FITBIT INC, 10-Q filed on 11/2/2015
Quarterly Report
Document and Entity Information
9 Months Ended
Sep. 30, 2015
Oct. 31, 2015
Common Class A [Member]
Oct. 31, 2015
Common Class B [Member]
Entity Information [Line Items]
 
 
 
Entity Registrant Name
FITBIT INC 
 
 
Entity Central Index Key
0001447599 
 
 
Current Fiscal Year End Date
--12-31 
 
 
Entity Filer Category
Non-accelerated Filer 
 
 
Document Type
10-Q 
 
 
Document Period End Date
Sep. 30, 2015 
 
 
Document Fiscal Year Focus
2015 
 
 
Document Fiscal Period Focus
Q3 
 
 
Amendment Flag
false 
 
 
Entity Common Stock, Shares Outstanding
 
42,061,250 
165,124,402 
Condensed Consolidated Balance Sheets (USD $)
In Thousands, unless otherwise specified
Sep. 30, 2015
Dec. 31, 2014
Current assets:
 
 
Cash and cash equivalents
$ 462,280 
$ 195,626 
Marketable securities
113,198 
Accounts receivable, net
244,921 
238,859 
Inventories
276,083 
115,072 
Deferred tax assets
56,846 
33,555 
Prepaid expenses and other current assets
21,199 
13,614 
Total current assets
1,174,527 
596,726 
Property and equipment, net
35,728 
26,435 
Goodwill
22,157 
Intangible assets, net
12,749 
Other assets
17,296 
9,890 
Total assets
1,262,457 
633,051 
Current liabilities:
 
 
Fitbit Force recall reserve
11,659 
22,476 
Accounts payable
320,195 
195,666 
Accrued liabilities
98,258 
70,940 
Deferred revenue
27,077 
9,009 
Income taxes payable
2,472 
30,631 
Long-term debt, current portion
132,589 
Total current liabilities
459,661 
461,311 
Redeemable convertible preferred stock warrant liability
15,797 
Other liabilities
18,624 
12,867 
Total liabilities
478,285 
489,975 
Commitments and contingencies (Note 8)
   
   
Redeemable convertible preferred stock, $0.0001 par value, no shares and 144,528,912 shares authorized as of September 30, 2015 and December 31, 2014, respectively; no shares and 139,851,483 shares issued and outstanding as of September 30, 2015 and December 31, 2014, respectively
67,814 
Stockholders’ equity:
 
 
Common stock
Additional paid-in capital
604,323 
7,979 
Accumulated other comprehensive income
1,074 
37 
Retained earnings
178,754 
67,242 
Total stockholders’ equity
784,172 
75,262 
Total liabilities, redeemable convertible preferred stock, and stockholders’ equity
1,262,457 
633,051 
Common Class A [Member]
 
 
Stockholders’ equity:
 
 
Common stock
Common Class B [Member]
 
 
Stockholders’ equity:
 
 
Common stock
$ 17 
$ 0 
Condensed Consolidated Balance Sheets (Parenthetical) (USD $)
Sep. 30, 2015
Dec. 31, 2014
Redeemable convertible preferred stock, par value (in dollars per share)
$ 0.0001 
$ 0.0001 
Redeemable convertible preferred stock authorized (in shares)
144,528,912 
Redeemable convertible preferred stock issued (in shares)
139,851,483 
Redeemable convertible preferred stock outstanding (in shares)
139,851,483 
Common stock, par value (in dollars per share)
$ 0.0001 
$ 0.0001 
Common stock authorized (in shares)
230,400,000 
Common stock issued (in shares)
40,875,583 
Common stock outstanding (in shares)
40,875,583 
Common Class A [Member]
 
 
Common stock, par value (in dollars per share)
$ 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 
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
3 Months Ended 9 Months Ended
Sep. 30, 2015
Sep. 30, 2014
Sep. 30, 2015
Sep. 30, 2014
Income Statement [Abstract]
 
 
 
 
Revenue
$ 409,262 
$ 152,862 
$ 1,146,428 
$ 375,249 
Cost of revenue
213,249 
69,257 
593,664 
188,486 
Gross profit
196,013 
83,605 
552,764 
186,763 
Operating expenses:
 
 
 
 
Research and development
42,890 
14,945 
95,808 
35,842 
Sales and marketing
65,115 
17,539 
178,672 
42,123 
General and administrative
20,698 
7,849 
48,327 
23,909 
Change in contingent consideration
(7,704)
Total operating expenses
128,703 
40,333 
315,103 
101,874 
Operating income
67,310 
43,272 
237,661 
84,889 
Interest expense, net
(216)
(680)
(1,062)
(1,541)
Other expense, net
(744)
(2,816)
(59,129)
(7,722)
Income before income taxes
66,350 
39,776 
177,470 
75,626 
Income tax expense (benefit)
20,516 
(29,136)
65,958 
(16,911)
Net income
45,834 
68,912 
111,512 
92,537 
Less: noncumulative dividends to preferred stockholders
(1,343)
(2,526)
(3,983)
Less: undistributed earnings to participating securities
(52,420)
(50,316)
(68,736)
Net income attributable to common stockholders—basic
45,834 
15,149 
58,670 
19,818 
Add: adjustments for undistributed earnings to participating securities
5,387 
7,655 
6,905 
Net income attributable to common stockholders—diluted
$ 45,834 
$ 20,536 
$ 66,325 
$ 26,723 
Net income per share attributable to common stockholders:
 
