It’s not just that Fitbit (FIT) reported a miss on the top-line, but more so that the company lowered expectations for the full-year and expectations regarding growth going forward. The average analyst estimate for revenue growth in 2016 was roughly 40%, before Fitbit’s revised guidance.Now, analysts expect the company to report revenue growth of roughly 26 percent for 2016.For 2017, analysts formerly modeled revenues growing roughly 16%, as of today and with Fitbit’s lowered expectations going forward, analysts model the company growing revenues roughly 3 percent.It remains to be seen if even that lowered 2017 top-line number can be achieved given Fitbit’s misunderstanding of demand for its products. A great deal of 2017 results will be determined by this holiday season’s sell-through and inventory levels in the retail channel coming out of the Q4 2016 holiday period.

Along with disappointing revenue results and guidance, earnings are now expected to come down to $1.07 for 2016 and only $.58 in 2017.Even I was taken by surprise when I saw that Fitbit had misunderstood its growth profile for 2016 as the company seemingly had a good deal of runway for growing its distribution chain internationally.I had modeled at least another 4-6 months of robust growth before the company would hit a “wall” in sales, brought on by a lack of additional distribution gains.But that is how it goes sometimes…everyone modeled wrong with regards to earnings and revenues.When such an occurrence comes to be, management must be called into question for their misguidance and misunderstanding regarding their product’s demand as well as operational execution shortcomings.

Back in early January I had warned investors about the pitfalls regarding Fitbit’s business model in an article titled “Fitbit's Total Addressable Market Hype May Leave Investors With Disappointment”.  As I expected, Fitbit’s executive team did not fully understand what their true, total addressable market (TAM) is or was given the state of business affairs. The company is still offering to investors and more obviously their employees that demand for fitness trackers should share in part of the smartphone market demand.This could not be further from accurate and is most illogical. A smartphone/cellphone is an essential good; in other words the average citizen has decided that a cellphone is a needs-based good.A fitness tracker, on the other hand, is not needed. Don’t get me wrong, it serves a purpose and can be proven useful as Fitbit continues to effort, but in no way shape or form is a fitness tracker necessary for any aspect of health & wellness. The consumer did just fine without it in the past.Having said that, Fitbit has found a niche market for itself and addresses a much smaller market demand than that garnered by cell phones. One can only hope, however, that management adjusts its understanding of the potential demand in light of what may be peak demand for fitness trackers.This is not to say Fitbit can’t grow revenues in the future, but it definitively suggests that double-digit growth is not likely in the cards without a diversification of the product segment.

Fitbit sold 5.3mm units in Q3 2016, up 11% year-over-year. Revenue grew 23% to $504 million. Domestic revenue grew 33% to $361 million, while international revenue grew 3% to $143 million. EMEA advanced 64% to $81 million, while APAC contracted 44% to $36 million. Fitbit’s latest product offerings, Blaze, Alta, Charge 2 and Flex 2 represented 79% of revenue in the quarter.Also during the quarter, 40% of the activations in the quarter came from repeat customers buying new products. And of these repeat customers, approximately 20% were re-activations, having been inactive for 90 days or more. While some may see this metric as a good thing, what should also be considered is that Fitbit is failing to drive significant new user growth.At 40% activation rate during the quarter, it shows that just under half of new product sales are coming from the existing user base.When we also consider the large attrition rate of >42% YOY, the total addressable market for fitness trackers shrinks at an alarming rate.For this reason amongst others, hardware sales tracking services provided by IDC will need to be continuously revised lower every single quarter as they have been since Q2 2016.I offered this same sentiment in an article titled “Apple's Smartwatch And The Smartwatch Category Facing Retail Discontinuation By 2018”.  In the article I discuss IDC’s proven inaccuracies when forecasting demand for smartwatches, another wearables sub-category. The category has performed so poorly, that Apple (AAPL ) has even offered its Apple Watch Series 1 as a door buster at Target (TGT) for Black Friday.  My verbiage on the subject matter is as follows:

IDC is generally proven to forecast product sales inaccurately and mostly by overshooting actual reported sales results by vendors. Like many firms, data tracking agencies and analysts, IDC often gets wrapped-up in the coolness and early adopter phase of product introduction. This phase is generally where the greatest velocity of sales is found to take place. With this in mind, I have previously offered that IDC will be found to continuously need to revise their lofty forecast for smartwatch and wearable sales. And it doesn't matter what time frame you utilize, they will all need to be revised by IDC. Here is what IDC offered in March with regards to wearable devices and smartwatches.

