (Parenthetical) (USD $)
Sep. 30, 2015
Dec. 31, 2014
Dec. 31, 2013
Redeemable convertible preferred stock, par value (in dollars per share)
$ 0.0001 
$ 0.0001 
$ 0.0001 
Redeemable convertible preferred stock authorized (in shares)
144,528,912 
144,528,912 
Redeemable convertible preferred stock issued (in shares)
139,851,483 
139,503,915 
Redeemable convertible preferred stock outstanding (in shares)
139,851,483 
139,503,915 
Aggregate liquidation preference
$ 0 
$ 66,619,000 
$ 66,544,000 
Common stock, par value (in dollars per share)
$ 0.0001 
$ 0.0001 
$ 0.0001 
Common stock authorized (in shares)
230,400,000 
230,400,000 
Common stock issued (in shares)
40,875,583 
40,140,159 
Common stock outstanding (in shares)
40,875,583 
40,140,159 
Common Class A [Member]
 
 
 
Common stock, par value (in dollars per share)
$ 0.0001 
$ 0.0001 
$ 0.0001 
Common stock authorized (in shares)
600,000,000 
Common stock issued (in shares)
42,061,250 
Common stock outstanding (in shares)
42,061,250 
Common Class B [Member]
 
 
 
Common stock, par value (in dollars per share)
$ 0.0001 
$ 0.0001 
$ 0.0001 
Common stock authorized (in shares)
350,000,000 
Common stock issued (in shares)
165,122,004 
Common stock outstanding (in shares)
165,122,004 
Condensed Consolidated Statements of Operations (USD $)
In Thousands, except Per Share data, unless otherwise specified
9 Months Ended 12 Months Ended
Sep. 30, 2015
Sep. 30, 2014
Dec. 31, 2014
Dec. 31, 2013
Dec. 31, 2012
Income Statement [Abstract]
 
 
 
 
 
Revenue
$ 1,146,428 
$ 375,249 
$ 745,433 
$ 271,087 
$ 76,373 
Cost of revenue
593,664 
188,486 
387,776 
210,836 
49,733 
Gross profit
552,764 
186,763 
357,657 
60,251 
26,640 
Operating expenses:
 
 
 
 
 
Research and development
95,808 
35,842 
54,167 
27,873 
16,210 
Sales and marketing
178,672 
42,123 
112,005 
26,847 
10,237 
General and administrative
48,327 
23,909 
33,556 
14,485 
3,968 
Change in contingent consideration
(7,704)
Total operating expenses
315,103 
101,874 
199,728 
69,205 
30,415 
Operating income (loss)
237,661 
84,889 
157,929 
(8,954)
(3,775)
Interest expense, net
(1,062)
(1,541)
(2,222)
(1,082)
(176)
Other income (expense), net
(59,129)
(7,722)
(15,934)
(3,649)
26 
Income (loss) before income taxes
177,470 
75,626 
139,773 
(13,685)
(3,925)
Income tax expense (benefit)
65,958 
(16,911)
7,996 
37,937 
291 
Net income (loss)
111,512 
92,537 
131,777 
(51,622)
(4,216)
Less: noncumulative dividends to preferred stockholders
(2,526)
(3,983)
(5,326)
Less: undistributed earnings to participating securities
(50,316)
(68,736)
(98,103)
Net income (loss) attributable to common stockholders-basic
58,670 
19,818 
28,348 
(51,622)
(4,216)
Add: adjustments for undistributed earnings to participating securities
7,655 
6,905 
10,175 
Net income (loss) attributable to common stockholders-diluted
$ 66,325 
$ 26,723 
$ 38,523 
$ (51,622)
$ (4,216)
Net income per share attributable to common stockholders:
 
 
 
 
 
Basic (in dollars per share)
$ 0.57 
$ 0.49 
$ 0.70 
$ (1.32)
$ (0.11)
Diluted (in dollars per share)
$ 0.48 
$ 0.44 
$ 0.63 
$ (1.32)
$ (0.11)
Shares used to compute net income per share attributable to common stockholders:
 
 
 
 
 
Basic (in shares)
102,741 
40,242 
40,351 
39,179 
36,759 
Diluted (in shares)
136,986 
60,323 
61,179 
39,179 
36,759 
Consolidated Statements of Comprehensive Income Statement (USD $)
In Thousands, unless otherwise specified
9 Months Ended 12 Months Ended
Sep. 30, 2015
Sep. 30, 2014
Dec. 31, 2014
Dec. 31, 2013
Dec. 31, 2012
Statement of Comprehensive Income [Abstract]
 
 
 
 
 
Net income (loss)
$ 111,512 
$ 92,537 
$ 131,777 
$ (51,622)
$ (4,216)
Cash flow hedges:
 
 
 
 
 
Change in unrealized gain on cash flow hedges
1,466 
Less reclassification for realized net gains included in net income
(548)
Net change, net of tax
918 
Change in foreign currency translation adjustment, net of tax
125 
29 
37 
Change in unrealized (loss) on available-for-sale investments
(6)
Comprehensive income (loss)
$ 112,549 
$ 92,566 
$ 131,814 
$ (51,622)
$ (4,216)
Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders' Equity (Deficit) (USD $)
In Thousands, except Share data
Total
USD ($)
Series D [Member]
USD ($)
Redeemable Convertible Preferred Stock [Member]
USD ($)
Redeemable Convertible Preferred Stock [Member]
Redeemable Convertible Preferred Stock Warrant [Member]
USD ($)
Redeemable Convertible Preferred Stock [Member]
Series D [Member]
USD ($)
Common Stock [Member]
USD ($)
Common Stock [Member]
Subject to Vesting [Member]
Additional Paid-in Capital [Member]
USD ($)
AOCI Attributable to Parent [Member]
USD ($)
Retained Earnings [Member]
USD ($)
Temporary equity, Beginning balance at Dec. 31, 2011
 
 
$ 23,425 
 
 
 
 
 
 
 
Beginning balance at Dec. 31, 2011
(8,627)
 
 
 
 
 
66 
 
(8,697)
Temporary equity, Beginning balance, shares at Dec. 31, 2011
 
 
110,354,028 
 
 
 
 
 
 
 
Beginning balance, shares at Dec. 31, 2011
 
 
 
 
 
36,720,000 
 
 
 
 
Issuance of common stock upon exercise of stock options
 
 
 
 
 
 
 
 
Issuance of common stock upon exercise of stock options, shares
137,000 
 
 
 
 
136,749 
 
 
 
 
Stock-based compensation expense
132 
 
 
 
 
 
 
132 
 
 
Net income (loss)
(4,216)
 
 
 
 
 
 
 
 
(4,216)
Temporary equity, Ending balance at Dec. 31, 2012
 
 
23,425 
 
 
 
 
 
 
 
Ending balance at Dec. 31, 2012
(12,707)
 
 
 
 
 
202 
 
(12,913)
Temporary equity, Ending balance, shares at Dec. 31, 2012
 
 
110,354,028 
 
 
 
 
 
 
 
Ending balance, shares at Dec. 31, 2012
 
 
 
 
 
36,856,749 
 
 
 
 
Issuance redeemable convertible preferred stock
 
 
 
 
42,811 
 
 
 
 
 
Issuance of common stock upon public offering, net of offering costs, shares
 
 
 
 
29,149,887 
 
 
 
 
 
Issuance of common stock upon exercise of stock options
205 
 
 
 
 
 
 
205 
 
 
Issuance of common stock upon exercise of stock options, shares
3,283,000 
 
 
 
 
3,283,410 
 
 
 
 
Stock-based compensation expense
620 
 
 
 
 
 
 
620 
 
 
Excess tax benefit from stock-based compensation
38 
 
 
 
 
 
 
38 
 
 
Net income (loss)
(51,622)
 
 
 
 
 
 
 
 
(51,622)
Temporary equity, Ending balance at Dec. 31, 2013
66,236 
42,811 
66,236 
 
 
 
 
 
 
 
Ending balance at Dec. 31, 2013
(63,466)
 
 
 
 
 
1,065 
 
(64,535)
Temporary equity, Ending balance, shares at Dec. 31, 2013
139,503,915 
29,149,887 
139,503,915 
 
 
 
 
 
 
 
Ending balance, shares at Dec. 31, 2013
 
 
 
 
 
40,140,159 
 
 
 
 
Issuance redeemable convertible preferred stock
 
 
 
1,578 
 
 
 
 
 
 
Issuance of common stock upon public offering, net of offering costs, shares
 
 
 
347,568 
 
 
 
 
 
 
Issuance of common stock upon exercise of stock options
97 
 
 
 
 
 
 
97 
 
 
Issuance of common stock upon exercise of stock options, shares
735,000 
 
 
 
 
735,424 
 
 
 
 
Stock-based compensation expense
6,804 
 
 
 
 
 
 
6,804 
 
 
Excess tax benefit from stock-based compensation
13 
 
 
 
 
 
 
13 
 
 
Net income (loss)
131,777 
 
 
 
 
 
 
 
 
131,777 
Other comprehensive income
37 
 
 
 
 
 
 
 
37 
 
Temporary equity, Ending balance at Dec. 31, 2014
67,814 
42,811 
67,814 
 
 
 
 
 
 
 
Ending balance at Dec. 31, 2014
75,262 
 
 
 
 
 
7,979 
37 
67,242 
Temporary equity, Ending balance, shares at Dec. 31, 2014
139,851,483 
29,149,887 
139,851,483 
 
 
 
 
 
 
 
Ending balance, shares at Dec. 31, 2014
 
 
 
 
 
40,875,583 
 
 
 
 
Issuance of common stock upon public offering, net of offering costs
415,759 
 
 
 
 
 
415,757 
 
 
Issuance of common stock upon public offering, net of offering costs, shares
 
 
 
 
 
22,387,500 
 
 
 
 
Issuance of redeemable convertible preferred stock upon net exercise of redeemable convertible preferred stock warrants
 
 
 
 
Issuance of redeemable convertible preferred stock upon net exercise of redeemable convertible preferred stock warrants, shares
 
 
1,485,583 
 
 
 
 
 
 
 
Conversion of redeemable convertible preferred stock to common stock upon public offering
67,814 
 
(67,814)
 
 
15 
 
67,799 
 
 
Conversion of redeemable convertible preferred stock to common stock upon public offering, shares
 
 
(141,337,066)
 
 
141,337,066 
 
 
 
 
Reclassification of redeemable convertible preferred stock warrant liability into additional paid in capital upon initial public offering
72,452 
 
 
 
 
 
 
72,452 
 
 
Issuance of common stock upon exercise of stock options
940 
 
 
 
 
 
 
940 
 
 
Issuance of common stock upon exercise of stock options, shares
1,215,000 
 
 
 
 
1,215,200 
 
 
 
 
Issuance of common stock in connection with acquisition
13,317 
 
 
 
 
 
 
13,317 
 
 
Issuance of common stock in connection with acquisition, shares
 
 
 
 
 
1,059,688 
308,216 
 
 
 
Stock-based compensation expense
26,079 
 
 
 
 
 
 
26,079 
 
 
Net income (loss)
111,512 
 
 
 
 
 
 
 
 
111,512 
Other comprehensive income
1,037 
 
 
 
 
 
 
 
1,037 
 
Temporary equity, Ending balance at Sep. 30, 2015
 
 
 
 
 
 
 
 
 
Ending balance at Sep. 30, 2015
$ 784,172 
 
 
 
 
$ 21 
 
$ 604,323 
$ 1,074 
$ 178,754 
Temporary equity, Ending balance, shares at Sep. 30, 2015
 
 
 
 
 
 
 
 
 
Ending balance, shares at Sep. 30, 2015
 
 
 
 
 
207,183,253 
 
 
 
 
Consolidated Statements of Cash Flows (USD $)
In Thousands, unless otherwise specified
9 Months Ended 12 Months Ended
Sep. 30, 2015
Sep. 30, 2014
Dec. 31, 2014
Dec. 31, 2013
Dec. 31, 2012
Cash Flows from Operating Activities
 
 
 
 
 
Net income (loss)
$ 111,512 
$ 92,537 
$ 131,777 
$ (51,622)
$ (4,216)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
 
 
 
 
 
Provision for (recovery of) doubtful accounts
(33)
15 
864 
651 
71 
Provision for inventory obsolescence
4,537 
523 
2,964 
1,099 
400 
Provision for inventory obsolescence related to Fitbit Force recall
10,251 
Depreciation and amortization
12,372 
2,964 
6,131 
3,012 
1,179 
Amortization of intangible assets
1,169 
Write-off of property and equipment
1,004 
1,712 
Revaluation of redeemable convertible preferred stock warrant liability
56,655 
6,821 
13,272 
3,370 
37 
Amortization of issuance costs and discount on debt
484 
614 
795 
82 
24 
Stock-based compensation
25,684 
3,445 
6,804 
620 
132 
Change in contingent consideration
(7,704)
Deferred income taxes
(32,288)
(26,693)
(42,001)
Excess of tax benefit from stock-based compensation
(13)
(38)
Accretion (amortization) of discount (premium) on marketable securities, net
(560)
Changes in operating assets and liabilities, net of acquisition:
 
