Let’s just jump right to a comment CEO Nick Woodman made during the conference call.
“I would say that we are more focused on revenue and margin and less focused on volume on a unit basis.”
That sounds to me like GoPro is more interested in the higher end of the market. And they should be. But if that’s their focus (I happen to think it should be, but dare I call it a niche?) is there enough revenue growth to satisfy the requirements of being a public company?
On to GoPro’s competitors. Here’s how they describe them and GoPro’s advantage.
“We compete against established, well-known camera manufacturers such as Canon Inc., Fujifilm Corporation, Nikon Corporation, Olympus Corporation and Vivitar Corporation, as well as large, diversified electronics companies such as, Panasonic Corporation, Samsung Electronics Co. and Sony Corporation and specialty companies such as Garmin Ltd. We believe we compete favorably with these companies’ products. Our durable and versatile product design facilitates increased functionality and wearability and we offer a variety of mounts and other accessories that enable a wide range of consumer use cases that are difficult for other competing products to address. Further, we offer many professional-grade features within our good, better, best product offering at attractive consumer price points…”
Hefty group of competitors. If I am reading between the lines correctly, GoPro is not, cannot and does not want to compete against low priced, less featured, products. Good- because in my judgment, they can’t.
On to GoPro’s strategy.
“We are committed to developing solutions that create an easy, seamless experience for consumers to capture, create and enjoy engaging personal content. When consumers use our products and services, those products and services enable compelling, authentic content that organically increases awareness for GoPro, driving a virtuous cycle and a self-reinforcing demand for our products.”
This isn’t just a technical, but a marketing strategy. I think it can work. It is working. But how big is this market, this “virtuous cycle?” I’ll ask again if it’s the basis for a public company?
GoPro points to five elements of its strategy. The first is “Drive profitability through improved efficiency, lower costs and better execution.” Nobody can argue with that, if only because everybody is doing it. As you are no doubt aware, during 2016 GoPro implemented some restructuring, rationalization and layoffs as part of this process. More coming in 2017.
Number two is “Make the smartphone central to the GoPro experience.” This is necessary and I’m glad they saw it clearly. Still, it feels more like a concession than a strategy.
I’ll come back to three. Number four is “Grow our business internationally.” Like everybody else, they’ve perceived limits in the U.S. market and see opportunities abroad.
Number five is “Expand the GoPro experience for advanced users.”
Now for number three. “Market the improved GoPro experience to our extended community.”
Let’s spend a little time on numbers three and five. GoPro’s strategy here sounds a bit like a core action sports strategy back in the good old days. The advanced users give you credibility, excitement and commitment. Dare I use the words, “vibe” or “core?” They are the thought leaders in creatively using GoPro’s capabilities and building the community.
Based on that, we used to think, you could reach “the extended community.” And you can- to a point. Where is that point? Well what do you know! Here we are back at distribution again. As I’ve said a few times, there comes a point in expanding distribution when they may know your brand, but they won’t know your story. That’s probably the limit of your brand’s growth without long term damage to it.
That’s not a completely accurate analogy. First, GoPro is hardware with real, distinctive features that evolve and improve. More like the bicycle market than the snowboard market, where meaningful differences these days are kind of hard to find. Second, distribution has evolved. GoPro’s biggest customer is Best Buy (17% of revenues) and they do a bunch of business on Amazon (11%). There’s nothing wrong with either of those. They also mention Walmart and Target as significant customers, but each is less than 10% of revenues. GoPro is in 45,000 retail outlets is over 100 countries. Less than 10% of their revenue comes from GoPro.com.
We know brands that were public, but got into various forms of trouble not least because they couldn’t meet Wall Street’s growth expectations without damaging their brand and market position because of how they expanded their distribution to grow revenue. They ended up private and are better off for it.
GoPro’s basic challenge is conceptually simple. Can they attract enough of their hoped for extended community to provide satisfactory top line growth? Keep that in mind as we review the financial results.