 
 
 
Basic (in dollars per share)
$ 0.22 
$ 0.38 
$ 0.57 
$ 0.49 
Diluted (in dollars per share)
$ 0.19 
$ 0.34 
$ 0.48 
$ 0.44 
Shares used to compute net income per share attributable to common stockholders:
 
 
 
 
Basic (in shares)
206,657 
40,376 
102,741 
40,242 
Diluted (in shares)
243,660 
61,003 
136,985 
60,323 
Consolidated Statements of Comprehensive Income Statement (USD $)
In Thousands, unless otherwise specified
3 Months Ended 9 Months Ended
Sep. 30, 2015
Sep. 30, 2014
Sep. 30, 2015
Sep. 30, 2014
Statement of Comprehensive Income [Abstract]
 
 
 
 
Net income
$ 45,834 
$ 68,912 
$ 111,512 
$ 92,537 
Cash flow hedges:
 
 
 
 
Change in unrealized gain on cash flow hedges
1,466 
1,466 
Less: reclassification for realized net gains included in net income
(548)
(548)
Net change, net of tax
918 
918 
Change in foreign currency translation adjustment, net of tax
40 
17 
125 
29 
Change in unrealized loss on available-for-sale investments
(6)
(6)
Comprehensive income
$ 46,786 
$ 68,929 
$ 112,549 
$ 92,566 
Consolidated Statements of Cash Flows (USD $)
In Thousands, unless otherwise specified
9 Months Ended
Sep. 30, 2015
Sep. 30, 2014
Cash Flows from Operating Activities
 
 
Net income
$ 111,512 
$ 92,537 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Provision for inventory obsolescence
4,537 
523 
Depreciation and amortization
12,372 
2,964 
Amortization of intangible assets
1,169 
Revaluation of redeemable convertible preferred stock warrant liability
56,655 
6,821 
Stock-based compensation
25,684 
3,445 
Change in contingent consideration
(7,704)
Deferred income taxes
(32,288)
(26,693)
Other
(109)
629 
Changes in operating assets and liabilities, net of acquisition:
 
 
Accounts receivable
(5,500)
2,676 
Inventories
(165,153)
(4,723)
Prepaid expenses and other assets
(4,664)
(3,421)
Fitbit Force recall reserve
(10,817)
(51,909)
Accounts payable
119,768 
(16,466)
Accrued liabilities and other liabilities
30,657 
2,185 
Deferred revenue
17,520 
2,598 
Income taxes payable
(28,159)
(7,577)
Net cash provided by operating activities
125,480 
3,589 
Cash Flows from Investing Activities
 
 
Change in restricted cash
2,310 
Purchase of property and equipment
(17,748)
(17,885)
Purchases 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)
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 
Repayment of debt
(294,503)
(41,346)
Payment of debt issuance costs
(2,575)
Payments of offering costs
(4,772)
Proceeds from exercise of stock options
940 
32 
Proceeds from exercise of redeemable convertible preferred stock warrants
75 
Net cash provided by (used in) financing activities
282,550 
(5,814)
Net increase (decrease) in cash and cash equivalents
266,602 
(17,800)
Effect of exchange rate on cash and cash equivalents
52 
29 
Cash and cash equivalents at beginning of period
195,626 
81,728 
Cash and cash equivalents at end of period
462,280 
63,957 
Supplemental Disclosure
 
 
Cash paid for interest
374 
820 
Cash paid for income taxes
120,774 
16,831 
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 
Deferred offering costs included in accounts payable and accruals
354 
Issuance of common stock in connection with acquisitions
$ 13,317 
$ 0 
Business Overview
Business Overview
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 an equivalent number of shares of our 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 our 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 and Summary of Significant Accounting Policies
Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation and Summary of Significant Accounting Policies
 
The accompanying condensed consolidated financial statements are unaudited. The condensed consolidated balance sheet at December 31, 2014 has been derived from the audited financial statements of the Company. The accompanying condensed financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information, 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, its results of operations, and cash flows for the interim periods presented. The results of operations for the three and 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.

The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, with the Securities and Exchange Commission (“SEC”) on June 18, 2015. There have been no significant changes in the Company’s accounting policies from those disclosed in its prospectus filed with the SEC on June 18, 2015, except as related to cash flow hedges entered into beginning in the third quarter of 2015 as disclosed in Note 5.

Principles of Consolidation
 
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated.
 
Stock Split
 
In May 2015, the Company effected a 3-for-2 stock split of all outstanding shares of the Company’s capital stock, including common stock and redeemable convertible preferred stock. All share, option, RSU, warrant, and per share information presented in the condensed consolidated financial statements has been adjusted to reflect the stock split on a retroactive basis for all periods presented and all share information is rounded down to the nearest whole share after reflecting the stock split.
 
Use of Estimates
 
The preparation of condensed consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the condensed 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 condensed consolidated financial statements.
 
Comprehensive Income
 
Comprehensive income consists of two components, net income 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. 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.

Recent Accounting Pronouncements
 
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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. 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
Fair Value Measurements
 
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.

