At one point on Thursday morning, as his company was proceeding through its initial public offering, Bill Zerella’s heart rate was up to 128, or about the rate he scores when he’s on the treadmill.
Zerella, the 58-year-old CFO of Fitbit, knew that because he had checked the activity tracker he wears on his wrist. He uses the device, one of the line of products his company’s known for, to see if he’s getting enough activity during his working day, to monitor his heart rate while doing intense exercise, and to measure sleep – “which I haven’t been getting much of, by the way,” he told CFO.
As of a little past noon yesterday, however, with the company’s shares going for about $30 a pop, or about $10 above the offering price, Zerella’s heart rate was down to 86.
In any event, the finance chief was handling the major question of the day with evident bullishness: How could Fitbit maintain its gangbusters revenue and earnings growth in the face of looming competition from the likes of Apple, Google, LG Electronics, Microsoft, and Samsung?
After all, as the company itself acknowledged in its June 16 registration statement, the market for devices that track health and fitness “is both evolving and competitive,” consisting of “a multitude of participants including specialized consumer electronics companies such as Garmin, Jawbone, and Misfit, and traditional health and fitness companies such as adidas and Under Armour,” as well as the computer giants.
Still, Zerella noted, Fitbit estimates that consumers spent over $200 billion in 2014 on health and fitness services. “We think, frankly, that there’s room for more than one company to be successful,” the CFO said.
Citing NPD Group research, he pointed out that his company held the leading position in the U.S. activity tracker market, with an 85% share, by dollars, in the first quarter of 2015. “So we’re pretty dominant today,” Zerella added.
Regarding the potential competition represented by the June 26 launch of the Apple Watch, which also tracks the user’s physical activity, he said that the stir created by Apple’s entrance into the market “is something that’s going to help us in the long run…. We think more visibility on the part of consumers as to what some of these devices can do to help in achieving health and fitness goals is a positive thing.”
Velocity of Innovation
For the time being, though, Fitbit ads are ubiquitous on television and its devices are being sold in more than 50 countries via 45,000 retail stores and retailers’ websites, its online store at Fitbit.com, and as part of the firm’s corporate wellness offering. Such merchandising and marketing efforts probably have helped push the company to four years of investor-alluring revenue growth: In 2011, 2012, 2013, and 2014, the firm recorded revenues of $14.5 million, $76.4 million, $271.1 million, and $745.4 million, respectively.
Yet unlike other tech firms with soaring sales growth, the firm was able to burst into the black after three years of diminishing net losses, recording $131.8 million in net income in 2014. The company’s ability to boost its profit margins stems from its ability to generate explosive revenue growth, however, rather than from any particular cost cutting effort, according to Zerella.
Nevertheless, “trying to grow a company this fast is not easy to do. So far we’ve been pretty good at it. But as we continue to grow, we want to make sure to put the people, the processes, and systems in place to manage that growth,” he said.
Further, in an effort to find new sources for such growth, Fitbit, which has doubled its research and development spending for a number of years, is looking to triple it for 2015 to roughly $150 million, according to Zerella. “We’re trying to add to the velocity of innovation that we can bring to market,” he added. “Obviously the focus there is to continue to deliver compelling products that allow us to maintain a strong marketshare position.”
But will those products be there if more and more consumers continue to clamor for them?
Zerella acknowledges that Fitbit faces manufacturing-capacity and supply chain risks stemming from the rising demand it’s trying to trigger. “Were in hypergrowth mode. There aren’t many companies in the world that are growing at this rate, nor are there many companies growing at this rate that can generate the kind of operating margins that we have. When you’re in that kind of environment, you have to factor into your planning the potential for big spikes of demand and being able to respond to that in terms of your production capacity,” he said.
“When you’re looking at a footprint this big, across 54 countries, and a set of products that [is] being embraced by consumers, you can potentially get very surprised by the upside opportunity and then be challenged as to how you meet that,” the finance chief added.
Noting that Fitbit has struggled with this issue in the past, Zerella says that the eight-year-old company has “always been supply constrained.” But during the first quarter, “for the first time, we believe, we’ve expanded our capacity to a point where we can better meet demand out there,” he said, noting that Fitbit “is investing a significant amount of money to increase our production capacity.”
Yet as Fitbit itself noted in its registration statement, many of the key components in its products come from a limited number of suppliers or a single one. In fact, Flextronics, a San Francisco-based firm, “is our primary contract manufacturer and is currently the sole manufacturer of the majority of our devices,” Fitbit reported.
As a result, Fitbit is “susceptible to supply shortages, long lead times for components, and supply changes, any of which could disrupt our supply chain,” the firm said.
To prepare for those potential exposures, Fitbit is “now starting to diversify” its contract manufacturers, Zerella said. “Number two, we are starting to multisource key components, which is very important in trying to minimize our risk.”