 
 
 
 
Accounts receivable
(5,500)
2,676 
(158,788)
(55,630)
(20,131)
Inventories
(165,153)
(4,723)
(61,595)
(47,376)
(9,369)
Prepaid expenses and other assets
(4,664)
(3,421)
(9,679)
(2,225)
(846)
Fitbit Force recall reserve
(10,817)
(51,909)
(60,462)
72,687 
Accounts payable
119,768 
(16,466)
123,761 
50,881 
14,340 
Accrued liabilities and other liabilities
30,657 
2,185 
47,733 
27,043 
7,882 
Deferred revenue
17,520 
2,598 
3,403 
859 
3,529 
Income taxes payable
(28,159)
(7,577)
12,804 
17,795 
84 
Net cash provided by (used in) operating activities
125,480 
3,589 
18,774 
33,171 
(6,884)
Cash Flows from Investing Activities
 
 
 
 
 
Change in restricted cash
2,310 
2,310 
(2,310)
Purchase of property and equipment
(17,748)
(17,885)
(26,495)
(7,524)
(2,505)
Purchase of marketable securities
(124,713)
Sales of marketable securities
12,070 
Acquisitions, net of cash acquired
(11,037)
Net cash used in investing activities
(141,428)
(15,575)
(24,185)
(9,834)
(2,505)
Cash Flows from Financing Activities
 
 
 
 
 
Net proceeds from initial public offering
420,885 
Proceeds from issuance of debt and revolving credit facility, net debt discount
160,000 
38,000 
163,000 
2,830 
7,872 
Repayment of debt
(294,503)
(41,346)
(41,346)
(596)
(58)
Payment of issuance costs
(2,575)
(2,575)
(45)
(69)
Payments of offering costs
(4,772)
Proceeds from issuance of redeemable convertible preferred stock, net of issuance costs
42,811 
Proceeds from exercise of stock options
940 
32 
97 
205 
Excess of tax benefit from stock-based compensation
13 
38 
Proceeds from exercise of redeemable convertible preferred stock warrants
75 
75 
Net cash provided by (used in) financing activities
282,550 
(5,814)
119,264 
45,243 
7,749 
Net increase (decrease) in cash and cash equivalents
266,602 
(17,800)
113,853 
68,580 
(1,640)
Effect of exchange rate on cash and cash equivalents
52 
29 
45 
Cash and cash equivalents at beginning of period
195,626 
81,728 
81,728 
13,148 
14,788 
Cash and cash equivalents at end of period
462,280 
63,957 
195,626 
81,728 
13,148 
Supplemental Disclosure
 
 
 
 
 
Cash paid for interest
374 
820 
835 
999 
87 
Cash paid for income taxes
120,774 
16,831 
34,616 
12,930 
Supplemental Disclosure of Non-Cash Investing and Financing Activity
 
 
 
 
 
Conversion of redeemable convertible preferred stock into Class B common stock
67,814 
 
 
 
Reclassification of redeemable convertible preferred stock warrant liability to additional paid in capital
72,452 
Issuance of redeemable convertible preferred stock upon net exercise of redeemable convertible preferred stock warrants
56,678 
1,503 
Purchase of property and equipment included in accounts payable
6,344 
4,872 
2,492 
1,904 
121 
Issuance of redeemable convertible preferred stock warrants in connection with debt financing
170 
410 
Deferred offering costs included in accounts payable and accruals
354 
Issuance of common stock in connection with acquisitions
13,317 
Contingent consideration related to acquisitions
$ 7,704 
$ 0 
$ 0 
$ 0 
$ 0 
Business Overview
Business Overview

1.    Business Overview

 

Fitbit, Inc. (the “Company”) is transforming the way millions of people around the world achieve their health and fitness goals. The Fitbit platform combines connected health and fitness devices with software and services, including an online dashboard and mobile apps, data analytics, motivational and social tools, personalized insights, and virtual coaching through customized fitness plans and interactive workouts. The Company sells devices through diversified sales channels that include distributors, retailers, a corporate wellness offering, and Fitbit.com. The Company was incorporated in Delaware in 2007. The Company has established wholly-owned subsidiaries globally and its corporate headquarters are located in San Francisco, California.

 

In June 2015, the Company completed its initial public offering (“IPO”) of Class A common stock, in which the Company sold 22,387,500 shares and certain of its stockholders sold 19,673,750 shares, including 5,486,250 shares pursuant to the underwriters’ over-allotment option. The shares were sold at an initial public offering price of $20.00 per share for net proceeds of $420.9 million to the Company, after deducting underwriting discounts and commissions of $26.9 million. Offering costs incurred by the Company were approximately $5.1 million. In addition, in connection with the IPO:

 

   

The Company authorized two new classes of common stock— Class A common stock and Class B common stock. All prior periods presented have been updated to reflect the new classes of common stock. The rights of the holders of Class A and Class B common stock are identical, except with respect to voting and conversion. Each share of Class A common stock is entitled to one vote per share and each share of Class B common stock is entitled to ten votes per share. Each share of Class B common stock is convertible at any time at the option of the stockholder into one share of Class A common stock, generally automatically converts into Class A common stock upon a transfer, and has no expiration date.

 

   

All shares of the then-outstanding common stock, as well as options to purchase common stock and restricted stock units (“RSUs”), were reclassified into the right to receive an equivalent number of shares of Class B common stock.

 

   

All 139,851,483 shares of the then-outstanding redeemable convertible preferred stock were converted and reclassified into an equivalent number of shares of Class B common stock. This resulted in a reclassification of the redeemable convertible preferred stock balance of $67.8 million to additional paid-in capital.

 

   

The Company issued 274,992 shares of Series B redeemable convertible preferred stock and 1,210,591 shares of Series C redeemable convertible preferred stock upon the net exercise of redeemable convertible preferred stock warrants, which occurred immediately prior to the completion of its IPO. These shares were sold as Class A common stock in the IPO. In addition, all of the remaining outstanding redeemable convertible preferred stock warrants automatically converted to Class B common stock warrants upon the closing of the IPO. As a result, the Company revalued the warrants as of the completion of the IPO and reclassified the redeemable convertible preferred stock warrant liability balance of $72.5 million to additional paid-in capital.

 

   

The Company recorded proceeds of $420.9 million to additional paid-in capital and reclassified $5.1 million of deferred offering costs previously recorded in other current assets as an offset to the proceeds from the IPO.

Basis of Presentation
Basis of Presentation

2.    Basis of Presentation

 

Principles of Consolidation

 

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

 

Stock Splits

 

In June 2013, the Company effected a 4-for-1 stock split of all outstanding shares of redeemable convertible preferred stock. In addition, in September 2014, the Company effected a 2-for-1 stock split of all outstanding shares of the Company’s capital stock, including common stock and redeemable convertible preferred stock.

 

On May 27, 2015, the Company effected a 3-for-2 stock split of all outstanding shares of the Company’s capital stock, including its common stock and its redeemable convertible preferred stock. All share, option, RSU, warrant, and per share information presented in the consolidated financial statements has been adjusted to reflect the stock splits on a retroactive basis for all periods presented and all share information is rounded down to the nearest whole share after reflecting the stock splits.

 

Use of Estimates

 

The preparation of consolidated financial statements in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated financial statements and accompanying notes. The estimates and assumptions made by management related to revenue recognition, accruals for the Fitbit Force recall, reserves for sales returns and incentives, reserves for warranty, valuation of stock options, fair value of warrant liability and derivative assets and liabilities, allowance for doubtful accounts, inventory valuation, and the valuations of deferred income tax assets and uncertain tax positions. Actual results could differ from those estimates, and such differences may be material to the consolidated financial statements.

 

Changes to Previously Issued Financial Statements

 

The Company has reclassified certain amounts from its previously issued consolidated financial statements to conform to the presentation for 2014. Specifically, the Company revised its presentation of its sales returns reserve, except for estimated returns for the Fitbit Force product recall, previously included in accrued liabilities, which is now presented as a reduction to accounts receivable. Accordingly, the accounts receivable and accrued liabilities decreased by $15.4 million on the consolidated balance sheet as of December 31, 2013. Additionally, the Company decreased both accounts receivable and deferred revenue by $16.8 million as of December 31, 2013 for amounts billed and in transit for which legal transfer of title had not yet occurred. These changes had no impact on the consolidated statements of operations or consolidated statements of cash flows.

 

The Company had certain immaterial reclassifications within the consolidated statements of cash flows to conform to the current year presentation. These reclassifications had no impact on the net change in cash and cash equivalents within the consolidated statements of cash flows.

 

During the preparation of the consolidated financial statements as of and for the year ended December 31, 2014, the Company identified errors within the Company’s consolidated statements of cash flows for the years ended December 31, 2012 and 2013, which financial statements were revised to correct the errors. The Company revised the consolidated statement of cash flows for the year ended December 31, 2012 to decrease both net cash used in operating activities and net cash provided by financing activities by $0.4 million and for the year ended December 31, 2013 to increase net cash provided by operating activities and decrease net cash provided by financing activities by $0.2 million. The Company evaluated the errors and concluded that they were not material to the 2012 and 2013 financial statements.

 

During the preparation of the consolidated financial statements as of and for the quarter ended March 31, 2015, the Company identified an error within the consolidated statement of cash flows for the year ended December 31, 2014. The Company revised the consolidated statement of cash flows for the year ended December 31, 2014 to correct an immaterial error in classification related to accruals for capital expenditure items. The revision increased both net cash provided by operating activities and net cash used in investing activities by $1.9 million. This had no impact on the net change in cash and cash equivalents within the consolidated statements of cash flows. The Company evaluated the error and concluded that it was not material to the 2014 financial statements.

 

Comprehensive Income (Loss)

 

Comprehensive income (loss) consists of two components, net income (loss) and other comprehensive income, net of tax. Other comprehensive income refers to revenue, expenses, and gains and losses that are recorded as an element of stockholders’ equity but are excluded from net income (loss). The Company’s other comprehensive income consists of net unrealized gains and losses on derivative instruments accounted for as cash flow hedges, foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, and unrealized gains and losses on available-for-sale securities.

 

Unaudited Interim Consolidated Financial Statements

 

The accompanying interim consolidated balance sheet as of September 30, 2015, the interim consolidated statements of operations, comprehensive income (loss), and cash flows for the nine months ended September 30, 2014 and 2015, and the interim consolidated statement of redeemable convertible preferred stock and stockholders’ equity (deficit) for the nine months ended September 30, 2015 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the audited consolidated financial statements, and in management’s opinion, includes all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the Company’s financial position as of September 30, 2015 and its results of operations and cash flows for the nine months ended September 30, 2014 and 2015. The financial data and the other financial information disclosed in the notes to these consolidated financial statements related to the nine-month periods are also unaudited. The results of operations for the nine months ended September 30, 2015 are not necessarily indicative of the results to be expected for the full fiscal year or any other period.

Significant Accounting Policies
Significant Accounting Policies

3.    Significant Accounting Policies

 

Cash and Cash Equivalents

 

Cash and cash equivalents include all cash balances and highly liquid investments with original maturities of three months or less from the date of purchase. As of December 31, 2013 and 2014, cash and cash equivalents consisted of cash in bank deposits and money market accounts held at financial institutions.

 

Restricted Cash

 

In 2013, the Company entered into a facility lease and a sublease under which the Company is required to maintain letters of credit, with the landlord named as the beneficiary. The letters of credit required a certain amount of cash to be kept in a separate account as collateral. The $2.3 million of restricted cash has been excluded from the Company’s cash and cash equivalents and is classified as restricted cash on the accompanying consolidated balance sheet as of December 31, 2013. The restricted cash related to the lease agreements was released during 2014 and was no longer restricted.

 

Marketable Securities

 

The Company’s marketable securities are classified as available-for-sale as of the balance sheet date and are reported at fair value with unrealized gains and losses reported as a separate component of accumulated other comprehensive income in stockholders’ equity, net of tax. Realized gains or losses and other-than-temporary impairments, if any, on available-for-sale securities are reported in other expense, net as incurred. Investments are reviewed periodically to identify possible other-than-temporary impairments. No impairment loss has been recorded on the securities as the Company believes that the decrease in fair value of these securities is temporary and expects to recover up to (or beyond) the initial cost of investment for these securities.

 

Fair Value of Financial Instruments

 

Assets and liabilities recorded at fair value on a recurring basis are categorized based upon the level of judgment associated with inputs used to measure their fair values. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the reporting date.

 

The Company estimates fair value by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

 

Level 1—Quoted prices in active markets for identical assets or liabilities;

 

Level 2—Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

 

Level 3—Inputs that are generally unobservable and typically reflect management’s estimate of assumptions that market participants would use in pricing the asset or liability.

 

Foreign Currencies

 

The Company and certain of the Company’s wholly-owned subsidiaries use the U.S. dollar as their functional currency. The Company’s subsidiaries that use the U.S. dollar as their functional currency remeasure local currency denominated monetary assets and liabilities at exchange rates in effect at the end of each period, and inventories, property, plant and equipment and other nonmonetary assets and liabilities at historical rates. Gains and losses from these remeasurements have been included in the Company’s operating results. Local currency transactions of these international operations are remeasured into U.S. dollars at the rates of exchange in effect at the date of the transaction.