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 value of the Company’s long-term debt approximated its fair value as of December 31, 2014 as the debt carried a variable rate or market rates available to the Company and other assumptions had 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
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

 
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 include derivative financial instruments associated with hedging activity, which 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. Prior to the IPO, the fair value of the warrant liability was calculated using an option-pricing model as discussed in Note 9. 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, 2014
$
15,797

Change in fair value
56,655

Settlement of warrant liability upon exercise
(56,678
)
Reclassification of unexercised warrants to additional paid-in capital upon the initial public offering
(15,774
)
Balance at September 30, 2015
$


 
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 the three and nine months ended September 30, 2015 and September 30, 2014.
Cash, Cash Equivalents, and Marketable Securities
Cash, Cash Equivalents, and Marketable Securities
Cash, Cash Equivalents, and 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, net of tax, as a separate component of accumulated other comprehensive income in stockholders’ equity. 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 potential other-than-temporary impairments. No impairment loss has been recorded on the securities included in the tables below 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. As of December 31, 2014, the Company did not carry any investments in marketable securities.

The following table sets forth the cash, cash equivalents, and marketable securities as of September 30, 2015 (in thousands):
 
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
$
575,484

 
$
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):
 
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.
Derivative Financial Instruments
Derivative Financial Instruments
Derivative Financial Instruments
 
The Company operates in foreign countries, which exposes it to market risk associated with foreign currency exchange rate fluctuations between the U.S. dollar and various foreign currencies. In order to manage this risk, the Company may hedge a portion of its foreign currency exposures related to outstanding monetary assets and liabilities as well as forecasted revenues and expenses, using foreign currency exchange forward or option contracts. In general, the market risk related to these contracts is offset by corresponding gains and losses on the hedged transactions. The Company does not enter into derivative contracts for trading or speculative purposes.

Cash Flow Hedges
 
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’s cash flow hedges consist of forward contracts with maturities of 12 months or less.

The Company assesses, both at inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting the changes in cash flows of the hedged items. 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 unrealized 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 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 certain 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, 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 expense, net and offset the foreign currency gain or loss on the underlying net monetary assets or liabilities.

The Company had outstanding balance sheet hedges with a total notional amount of $76.3 million and $37.2 million as of September 30, 2015 and December 31, 2014, respectively.  
 
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
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):
 
 
 
Three Months Ended September 30,
 
Nine Months Ended
September 30,
 
Income Statement Location
 
2015
 
2014
 
2015
 
2014
Foreign exchange cash flow hedges
 
 
 
 
 
 
 
 
 
Gain (loss) recognized in OCI – effective portion
 
 
$
1,466

 
$

 
$
1,466

 
$

Gain (loss) reclassified from OCI into income – effective portion
Revenue
 
580

 

 
580

 

Gain (loss) reclassified from OCI into income – effective portion
Operating expenses
 
(32
)
 

 
(32
)
 

Gain (loss) recognized in income – ineffective portion
Other expense, net
 
104

 

 
104

 

 
 
 
 
 
 
 
 
 
 
Foreign exchange balance sheet hedges
 
 
 
 
 
 
 
 
 
Gain (loss) recognized in income
Other expense, net
 
$
3,705

 
$

 
$
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. The Company generally enters 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):
 
 
 
 
 
 
 
Gross Amounts Not Offset in Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts Presented 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):
 
 
 
 
 
 
 
Gross Amounts Not Offset in Condensed Consolidated Balance Sheets
 
 
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset in the Condensed Consolidated Balance Sheets
 
Net Amounts Presented 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
Balance Sheet Components
 
Revenue Reserve
 
Revenue returns reserve activities were as follows (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
Beginning balances
$
35,265

 
$
17,149

 
$
26,559

 
$
15,416

Increases (reductions)
46,990

 
(2,574
)
 
100,342

 
12,087

Returns taken
(41,043
)
 
(5,711
)
 
(85,689
)
 
(18,639
)
Ending balances
$
41,212

 
$
8,864

 
$
41,212

 
$
8,864



Inventories
 
Inventories consisted of the following (in thousands):
 
September 30, 2015
 
December 31, 2014
 
 
Components
$
15,936

 
$
53,383

Finished goods
260,147

 
61,689

Total inventories
$
276,083

 
$
115,072


 
Prepaid Expenses and Other Current Assets
 
Prepaid expenses and other current assets consisted of the following (in thousands):
 
September 30, 2015
 
December 31, 2014
 
 
Derivative assets
$
5,313

 
$
316

POP displays, net
5,094

 
7,121

Prepaid expenses and other current assets
10,792

 
6,177

Total prepaid expenses and other current assets
$
21,199

 
$
13,614












Property and Equipment, Net
 
Property and equipment, net, consisted of the following (in thousands):
 
September 30, 2015
 
December 31, 2014
 
 
Tooling and manufacturing equipment
$
45,754

 
$
28,344

Furniture and office equipment
5,859

 
2,891

Purchased and internally-developed software
2,403

 
1,396

Leasehold improvements
3,874

 
3,594

Total property and equipment
57,890

 
36,225

Less: Accumulated depreciation and amortization
(22,162
)
 
(9,790
)
Property and equipment, net
$
35,728

 
$
26,435


 
Goodwill and Intangible Assets

The changes in the carrying amount of goodwill for the nine months ended September 30, 2015 were as follows (in thousands). See Note 14 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 (in thousands, except useful life). See Note 14 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 (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):
 
September 30, 2015
 
December 31, 2014
 
 
Product warranty
$
25,072

 
$
20,098

Employee-related liabilities
18,153

 
4,115

Accrued advertising and marketing development funds
17,097

 
7,833

Inventory received but not billed
3,777

 
6,242

Accrued manufacturing expense and freight
9,235

 
16,229

Accrued sales incentives
3,568

 
2,355

Sales taxes and VAT payable
3,360

 
2,291

Accrued legal fees
2,111

 
678

Customer deposits
1,406

 
6,391

Other
14,479

 
4,708

Accrued liabilities
$
98,258

 
$
70,940



Product warranty reserve activities were as follows (in thousands)(1):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
Beginning balances
$
31,063

 
$
7,625

 
$
20,098

 
$
8,480

Charged to cost of revenue
15,687

 
3,726

 
37,752

 
5,788

Changes related to pre-existing warranties
(8,968
)
 

 
(8,968
)
 

Settlement of claims
(12,710
)
 
(2,450
)
 
(23,810
)
 
(5,367
)
Ending balances
$
25,072

 
$
8,901

 
$
25,072

 
$
8,901

 
(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.