Having found to largely saturate the consumer channels, Fitbit does continue to make inroads with its corporate wellness division.During the Q3 2016 period, the company added Pitney Bowes and Dr. Pepper/Snapple Group (DPS) to its corporate family. Fitbit Group Health has also strategically partnered with Virgin Pulse, a leading provider of wellbeing technology solutions. Virgin Pulse will offer Fitbit as its brand name fitness tracker of choice to their 2,200 global employer customers.

What has been most disappointing with regards to Fitbit’s internal growth models is the lack of risk aversion to the model.The company has executed lofty expenses under the guise of outsized growth in 2016 and more modest growth in 2017.Fitbit has increased its R&D and headcount through the majority of the year while supplanting regional headquarters in Ireland and Taipei.  The increase in research and development expense was primarily related to growth in headcount. Overall, Fitbit added 81 additional engineering heads, and another 73 additional employees to close the quarter with 1627 total heads. Investment in research and development were up five points YOY to $71 million, represented 14% of revenue and was the largest contribution to expense growth. Look for cuts regarding both headcount and R&D to come as early as Q1 2017. 

The most unfortunate aspect of these expenses is some are assumed to deliver a return on the investment from the operations and mostly from an international sales view.This may take longer than expected, but even worse, not prove of any benefit to investors given the majority of sales for Fitbit come from N. America.Fitbit discusses, in part, why they opened an office in Ireland to address European opportunities for greater sales.

As we look to grow, we believe Europe represents a large, underpenetrated market. The population of the five largest countries - Germany, France, the UK, Italy and Spain - equals the approximate size of the US, but less than 15% of our total devices sold today.

What is comical or unfortunate about this perspective offered by management is that it mirrors the sentiment offered by Keurig Green Mountain when they were found to have saturated the market for Keurig machines with respect to declining sales in N. America.But even for N. America, Keurig offered the TAM for European coffee makers to mimic what could be achieved in N. America.This never came to pass of course, as the European coffee market is not the same as in N. America. The fact is that Europe is not N. America and Europeans don’t spend like Americans for like goods.Moreover, I would hope not to see management fail to understand this proven perspective I’m offering and which has been proven by Keurig, Skullcandy, GoPro (GPRO) and other gadget/hardware vendors. 

A rather sizeable bright spot in Fitbit’s Q3 2016 report was the 281% growth in India.But don’t get too excited! As with immature markets, this growth is largely the result of new distribution and not true sell-through/demand of the products by consumers.

Now let’s talk about Fitbit’s guidance for Q4 2016. 

• The company expects Q4 revenue in the range of $725 million to $750 million.
• Softness in overall demand.
• Following the favorable production ramp of Charge 2, a pull-forward of revenue to Q3.

• Flex 2 supply constraints, will result in approximately $50 million of unfilled demand.
• Earnings in the range of $0.14 to $0.18. Growth in 2016 is less than what was expected.
• Q4 gross margins will be lower than expected, driven by fixed cost deleveraging in cost of goods sold line item of approximately 400 basis points due to lower revenue and higher costs related to scrap materials. Gross margins of approximately 46%.Fitbit expects these issues have largely run their course by the end of the year.
• In Q1 2017, when cash balances typically peak from post hpost-holidayctions, Fitbit expects the cash balances to reach approximately $900 million to $950 million.

In terms of the sell through, our guidance basically reflects our assumption of 15% to 20% growth in sell through in Q4, which would be a reacceleration of sell through growth from Q3. That's inherent in our guidance, although the revenues don't play out that way. That's basically what we're assuming in terms of consumer demand. And lastly, in terms of channel inventory by the end of December. We think all the inventory levels will be normalized.

Investors might view the company’s statements regarding sell-through for the Q4 period to be a bright spot.But what is apparent is that sell-through for the holiday period/Q4 is always greater than the summer/fall/Q3 period and has accounted for the bulk of Fitbit’s sales each and every year.It’s not a matter of Fitbit returning to former glory as one might think, but the typical and widely expected holiday sales period that is stronger than Q3 periods.