 

The Company translates the assets and liabilities of its non-U.S. dollar functional currency subsidiaries into U.S. dollars using exchange rates in effect at the end of each period. Revenue and expenses for these subsidiaries are translated using rates that approximate those in effect during the related period. Gains and losses from translations are recognized in foreign currency translation included in accumulated other comprehensive income (loss).

 

Foreign currency transaction gains and losses are recognized in other income (expense), net and were comprised of net losses of $0.2 million, $2.7 million, and $1.4 million for 2013, 2014, and the nine months ended September 30, 2015, respectively. Foreign currency transaction gains and losses were a net loss of $0.9 million for the nine months ended September 30, 2014. Foreign currency transaction gains and losses were insignificant for 2012.

 

Derivative Instruments

 

The Company accounts for its derivative instruments as either assets or liabilities and carries them at fair value. Derivatives held by the Company that are not designated as hedges are adjusted to fair value through earnings at each reporting date. In addition, the Company enters into derivatives that are accounted for as cash flow hedges. The Company records the gains or losses, net of tax, related to the effective portion of its cash flow hedges as a component of accumulated other comprehensive income in stockholders’ equity and subsequently reclassifies the gains or losses into revenue and operating expenses when the underlying hedged transactions are recognized. The Company periodically assesses the effectiveness of its cash flow hedges. The fair value of derivative assets and liabilities are included in prepaid expenses and other current assets and accrued liabilities on the consolidated balance sheets.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, accounts receivables, and derivative instruments. Cash and cash equivalents are deposited with high quality financial institutions and may, at times, exceed federally insured limits. Management believes that the financial institutions that hold the Company’s deposits are financially credit worthy and, accordingly, minimal credit risk exists with respect to those balances. Generally, these deposits may be redeemed upon demand and, therefore, bear minimal interest rate risk.

 

The Company’s accounts receivable are derived from customers located principally in the United States. The Company maintains credit insurance for some of its customer balances, performs ongoing credit evaluations of its customers, and maintains allowances for potential credit losses on customers’ accounts when deemed necessary. Credit losses historically have not been significant. The Company continuously monitors customer payments and maintains an allowance for doubtful accounts based on its assessment of various factors including historical experience, age of the receivable balances, and other current economic conditions or other factors that may affect customers’ ability to pay.

 

The Company’s derivative instruments expose it to credit risk to the extent that its counterparties may be unable to meet the terms of the agreements. The Company seeks to mitigate this risk by limiting counterparties to major financial institutions and by spreading the risk across several major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored on an ongoing basis.

 

Supplier Concentration

 

The Company relies on third parties for the supply and manufacture of its products, as well as third-party logistics providers. In instances where these parties fail to perform their obligations, the Company may be unable to find alternative suppliers or satisfactorily deliver its products to its customers on time, if at all.

 

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 market on a first-in, first-out basis. The Company assesses the valuation of inventory and periodically writes down the value for estimated excess and obsolete inventory based upon estimates of future demand and market conditions.

 

Point of Purchase (“POP”) Displays

 

The Company provides retailers with POP displays, generally free of charge, in order to facilitate the marketing of the Company’s products within retail stores. Any amounts capitalized related to the costs of the POP displays are recorded as prepaid expense on the consolidated balance sheets and recognized as expense over the expected period of the benefit provided by these assets, which is generally 12 months. The related expenses are included in sales and marketing expenses on the consolidated statements of operations and were $0.1 million, $0.4 million, $5.2 million, $3.2 million, and $16.2 million, for 2012, 2013, and 2014, and the nine months ended September 30, 2014 and September 30, 2015, respectively.

 

Property and Equipment, Net

 

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization of property and equipment is calculated using the straight-line method over the estimated useful lives of the assets. Cost of maintenance and repairs that do not improve or extend the lives of the respective assets are expensed as incurred.

 

The useful lives of the property and equipment are as follows:

 

Tooling and manufacturing equipment

   One to three years

Furniture and office equipment

   Three years

Purchased software

   Six months to three years

Capitalized internally-developed software

   Two to three years

Leasehold improvements

   Shorter of remaining lease term or estimated useful life

 

Internally-Developed Software Costs

 

The Company capitalizes costs to develop internal-use software when preliminary development efforts are successfully completed, management has authorized and committed project funding, and it is probable that the project will be completed and the software will be used as intended. Costs incurred prior to meeting these criteria, together with costs incurred for training and maintenance, are expensed as incurred. Costs incurred for enhancements that are expected to result in additional material functionality are capitalized and expensed over the estimated useful life of the upgrades.

 

Capitalized internally-developed software costs, net, were $0.4 million as of December 31, 2014. The Company did not have any internally-developed software prior to 2014. Amortization expense related to capitalized internally-developed software costs was $0.1 million and $0.1 million for 2014 and the nine months ended September 2015, respectively.

 

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 the Company’s research and development expenses are related to developing new products and services and improving existing products and services. To date, research and development expenses have been expensed as incurred, because the period between achieving technological feasibility and the release of products and services for sale has been short and development costs qualifying for capitalization have been insignificant.

 

Business Combinations, Goodwill, and Intangible Assets

 

The Company allocates 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 from acquired customers, acquired technology, and trade names from a market participant perspective, 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, the Company 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.

 

The Company assesses goodwill for impairment at least annually and whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. Consistent with the determination that the Company has one reporting segment, the Company has determined that there is one reporting unit and tests goodwill for impairment at the entity level. Goodwill is tested using the two-step process in accordance with ASC 350, Intangibles—Goodwill and Other. In the first step, the carrying amount of the reporting unit is compared to the fair value based on the fair value of the Company’s 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, the implied fair value of the goodwill, as defined by ASC 350, is compared to its carrying amount to determine the amount of impairment loss, if any.

 

Acquired finite-lived intangible assets are amortized over their estimated useful lives. The Company evaluates the recoverability of 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 property and equipment and intangible assets is not recoverable, the carrying amount of such assets is reduced to fair value. The Company has not recorded any such impairment charge during the years presented.

 

Impairment of Long-Lived Assets

 

The Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by comparison of the carrying amounts to the expected future undiscounted cash flows attributable to these assets. If it is determined that an asset is not recoverable, an impairment loss is recorded in the amount by which the carrying amount of the assets exceeds the expected discounted future cash flows arising from those assets.

 

Deferred Rent

 

Rent expense is recognized on a straight-line basis over the non-cancelable term of the operating lease. The Company records the difference between cash rent payments and recognized rent expense as a deferred rent liability included in accrued liabilities and other liabilities on the consolidated balance sheets. Incentives granted under the Company’s facility leases, including allowances to fund leasehold improvements, are deferred and are recognized as adjustments to rental expense on a straight-line basis over the term of the lease.

 

Redeemable Convertible Preferred Stock Warrant Liability

 

The Company’s redeemable convertible preferred stock warrants require liability classification and accounting as the underlying preferred stock is considered redeemable as discussed in Note 9. At initial recognition, the warrants are recorded at their estimated fair value. The warrants are subject to remeasurement at each balance sheet date, with changes in fair value recognized as a component of other income (expense), net. The Company will continue to adjust the warranty liability for changes in fair value until the earlier of the expiration or exercise of the warrants, or upon their automatic conversion into warrants to purchase common stock in connection with a qualified IPO such that they qualify for equity classification and no further remeasurement is required. Refer to Note 10 for additional information.

 

Revenue Recognition

 

The Company derives substantially all of its revenue from sales of connected health and fitness devices and accessories. The Company also generates a small portion of revenue from its subscription-based premium services. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is reasonably assured. The Company considers delivery of its products to have occurred once title and risk of loss has been transferred. The Company recognizes revenue, net of estimated sales returns, sales incentives, discounts, and sales tax. The Company generally recognizes revenue for products sold through retailers and distributors on a sell-in basis.

 

The Company has determined its multiple element arrangements generally include three separate units of accounting. The first deliverable is the hardware and firmware essential to the functionality of the connected health and fitness device delivered at the time of sale. The second deliverable is the software services included with the products, which are provided free of charge and enable users to sync, view, and access real-time date on the Company’s online dashboard and mobile apps. The third deliverable 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. Commencing in the first quarter of 2015, the Company began accounting for the embedded right as a separate unit of accounting, which is when it believes, through recent public announcements, it had created an implied obligation to, from time to time, provide future unspecified firmware upgrades and features to the firmware to improve and add new functionality to the health and fitness devices.

 

The Company allocates revenue to all deliverables based on their relative selling prices. The Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence (“VSOE”) of fair value, (ii) third-party evidence (“TPE”), and (iii) best estimate of the selling price (“BESP”). The Company currently cannot establish VSOE for any of its deliverables since none of the deliverables are sold separately. The Company’s process for determining its BESP considers multiple factors including consumer behaviors and the Company’s internal pricing model and may vary depending upon the facts and circumstances related to each deliverable. BESP for the health and fitness devices and unspecified upgrade rights reflect the Company’s best estimate of the selling prices if they were sold regularly on a stand-alone basis and comprises the majority of the arrangement consideration. BESP for upgrade rights currently ranges from $1 to $5. TPE for the online dashboard and mobile apps is currently estimated at $0.99.

 

Amounts allocated to the connected health and fitness 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 their estimated usage period of approximately ten to twelve months.

 

The Company offers its users the ability to purchase subscription-based premium services, through which the users receive incremental features, including access to a digital personal trainer and in-depth analytics regarding the user’s personal metrics. Amounts paid for premium subscriptions are deferred and recognized ratably over the service period which is typically 12 months. Revenue from subscription-based premium services was less than 1% of revenue for all periods presented.

 

In addition, the Company offers access to a customized corporate dashboard tool to certain customers in the corporate wellness program. This tool is currently being offered at no cost for the first year. The Company is currently unable to establish VSOE or TPE for the corporate dashboard tool. Current BESP of $20,000 for the corporate dashboard is determined based on the Company’s internal pricing model for anticipated renewals for existing customers and pricing for new customers. Revenue allocated to the corporate dashboard is deferred and recognized on a straight-line basis over the estimated access period of 12 months. Revenue from the corporate dashboard tool was less than 1% of revenue for all periods presented.

 

The Company accounts for shipping and handling fees billed to customers as revenue. Sales taxes and value added taxes (“VAT”) collected from customers 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

 

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

 

   

Certain retailers and distributors are allowed to return products that were originally sold through to an end user, called “open box” returns, and such returns may be made at any time after original sale.

 

   

All purchases through Fitbit.com are covered by a 45-day right of return.

 

   

Distributors are allowed stock rotation rights which are limited rights of return of products purchased during a prior period, generally one quarter.

 

   

Distributors and retailers are allowed return rights for defective products.

 

   

Certain distributors are offered price protection that allows for the right to a partial credit for unsold inventory held by the distributor if the Company reduces the selling price of a product.

 

The Company meets all conditions required to recognize revenue at the time of sale when a right of return exists. For example, the price to the buyer is fixed or determinable at time of sale; the buyer’s obligation to pay is not contingent on resale of the product; and the Company is able to reasonably estimate the amount of future returns. The Company estimates and records reserves for these policies and programs as a reduction of revenue and accounts receivable. On a quarterly basis, the amount of revenue that is reserved for future returns is calculated based on the Company’s historical trends and data specific to each reporting period. The Company reviews the actual returns evidenced in prior quarters as a percent of related revenue to determine the historical returns rate. It then applies the historical returns rate to the current period revenue as a basis for estimating future returns. Through December 31, 2014, actual returns have primarily been open-box returns. In addition, through December 31, 2014, the Company has had minimal stock rotation or price protection claims. When necessary, the Company also provides a specific reserve for product in the distribution channel in excess of estimated requirements. This estimate can be affected by the amount of a particular product in the channel, the rate of sell-through, product plans, and other factors. The Company also considers whether there are circumstances which may result in anticipated returns higher than the historical return rate from direct users and records an additional reserve as necessary.

 

Sales Incentives

 

The Company offers sales incentives through various programs, consisting primarily of cooperative advertising and marketing development fund programs. The Company records advertising and marketing development fund programs with customers as a reduction to revenue unless it receives an identifiable benefit in exchange for credits claimed by the customer and can reasonably estimate the fair value of the identifiable benefit received, in which case the Company records it as a marketing expense. The Company recognizes a liability and reduces revenue for rebates or other incentives based on the estimated amount of rebates or credits that will be claimed by customers.

 

Cost of Revenue

 

Cost of revenue consists of product costs, including costs of contract manufacturers for production, shipping and handling costs, packaging, warranty replacement costs, fulfillment costs, manufacturing and tooling equipment depreciation, warehousing costs, excess and obsolete inventory write-downs, costs related to the Fitbit Force product recall, and certain allocated costs related to management, facilities, and personnel-related expenses and other expenses associated with supply chain logistics.