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):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
Beginning balances
$
12,894

 
$
57,074

 
$
22,476

 
$
82,938

Charged to revenue

 

 

 
11,561

Charged (benefit) to cost of revenue

 
(1,485
)
 
(2,040
)
 
9,117

Charged (benefit) to general and administrative
20

 

 
(53
)
 
505

Settlement of claims
(1,255
)
 
(24,560
)
 
(8,724
)
 
(73,092
)
Ending balances
$
11,659

 
$
31,029

 
$
11,659

 
$
31,029


 

Accumulated Other Comprehensive Income

The components and activity of accumulated other comprehensive income (“AOCI”), net of tax, were as follows (in thousands):
 
Unrealized Gains on Cash Flow Hedges
 
Currency Translation Adjustments
 
Unrealized Gains (Losses) on Available-for-Sale Investments
 
Total
Balance at December 31, 2014
$

 
$
37

 
$

 
$
37

Other comprehensive income (loss) before reclassifications
1,466

 
125

 
(6
)
 
1,585

Amounts reclassified from AOCI

(548
)
 

 

 
(548
)
Other comprehensive income (loss)
918

 
125

 
(6
)
 
1,037

Balance at September 30, 2015
$
918

 
$
162

 
$
(6
)
 
$
1,074



Other comprehensive income consisted only of currency translation adjustments of an immaterial amount in the nine months ended September 30, 2014.
Long-Term Debt
Long-Term Debt
Long-Term Debt
 
2014 Credit Agreement
 
In August 2014, the Company entered into an amended and restated credit agreement (“Asset-Based Credit Facility”), with a borrowing limit of $180.0 million. 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 condensed 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”). In October 2014, the Company 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, and September 30, 2015, 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 over the term of the related financing arrangement to interest expense using the straight-line method. 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 was $0.4 million and $0.7 million for the three months ended September 30, 2015 and 2014, respectively, and $1.3 million and $1.6 million for the nine months ended September 30, 2015 and 2014, respectively.
 
Letters of Credit
 
As of September 30, 2015 and December 31, 2014, the Company had outstanding letters of credit totaling $16.8 million and $2.9 million, respectively, issued to cover various security deposits on the Company’s facility leases.
Commitments and Contingencies
Commitments and Contingencies
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 2024. 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 $2.5 million and $1.0 million for the three months ended September 30, 2015 and 2014, respectively, and $5.1 million and $3.2 million for the nine months ended September 30, 2015 and 2014, respectively.

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 were as follows (in thousands):
 
Amounts
Remaining 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 September 30, 2015 and December 31, 2014 was approximately $508.1 million and $257.0 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
 
Fitbit Force

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, including several complaints filed in 2015, but the Company believes that the liabilities arising under these claims fall within the proceeds of the insurance policies that apply to these claims.

Fitbit Zip, Fitbit One, Fitbit Flex, Fitbit Charge, Fitbit Charge HR, and Fitbit Surge

In 2014, one personal injury lawsuit was filed against the Company based upon claims of skin irritation from the Fitbit Flex. Additional lawsuits were filed in 2015 based upon claims of skin irritation from the Fitbit Zip, Fitbit One, Fitbit Flex, Fitbit Charge, Fitbit Charge HR, and Fitbit Surge. These personal injury complaints remain outstanding, but the Company believes that the liabilities arising under these claims fall within the proceeds of the insurance policies that apply to these claims.

Jawbone

On May 27, 2015, Aliphcom, Inc. d/b/a Jawbone (“Jawbone”) filed a lawsuit against the Company and certain of its employees who were formerly employed by Jawbone in the Superior Court of the State of California in the County of San Francisco alleging trade secret misappropriation and unfair and unlawful business practices against all defendants, and alleging breach of contract and breach of implied covenant of good faith and fair dealing against the employee defendants. The complaint alleges, among other things, that prior to leaving Jawbone at various times in 2015, the employees downloaded Jawbone company documents and materials, including allegedly confidential and trade secret information, and that these employees are using such information in the development of the Company’s products. The complaint also alleges that the Company recruited those employees with the intent of using Jawbone’s proprietary information. The complaint seeks unspecified damages, including punitive damages and injunctive relief. On June 26, 2015, the Company and the employee defendants filed demurrers to Jawbone’s complaint. Fitbit sought to dismiss both causes of action brought against it (those for misappropriation of trade secrets and unfair business practices). The employee defendants sought to dismiss the breach of implied covenant and unfair business practices causes of action. On October 2, 2015, Jawbone filed a First Amended Complaint asserting the same causes of action and adding additional allegations to those raised in the initial complaint. On October 21, 2015, the Company and the employee defendants demurred to the First Amended Complaint, in which Fitbit once again moved to dismiss the misappropriation and unfair business practices causes of action and the employee defendants moved to dismiss those for breach of the implied covenant and unfair business practices. A hearing on the demurrers is currently scheduled for March 22, 2016.