By the Numbers
Revenue for the quarter ended December 31 grew 23.8% to $541 million from $437 million in the same quarter last year. The gross profit margin rose from 29.4% to 39.2%. I imagine much of that increase is explained by a 9% increase in average selling price. Operating expenses rose from $170 to $239 million, or by 40.6%. As a percentage of revenue, they rose from 38.9% to 44.2%.
There was a net loss of $116 million during the quarter, compared to a loss of $34 million in last year’s quarter. However, that loss “…includes a charge of $102 million to account for a full valuation allowance on our U.S. deferred tax assets…” That’s $102 million they won’t be able to apply against future taxes on profits.
For the year, revenue fell 26.9% from $1.620 to $1.185 million. Units shipped fell by 28%. The decline reflected “…global channel unit sell-through that exceeded sell-in for the first three quarters of 2016 as we worked to reduce channel inventory in preparation for the launch of HERO5 in September 2016.” They also had some manufacturing issues that left them undersupplied with HERO5s in the fourth quarter. That lead to some partners cancelling promotional efforts and impacted demand.
Presently, almost all of GoPro’s revenues come from cameras and accessories. I’ll be interested to see what kind of reception the Karma drone gets now that it’s back on the market. They got no revenue from it during 2016.
The gross margin dropped from 41.6% to 39.0%. Product costs rose because of new features. I’m fine with a bit lower gross margin if they are selling higher priced products and generating more gross margin dollars. They are now projecting their long-term gross margin to be 39% to 41%, down from 42% to 44%.
Research and development expense rose 48.3% from $242 to $359 million. As a percentage of revenue, they doubled from 15% to 30%. Their 10K has a section on intellectual property, where we learn they have 208 issued patents and 497 patent applications in the U.S.
Sales and marketing expense also grew rather handily from $269 to $369 million or by 37.2%. As a percent of revenue, they rose from 17% to 31%. General and administrative expenses, at $107 million, were constant.
There was a net loss of $419 million compared to a profit of $36 million the previous year.
Let’s think about those operating expenses. Pretty large increases in R & D and sales and marketing expenses for a company that lost $419 million and had a 27% decline in revenues. But they are consistent with the strategy they outline- especially the parts about marketing to advanced users and the extended community. They must be cooler and have generally better product than their competitors. Then they have to convince enough people who are getting by with their cell phones or a cheaper, less functional, camera that GoPro has something they need.
Their ability to continue this depends on their balance sheet and turning around the operating performance. They are reducing operating expenses. They’ve come out with a new camera (I’d include the software and call it a system) that they tell us is leading in market acceptance and features. They seem to be getting better at transitioning from old product to new. The fourth quarter of 2016 was the second highest quarter by revenue they’d ever had.
In summary, there is progress on the operating side.
Now, the balance sheet. The current ratio at year end was 1.36, down from 2.82 at the end of the prior year. That’s largely due to a 54% decline in cash and marketing securities. Meanwhile, receivables grew from $146 to $165 12.9%) million even as sales declined. But they factor some receivables, so it’s hard to know how to think about that. Inventory fell 11.2% from $188 to $167 million. They tell us in the conference call that inventory in their channels was down 15% compared to the end of 2015 and that “…the vast majority of the inventory in the channel…were our newer products.”
They have no long-term debt, but accounts payable and accrued liabilities ended the year at $416 million, up 47.5% from $282 million at the end of the prior year. That suggests to me they are using their suppliers as a source of working capital, not that there’s necessarily anything wrong with that. Done it myself a few times.
Equity fell 42.1% from $772 to $447 million. Total liabilities to equity rose from 0.43 to 1.06. GoPro had some expenses last year you can characterize as one time, though as you’ve heard me bitch and moan, lots of companies always seem to have new onetime expenses every year.
The point, however, is that they can’t continue this level of spending unless the operating performance recovers quickly and significantly. Net cash provided by operating activities was a negative $108 million, compared to a positive $158 million last year.
I guess I’ll summarize with what I said in the middle of the article. “GoPro’s basic challenge is conceptually simple. Can they attract enough of their hoped for extended community to provide adequate growth?”