 

Advertising Costs

 

Costs related to advertising and promotions, excluding co-op advertising costs, are expensed to sales and marketing as incurred. Advertising and promotion expenses for 2012, 2013, 2014, and the nine months ended September 30, 2014 and 2015 were $3.3 million, $9.5 million, $71.9 million, $16.1 million, and $119.5 million, respectively. Co-op advertising costs are recorded as a reduction to revenue, and for 2012, 2013, 2014, and the nine months ended September 30, 2014 and 2015 were $1.9 million, $5.7 million, $12.7 million, $6.9 million, and $21.9 million, respectively.

 

Product Warranty

 

The Company offers a standard product warranty that the product will operate under normal use for a period of one year from date of original purchase except in the European Union where the Company provides a two-year warranty. The Company has the obligation, at its option, to either repair or replace the defective product.

 

At the time revenue is recognized, an estimate of future warranty costs is recorded as a component of cost of revenues. Factors that affect the warranty obligation include product failure rates, service delivery costs incurred in correcting the product failures, and warranty policies. The warranty obligation does not consider historical experience of the Fitbit Force product as a separate reserve has been established for the Fitbit Force recall. The Company’s products are manufactured by third-party contract manufacturers, and in certain cases, the Company may have recourse to such third-party contract manufacturers.

 

Fitbit Force Product Recall

 

The Company established reserves for the Fitbit Force recall when circumstances giving rise to the recall became known. It considered various factors in estimating the product recall exposure. These include estimates for:

 

   

refunds and product returns from retailer and distributor customers and end-users, which were charged to revenue and cost of revenue on the consolidated statements of operations;

 

   

logistics and handling fees for managing product returns and processing refunds, obsolescence of on-hand inventory, cancellation charges for existing purchase commitments and rework of component inventory by the Company’s contract manufacturers, write-offs of tooling and manufacturing equipment, which were charged to cost of revenue on the consolidated statements of operations; and

 

   

legal fees and settlement costs, which were charged to general and administrative expenses on the consolidated statements of operations.

 

These factors above are updated and reevaluated each period and the related reserves are adjusted when factors indicate that the recall reserves are either insufficient to cover or exceed the estimated product recall expenses.

 

Stock-Based Compensation

 

The Company measures its stock-based awards made to employees based on the estimated fair values of the awards as of the grant date using the Black-Scholes option-pricing model. The fair value of restricted stock units (“RSUs”) is the fair value of the Company’s common stock on the grant date. Stock-based compensation expense is recognized over the requisite service period on a straight-line basis and is recorded net of estimated forfeitures.

 

Stock-based compensation expenses for options granted to non-employees as consideration for services received are measured on the date of performance at the fair value of the consideration received or the fair value of the equity instruments issued, using the Black-Scholes option-pricing model, whichever can be more reliably measured. Stock-based compensation expenses for options granted to non-employees are remeasured as the underlying options vest.

 

The Company recognizes tax benefits related to stock-based compensation to the extent that the total reduction to its income tax liability from stock-based compensation is greater than the amount of the deferred tax assets previously recorded in anticipation of these benefits. The Company recognizes a benefit from stock-based compensation in equity to the extent that an incremental tax benefit is realized by following the ordering provisions of the tax laws.

 

Segment Information

 

The Company operates as one operating segment as it only reports financial information on an aggregate and consolidated basis to its Chief Executive Officer, who is the Company’s chief operating decision maker.

 

Income Taxes

 

The Company utilizes 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. The Company makes estimates, assumptions, and judgments to determine its expense (benefit) for income taxes and also for deferred tax assets and liabilities and any valuation allowances recorded against its deferred tax assets. The Company assesses the likelihood that its deferred tax assets will be recovered from future taxable income and, to the extent it believes that recovery is not likely, the Company establishes a valuation allowance.

 

The calculation of the Company’s income tax expense involves the use of estimates, assumptions, and judgments while taking into account current tax laws, its interpretation of current tax laws, and possible outcomes of future tax audits. The Company has established reserves to address potential exposures related to tax positions that could be challenged by tax authorities. Although the Company believes its estimates, assumptions, and judgments to be reasonable, any changes in tax law or its interpretation of tax laws and the resolutions of potential tax audits could significantly impact the amounts provided for income taxes in its consolidated financial statements.

 

The calculation of the Company’s 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 the Company’s estimates, assumptions, and judgments, thereby impacting its financial position and operating results.

 

The Company includes 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.

 

Net Income (Loss) per Share Attributable to Common Stockholders

 

Basic and diluted net income per share attributable to common stockholders is presented in conformity with the two-class method required for participating securities. The Company considers its redeemable convertible preferred stock to be participating securities. The holders of the Company’s Series D redeemable convertible preferred stock are entitled to receive non-cumulative dividends at the annual rate of approximately 8% of the Series D original issuance price per share per annum, payable prior and in preference to any dividends on any shares of the Company’s other redeemable convertible preferred stock, which is payable prior and in preference to any dividends on any shares of the common stock. In the event a cash dividend is paid on common stock, the holders of redeemable convertible preferred stock are also entitled to a proportionate share of any such dividend as if they were holders of common stock (on an as-if converted basis). All participating dividends paid on the Company’s redeemable convertible preferred stock reduce accruals of past or future preferred dividends by such amount. The holders of the redeemable convertible preferred stock do not have a contractual obligation to share in losses. In accordance with the two-class method, earnings allocated to these participating securities and the related number of outstanding shares of the participating securities, which include contractual participation rights in undistributed earnings, have been excluded from the computation of basic and diluted net income per share attributable to common stockholders.

 

In connection with the IPO, the Company established two classes of authorized common stock: Class A common stock and Class B common stock. As a result, all then-outstanding shares of common stock were converted into shares of Class B common stock. The rights of the holders of Class A common stock and Class B common stock are identical, except with respect to voting and conversion. Each share of Class A common stock is entitled to one vote per share and each share of Class B common stock is entitled to ten votes per share. Each share of Class B common stock is convertible at any time at the option of the stockholder into one share of Class A common stock, generally automatically converts into Class A common stock upon a transfer, and has no expiration date.

 

In 2012 and 2013, basic net loss per share attributable to common stockholders is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period without consideration of common stock equivalents or the participation rights of the preferred stock as they do not share in losses. During the periods when the Company is in a net loss position, basic net loss per share attributable to common stockholders is the same as diluted net loss per share attributable to common stockholders as the inclusion of all potential shares of common stock outstanding would have been anti-dilutive.

 

Recent Accounting Pronouncements

 

In May 2014, the FASB issued ASU 2014-09 (ASC 606), Revenue from Contracts with Customers, which affects any entity that either enters into contracts with customers to transfer goods and services or enters into contracts for the transfer of nonfinancial assets. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under the currently effective guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for annual periods beginning after December 15, 2016, including interim periods within that period. Early adoption is not permitted. The FASB recently issued an exposure draft of a proposed ASU that would delay the effective date of ASU 2014-09 by one year and allow for early adoption. In July 2015, the FASB approved a one-year deferral of the effective date of the standard. ASU 2014-09 will become effective for the Company on January 1, 2018 and can be adopted either retrospectively to each prior reporting period presented or as a cumulative effect adjustment as of the date of adoption. Early adoption is permitted but not before the original effective date of annual periods beginning after December 15, 2016. The Company is currently evaluating the impact of this guidance on its consolidated financial statements.

Fair Value Measurements
Fair Value Measurements

4.    Fair Value Measurements

 

The carrying values of the Company’s accounts receivable and accounts payable, approximated their fair values due to the short period of time to maturity or repayment. The carrying values of the Company’s long-term debt approximate their fair values as of December 31, 2013 and 2014, as the debt carries a variable rate or market rates currently available to the Company and other assumptions have not changed significantly.

 

The following tables set forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy (in thousands):

 

     September 30, 2015  
     Level 1      Level 2      Level 3      Total  
    

(unaudited)

 

Assets:

           

Money market funds

   $ 285,079       $       $       $ 285,079   

U.S. government agencies

             105,542                 105,542   

Corporate debt securities

             80,962                 80,962   

Derivative assets

             5,313                 5,313   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 285,079       $ 191,817       $       $ 476,896   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           

Derivative liabilities

   $       $ 2,325       $       $ 2,325   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2014  
     Level 1      Level 2      Level 3      Total  

Assets:

           

Derivative assets

   $       $ 316       $       $ 316   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities:

           

Redeemable convertible preferred stock warrant liability

   $       $       $ 15,797       $ 15,797   

Derivative liabilities

             105                 105   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $       $ 105       $ 15,797       $ 15,902   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2013  
     Level 1      Level 2      Level 3      Total  

Liabilities:

           

Redeemable convertible preferred stock warrant liability

   $       $   —       $   4,028       $   4,028   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

The fair value of the Company’s Level 1 financial instruments is based on quoted market prices in active markets for identical instruments. The fair value of the Company’s Level 2 financial instruments is based on observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data. In addition, level 2 assets and liabilities are comprised of derivative financial instruments associated with hedging activity is further discussed in Note 5. Derivative financial instruments are initially measured at fair value on the contract date and are subsequently remeasured to fair value at each reporting date using inputs such as spot rates and forward rates. There is not an active market for each hedge contract, but the inputs used to calculate the value of the instruments are tied to active markets.

 

The Company’s Level 3 liabilities measured and recorded on a recurring basis consist of the redeemable convertible preferred stock warrant liability and contingent consideration. The fair value of the warrant liability is calculated using an option-pricing model as discussed in Note 10. Generally, increases or decreases in the fair value of the underlying redeemable convertible preferred stock would result in a directionally similar impact in the fair value measurement of the associated warrant liability. The unexercised warrants to purchase redeemable convertible preferred stock were converted into warrants to purchase shares of Class B common stock upon the closing of the IPO. As a result, the Company revalued and reclassified the redeemable convertible preferred stock liability to additional paid-in capital upon the closing of the IPO. The following table sets forth a summary of the changes in the fair value of the redeemable convertible preferred stock warrant liability (in thousands):

 

Balance at December 31, 2011

   $ 41   

Fair value of redeemable convertible preferred stock warrants issued

     410   

Change in fair value

     37   
  

 

 

 

Balance at December 31, 2012

     488   

Fair value of redeemable convertible preferred stock warrants issued

     170   

Change in fair value

     3,370   
  

 

 

 

Balance at December 31, 2013

     4,028   

Settlement of warrant liability upon exercise

     (1,503

Change in fair value

     13,272   
  

 

 

 

Balance at December 31, 2014

     15,797   
  

 

 

 

Change in fair value (unaudited)

     56,655   

Settlement of warrant liability upon exercise (unaudited)

     (56,678

Reclassification of unexercised warrants to additional paid in capital upon the IPO (unaudited)

     (15,774
  

 

 

 

Balance at September 30, 2015 (unaudited)

   $   
  

 

 

 

 

The Company’s acquisition-related contingent consideration is determined using the Monte Carlo simulation method. The increases or decreases in the fair value of the contingent consideration payable could result from changes in the anticipated fair value of the Company’s common stock, stock price volatility, and probability of various market-based scenarios. As the fair value measure is based on significant inputs that are not observable in the market, they are categorized as Level 3.

 

The following table sets forth a summary of the changes in the fair value of the acquisition-related contingent consideration (in thousands):

 

Balance at December 31, 2014

   $   

Addition from acquisition

     7,704   

Change in fair value of contingent consideration

     (7,704
  

 

 

 

Balance at September 30, 2015

   $   
  

 

 

 

 

There have been no transfers between fair value measurement levels during 2013 and 2014.

Derivative Financial Instruments
Derivative Financial Instruments

5.    Derivative Financial Instruments

 

The Company’s earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. In December 2014, the Company entered into foreign exchange contracts to hedge monetary assets and liabilities that are denominated in currencies other than the functional currency of its subsidiaries. Beginning in the third quarter of 2015, the Company uses foreign currency derivative contracts designated as cash flow hedges to hedge certain forecasted revenue and expense transactions denominated in currencies other than the U.S. dollar. The Company and its subsidiaries do not enter into derivative contracts for trading or speculative purposes.

 

Cash Flow Hedges

 

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

 

The Company had outstanding contracts with a total notional amount of $149.2 million and $27.2 million in cash flow hedges for forecasted revenue and expense transactions, respectively, as of September 30, 2015.

 

Balance Sheet Hedges

 

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

 

The notional amount of foreign currency contracts open in U.S. dollar equivalents was $37.2 million as of December 31, 2014 and $76.3 million as of September 30, 2015.