On June 10, 2015, Jawbone and BodyMedia, Inc., a wholly-owned subsidiary of Jawbone (“BodyMedia”), filed a lawsuit against the Company in the United States District Court for the Northern District of California alleging that the Company infringes three U.S. patents held by them: U.S. Patent No. 8,446,275, titled “General Health and Wellness Management Method and Apparatus For A Wellness Application Using Data From a Data-Capable Band,” U.S. Patent No. 8,073,707, titled “System For Detecting, Monitoring, And Reporting An Individual’s Physiological Or Contextual Status,” and U.S. Patent No. 8,398,546, titled “System For Monitoring And Managing Body Weight And Other Physiological Conditions Including Iterative And Personalized Planning, Intervention And Reporting Capability.” Jawbone and BodyMedia allege that these patents have been infringed by a substantial majority of the Company’s products that it has sold historically, as well as several current products. The complaint seeks unspecified compensatory damages and attorney’s fees from the Company and to permanently enjoin the Company from making, manufacturing, using, selling, importing, or offering the Company’s products for sale.

On July 3, 2015, Jawbone and BodyMedia amended their complaint to add three additional U.S. patents to the infringement claims against the Company: U.S. Patent No. 8,529,811, titled “Component Protective Overmolding Using Protective External Coatings,” U.S. Patent No. 8,793,522, titled “Power Management in a Data-Capable Strapband,” and U.S. Patent No. 8,961,413, titled “Wireless Communications Device and Personal Monitor.”

On July 7, 2015, Jawbone and BodyMedia filed a complaint with the U.S. International Trade Commission (the “ITC”) requesting an investigation into purported violations of the Tariff Act of 1930 by the Company and Flextronics International Ltd. and Flextronics Sales and Marketing (A-P) Ltd. The complaint alleges that the Company’s products infringe the same six U.S. patents at issue in action brought against the Company in the U.S. District Court for the Northern District of California. Furthermore, the complaint makes the same allegations of trade secret misappropriation, unfair competition and unfair acts as a result of our hiring of the former Jawbone employees, as in the action brought against us and certain of our employees in the Superior Court in the State of California. The complaint seeks a limited exclusion order and a cease and desist order halting the importation and sale of our products that allegedly infringe upon Jawbone’s patents and misappropriate Jawbone’s trade secrets. On July 24, 2015, Jawbone and BodyMedia filed a letter with the ITC seeking to amend and supplement their ITC complaint. In their letter, Jawbone and BodyMedia, among other things, purport to identify the trade secrets allegedly misappropriated by the employee defendants. The ITC instituted the investigation on August 17, 2015, and has now set a hearing on May 9-16, 2016 and a target date for completion of the investigation on December 21, 2016.

On September 3, 2015, the Company filed a complaint for patent infringement against Jawbone in the U.S. District Court for the District of Delaware, asserting that its activity trackers (UP Move, UP24, UP3, and UP4) infringe U.S. Patent Nos. 8,909,543, 9,031,812, and 9,042,971. On September 8, 2015, Fitbit filed a complaint for patent infringement against Jawbone in the U.S. District Court for the Northern District of California, asserting that its activity trackers infringe U.S. Patent Nos. 9,026,053, 9,084,923, and 9,106,307. On October 29, 2015, the Company filed a complaint for patent infringement against Jawbone in the United States District Court for the District of Delaware, asserting that its activity trackers infringe U.S. Patent Nos. 8,920,332, 8,868,377, and 9,089,760.

On November 2, 2015, the Company filed a complaint with the ITC requesting an investigation into violations of the Tariff Act of 1930 by Jawbone and Body Media. The complaint asserts that Jawbone’s products infringe U.S. Patent Nos. 8,920,332, 8,868,377, and 9,089,760. The complaint seeks a limited exclusion order and a cease and desist order halting the importation and sale of Jawbone’s products that the Company believes infringe upon its patents.

The Company intends to vigorously defend and prosecute each of the Jawbone litigation matters and, based on its review, the Company believes it has valid defenses and claims with respect to each of these matters. However, litigation is inherently uncertain, and any judgment or injunctive relief entered against the Company or any adverse settlement could materially and adversely impact its business, financial condition, operating results, and prospects. Because the Company is in the early stages of these litigation matters, the Company is unable to estimate a reasonably possible range of loss, if any, that may result from these matters. In addition, these litigation matters are complex, likely to involve significant management time and attention, and the cost of defending and prosecuting these matters is likely to be expensive, regardless of outcome.

Other

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 and Warrants
Redeemable Convertible Preferred Stock and Warrants
Redeemable Convertible Preferred Stock and Warrants
 
Redeemable Convertible Preferred Stock

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 below, automatically converted on a one-for-one basis into an aggregate of 139,851,483 shares of Class B common stock. Redeemable convertible preferred stock outstanding as of December 31, 2014 and as of immediately prior to the conversion into Class B common stock consisted of the following (in thousands, except per share data):

 
Shares
Authorized
 
Shares
Outstanding
 
Price per
Share
 
Net
Carrying
Value
 
Liquidation
Preference
Series A
10,200

 
10,200

 
$
0.04167

 
$
421

 
$
425

Series A-1
22,369

 
22,369

 
0.09165

 
2,000

 
2,050

Series B
42,360

 
42,052

 
0.21580

 
10,533

 
9,075

Series C
39,600

 
36,080

 
0.33452

 
12,049

 
12,069

Series D
30,000

 
29,150

 
1.47513

 
42,811

 
43,000

Total
144,529

 
139,851

 
 
