It’s official; the true Battle of the Smartwatches has begun. In past years, the smartwatch category has come under pressure due to several factors. The most problematic factors for the category have been poor duplicative utility when compared to the smartphone, general lack of utility, price points and battery life. For all of the aforementioned variables, however, sales for smartwatches have done nothing but grow over the last couple of years. The reason for this growth should not be misunderstood. The vast majority of the growth has come directly from an increase in the number of smartwatch skus from a select few vendors in the sub-category of wearables. Last year, Samsung introduced its 3^rd attempt at a smartwatch with the launch of Samsung Gear S Classic and to compliment its previous smartwatch iterations. That was followed by Apple’s launch of the Apple Watch Series 2, again complimenting its previous smartwatch iterations. Both manufacturers were able to sell these devices into retail channels, but fewer units actually found their way onto the wrists of the consumer when compared to the sell-in to retail partners. Nonetheless, the units shipped facilitated the overall growth in the sub-category of wearables. And as for the factors putting pressure on the category, some vendors have yet to express incremental improvements.

This year will be no different than last year with regards to smartwatch growth shy of one additional vendor of significance joining the group of collective manufacturers in 2017, Fitbit (FIT). In the month of September, Apple (AAPL, Samsung and Fitbit all announced and detailed their 2017 smartwatch launches. Each smartwatch announced by the competing vendors has its “puts and takes” for which only time will tell who reigns supreme in the smartwatch sub-category. Fitbit’s launch of it’s Ionic smartwatch has widely been mischaracterized as its make or break opportunity. The reality couldn’t be farther from the truth given its already leading wearable brand, rank as the #2 wearable brand in terms of market share and global presence and running neck and neck with Apple.

And when I say global presence I’m not just speaking in terms of the sheer number of countries for which the company generates sales, but also its dominant linear footage in retailers across the globe. Fitbit’s wearable products have the largest on-shelf presentation of any brand in the category. The company’s greatest sales come from its Charge 2 fitness tracker. Fitbit Charge 2 remains the #1 selling connected health and fitness tracker in the United States and continues to not only take market share, but also completely eliminate competition. Garmin’s (GRMN) Vivoactive fitness tracker line is about to become a thing of the past and as the hardware provider all but announced on its Q2 2017 conference call. Garmin recognized sales for its basic fitness trackers were down double digits and it is now more focused on advanced smartwatch products going forward. 

Sales from Garmin’s fitness device business also fell about 15% amid stiff competition from makers of smartwatches and wearable health trackers such as Fitbit and Apple.

Garmin won’t be the first fitness tracker vendor to find itself moving on from this vector of the wearables category as Fitbit has dispensed with most of its competition in recent years. Since Fitbit began selling fitness trackers nearly 9 years ago, the firm has sold some 67 million units, far surpassing any other vendor to date.

The narrative around the Fitbit Ionic smartwatch “make or break” moment oversimplifies Fitbit’s business operation and feeds into the share price decline hysteria since the company IPO’d in 2015. It’s been a lot easier to look at Fitbit’s past metric performance declines and suggest Ionic to be a catalyst or nail in Fitbit’s coffin than it has been for the media pundits to dig into the more recent metric performance as well as wearable category sales. Fitbit sold 3.4mm wearable units that don’t include smartwatches or ear buds (designated as device that supports 3^rd party apps) while Apple sold roughly 2.8mm smartwatches during the Q2 2017 calendar period according to Strategy Analytics. In order to get to the total wearable shipments number indicated in the IDC reporting, Apple must have sold 600,000 ear buds and bands. So much for the smartwatch dominance huh? Amazing what the numbers indicate versus media hyperbole. 

In Q2 2017, Fitbit all but found a bottom in many of its metrics as the company has diligently sold through excess inventory over the last 9-12 months.  Having clear inventory in the sales channels is a key ingredient to the validation of a metric performance bottom and foreshadows a more positive metric performance to come. As of the Q2 2017 reporting period, Fitbit outlined its sell-through was greater than its sell-in. I outlined much of this for investors in an article titled Fitbit Beat Q2 2017 Expectations With Channel Inventory Levels Improving. Below is statement regarding sell-in vs. sell through during the Q2 period, taken directly from the Q2 2017 transcript. 