The table below presents the notional amount of the non-designated foreign currency contracts as of September 30, 2015 (unaudited) (in thousands):

 

     Notional Amount Sold, Net  

Functional Currency:

   Foreign
Amount
     USD
Equivalent
 

AUD

     48,449       $ 35,397   

CAD

     14,982         11,555   

EUR

     5,863         6,522   

GBP

     12,683         19,775   

NZD

     4,800         3,043   
     

 

 

 
      $ 76,292   
     

 

 

 

 

The table below presents the notional amount of the foreign currency contracts as of December 31, 2014 (in thousands):

     Notional Amount Purchased  

Functional Currency:

   Foreign
Amount
     USD
Equivalent
 

AUD

     32,700       $ 26,810   

CAD

     3,200         2,782   

EUR

     2,700         3,355   

GBP

     2,100         3,295   

NZD

     1,200         930   
     

 

 

 
      $ 37,172   
     

 

 

 

 

Currently, the Company does not have master netting agreements with its counterparties for its foreign currency contracts. As of December 31, 2014, the fair value of the derivative assets and liabilities totaling $0.3 million and $0.1 million were recorded in prepaid expenses and other assets and accrued liabilities on the consolidated balance sheets. The gain recognized in other income (expense), net for non-designated foreign currency forward contracts was $0.2 million for 2014.

 

Fair Value of Foreign Currency Derivatives

 

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

 

          September 30, 2015      December 31, 2014  
    

Balance Sheet Location

   Fair
Value
Derivative

Assets
     Fair
Value
Derivative
Liabilities
     Fair
Value
Derivative

Assets
     Fair
Value
Derivative
Liabilities
 
          (unaudited)                

Cash flow designated hedges

  

Prepaid expense and other current assets

   $ 2,437       $       $       $   

Cash flow designated hedges

  

Accrued liabilities

             1,585                   

Hedges not designated

  

Prepaid expense and other current assets

     2,876                 316           

Hedges not designated

  

Accrued liabilities

             740                 105   
     

 

 

    

 

 

    

 

 

    

 

 

 

Total fair value of derivative instruments

      $ 5,313       $ 2,325       $ 316       $ 105   
     

 

 

    

 

 

    

 

 

    

 

 

 

 

Financial Statement Effect of Foreign Currency Derivative Contracts

 

The following table presents the pre-tax impact of the Company’s foreign currency derivative contracts on other comprehensive income (“OCI”) and the condensed consolidated statement of operations for the periods presented (in thousands):

 

          Nine Months
Ended

September 30,
 
    

Income Statement Location

   2015     2014  
          (unaudited)  
Foreign exchange cash flow hedges:        

Gain (loss) recognized in OCI—effective portion

      $ 1,466      $   

Gain (loss) reclassified from OCI into income—effective portion

  

Revenue

     580          

Gain (loss) reclassified from OCI into income—effective portion

  

Operating expenses

     (32       

Gain (loss) recognized in income—ineffective portion

  

Other expense, net

     104          
Foreign exchange balance sheet hedges:        

Gain (loss) recognized in income

  

Other expense, net

   $ 6,009      $   

 

As of September 30, 2015, all net derivative gains related to the Company’s cash flow hedges will be reclassified from OCI into net income within the next 12 months.

 

Offsetting of Foreign Currency Derivative Contracts

 

The Company presents its derivative assets and derivative liabilities at gross fair values in the condensed consolidated balance sheets. In July 2015, the Company started to enter into master netting arrangements, which mitigate credit risk by permitting net settlement of transactions with the same counterparty. The Company is not required to pledge, and is not entitled to receive, cash collateral related to these derivative instruments. As of December 31, 2014, the Company did not have master netting agreements with its counterparties for its foreign currency contracts.

 

The following table sets forth the available offsetting of net derivative assets under the master netting arrangements as of September 30, 2015 (in thousands) (unaudited):

 

     Gross Amounts
of Recognized
Assets
     Gross Amounts
Offset in the
Condensed
Consolidated
Balance Sheets
     Net Amounts
Presented in
Condensed
Consolidated
Balance Sheets
     Gross Amounts Not
Offset in Condensed
Consolidated Balance
Sheets
        
              Financial
Instruments
     Cash
Collateral
Received
     Net
Amount
 

Foreign exchange contracts

   $ 5,313       $       $ 5,313       $ 1,971       $       $ 3,342   

 

The following table sets forth the available offsetting of net derivative liabilities under the master netting arrangements as of September 30, 2015 (in thousands) (unaudited):

 

     Gross Amounts
of Recognized
Liabilities
     Gross Amounts
Offset in the
Condensed
Consolidated
Balance Sheets
     Net Amounts
Presented in
Condensed
Consolidated
Balance Sheets
     Gross Amounts Not
Offset in Condensed
Consolidated Balance
Sheets
        
              Financial
Instruments
     Cash
Collateral
Pledged
     Net
Amount
 

Foreign exchange contracts

   $ 2,325       $       $ 2,325       $ 1,971       $       $ 354   

Balance Sheet Components
Balance Sheet Components

6.    Balance Sheet Components

 

Cash, Cash Equivalents, and Marketable Securities (unaudited)

 

The following table sets forth the cash, cash equivalents, and marketable securities as of September 30, 2015 (in thousands) (unaudited):

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value      Cash and
Cash
Equivalents
     Marketable
Securities
 

Cash

   $ 103,895       $       $        103,895       $ 103,895       $   

Money market funds

     285,079                        285,079         285,079           

U.S. government agencies

     105,530         13         (1     105,542         41,649         63,893   

Corporate debt securities

     80,980         3         (21     80,962         31,657         49,305   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 575,483       $ 16       $ (22   $ 575,478       $ 462,280       $ 113,198   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

All available-for-sale investments as of September 30, 2015 have a contractual maturity of one year or less. The following table presents fair values and gross unrealized losses of investments that have been in an unrealized loss position for less than twelve months as of September 30, 2015 (in thousands) (unaudited):

 

     Fair
Value
     Gross
Unrealized
Losses
 

U.S. government agencies

   $ 13,401       $ (1

Corporate debt securities

     45,851         (21
  

 

 

    

 

 

 

Total

   $ 59,252       $ (22
  

 

 

    

 

 

 

 

There were no available-for-sale investments as of September 30, 2015 that have been in a continuous unrealized loss position for greater than twelve months.

 

Accounts Receivable Reserves

 

Changes in accounts receivable reserves were as follows (in thousands):

 

     Allowance for
Doubtful
Accounts
    Revenue
Reserve
 

Balance at December 31, 2011

   $ 30      $ 255   

Increases

     71        3,871   

Write-offs/returns taken

     (9     (939
  

 

 

   

 

 

 

Balance at December 31, 2012

     92        3,187   

Increases

     651        20,307   

Write-offs/returns taken

            (8,078
  

 

 

   

 

 

 

Balance at December 31, 2013

     743        15,416   

Increases

     864        42,740   

Write-offs/returns taken

     (769     (31,597
  

 

 

   

 

 

 

Balance at December 31, 2014

     838        26,559   
  

 

 

   

 

 

 

Increases (decreases) (unaudited)

     (32     100,342   

Write-offs/returns taken (unaudited)

     79        (85,689
  

 

 

   

 

 

 

Balance at September 30, 2015 (unaudited)

   $ 727      $ 41,212   
  

 

 

   

 

 

 

 

Inventories

 

Inventories consisted of the following (in thousands):

 

     December 31,      September 30,
2015
 
     2013      2014     
                   (unaudited)  

Components

   $ 35,551         $53,383         $15,936   

Finished goods

     20,890         61,689         260,147   
  

 

 

    

 

 

    

 

 

 

Total inventories

   $ 56,441       $ 115,072       $ 276,083   
  

 

 

    

 

 

    

 

 

 

 

Prepaid Expenses and Other Current Assets

 

Prepaid expenses and other current assets consisted of the following (in thousands):

 

     December 31,      September 30,
2015
 
     2013      2014     
                   (unaudited)  

Derivative assets

   $       $ 316       $ 5,313   

POP displays, net

     1,212         7,121         5,094   

Prepaid expenses and other current assets

     1,973         6,177         10,792   
  

 

 

    

 

 

    

 

 

 

Total prepaid expenses and other current assets

   $ 3,185       $ 13,614       $ 21,199   
  

 

 

    

 

 

    

 

 

 

 

Property and Equipment, Net

 

Property and equipment, net, consisted of the following (in thousands):

 

     December 31,     September  30,
2015
 
     2013     2014    
                 (unaudited)  

Tooling and manufacturing equipment

   $ 9,094      $  28,344      $ 45,754   

Furniture and office equipment

     828        2,891        5,859   

Purchased and internally-developed software

     482        1,396        2,403   

Leasehold improvements

     293        3,594        3,874   
  

 

 

   

 

 

   

 

 

 

Total property and equipment

     10,697        36,225        57,890   

Less: Accumulated depreciation and amortization

     (4,211     (9,790     (22,162
  

 

 

   

 

 

   

 

 

 

Property and equipment, net

   $ 6,486      $ 26,435      $ 35,728   
  

 

 

   

 

 

   

 

 

 

 

Goodwill and Intangible Assets (unaudited)

 

The changes in the carrying amount of goodwill for the nine months ended September 30, 2015 were as follows (unaudited) (in thousands). See Note 17 for additional information.

 

     Goodwill  

Balance at December 31, 2014

   $ —     

Goodwill acquired

     22,562   

Subsequent goodwill adjustments

     (405
  

 

 

 

Balance at September 30, 2015

   $ 22,157   
  

 

 

 

There were no intangible assets outstanding as of December 31, 2014. The carrying amounts of the intangible assets as of September 30, 2015 were as follows (unaudited) (in thousands, except useful life). See Note 17 for additional information.

 

     September 30, 2015      Weighted
Average
Remaining
Useful Life
(years)
 
     Gross      Accumulated
Amortization
    Net     

Developed technology

   $ 12,640       $ (990   $ 11,650         6.5   

Trademarks and other

     1,278         (179     1,099         4.0   
  

 

 

    

 

 

   

 

 

    

Total intangible assets, net

   $ 13,918       $ (1,169   $ 12,749      
  

 

 

    

 

 

   

 

 

    

 

Total amortization expense related to intangible assets was $0.5 million and $1.2 million for the three and nine months ended September 30, 2015, respectively.

 

The estimated future amortization expense of acquired intangible assets to be charged to cost of revenue and operating expenses after September 30, 2015, is as follows (unaudited) (in thousands):

 

     Cost of
Revenue
     Operating
Expenses
     Total  

Remaining 2015

   $ 451       $ 82       $ 533   

2016

     1,806         281         2,087   

2017

     1,806         230         2,036   

2018

     1,806         230         2,036   

2019

     1,806         230         2,036   

Thereafter

     3,975         46         4,021   
  

 

 

    

 

 

    

 

 

 

Total intangible assets, net

   $ 11,650       $ 1,099       $ 12,749   
  

 

 

    

 

 

    

 

 

 

 

Accrued Liabilities

 

Accrued liabilities consisted of the following (in thousands):

 

     December 31,      September  30,
2015
 
     2013      2014     
                   (unaudited)  

Product warranty

   $ 8,480       $ 20,098       $ 25,072   

Employee related liabilities

     2,395         4,115         18,153   

Accrued advertising and marketing development funds

     2,120         7,833         17,097   

Accrued manufacturing expense and freight

     7,710         16,229         9,235   

Inventory received but not billed

     —           6,242         3,777   

Accrued sales incentives

     2,469         2,355         3,568   

Sales taxes and VAT payable

     1,766         2,291         3,360   

Accrued legal fees

     408         678         2,111   

Customer deposits

     836         6,391         1,406   

Other

     2,381         4,708         14,479   
  

 

 

    

 

 

    

 

 

 

Accrued liabilities

   $ 28,565       $ 70,940       $ 98,258   
  

 

 

    

 

 

    

 

 

 

 

Product warranty reserve activities were as follows (in thousands):

 

     Reserve  For
Product
Warranty(1)
 

Balance at December 31, 2011

   $ 677   

Charged to cost of revenue

     3,179   

Settlement of claims

     (1,624
  

 

 

 

Balance at December 31, 2012

     2,232   

Charged to cost of revenue

     9,078   

Settlement of claims

     (2,830
  

 

 

 

Balance at December 31, 2013

     8,480   

Charged to cost of revenue

     19,462   

Settlement of claims

     (7,844
  

 

 

 

Balance at December 31, 2014

     20,098   

Charged to cost of revenue (unaudited)

     38,210   

Changes related to pre-existing warranties

     8,968   

Settlement of claims (unaudited)

     (24,268
  

 

 

 

Balance at September 30, 2015 (unaudited)

   $ 25,072   
  

 

 

 

 

(1)  

Does not include reserves established as a result of the recall of the Fitbit Force. See the section titled “—Fitbit Force Recall Reserve” for additional information regarding such reserves.

 

The changes related to pre-existing warranties resulted from a reduction in the estimated number of units to be replaced and in the estimated cost of replacement units.

 

Fitbit Force Recall Reserve

 

In March 2014, the Company announced a recall for one of its products, the Fitbit Force (“Fitbit Force Recall”). The product recall, which is regulated by the U.S. Consumer Product Safety Commission, covered all Fitbit Force units sold since the product was first introduced in October 2013. The product recall program has no expiration date.

 

As a result of the product recall, the Company established reserves that include cost estimates for customer refunds, logistics and handling fees for managing product returns and processing refunds, obsolescence of on-hand inventory, cancellation charges for existing purchase commitments and rework of component inventory with the contract manufacturer, write-offs of tooling and manufacturing equipment, and legal settlement costs.