 
$
67,814

 
$
66,619


 
Redeemable Convertible Preferred Stock Warrants

As of December 31, 2014, and until immediately prior to the completion of the IPO, the Company had the following redeemable convertible preferred stock warrants issued and outstanding (in thousands, except per share data): 
Warrant Class
 
Number of Shares Underlying Warrants
 
Fair Value
 
Issuance Date
 
Exercise
Price  per
Share
 
 
 
 
 
 
 
 
 
 
 
Series B
 
278

 
$
2,351

 
June 2011
 
$
0.22

Series C
 
57

 
475

 
April 2012
 
0.33

Series C
 
1,215

 
9,728

 
September 2012
 
0.67

Series C(1)
 
405

 
3,243

 
September 2012
 
0.67

Total
 
1,955

 
$
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.

Prior to the IPO, as the redeemable convertible preferred stock warrants were exercisable into contingently redeemable preferred shares, the Company had recognized a liability for the fair value of its warrants upon issuance and subsequently remeasured the liability at the end of each reporting period. The Company estimated the fair values of the redeemable convertible preferred stock warrants using the Black-Scholes option-pricing model based on inputs as of the valuation measurement dates, including the fair values of our convertible preferred stock, the estimated volatility of the price of our convertible preferred stock, the expected term of the warrants, and the risk-free interest rates.

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.
Stock Plan
Stock Plan
Stock Plan
 
Preferred Stock

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

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 September 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, 201542,061,250 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.

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 provided 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 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 restricted stock units (“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

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. 

2015 Employee Stock Purchase Plan

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 common stock (i) on the first trading day of the applicable offering period and (2) 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 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
 
Stock option activity under the equity incentive plans was as follows:
 
Options Outstanding
 
Number of
Shares Subject
to
Options
 
Weighted–
Average
Exercise
Price
 
Aggregate
Intrinsic
Value
 
(in thousands)
 
 
 
(in thousands)
Balance—December 31, 2014
43,998

 
$
1.72

 
$
207,863

Granted
6,948

 
10.67

 
 
Exercised
(1,215
)
 
0.78

 
$
28,694

Forfeited or canceled
(1,076
)
 
3.16

 
 
Balance—September 30, 2015
48,655

 
2.99

 
$
1,688,589

 
 
 
 
 
 
Options exercisable—September 30, 2015
22,704

 
0.73

 
$
839,143

Options vested and expected to vest—September 30, 2015
47,634

 
2.94

 
$
1,655,571


 
The aggregate intrinsic values of options outstanding, exercisable, vested and expected to vest as of September 30, 2015 were calculated as the difference between the exercise price of the options and the fair value of the Class A common stock of $37.69 as of September 30, 2015.
 
Restricted Stock Units
 
RSU activity under the equity incentive plans was 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):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Cost of revenue
$
1,351

 
$
346

 
$
2,622

 
$
534

Research and development
5,893

 
873

 
10,910

 
1,157

Sales and marketing
2,451

 
466

 
5,080

 
649

General and administrative
3,339

 
785

 
7,072

 
1,105

Total stock-based compensation expense
$
13,034

 
$
2,470

 
$
25,684

 
$
3,445


 
As of September 30, 2015, the total unrecognized compensation expense related to unvested options, net of estimated forfeitures, was $84.5 million, which the Company expects to recognize over an estimated weighted average period of 3.1 years. 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 Company’s acquisition of FitStar, Inc. (“FitStar”), net of estimated forfeitures, was $2.4 million, which the Company expects to recognize over an estimated weighted average period of 2.5 years. See Note 14 for additional information on the acquisition.
 
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 common stock on the grant date. In determining the fair value of the options and 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.

Prior to the Company’s IPO, the fair value of the shares of common stock underlying stock options was historically established by the Company’s board of directors, and was based in part upon a valuation provided by an independent third-party valuation firm. Subsequent to the completion of the IPO, the Company uses the market closing price for Class A common stock as reported on the New York Stock Exchange. The Company has consistently used peer company volatilities for calculating the expected volatilities for employee stock options and the 2015 ESPP. The expected term of options granted to employees is based on the simplified method as the Company does not have sufficient historical exercise data, and the expected term of the 2015 ESPP is based on the contractual term. The risk-free interest rate for the expected term of the options and the 2015 ESPP is based on the U.S. Treasury yield curve in effect at the time of grant. The Company recognizes its stock-based compensation related to options using a straight-line method over the vesting term of the awards. The Company recognizes its stock-based compensation related to ESPP using a straight-line method over the offering period.
 
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.

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:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Employee stock options
 
 
 
 
 
 
 
Expected term in years
6.25
 
6.25
 
6.25
 
6.25
Volatility
52.1%
 
54.8% - 60.8%
 
52.1% - 56.9%
 
54.8% - 60.9%
Risk-free interest rate
1.8%
 
1.7% - 2.0%
 
1.5% - 1.9%
 
1.7% - 2.0%
Dividend yield
—%
 
—%
 
—%
 
—%
Employee stock purchase plan
 
 
 
 
 
 
 
Expected term in years
0.92
 
 
0.92
 
Volatility
27.7%
 
—%
 
27.7%
 
—%
Risk-free interest rate
0.3%
 
—%
 
0.3%
 
—%
Dividend yield
—%
 
—%
 
—%
 
—%
Income Taxes
Income Taxes
Income Taxes
  
The Company is subject to income tax in the United States as well as other tax jurisdictions in which it conducts business. Earnings from non-U.S. activities are subject to local country income tax. The Company does not provide for federal income taxes on the undistributed earnings of its foreign subsidiaries as such earnings are to be reinvested indefinitely.