Demand for connected health and fitness trackers was better than anticipated, with sell-in unit growth up 14% sequentially. For the second quarter in a row, using “North America as a proxy and consumer demand, sell-through surpassed our sell-in unit shipment numbers. From a third-party market share optics perspective, this disconnect between sell-through and sell-in understates our true size and relevance, but I am pleased to report that based upon North America inventory levels, the channel is now relatively clean with sell-through expected to match sell-in looking forward.

Fitbit unit sales are down year-to-date and down mightily as they have been forecasted coming into 2017. In order to clear out excess inventory the vendor took steep discounts on units sold while they streamlined operations to represent equilibrium of supply and demand. This operation also forced Fitbit to reduce the total number of units it sold in the first half of 2017. Having successfully accomplished the rebalancing objectives, the company actually expressed an increase in the average unit selling price (ASP) both Q0Q and YOY during the Q2 2017 period. This improvement in ASP also improved Fitbit’s gross profit margin performance. Gross margins increased 100 basis points YOY and 300 basis points sequentially to 43% in the Q2 2017 period. Again, all of this without the widely characterized “make or break” Ionic smartwatch. One of the keys to the increased ASP and gross profit margin performance is a rarely discussed product extension Fitbit introduced in late 2016 called “accessories”. Accessories and other revenue in the quarter added an additional $3.98 of revenue per device. See what happens when we dig a little deeper into the product mix offered by Fitbit? But now let’s get back to those highlighted smartwatch launches that headline the spirit of this narrative.

Apple Watch Series 3/LTE $329-$399

The Apple Watch Series has had its fare share of criticisms and sales headwinds since Apple launched its products in 2014. The Apple Watch has been plagued by reductions in ASP, poor battery life and equally poor utility. The Apple Watch doesn’t address any relevant consumer problems that Apple found with such great success via the iPhone. There is no must have feature in the Apple Watch or any smartwatch in general. Smartwatches are known to be solutions in search of a problem; something understood to be more a fact today than ever. It’s kind of like the tablet or iPad. The iPad fit in between the smartphone and Mac. The problem with an in between device is, “Do we really need it”. The answer is clearly no, as has also been identified in iPad sales that post launch and subsequent market saturation that occurred in less than 2 years, iPad sales fell for 13 straight quarters. Such sales performance for a device doesn’t mean it doesn’t have a place in the consumer world, but it does identify its potential in the consumer world. And such sales performance issues have plagued the smartwatch and Apple Watch sales. With the Apple Watch Series 3, however, Apple believes it has found greater utility and a must have feature to entice consumers. 

Apple Watch Series 3 has LTE cellular connectivity in its upper end model, which aims to sell for $399. The Apple Watch Series 3 without LTE will carry a selling price of $329. This is Apple’s first LTE smartwatch and one that has been highly speculated to become a big success. At the highest selling price point in the Apple Watch history, the audience for AWS 3 is automatically curtailed. There are few consumers that will be wiling to pay out $450 after tax and connection fee for a smartwatch. And of course for that connectivity the AWS 3 LTE will require an additional data plan that will cost $10-$15 a month.  While the AWS 3 may now allow consumers to leave their iPhone at home (can only operate on an iOS system) it still can’t take photos or perform gaming activity well or at all. The AWS 3 LTE also still requires the ownership of an iPhone. If you plan on leaving the country, the LTE connectivity will not operate as it is connected to your U.S. based carrier and is not operable as a roaming device. The AWS 3 or any AWS for that matter must be pared with an original mobile iOS system. One of the major conflicts if you are buying an AWS 3 LTE in the near term is the connectivity failure that Apple plans to remedy with a software fix in the near future. Another issue with buying and connecting a new Apple Watch continues to be the data updated when the watch is first connected. Most carriers in the U.S. do not update the data from one generational phone to the next. You literally have to call in your IMEI number each time you update your device. In laymen terms, your new Apple Watch may connect with the data originally found on your iPhone 4, 5, or 6 depending on the last time your data was updated. And, you’ll need an updated SIM that supports Wi-Fi calling. How about that huh? 

The novelty of being able to tele-communicate from an on-wrist AWS 3 is a compelling headline, but will the reality of practically using an AWS 3 be found different. I think it’s comical that we don’t recall the fad that was blue tooth ear buds about 8,9 years ago. People were walking around with their smartphone in their pocket and talking through the blue tooth device, seemingly to nobody and into thin air. It was an odd sight that found critical onlookers who may have thought the individual was talking to himself. Those critical onlookers and bewildering gazes eventually found users of blue tooth technology abandoning such applications. It’s one thing to have a conversation out in the open it’s another to draw attention to yourself by talking into the air without a smartphone device in hand. So now, with that historical precedence set, Apple would have the media pundits and talking heads believe that talking at our wrist and through the air is going to be any less awkward than blue tooth ear buds? Really? All of a sudden consumers are going to turn into Dick Tracy? 

Moreover, the AWS 3 is a strong device, well built and with the standard abundance of features and a laundry list of applications. Again, it is unfortunate with these devices that nothing on the AWS 3 can’t be found in the iPhone 8 or downloaded shy of an on-wrist heart rate monitor application. That’s what you get folks and for the additional $329-$399 price point, a heart rate monitor that is somewhat water resistant. One more thing for which is of critical importance to the potential AWS 3 consumers, battery life. Most smartwatches are plagued with a high attrition rate due to poor battery life. Consumers already have to charge their smartphones daily/nightly. The AWS 3, like its predecessors, has a rather poor battery life that will find the user of the device lucky to get a full 18-20 hours worth of use before charging. Under even moderate application usages like GPS, music and LTE, that battery life dwindles down mightily and will find the user needing to recharge the device during the course of the day. The AWS 3 is not a true stand-alone device and will find consumers who choose to leave their phone home all day greatly disappointed. 

I get it, there are the rare use case scenarios and small populations of consumers that will purchase these devices for fashion forward and fitness purposes, but these are really limited use case scenarios even when combined. Let’s face facts, I’ve never nor will I ever “need” to take a call while surfing. I’ll never need to pull out of a dedicated 5K run to buy a Gatorade or banana at the nearest convenience store. If I want to listen to music on a run though the AWS 3 is ideal. 

Samsung Gear Sport $349

Samsung is at it again with its launch of the Samsung Gear Sport. Samsung largely pioneered the smartwatch business segment back in 2013 and for the “big brand” vendors. But Samsung has found little to no success with its Gear smartwatches over the years. Quality, utility, price point and limited marketing punch have plagued Samsung Gear unit sales. I wouldn’t, despite the advanced features and feel of the Gear Sport, expect this iteration to prove differently for Samsung. Like Apple, Samsung has some tie-ins with its Gear Sport to include Spotfiy music, Speedo and MyFitnessPal. The Speedo tie-in may prove to be the best feature of the new Gear Sport with its varied capabilities, but being the best swimmers smartwatch, well…talk about a limited audience. The Under Armour (UAA) suite of apps, announced earlier this year are good third party running and workout ecosystems available on the Gear Sport, if you don't prefer the already available Samsung Health app. There's Endomondo, MyFitnessPal and MapMyRun on the watch as well. Lacking LTE in various other applications the Samsung Gear Sport has a slightly better battery life than the AWS 3, but as stated previously, it’s unlikely that the Gear Sport is going to be a game changer for Samsung or the smartwatch business segment and especially at $349. 

Fitbit Ionic $299

That brings us to the Fitbit Ionic. The Ionic will launch in-store the first week of October and has been reviewed by the media in abundance since Fitbit detailed its first entry into the smartwatch business segment. Oddly enough and given previous critiques of Fitbit, the Ionic has achieved rather favorable reviews on many accounts. Whether it’s the slim and sleek look or general applications and utility, most reviews have touted Ionic to be an elite smartwatch device when it hits store shelves. The screen size and color vibrancy are, at first glance, a vast differentiator from the competition.

The Ionic can do pretty much everything that the Blaze and Charge 2 can do... and then some. The Ionic takes the next step in the evolution of Fitbit devices by including an app store, music download capability with Pandora (P), mobile payments and GPS just to name a few added features. What is critical to understand for Fitbit enthusiasts and even investors in FIT shares is that Fitbit has dominated wearables for years and without all these added features. 

Specifications:

• Display: 36mm LCD Gorilla Glass 3 curved display with brightness up to 1000 nits
• Materials: 600 series aluminum and elastomer material with stainless steel buckle
• Wireless: Bluetooth 4.0, 802.11 b/g/n Wi-Fi, NFC
• Water resistance: Up to 50 meters and sweat, rain, and splash proof
• Storage: About 2.5GB to store an estimated 300 songs
• Sensors: Altimeter, 3-axis accelerometer, digital compass, GPS/GLONASS, optical heart rate monitor, ambient light sensor, vibration motor
• Battery life: Up to 10 hours with GPS, 4+ days of standard smartwatch usage
• Dimensions: 38 mm width and 12.7 mm thickness, 50 grams

So what’s the logical conclusion going forward for the Ionic and Fitbit with these added features and functionality and given what the vendor has accomplished without those features? Just a thought before continuing.

Fitbit has and will continue to be embattled by the heart rate efficacy application, as it is a leader in the wearable space.  Denoted in the company’s 10K quarterly filings is the ongoing class action lawsuit against the company that lays claims against the Fitbit heart rate monitor for effective usage as Fitbit has marketed the product. It should be understood that none of the wearables on the market today measure the heart rate, but rather the pulse rate.  It’s quite the impossibility to measure true heart rate with an optical sensor.

The heart rate sensors in the Ionic provide PurePulse technology for one of the most advanced heart rate tracking experiences ever. Notice Fitbit will continue to elevate the term “pulse” in its heart rate feature going forward. The Ionic also advances sleep cycle tracking, measuring and showing light sleep, deep sleep, and REM sleep.The Apple Watch Series doesn't measure sleep organically in comparison. The truth of the matter is that while sleep tracking “can be” a useful feature, it is only a sleep tracker for which most users of fitness trackers simply don’t use. They don’t use the application largely because a person who knows they have difficulty sleeping also recognizes that a tracker doesn’t fix that ailment; it simply recognizes the ailment. It’s actually the problem that plagues physicians trying to combat sleep apnea as most clinical applications find patient compliance for such solutions lacking. There’s largely no cure for sleep apnea and most patients abandon treatment within months of first being treated.  Nonetheless, the Ionic includes sleep tracking as another application. What I will offer with regards to the Ionic when compared to its sister devices is that the sleek and uniform fit of the Ionic lend itself better to sleeping with nightly. The Samsung Gear Sports sheer bulk alone wouldn’t do as such and I’d be a little cautious if sleeping next to someone wearing that device for fear of being smacked in the head with in your sleep.

The Fitbit Ionic app store is paltry, but wait, wait just a second. The fact is that we simply don’t need a ton of apps for a smartwatch and for which there are limited use case scenarios for using a multitude of apps on such a small screen. Music is and will continue to be a key app for smartwatch devices as they are of great benefit to fitness users and complimentary to fitness applications. All of these wearables nowadays have a heightened fitness component to them and as such we simply don’t need all the varied apps being offered. The Fitbit Ionic has internal storage so you can load up to about 300 songs for offline listening while you workout. There are currently two supported methods for music, Pandora and direct PC music syncing. With a Pandora Plus subscription, $4.99 per month, you can choose up to three stations for offline music listening and then sync those to your Ionic. For your own music, you can sync iTunes or Windows Media playlists to your Ionic using a Wi-Fi connection when both your PC and Ionic are connected to the same wireless network.

The price point, multitude of direct applications aimed at the core fitness wearable community whom desire advanced applications and battery life are likely going to pave the way for Ionic adoption. The battery life is keenly important in the development of Fitbit’s first smartwatch. The Ionic achieves 4+ days of battery life under even above average usage. Even with extended music or GPS usage the battery will achieve more than 2 days of charge before needing to recharge. I’ve achieved 5 days of battery life with my Ionic and that included music play while walking my 2-year old on our local park’s, mile long pathway. The $299 price point is the most expensive Fitbit yet for which I also own the Fitbit Flyer ear buds ($129) to listen to music. These price points are reasonable and below that of the Apple Watch Series 3 and Samsung Gear Sport. For true smartwatch enthusiasts, it’s hard to rationalize against the Fitbit Ionic for daily usage when compared to its peers. And as far as the addressable market for Fitbit Ionic, the smartwatch is OS agnostic. 