 

Fitbit Force recall reserve activities were as follows (in thousands):

 

     Reserve For
Fitbit Force
Recall
 

Balance at December 31, 2012

   $   

Charged to revenue

     30,607   

Charged to cost of revenue

     49,493   

Charged to general and administrative

     2,838   

Settlement of claims

       
  

 

 

 

Balance at December 31, 2013

     82,938   

Charged to revenue

     8,112   

Charged to cost of revenue

     11,339   

Charged to general and administrative

     505   

Settlement of claims

     (80,418
  

 

 

 

Balance at December 31, 2014

     22,476   
  

 

 

 

Benefit to cost of revenue (unaudited)

     (2,040

Settlement of claims (unaudited)

     (8,777
  

 

 

 

Balance at September 30, 2015 (unaudited)

   $ 11,659   
  

 

 

 

 

During 2013, the Company recorded excess and obsolete Fitbit Force inventory-related amounts of $10.3 million, included in the reserve, and wrote-off $1.7 million for specialized Fitbit Force tooling and manufacturing equipment to cost of revenue as incurred in the consolidated statement of operations. During 2014, legal fees of $2.9 million were recognized as incurred, in addition to legal settlement costs of $0.5 million related to the Fitbit Force recall, which were included in general and administrative costs in the consolidated statement of operations. During the nine months ended September 30, 2015, a benefit to legal expenses of $0.1 million was recognized as incurred in general and administrative costs.

 

Long-Term Debt
Long-Term Debt

7.    Long-Term Debt

 

2012 Financing Facility

 

As of December 31, 2013, the Company had term loan facilities with Silicon Valley Bank (“SVB”) totaling $26.0 million consisting of a $14.0 million revolving line of credit, a $3.0 million senior term loan, and a $9.0 million mezzanine term loan facility. The annual interest rate on the revolving line of credit is the greater of 0.75% above the bank’s prime rate or 4.0%. The annual interest rate on the senior term loan is equal to the greater of 0.50% above the bank’s prime rate or 4.5%. The annual interest rate on the mezzanine term loan facility is equal to 10.5% per annum. For December 31, 2012 and 2013, the effective interest rates on the revolving line of credit and the senior term loan were 4.5% and 4.0% per annum, respectively. The interest on these facilities are payable monthly. The revolving line of credit and the senior term loan advances had original maturity dates ranging from June 2014 to June 2016. The mezzanine term loan had a maturity of May 2016. As of December 31, 2013, $2.3 million was outstanding under the senior term loan, $9.0 million was outstanding under the mezzanine facility, and nothing was outstanding under the revolving line of credit. The revolving line of credit, senior term loan, and mezzanine term loan facility were all terminated in August 2014.

 

2014 Credit Agreement

 

In August 2014, the Company entered into an amended and restated credit agreement (“Asset-Based Credit Facility”) with SVB, as administrative agent and lender, and several other lenders, including affiliates of Morgan Stanley & Co. LLC, SunTrust Robinson Humphrey, Inc., and Deutsche Bank Securities Inc. The Asset-Based Credit Facility allows the Company to borrow up to the lesser of (i) $180.0 million, including up to $50.0 million for the issuance of letters of credit and up to $25.0 million for swing line loans and (ii) the borrowing base then in effect less the amount then outstanding under letters of credit and loans. The borrowing base is determined by the Company’s collateral agents based on several variables, including percentages of the book value of certain eligible accounts receivable and a percentage of certain eligible inventories. Borrowings under the Asset-Based Credit Facility may be drawn as Alternate Base Rate or ABR loans or Eurodollar loans, and matures in August 2018. ABR loans bear interest at a variable rate equal to the applicable margin plus the highest of (i) the prime rate, (ii) the federal funds effective rate plus 0.5%, and (iii) the Eurodollar rate plus 1.0%, but in any case at a minimum rate of 3.25% per annum. Eurodollar loans bear interest at a variable rate based on the LIBOR rate and Euro currency reserve requirements. The Company is also required to pay an annual commitment fee on the average daily unused portion of the facility of 0.25%, 0.35%, or 0.45%, based on usage of the facility. As of December 31, 2014 and September 30, 2015, the effective interest rate on the revolving line of credit was 4.25%.

 

The Company has the option to repay its borrowings under the Asset-Based Credit Facility without penalty prior to maturity. The Asset-Based Credit Facility requires the Company to comply with certain financial covenants, including maintaining a consolidated fixed charge coverage ratio of at least 1.1:1, consolidated leverage ratios of between 3:1 and 2:1, and levels of liquidity of not less than $15.0 million. The Asset-Based Credit Facility also requires the Company to comply with certain non-financial covenants. The Company was in compliance with these covenants as of December 31, 2014 and September 30, 2015.

 

As of December 31, 2014, the Company had $125.0 million of outstanding borrowings under the Asset-Based Credit Facility. In January 2015, the Company repaid $125.0 million of its indebtedness under the Asset-Based Credit Facility. As a result, the long-term debt that was repaid was classified as long-term debt, current portion, on the Company’s consolidated balance sheet as of December 31, 2014. As of September 30, 2015, the Company had no outstanding borrowings under the Asset-Based Credit Facility.

 

2014 Revolving Credit and Guarantee Agreement

 

In August 2014, the Company entered into a revolving credit and guarantee agreement (“Cash Flow Facility”) with an affiliate of Morgan Stanley & Co. LLC, as administrative agent and collateral agent, and several other lenders, including SVB and an affiliate of SunTrust Robinson Humphrey, Inc. In October 2014, the Company entered into an incremental joinder agreement with an affiliate of Barclays Capital, Inc., which amended the Cash Flow Facility to increase the borrowing limit under the Cash Flow Facility. The Cash Flow Facility allows the Company to borrow up to $50.0 million, including up to $10.0 million for the issuance of letters of credit and up to $10.0 million for swing line loans, and matures in August 2018. Borrowings under the Cash Flow Facility may also be drawn as ABR loans or Eurodollar loans. ABR loans under our Cash Flow Facility bear interest at a variable rate equal to the applicable margin plus the highest of (i) 3.5%, (ii) the prime rate, (iii) the federal funds effective rate plus 0.5%, and (iv) the adjusted LIBOR rate plus 1.0%. Eurodollar loans under the Cash Flow Facility bear interest at a variable rate for any day based on the LIBOR rate and Euro currency reserve requirements. The Company is also required to pay an annual commitment fee on the average daily unused portion of the facility of 0.375% or 0.5%, based on usage of the facility. As of December 31, 2014, the effective interest rate on the revolving line of credit was 3.59%. The Cash Flow Facility also requires the Company to comply with certain financial covenants, including maintaining certain consolidated leverage ratios of between 3:1 and 2:1, and other non-financial covenants.

 

As of December 31, 2014, the Company had $8.0 million of outstanding borrowings under the Cash Flow Facility. Subsequent to December 31, 2014, the Company repaid $8.0 million of its indebtedness under the Cash Flow Facility. As of September 30, 2015, the Company had no outstanding borrowings under the Cash Flow Facility.

 

The fair value of warrants issued in connection with debt agreements prior to 2012 was recorded as a debt discount and is amortized to interest expense using the straight-line method which approximated the effective interest method over the term of the related debt agreement. In addition, capitalized issuance costs are amortized to interest expense over the term of the related financing arrangement on a straight-line basis. Interest expense for 2012, 2013, 2014, and the nine months ended September 30, 2014 and 2015 was $0.2 million, $1.1 million, $2.2 million, $1.6 million, and $1.3 million, respectively.

 

Letters of Credit

 

As of December 31, 2014 and September 30, 2015, the Company had outstanding letters of credit of $2.9 million and $16.8 million, respectively, issued to cover the security deposit on the lease of its office headquarters in San Francisco, California, and other facility leases.

Commitments and Contingencies
Commitments and Contingencies

8.    Commitments and Contingencies

 

Leases

 

The Company’s principal facility is located in San Francisco, California. The Company also leases office space in various locations with expiration dates between 2015 and 2020. The lease agreements often include leasehold improvement incentives, escalating lease payments, renewal provisions and other provisions which require the Company to pay taxes, insurance, maintenance costs or defined rent increases. All of Company’s leases are accounted for as operating leases.

 

Rent expense is recorded over the lease terms on a straight-line basis. Rent expense was $0.4 million, $0.9 million, $4.1 million, $3.2 million, and $5.1 million, for 2012, 2013, 2014, and the nine months ended September 30, 2014 and 2015, respectively. Future minimum payments under the leases as of December 31, 2014 were as follows (in thousands):

 

Year ending December 31,

   Amounts  

2015

   $ 4,224   

2016

     3,848   

2017

     3,705   

2018

     3,812   

2019

     3,725   

Thereafter

     874   
  

 

 

 

Total

   $ 20,188   
  

 

 

 

 

In June 2015, the Company entered into a lease to expand the Company’s existing headquarters. The lease expires in 2024 and future minimum payments under the lease are included in the table below.

 

Future minimum payments under the leases as of September 30, 2015 (unaudited) were as follows (in thousands):

 

     Amounts  

2015

   $ 2,092   

2016

     14,108   

2017

     16,993   

2018

     16,928   

2019

     16,263   

Thereafter

     56,294   
  

 

 

 

Total

   $ 122,678   
  

 

 

 

 

Purchase Commitments

 

The aggregate amount of purchase orders open as of December 31, 2014 and September 30, 2015 was approximately $257.0 million and $508.1 million, respectively. The Company 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. The Company’s purchase orders are based on its current needs and are fulfilled by its suppliers, contract manufacturers, and logistics providers within short periods of time.

 

Legal Proceedings

 

In 2014, class action and personal injury lawsuits were filed against the Company based upon claims of allergic reactions from adhesives in the Fitbit Force, and alleged violations of various state false advertising and unfair competition statutes based on the Company’s sale and marketing of the Fitbit Force. The class action cases were settled in 2014. Certain personal injury complaints remain outstanding but the Company believes that liabilities arising under these claims are covered by the Company’s commercial general liability insurance.

 

Further, the Company is and, from time to time, may in the future become, involved in other legal proceedings in the ordinary course of business. The Company currently believes that the outcome of any of these existing legal proceedings, either individually or in the aggregate, will not have a material impact on the operating results, financial condition or cash flows of the Company. With respect to existing legal proceedings, the Company has either determined that the existence of a material loss is not reasonably possible or that it is unable to estimate a reasonably possible range of loss.

 

Indemnifications

 

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

Redeemable Convertible Preferred Stock
Redeemable Convertible Preferred Stock

9.    Redeemable Convertible Preferred Stock

 

As of December 31, 2013, the Company’s redeemable convertible preferred stock consisted of the following (in thousands, except share and per share data):

 

     Shares
Authorized
     Shares
Outstanding
     Price per
Share
     Net
Carrying
Value
     Liquidation
Preference
 

Series A

     10,200,000         10,200,000       $ 0.04167       $ 421       $ 425   

Series A-1

     22,368,912         22,368,912         0.09164         2,000         2,050   

Series B

     42,360,000         41,705,112         0.21580         8,955         9,000   

Series C

     39,600,000         36,080,004         0.33452         12,049         12,069   

Series D

     30,000,000         29,149,887         1.47513         42,811         43,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

Total

     144,528,912         139,503,915          $ 66,236       $ 66,544   
  

 

 

    

 

 

       

 

 

    

 

 

 

 

As of December 31, 2014, the Company’s redeemable convertible preferred stock consisted of the following (in thousands, except share and per share data):

 

     Shares
Authorized
     Shares
Outstanding
     Price per
Share
     Net
Carrying
Value
     Liquidation
Preference
 

Series A

     10,200,000         10,200,000       $ 0.04167       $ 421       $ 425   

Series A-1

     22,368,912         22,368,912         0.09164         2,000         2,050   

Series B

     42,360,000         42,052,680         0.21580         10,533         9,075   

Series C

     39,600,000         36,080,004         0.33452         12,049         12,069   

Series D

     30,000,000         29,149,887         1.47513         42,811         43,000   
  

 

 

    

 

 

       

 

 

    

 

 

 

Total

     144,528,912         139,851,483          $ 67,814       $ 66,619   
  

 

 

    

 

 

       

 

 

    

 

 

 

 

Upon the closing of the Company’s IPO, all shares of the Company’s then-outstanding redeemable convertible preferred stock, as shown in the table above, automatically converted on a one-for-one basis into an aggregate of 139,851,483 shares of Class B common stock.

 

Significant provisions of the redeemable convertible preferred stock are as follows:

 

Voting—Each holder of redeemable convertible preferred stock is entitled to the number of votes equal to the number of shares of common stock into which each such shares of redeemable convertible preferred stock could be converted on the record date for the vote or consent of the stockholders, except as otherwise required by law or other provisions of the Certificate of Incorporation, and have voting rights and powers equal to the voting rights and powers of the common stockholders. The holders of Series A-1, Series B, and Series D redeemable convertible preferred stock, voting as a separate class, are each entitled to elect one member of the board of directors. The holders of redeemable convertible preferred stock and common stock, voting on an as-converted basis, are entitled to elect two members of the Board of Directors.