So what’s next for Fitbit in light of potential sales contractions to come?Fitbit has offered its ability to transform itself from a consumer driven gadget company to a digital health company. While they have a platform to do so, it will take a lot more technology and possibly acquisitions to accommodate this transformation.Fitbit’s devices, as implemented today, have little efficacy in the healthcare industry. They don’t’ have FDA clearance and most every aspect of Fitbit’s participation in clinical trials is simply an attempt to circumvent FDA clearance by establishing self-imposed benchmarks. To date, this has proven to lack any relevance for shareholders.Moreover, the hope that Fitbit is working on FDA clearance would be found in error by investors, as Fitbit has not yet filed any current or future products for FDA 510 clearance.

Fitbit would definitively have a long road to achieving meaningful revenues and profits in the digital health or healthcare industry. I would be of the opinion that an acquisition of like interest in the healthcare industry would be optimal in 2017 and when the cash balance improves, even if only modestly.An optimal play for Fitbit would be something that improves upon the existing business model. Today Fitbit is pretty much a one-trick gadget manufacturer with no recurring revenues. Once their product is purchased by a consumer that is usually the last time Fitbit generates revenues from that consumer. And once Fitbit saturates a consumer market…well, investors are experiencing the effects of such an occurrence with the recent revised expectations for growth. 

Fitbit’s best opportunity to benefit from digital health and the overall healthcare industry may come from the remote patient monitoring segment of healthcare.A company like BioTelemetry (BEAT) is an ideal business model for Fitbit to either emulate or aspire to become in this regard.BioTelemetry’s business model consists of recurring revenues, hardware and software sales. It’s with this business model that one can see BEAT shares generate a greater PE multiple than do FIT shares.It’s quite often the case that business models akin to Fitbit’s generate a very low PE multiple. 

Another company that has largely gone under the radar for the last 2 years is biotricity Inc. (BTCY).Biotricity is a pre-revenue company but has FDA 510 cleared software aimed directly at a market adjacent to Fitbit’s consumer market.In the coming weeks or months, the company’s flagship bioflux mobile cardio telemetry hardware device will be granted FDA 510 clearance.

• bioflux consists of an ECG monitoring device†, software† and access to a monitoring lab.
•  The bioflux software component is an acquisition that is already FDA cleared and a standard for ECG monitoring in hospitals and cardiac clinics.
• Solution that enables physicians to diagnose Cardiovascular Disease (CVD) or Coronary Heart Disease (CHD)
• Ambulatory monitor that detects arrhythmias
• Performs remote MCT diagnostic monitoring for up to 30 consecutive days
• Transmits ECG data via a built-in cellular radio in real-time so cardiac-triggered events can be monitored remotely as they occur

Every bullet point noted above is everything Fitbit desires to apply in its product segment and business model, but today’s Fitbit products carry low-grade optical sensors for tracking your physical activity and pulse rate. (Fitbit fitness tracker do not track your heart rate, but rather your pulse rate)

Biotricity is a total solution provider for the remote patient monitoring (RPM) segment of the healthcare industry, focused on chronic disease care management.Its hardware and software are designed to serve the MCT segment of remote patient monitoring…today, but can easily be scaled horizontally across many chronic care segments of the healthcare industry.  These other segments can include Sleep Apnea, Pre-natal care, Diabetes and COPD just to name a few.  Biotricity has nearly completed all of its infrastructure needs over the last two years and has embarked on many clinical trials and early adoption of its products.Come 2017, I expect to hear a great deal more from and/or about biotricity as the company places some 1,000 devices into the healthcare industry.While the number may seem small compared to Fitbit’s consumer-related product line, biotricity’s hardware and software sales have recurring revenues due to the nature of the products and ability for healthcare providers using said products to achieve medial reimbursement. For every bioflux device prescribed to a patient a subsequent diagnostic reading of the device is taken. Biotricity will receive roughly $350 for each diagnostic reading and a single bioflux device can produce some 20+ diagnostic readings annually. These elements in the biotricity business model are absent in Fitbit’s business model, but could definitely be attractive to Fitbit going forward.  

Fitbit has a long road ahead of itself and has dug itself a deep hole to climb out of regarding future growth. The 4^th quarter of 2016 will give investors and analysts greater clarity for modeling metrics for 2017 and beyond. Investors would be wise to pay attention to sell-through statistics for the Q4 period, as this will shed light on the retail inventory channel and potential earnings and revenues for 2017.