As an opinion, Fitbit Ionic should perform as well as the sell-in has assumed by Fitbit and it’s retail partners. Fitbit’s Ionic smartwatch launch is not as robust as it’s total retail distribution network. The product will launch in limited countries and retailers globally. In the U.S. alone, the Ionic won’t initially be found at the likes of Wal-Mart (WMT) or AT&T (T) (some 10,000 stores combined). Such a soft launch is likely in line with Fitbit’s go-forward strategy to maintain greater supply/demand equilibrium. Fitbit investors would be wise to recognize this as a limited launch and one that won’t incrementally impact the company’s Q3 results. The following exchange was taken directly from Fitbit’s Q2 2017 Conference Call:

Tavis C. McCourt - Raymond James & Associates, Inc.

Okay. And if we think about your Q3 guidance, and I know timing can be tricky on these fall launches, are you assuming any smartwatch shipments into that 3Q guidance or is it, are you assuming that all falls in Q4 at this point?

William R. Zerella - Fitbit, Inc.

Yeah. So what I would tell you is that the vast majority of our revenue in Q3 is related to legacy products.

Having said that, I would expect a robust consumer response to the Ionic product launch that finds it to be the #1 ranked smartwatch seller on Amazon in short order. At present, the Fitbit Blaze is the #1 best selling smartwatch as defined by amazon.com sales.  

The Ionic and Flyer ear buds will aid in lifting Fitbit’s ASP further and going forward, but Ionic will also impact gross margins negatively as Fitbit has forecasted a negative gross margin impact from the Ionic. More than likely that negative margin impact will be offset in the total margin mix. For all the hype surrounding the smartwatch usurping the fitness tracker sales in the wearables category I would also take that with the grain of salt. Keep in mind that Fitbit hasn’t been shipping as many fitness trackers to largely course correct its channel inventory issues and even with sell-through surpassing that critical sell-in metric. With the inventory issues largely behind Fitbit, one could expect the vendor to ramp up fitness tracker shipments/sell-in into 2018. This may prove to once again blur the lines between smartwatch and fitness tracker sales. 

So there you have it folks, let the smartwatch battle begin. One more thing! Most recently the FDA announced a huge breakthrough for tech companies.  The FDA has selected Fitbit, Apple, Google (GOOGL) and other tech companies for its pre-certification pilot program that would otherwise fast track proven solutions/technologies. Okay so I was being sarcastic about the “huge breakthrough” aspect of the announcement. The reality is this is just a step that advances timelines but is still just a step that for hardware providers may simply be a means to yet another brick wall. What’s the point of achieving FDA 510K clearance. Well the point is to provide products/solutions for clinical applications in the medical industry and to doctors, physicians and hospitals around the nation. But the problem has never been achieving 510K clearance it’s been achieving medical reimbursement. You see, these physicians and clinical care networks aren’t in the business of being your retail partner, they’re in the business of providing healthcare services. To the extent that they will sell/prescribe healthcare products, the healthcare providers must be able to achieve medical reimbursement. And that’s the next step these mentioned tech companies would need to take.

In order to take this next step the solutions provided and FDA cleared will need a specific billing code, the road only gets longer from that achievement. That’s often a difficult obstacle, but let’s say it is achieved, what’s next? Well once a billing code is established from the American Medical Association (AMA), the Companies will have the added hurdle of trying to convince CMS (Center for Medicaid and Medicare) to adopt that billing code. And just because the Companies have a code from the AMA does not mean the CMS will accept it. The “holy grail”, as they call it in the industry, is a code recognized by CMS since the device would get the federal reimbursement. After successfully achieving all the aforementioned steps and clearing all the obstacles, now healthcare providers might be will to prescribe your approved and reimbursable device/solution. Good luck with that.

Most of these tech companies are hoping to provide digital healthcare solutions for which such ventures have largely proven to be nothing more than investor money pits. In the article published last month on CNBC.com titled Digital health is dead, says this health-tech investor, this subject matter is validated with eye-opening relevance. Having said that, for ever venture and every idea there remains optimism in the investor community.