 

Dividends—The holders of Series D redeemable convertible preferred stock are entitled to receive noncumulative dividends prior and in preference to any payment of any dividend on the holders of other redeemable convertible preferred stock at a rate of 8% of original issuance price per share per annum. The holders of Series A, Series A-1, Series B, and Series C redeemable convertible preferred stock are entitled to receive, on a pari passu basis, non-cumulative dividends, as adjusted for stock splits, dividends, reclassifications or the like, prior and in preference to any declaration or payment of any dividends to the holders of common stock, when and if declared by the Board of Directors, at a rate of 8% of original issuance price per share for redeemable convertible preferred stock, per annum. No cash dividends have been declared by the Board of Directors or paid since inception.

 

After payment of such preferential dividends on redeemable convertible preferred stock during any year, any further dividends or distribution distributed during such year shall be declared and paid ratably on the outstanding redeemable convertible preferred stock (on an as converted to common stock basis) and the common stock.

 

Liquidation—In the event of any voluntary or involuntary liquidation, the holders of shares of Series D redeemable convertible preferred stock shall be entitled to receive, prior and in preference to any distribution of proceeds, to the holders of Series A, Series A-1, Series B, and Series C redeemable convertible preferred stock and common stock, an amount per share equal to the original issuance price of the Series D redeemable convertible preferred stock plus declared but unpaid dividends on such share. If upon the occurrence of such event, the proceeds thus distributed among the holders of the Series D redeemable convertible preferred stock are insufficient to permit the payment to such holders of the full aforesaid preferential amounts, then the proceeds shall be distributed ratably among the holders of Series D redeemable convertible preferred stock in proportion to the full preferential amount that each such holder is otherwise entitled to receive. Upon the completion of the distribution to the holders of Series D redeemable convertible preferred stock shares, the holders of shares of Series A, Series A-1, Series B, and Series C redeemable convertible preferred stock shall be entitled to receive, prior and in preference to any distribution of the proceeds to the holders of common stock, an amount per share equal to the applicable original issuance price for such series of redeemable convertible preferred stock plus declared but unpaid dividends on such share. If, upon the occurrence of such event, the proceeds thus distributed among the holders of shares of Series A, Series A-1, Series B, and Series C redeemable convertible preferred stock are insufficient to permit the payment to such holders of the full aforesaid preferential amounts, then the proceeds shall be distributed ratably among the holders of shares of Series A, Series A-1, Series B, and Series C redeemable convertible preferred stock in proportion to the full preferential amount that each such holder is otherwise entitled to receive. Thereafter, the remaining proceeds, if any, shall be distributed to the holders of shares of Series D redeemable convertible preferred stock and common stock pro rata based on the number of shares of common stock held by each, on an as-converted basis (as if such conversion happened immediately prior to such liquidation event but following the payments described above); provided, however, that if the aggregate amount per share that the holders of Series D redeemable convertible preferred stock shall be entitled to receive shall exceed three times of the Series D original issuance price (the participation cap amount), each holder of Series D redeemable convertible preferred stock shall be entitled to receive upon such liquidation event the greater of (i) the participation cap amount and (ii) the amount such holder would have received if all shares of Series D redeemable convertible preferred stock had been converted into common stock immediately prior to such liquidation event.

 

A liquidation may be deemed to be occasioned by or to include (unless waived by the vote or written consent of the majority of the outstanding redeemable convertible preferred stock holders, voting as a single class on an as-converted basis, and the holders of at least 66.67% of the then outstanding shares of Series D redeemable convertible preferred stock, voting as a separate series on an as-converted basis) (i) the closing of a sale, transfer, or disposition of all or substantially all of the assets of the Company; (ii) the consummation of a consolidation or merger of the Company with or into another entity (except a consolidation or merger in which the Company’s stockholders immediately prior to such transaction continue to hold at least 50% of the voting power of the capital stock of the Company or the surviving or acquiring entity); or (iii) after the transfer of the Company’s securities to a person or group of affiliated persons, such person or group hold at least 50% of the voting power of the Company (or the surviving or acquiring entity). The Company considers its convertible preferred stock as redeemable and as such has classified it as temporary equity in the balance sheet due to the existence of certain change in control events that are outside of the Company’s control including liquidation, or the sale or transfer of the Company, that trigger the ability of the holders of the redeemable preferred stock to call for redemption of the shares.

 

Conversion—Each share of Series A, Series A-1, Series B, Series C, and Series D redeemable convertible preferred stock is convertible into such number of shares of common stock as is determined by dividing the original issuance price for such series of redeemable convertible preferred stock by the applicable conversion price for such series of redeemable convertible preferred stock. The initial conversion price per share for each series of redeemable convertible preferred stock is equal to the original issuance price for such series of redeemable convertible preferred stock, which is subject to adjustment. As of December 31, 2014, the conversion price per share equals the original issuance price. Conversion is either at the option of the holder or is automatic upon the closing date of a public offering of the Company’s common stock for which the aggregate public offering price is not less than $70.0 million, or upon the written consent of the holders of a majority of the then outstanding shares of redeemable convertible preferred stock, voting together as a single class on an as-converted basis, and the holders of at least 66.67% of the then outstanding shares of Series D redeemable convertible preferred stock, voting as a separate series on an as-converted to basis.

 

Protective Provisions—The holders of Series D redeemable convertible preferred stock have certain protective provisions. As long as 12.0 million shares of Series D redeemable convertible preferred stock are outstanding, the Company cannot, without the approval of the holders of at least 66.67% of the then outstanding shares of Series D redeemable convertible preferred stock, voting as a separate class on an as-converted basis, take any actions that to: (i) authorize or issue, or obligate itself to issue, any equity security (including any other security convertible into or exercisable for any such equity security) having a preference over any series of redeemable convertible preferred stock with respect to dividends, liquidation or redemption; or (ii) alter or change the rights, preferences or privileges of Series D redeemable convertible preferred stock so as to adversely affect such shares; or (iii) reclassify, alter or amend any existing equity security that is junior or pari passu with the Series D redeemable convertible preferred stock in respect of the distribution of assets on a liquidation event, the repayment of dividends or rights of redemption, if such reclassification, alteration or amendment would render such other security senior to the Series D redeemable convertible preferred stock in respect of any such right, preference or privilege.

 

The holders of Series A, Series A-1, Series B, Series C, and Series D redeemable convertible preferred stock have certain protective provisions. As long as at least 81.6 million shares of all series of redeemable convertible preferred stock are outstanding, the Company cannot, without the approval of the holders of at least a majority of the then outstanding shares of redeemable convertible preferred stock, voting as a single class on an as-converted basis, take any action that to: (i) authorize or issue, or obligate itself to issue, any equity security (including any other security convertible into or exercisable for any such equity security) having a preference over any series of redeemable convertible preferred stock with respect to dividends, liquidation or redemption; (ii) declare or pay any dividends; (iii) redeem, purchase or otherwise acquire (or pay into or set aside for a sinking fund for such purpose) shares of any class of stock with certain exceptions; (iv) consummate a liquidation event; (v) alter the total authorized number of shares of redeemable convertible preferred stock (other than by redemption or conversion); (vi) alter or change the rights, preferences or privileges of redeemable convertible preferred stock so as to adversely affect such shares; (vii) amend the Company’s certificate of incorporation or bylaws in any manner which adversely affects the rights of the redeemable convertible preferred stock; or (viii) change the authorized number of members of the board of directors.

Redeemable Convertible Preferred Stock Warrants
Redeemable Convertible Preferred Stock Warrants

10.    Redeemable Convertible Preferred Stock Warrants

 

As of December 31, 2013 and 2014, the Company had the following redeemable convertible preferred stock warrants issued and outstanding:

 

Warrant Class:

   Number of Shares Underlying Warrants      Fair Value      Issuance Date    Exercise
Price  per
Share
 
     2013      2014      March 31,
2015
     2013      2014        
                   (unaudited)     

(in thousands)

             

Series B

     347,568                       $ 712       $       August 2009    $ 0.22   

Series B

     277,992         277,992         277,992         570         2,351       June 2011      0.22   

Series C

     57,000         57,000         57,000         110         475       April 2012      0.33   

Series C

     1,215,000         1,215,000         1,215,000         1,978         9,728       September 2012      0.67   

Series C(1)

     405,000         405,000         405,000         658         3,243       September 2012      0.67   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

Total

     2,302,560         1,954,992         1,954,992       $ 4,028       $ 15,797         
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

       

 

(1)  

Represents additional shares that may be exercised pursuant to the Series C redeemable convertible preferred stock warrant issued in September 2012 due to a draw down on a debt financing arrangement in March 2013.

 

In August 2009, secured convertible promissory notes were issued to the Company’s founders and investors and subsequently converted to warrants to purchase 347,568 shares of Series B redeemable convertible preferred stock in 2010. The Company determined the fair value of these warrants to be $30,000 on the date of grant. In August 2014, the warrants were exercised into 347,568 shares of Series B redeemable convertible preferred stock for total consideration of $0.1 million.

 

In June 2011, as part of financing arrangements with a financial institution, the Company issued a warrant to purchase 277,992 shares of Series B redeemable convertible preferred stock. The warrant is immediately exercisable and expires, if not exercised, in June 2018. The Company determined the fair value of the warrants to be $25,000 on the date of grant.

 

In April and September 2012, in connection with entering into a debt financing arrangement, the Company issued warrants to purchase an aggregate of 1,272,000 shares of Series C redeemable convertible preferred stock. These warrants are exercisable immediately and expire, if not exercised, in April and September 2019. The Company determined the fair value of the warrants granted in April and September to be $10,000 and $0.4 million on the date of grant.

 

In March 2013, the Company drew down under an existing debt financing arrangement. In connection with the draw down, the existing September 2012 warrants to purchase 1,215,000 shares of Series C redeemable convertible preferred stock became exercisable for 1,620,000 shares of Series C redeemable convertible preferred stock. The Company determined the fair value of these warrants to be $0.2 million on the date of grant using the Black-Scholes option-pricing model.

 

As the redeemable convertible preferred stock warrants are exercisable into contingently redeemable preferred shares, the Company has recognized a liability for the fair value of its warrants on the consolidated balance sheets upon issuance and subsequently remeasures the liability at the end of each reporting period.

 

The key assumptions used in the Black-Scholes option-pricing model for the revaluation of the redeemable convertible preferred stock warrants were as follows:

 

     Year Ended December 31,
     2012    2013    2014

Expected term (in years)

   1.6 – 6.75    0.61 – 6.94    0.75 – 1.25

Volatility

   51.83 – 57.22%    31.24 – 62.72%    46.70 – 54.90%

Risk-free interest rate

   0.22 – 1.04%    0.06 – 2.47%    0.11 – 0.21%

Dividend yield

   —%    —%    —%

 

As these warrants to acquire convertible preferred stock are classified as liabilities, any potential beneficial conversion feature related to those underlying shares of convertible preferred would not be recognized until such time as the warrant is exercised. At that point any excess of the fair value of the Company’s common stock into which the shares of convertible preferred are convertible over the effective conversion price, measured as the sum of the carrying amount of the warrant liability and the exercise price of the warrant, would be recognized as a beneficial conversion feature and would reduce earnings available to common stockholders in the calculation of earnings per share for that period.

 

In connection with the closing of a qualifying IPO, all of the outstanding redeemable convertible preferred stock warrants will automatically convert to common stock warrants, and the redeemable convertible preferred stock warrant liability will be remeasured to the extent the warrants qualify for equity classification and no further measurement will be required thereafter.

 

Immediately prior to the completion of the IPO, the Company issued 274,992 shares of Series B redeemable convertible preferred stock and 1,210,591 shares of Series C redeemable convertible preferred stock upon the exercise of 277,992 and 1,251,357 of Series B and Series C redeemable convertible preferred stock warrants, respectively, after the forfeiture of 3,000 and 40,766 Series B and Series C redeemable convertible preferred stock warrants, respectively. The shares issued upon the net exercise were sold as Class A common stock in the IPO. In addition, all of the remaining outstanding redeemable convertible preferred stock warrants automatically converted to Class B common stock warrants upon closing of the IPO. As a result of the net exercise of redeemable convertible preferred stock warrants and automatic conversion of the remaining warrants to Class B common stock warrants, the Company revalued the warrants as of the completion of the IPO and reclassified the remaining redeemable convertible preferred stock warrant liability balance related to the unexercised warrants to additional paid-in capital. As of September 30, 2015, there were 425,643 Class B common stock warrants outstanding. These Class B common stock warrants expire in June 2025 and are exercisable at an exercise price of $0.67 per share.