For the three and nine months ended September 30, 2015, the Company recorded an expense for income taxes of $20.5 million and $66.0 million, respectively, for an effective tax rate of 30.9% and 37.2%, respectively. The reduction in the effective tax rate for the three months ended September 30, 2015 as compared to the effective tax rate for the nine months ended September 30, 2015 is due to the effect of the growth of international operations. The effective tax rate is higher than the statutory federal tax rate primarily due to certain permanent differences related to the change in fair value of the redeemable convertible preferred stock warrant liability and non-deductible stock-based compensation expense, partially offset by non-taxable income associated with contingent consideration from the FitStar acquisition and a permanent domestic production activities deduction. For the three and nine months ended September 30, 2014, the Company recorded a benefit for income taxes of $29.1 million and $16.9 million, respectively, for an effective tax rate of (73.3)% and (22.4)%, respectively. The tax benefit for the three and nine months ended September 30, 2014 reflect tax benefits of $51.3 million from the full release of the Company’s deferred income tax asset valuation allowance, partially offset by income tax expense on earnings.

As of September 30, 2015, the total amount of gross unrecognized tax benefits was $16.0 million, all of which would affect the effective tax rate if recognized. The Company does not have any tax positions as of September 30, 2015 for which it is reasonably possible the total amount of gross unrecognized tax benefits will increase or decrease within the following 12 months. The Company’s policy is to record interest and penalties related to unrecognized tax benefits as income tax expense. During the three and nine months ended September 30, 2015, the Company recorded $0.1 million and $0.5 million, respectively, related to the accrual of interest and penalties. During the three and nine months ended September 30, 2014, the Company recorded a negligible amount related to the accrual of interest and penalties.
Net Income per Share Attributable to Common Stockholders
Net Income per Share Attributable to Common Stockholders
Net Income 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. 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 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.

Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic net income per share attributable to common stockholders is computed by dividing the net income attributable to common stockholders by the weighted-average number of common shares outstanding during the period. All participating securities are excluded from basic weighted-average common shares outstanding.

For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities. Diluted net income per share attributable to common stockholders is computed by dividing the net income attributable to common stockholders by the weighted-average number of common shares outstanding, including all potentially dilutive common shares, if the effect of each class of potential shares of common stock is dilutive. The undistributed earnings are allocated based on the contractual participation rights of the Class A and Class B common shares as if the earnings for the year have been distributed. As the liquidation and dividend rights are identical, the undistributed earnings are allocated on a proportionate basis. The computation of the diluted net income per share of Class A common stock assumes the conversion of Class B common stock, while diluted net income per share of Class B common stock does not assume the conversion of Class A common stock as Class A common stock is not convertible into Class B common stock.

The following table sets forth the computation of the Company’s basic and diluted net income per share attributable to common stockholders (in thousands, except per share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
Class A
 
Class B
 
Class B
 
Class A
 
Class B
 
Class B
Numerator:
 
 
 
 
 
 
 
 
 
 
 
Net income
$
9,328

 
$
36,506

 
$
68,912

 
$
16,890

 
$
94,622

 
$
92,537

Less: noncumulative dividends to preferred stockholders

 

 
(1,343
)
 
(383
)
 
(2,143
)
 
(3,983
)
Less: undistributed earnings to participating securities

 

 
(52,420
)
 
(7,621
)
 
(42,695
)
 
(68,736
)
Net income attributable to common stockholders—basic
9,328

 
36,506

 
15,149

 
8,886

 
49,784

 
19,818

Add: adjustments to undistributed earnings to participating securities

 

 
5,387

 
7,655

 
6,495

 
6,905

Reallocation of net income as a result of conversion of Class B to Class A common stock

36,506

 

 

 
49,784

 

 

Reallocation of net income to Class B common stock


 
1,377

 

 

 
2,472

 

Net income attributable to common stockholders—diluted
$
45,834

 
$
37,883

 
$
20,536

 
$
66,325

 
$
58,751

 
$
26,723

 
 
 
 
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
 
 
 
 
Weighted-average shares of common stock—basic
42,061

 
164,596

 
40,376

 
15,561

 
87,180

 
40,242

Conversion of Class B to Class A common stock

164,596

 

 

 
87,180

 

 

Effect of potentially dilutive stock options, RSUs, common stock warrants, and employee stock purchase plan
37,003

 
36,795

 
20,627

 
34,244

 
34,163

 
20,081

Weighted-average shares of common stock—diluted
243,660

 
201,391

 
61,003

 
136,985

 
121,343

 
60,323

Net income per share attributable to common stockholders:
 
 
 
 
 
 
 
 
 
 
 
Basic
$
0.22

 
$
0.22

 
$
0.38

 
$
0.57

 
$
0.57

 
$
0.49

Diluted
$
0.19

 
$
0.19

 
$
0.34

 
$
0.48

 
$
0.48

 
$
0.44



The following common stock equivalents were excluded from the computation of diluted net income per share for the periods presented because including them would have been anti-dilutive (in thousands):
 
Three Months
Ended September 30,
 
Nine Months
Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
Redeemable convertible preferred stock

 
139,708

 
88,112

 
139,573

Stock options to purchase common stock
88

 
13,824

 
562

 
3,614

Restricted stock units
921

 

 
307

 

Redeemable convertible preferred stock warrants

 
1,802

 
1,231

 
1,796

Total
1,009

 
155,334

 
90,212

 
144,983

Significant Customer Information and Other Information
Significant Customer Information and Other Information
Significant Customer Information and Other Information
 
Retailer and Distributor Concentration
 
Retailers and distributors with revenue equal to or greater than 10% of total revenue for the three and nine months ended September 30, 2015 and 2014 were as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
A
14
%
 
14
%
 
15
%
 
12
%
B
11

 
12

 
12

 
13

C
12

 
12

 
12

 
13

*Revenue was less than 10%.

Retailers and distributors that accounted for equal to or greater than 10% of accounts receivable at September 30, 2015 and December 31, 2014 were as follows:
 
September 30,
2015
 
December 31,
2014
 
 
 
 
 
 
A
16
%
 
*

B
15

 
17
%
C
15

 
14

D
*

 
13

E
*

 
10

 *Accounts receivable were less than 10%.
 
Geographic and Other Information
 
Revenue by geographic region, based on ship-to destinations, was as follows (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
 
 
 
 
 
 
 
 
United States
$
270,814

 
$
117,997

 
$
848,789

 
$
296,333

Americas excluding United States
24,180

 
6,261

 
54,408

 
17,154

Europe, Middle East, and Africa
49,214

 
12,892

 
123,981

 
31,531

APAC
65,054

 
15,712

 
119,250

 
30,231

Total
$
409,262

 
$
152,862

 
$
1,146,428

 
$
375,249


 
As of September 30, 2015 and December 31, 2014, long-lived assets, which represent property and equipment, located outside the United States were $26.6 million and $20.0 million, respectively.
Acquisition
Acquisition
Acquisition

In March 2015, the Company acquired all of the outstanding securities of FitStar, a provider of interactive video-based exercise experiences on mobile devices and computers that utilize proprietary algorithms to adjust and customize workouts for individual users, for aggregate acquisition consideration of $32.5 million. The aggregate acquisition consideration was comprised of $13.3 million related to the issuance of 1,059,688 shares of the Company’s Class B common stock, $11.5 million of cash, and $7.7 million of contingent consideration. The acquisition is expected to enhance the Company’s software and services offerings.

As of the acquisition date, the Company was potentially obligated to issue additional common stock or pay cash to FitStar stockholders. The actual amount of any contingent consideration paid with respect to the FitStar acquisition, if any, was dependent on market-based events in the future. The Company determined the fair market value of this contingent consideration to be $7.7 million as of the acquisition date using the Monte Carlo simulation method. The fair value of this liability is adjusted at each reporting period, and the change in fair value is included in total operating expenses on the condensed consolidated statement of operations. As a result of the Company’s IPO, the Company recorded a change in fair value of $7.7 million as a benefit and as of September 30, 2015, the fair value of the contingent consideration liability was zero. In addition, the terms related to the contingent consideration have expired as of September 30, 2015.

The following table summarizes the fair value of assets acquired and liabilities assumed (in thousands):
 
 
Goodwill
$
22,157

Developed and core technology
12,640

Customer relationships
128

Trademarks
1,150

Assumed liabilities, net of assets
(3,552
)
Total
$
32,523



The amortization periods of the acquired developed technology, customer relationships, and trademarks are 7.0 years, 1.3 years, and 5.0 years, respectively. Goodwill is not deductible for tax purposes.

In addition, upon acquisition, the Company issued 308,216 additional shares of common stock valued at $4.2 million. The Company is also obligated to make cash payments up to $1.2 million. Both the common stock and the cash payments are additional consideration which is contingent upon former employees of FitStar continuing to be employed by the Company. As such, this additional consideration was not part of the purchase price and is recognized as post-acquisition compensation expense over the related requisite service period of 3 years. The Company also recorded acquisition-related transaction costs of $0.3 million, which were included in general and administrative expenses in the condensed consolidated statement of operations during the nine months ended September 30, 2015.

The results of operations of FitStar are included in the accompanying condensed consolidated statements of operations from the date of acquisition. Pro forma results of operations for this acquisition have not been presented because they are not material to the Company’s condensed consolidated financial statements.
Subsequent Events
Subsequent Events
Subsequent Events

In October 2015, the Company entered into an engagement letter to establish a new senior credit facility to increase its borrowing capacity to $250.0 million, which is to replace the Company’s Asset-Based Credit Facility and our Cash Flow Facility. This new facility would mature in five years and would require the Company to comply with certain customary financial and non-financial covenants. There can be no assurances as to whether, or when, the Company will enter into a definitive credit agreement with respect to this facility, or as to its terms.
Basis of Presentation and Summary of Significant Accounting Policies (Policies)
The accompanying condensed consolidated financial statements are unaudited. The condensed consolidated balance sheet at December 31, 2014 has been derived from the audited financial statements of the Company. The accompanying condensed financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information, 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, its results of operations, and cash flows for the interim periods presented. The results of operations for the three and 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.
Principles of Consolidation
 
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated.
Use of Estimates
 
The preparation of condensed consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the condensed 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 condensed consolidated financial statements.
Comprehensive Income
 
Comprehensive income consists of two components, net income 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. 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.
Recent Accounting Pronouncements
 
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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. 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 (Tables)
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
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