 

Common Stock
Common Stock

11.    Common Stock

 

The Company has reserved shares of common stock, on an as-converted basis, for future issuance as follows (in thousands):

 

     December 31,      September  30,
2015
 
     2013      2014     
                   (unaudited)  

Redeemable convertible preferred stock outstanding

     139,504         139,851           

Options issued and outstanding

     23,404         43,998         48,655   

Restricted stock units issued and outstanding

                     2,096   

Shares available for future equity grants

     53         3,624         4,770   

Series B redeemable convertible preferred stock warrants

     625         278           

Series C redeemable convertible preferred stock warrants

     1,677         1,677           

Common stock warrants

                     427   

Employee stock purchase plan

                     3,750   
  

 

 

    

 

 

    

 

 

 

Total

     165,263         189,428         59,698   
  

 

 

    

 

 

    

 

 

 
Stock Plan
Stock Plan

12.    Stock Plan

 

2007 Equity Incentive Plan

 

In September 2007, the Company adopted the Amended and Restated 2007 Stock Plan (the “2007 Plan”), which was most recently amended in March 2015. The 2007 Plan provides for the grant of incentive and non-statutory stock options and RSUs to employees, directors, and consultants under terms and provisions established by the board of directors. The board of directors determines the period over which the options vest and become exercisable. Options granted under the 2007 Plan are generally subject to a four-year vesting period, with 25% vesting after a one-year period and monthly vesting thereafter. Options expire after ten years. The exercise price of incentive stock options granted under the 2007 Plan must be at least equal to 100% of the fair value of the common stock at the date of grant, as determined by the board of directors. The exercise price of non-statutory options granted under the 2007 Plan must be at least equal to 85% of the fair value of the common stock at the date of grant, as determined by the board of directors. RSUs granted under the 2007 Plan are generally subject to a three- or four-year vesting period with annual vesting.

 

The 2015 Equity Incentive Plan (the “2015 Plan”) became effective on June 16, 2015. As a result, the Company will not grant any additional stock options under the 2007 Plan and the 2007 Plan has terminated. Any outstanding stock options and RSUs granted under the 2007 Plan will remain outstanding, subject to the terms of the 2007 Plan and applicable award agreements, until such shares are issued under those awards, by exercise of stock options or settlement of RSUs, or until the awards terminate or expire by their terms. Stock options and RSUs granted under the 2007 Plan generally have terms similar to those described below with respect to stock options and RSUs granted under the 2015 Plan.

 

2015 Equity Incentive Plan (unaudited)

 

In May 2015, the Company’s board of directors and stockholders adopted and approved the 2015 Plan. The 2015 Plan became effective on June 16, 2015 and serves as the successor to the 2007 Plan. The remaining shares available for issuance under the 2007 Plan became reserved for issuance under the 2015 Plan, and the Company ceased granting awards under the 2007 Plan. The number of shares reserved for issuance under the 2015 Plan will increase automatically on the first day of January of each year starting in 2016 through 2025 by the number of shares of Class A common stock equal to 5% of the total outstanding shares of common stock as of the immediately preceding December 31. The share reserve may also increase to the extent that outstanding awards expire or terminate un-exercised. As of September 30, 2015, 4,768,814 shares were reserved for issuance under the 2015 Plan.

 

The 2015 Plan authorizes the award of stock options, restricted stock awards, stock appreciation rights, RSUs, performance awards, and stock bonuses to employees, directors, consultants, independent contractors, and advisors. In general, stock options and RSUs will vest over a four-year period, and have a maximum term of ten years. The exercise price of an option will be not less than 100% of the fair market value of the shares on the date of grant.

 

Preferred Stock (unaudited)

 

Upon completion of its IPO on June 22, 2015, the Company filed a Restated Certificate of Incorporation, which authorized the issuance of preferred stock with rights and preferences, including voting rights, designated from time to time by the board of directors. As of September 30, 2015, there were 10,000,000 shares of preferred stock authorized with a par value of $0.0001 per share, and no shares of preferred stock issued or outstanding.

 

Common Stock (unaudited)

 

As of December 31, 2014, the Company had 230,400,000 shares of common stock authorized for issuance and 40,875,583 shares issued and outstanding. In connection with the IPO, the Company established two classes of authorized common stock, Class A common stock and Class B common stock. All shares of common stock outstanding immediately prior to the IPO were converted into an equivalent amount of shares of Class B common stock. As of June 30, 2015, the Company had 600,000,000 shares of Class A common stock authorized with a par value of $0.0001 per share and 350,000,000 shares of Class B common stock authorized with a par value of $0.0001 per share. As of September 30, 2015, 42,061,250 shares of Class A common stock were issued and outstanding and 165,122,004 shares of Class B common stock were issued and outstanding.

 

Holders of Class A common stock are entitled to one vote for each share of Class A common stock held on all matters submitted to a vote of stockholders and holders of Class B common stock are entitled to ten votes for each share of Class B common stock held on all matters submitted to a vote of stockholders. Except with respect to voting, the rights of the holders of Class A and Class B common stock are identical. Shares of Class B common stock are voluntarily convertible into shares of Class A common stock at the option of the holder and generally automatically convert into shares of our Class A common stock upon a transfer.

2015 Employee Stock Purchase Plan (unaudited)

 

In May 2015, the Company’s board of directors adopted the 2015 Employee Stock Purchase Plan (“2015 ESPP”), which became effective on June 17, 2015. A total of 3,750,000 shares of Class A common stock were initially reserved for issuance under the 2015 ESPP. The 2015 ESPP allows eligible employees to purchase shares of the Company’s Class A common stock at a discount through payroll deductions of up to 15% of eligible compensation, subject to any plan limitations. Except for the initial offering period, the 2015 ESPP provides for 6-month offering periods beginning in May and November of each year. The initial offering period began June 17, 2015, and will end in May 2016.

 

On each purchase date, eligible employees will purchase Class A common stock at a price per share equal to 85% of the lesser of the fair market value of the Company’s Class A common stock (i) on the first trading day of the applicable offering period and (ii) the last trading day of each purchase period in the applicable offering period. For the first offering period, which began on June 17, 2015, the fair market value of the Class A common stock on the offering date was $20.00, the price at which the Company’s Class A common stock was first sold to the public in its IPO, as specified in the final prospectus filed with the SEC on June 18, 2015, pursuant to Rule 424(b).

 

Stock Options

 

Activity under the 2007 Plan and 2015 Plan is as follows:

 

           Options Outstanding  
     Shares
Available

for
Grant
    Number of
Shares Subject

to
Options
    Weighted–
Average
Exercise
Price
     Aggregate
Intrinsic
Value
 
     (in thousands)            (in thousands)  

Balance—December 31, 2011

     4,786        18,116      $ 0.05       $     

Granted

     (3,664     3,664        0.13      

Exercised

            (137     0.03       $ 3   

Canceled

     696        (696     0.03      
  

 

 

   

 

 

      

Balance—December 31, 2012

     1,818        20,947        0.06      

Authorized

     3,975                    

Granted

     (6,476     6,476        0.61      

Exercised

            (3,283     0.05       $ 1,111   

Canceled

     736        (736     0.16      
  

 

 

   

 

 

      

Balance—December 31, 2013

     53        23,404        0.21      

Authorized

     24,900                    

Granted

     (22,094     22,094        3.25      

Exercised

            (735     0.14       $ 3,001   

Canceled

     765        (765     0.95      
  

 

 

   

 

 

      

Balance—December 31, 2014

     3,624        43,998        1.72       $ 207,863   
  

 

 

   

 

 

      

Authorized (unaudited)

     9,115               

Granted (unaudited)

     (9,061     6,948        10.67      

Exercised (unaudited)

            (1,215     0.78       $ 28,694   

Canceled (unaudited)

     1,092        (1,076     3.16      
  

 

 

   

 

 

      

Balance—September 30, 2015 (unaudited)

     4,770        48,655        2.99       $ 1,688,589   
  

 

 

   

 

 

      

Options exercisable—December 31, 2014

       16,577        0.18       $ 104,027   
    

 

 

      

Options vested and expected to vest— December 31, 2014

       41,411        1.67       $ 197,803   
    

 

 

      

Options exercisable—September 30, 2015 (unaudited)

       22,704        0.73       $ 839,143   
    

 

 

      

Options vested and expected to vest—September 30, 2015 (unaudited)

       47,634        2.94       $ 1,655,571   
    

 

 

      

 

The aggregate intrinsic values of options outstanding, exercisable, vested and expected to vest were calculated as the difference between the exercise price of the options and the estimated fair value of the Company’s common stock, as determined by the board of directors, as of December 31, 2014 and the fair value of the Class A common stock of $37.69 as of September 30, 2015.

 

The total grant date fair value of options that vested during 2012, 2013, 2014, and the nine months ended September 30, 2014 and 2015 was $0.1 million, $0.3 million, $1.7 million, $1.1 million, and $11.1 million, respectively.

 

As of December 31, 2014 and September 30, 2015, the weighted-average remaining contractual life was 6.7 years and 6.4 years, respectively, for exercisable options and 8.2 years and 7.7 years, respectively, for vested and expected to vest options. The weighted-average remaining contractual life of options outstanding was 8.0 years, 8.3 years, and 7.7 years at December 31, 2013 and 2014 and September 30, 2015, respectively.

 

Restricted Stock Units (unaudited)

 

RSU activity under the equity incentive plans is as follows:

 

     RSUs
Outstanding
    Weighted-
Average
Grant Date
Fair Value
 
    

(in thousands)

       

Unvested balance—December 31, 2014

          $   

Granted

     2,113        35.02   

Forfeited or canceled

     (16     36.43   
  

 

 

   

Unvested balance—September 30, 2015

     2,097        35.01   
  

 

 

   

 

Stock-Based Compensation Expense

 

Total stock-based compensation recognized was as follows (in thousands):

 

       Year Ended December 31,        Nine Months Ended
September 30,
 
       2012        2013        2014        2014        2015  
                                  (unaudited)  

Cost of revenue

     $ 15         $ 37         $ 890         $ 534         $ 2,622   

Research and development

       62           288           2,350           1,157           10,910   

Sales and marketing

       29           204           1,295           649           5,080   

General and administrative

       26           91           2,269           1,105           7,072   
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Total stock-based compensation expense

     $ 132         $ 620         $ 6,804         $ 3,445         $ 25,684   
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

 

The weighted-average grant date fair value of stock options granted during 2012, 2013, 2014, and the nine months ended September 30, 2015 was $0.07, $0.52, $2.40, and $8.15 per share. As of December 31, 2014 and September 30, 2015, the total unrecognized compensation expense related to unvested options, net of estimated forfeitures, was $43.9 million and $84.5 million, respectively, which the Company expects to recognize over an estimated weighted average period of 3.8 years and 3.1 years, respectively.

 

As of September 30, 2015, the total unrecognized compensation expense related to unvested RSUs, net of estimated forfeitures, was $65.1 million, which the Company expects to recognize over an estimated weighted average period of 3.6 years. As of September 30, 2015, the total unrecognized compensation expense related to unvested common stock issued in connection with the FitStar acquisition, net of estimated forfeitures, was $2.4 million, which the Company expects to recognize over an estimated weighted average period of 2.5 years.

 

Stock-based compensation is measured at the grant date based on the fair value of the award and is recognized as expense, net of estimated forfeitures, over the requisite service period, which is generally the vesting period of the respective award. The fair value of RSUs is the fair value of the Company’s Class A common stock on the grant date. In determining the fair value of the options and the equity awards issued under the 2015 ESPP, the Company uses the Black-Scholes option-pricing model and assumptions discussed below. Each of these inputs is subjective and generally requires significant judgment.

 

Fair Value of Common Stock—The fair value of the shares of common stock underlying stock options has historically been established by the Company’s board of directors, which is responsible for these estimates, and has been based in part upon a valuation provided by an independent third-party valuation firm. Because there has been no public market for the Company’s common stock, its board of directors considered this independent valuation and other factors, including, but not limited to, revenue growth, the current status of the technical and commercial success of its operations, its financial condition, the stage of development and competition to establish the fair value of the Company’s common stock at the time of grant of the option. The fair value of the underlying common stock will be determined by the board of directors until such time as its common stock is listed on a stock exchange. Following the completion of the IPO, the Company began using the market closing price for Class A common stock as reported on the New York Stock Exchange.

 

Expected Term—The expected term represents the period over which the Company anticipates stock-based awards to be outstanding. The Company does 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, the Company used the simplified method to calculate the expected term estimate based on the vesting and contractual terms of the 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 the 2015 ESPP is based on the contractual term.

 

Volatility—Expected volatility is a measure of the amount by which the stock price is expected to fluctuate. The Company estimates the expected volatility of the common stock underlying its stock options 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 of the options.

 

Risk-Free Rate—The risk-free interest rate is estimated average interest rate based on U.S. Treasury zero-coupon notes with terms consistent with the expected term of the awards.

 

Dividend Yield—The Company has never declared or paid any cash dividends and does not presently plan to pay cash dividends in the foreseeable future. Consequently, it used an expected dividend yield of zero.

 

In addition, the Company is required to estimate the amount of stock-based compensation that it expects to be forfeited based on historical experience. 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. For 2012, 2013, 2014, and the nine months ended September 30, 2014 and 2015, the Company recognized $0.1 million, $0.5 million, $6.2 million, $3.2 million, and $23.3 million, respectively, of stock-based compensation related to options granted to employees. The fair value of the stock option awards granted to employees was estimated at the date of grant using a Black-Scholes option-pricing model with the following assumptions: