GoPro’s Quarter: Tactics VS Strategy

Just what kind of company is GoPro exactly?  Well, obviously, in spite of its recent difficulties, it’s a huge success.  How else can you characterize a founder and a company that recognized and created a new market, took the lead in it and built a billion-dollar business?  But having accomplished that, it now has to wrestle with being a consumer electronics/device company or an active outdoor, content/media company.

There’s really not much wrestling to do.  As I’ve been pointing out since they went public, they are in trouble if they can’t evolve from the first towards the second.  Right now, their capture devices (cameras) and the associated accessories generate all their revenue.  I’ve never seen a mention of any proprietary technology they own, and certainly their resources are not as great as some of their competitors.

We’ve all seen way cheaper cameras that seem (at least to me) to be competitive with GoPro’s product, and I’m hard pressed to think of a consumer electronics product that hasn’t eventually ended up as something of a commodity.

The smart people at GoPro know this, so what are they going to do?

Tactically, they seem to have responded pretty effectively to their recent setbacks.  We’ll talk about those when we get to their financial results.  Founder, Chairman and CEO Nick Woodman says, “We now have a simple product line, a clean retail channel and clear indications of strong consumer demand.”  I especially see this in the end of their inventory problems.

The strategic challenges are awfully similar to those other public industry companies have faced.  Let me remind you of the usual issues.

• As you grow your distribution, by definition you get further and further away from your “core” customer. They may know your brand name, but your story- your brand positioning- is less likely to resonate with them.  Certainly, this was part of Quiksilver’s problem.
• As a public company you need revenue growth. But Wall Street attractive revenue growth may not be consistent with brand building lacking a really meaningful product differentiation.  I can’t help but think of Skullcandy’s current process of going private as an attempt to address this issue.

As GoPro tries to move away from a device to a media/active outdoor company, it’s running directly into both of these.  If, as I suspect, its cameras can’t enjoy a sustainable advantage in features or functionality, then it’s going to have to be, using the word we all fall back on, “cool.”  I suppose cool means that some of a brand’s positioning goes beyond the functionality of the product.  This will require some cautious distribution management and perhaps ceding the lower priced market to its competitors.  It will, in short mean some reduced revenue growth but perhaps with the benefit of higher margins and a better bottom line.

GoPro management will also tell us that they are working to improve accessibility and ease of use not just through the features of the camera, but with the associated software.  To this end, they’ve purchased a couple of editing applications and rebranded them both as GoPro.  They are both free to download.

Making what some no doubt think is a crazy decision, GoPro decided to allow these apps to continue to support content created on smart phones.  I think it’s exactly the right strategic decision.  Reminds me a bit of Microsoft deciding to support Office on the Apple platform.

Look, a lot of people are going to make the decision that they can create all the content they need to create on their phones.  GoPro acknowledging this seems consistent with a strategy of being more of a media/active outdoor company.  GoPro will take all the casual, occasional users they can get, but maybe that isn’t their primary market.  If they take away the compatibility with the software that its smartphone users previously enjoyed while branding those apps GoPro, they piss some people off.  But if they let them use the apps under the GoPro name, maybe some of those people eventually decide to “step up,” as I would position it, to GoPro.

Meanwhile their drone, named Karma, will launch later this year.  And you can preorder the GoPro VR and the GoPro Omni (ships in about ten days) to create immersive 360-degree video.

But for now, this is a company that makes all its money from its capture devices.  And that seems like a good transition to the financial results.

Interestingly, in their discussion of the June 30 quarter, they started, in the conference call and in the 10-Q, by comparing the quarter to the quarter than ended March 31.  The usual practice is to compare it with the same quarter last year and they provide that information as well.

Because of some of the tactical things they’ve done, I guess I can see what they might have chosen to look first at sequential rather than year over quarters.  An 11% sequential selling price increase is worth noting, as is the gross margin increase from 32.5% to 42.1% which, they tell us, reflected “…an improvement in both product mix of higher price point cameras and a higher proportion of sales through our direct channel.”  I’m sure leading with the sequential results had nothing to do with the fact that the results look way better sequentially (revenues up 20%) than they do year over year (revenues down 47%).

But I’m a creature of habit, and I think I’ll stick with the year over year comparison.

Revenues for the quarter ended this June 30 were $221 million, down 47.3% from $420 million in last year’s June 30 quarter.  Two customers represented 35% of this quarter’s revenues. There were large declines in revenues in all geographic regions.  Units shipped fell 54%.  GoPro got 48% of revenue from outside the U. S.

From the 10-Q:

“The year-over-year decrease in revenue and units shipped during the second quarter and first half of 2016 compared to 2015 was driven by seasonally weaker camera sales than the prior year, across all geographic regions, reflecting the lack of a major new camera launch during the 2015 holiday season or during 2016 to date.”

“The average selling price of units shipped, defined as total revenue divided by unit shipments, increased approximately 14% year-over-year due to a shift to a good-better-best offering of HERO Session, HERO4 Silver and HERO4 Black cameras, and the discontinuation of our entry-level HERO cameras.”  I added the emphasis.

I’d be very interested to see the mathematics explaining how much of the selling price increase was due to eliminating the entry level cameras.  Perhaps this is representative of a move towards being a premium product.  That would be consistent with the strategy I think they have to pursue.

The gross margin was down from 45.3% to 42.1%.  “Gross margin of 42.1% in the second quarter of 2016 decreased 420 bps compared with the same period in 2015 due to higher marketing development funds in 2016 of approximately $6 million (or 150 bps) to accelerate sell-thru, changes in product mix (140 bps) and the allocation of fixed overhead costs across fewer units shipped in 2016 (130 bps).”

Now wait a minute.  Just what the hell are “marketing development funds?”  It wouldn’t be discounts or some other form of retailer financial incentive would it?

Meanwhile, research and development spending rose 59% from $58.4 to $93 million.  Sales and marketing expense was up 33.7% from $63.5 to $84.9 million.  The result was an operating loss of $109 million, compared to an operating profit of $46.1 million.

“The year-over-year growth of $54 million, or 37%, in operating expenses in the second quarter of 2016 compared with the same period in 2015 was primarily attributable to an approximate $22 million year-over-year increase in cash-based personnel-related expenses, resulting from an approximate 26% growth in our global headcount, an approximate $11 million year-over-year increase in advertising and promotional activity costs, and an approximate $8 million year-over-year increase for allocated facilities, depreciation and other supporting overhead expenses.”

R & D spending was focused on the upcoming Hero5 cameras, content management software, and drone related products.

I’m left wondering if some of these expenses were committed before revenues went south.

There was a 7% decline in general and administrative expenses, but that was the result of a predictable decline in stock-based compensation.

Net income fell from a profit of $35 million in last year’s quarter to a loss of $92 million in this year’s.

Okay, let’s move to the balance sheet.  The current ratio is still good at 2.0, but that’s down from 3.0 a year ago.  Cash and marketable securities fell from $517 to $279 million.  Not a surprise given the decline in revenues and increase in expenses.  Cash provided by operating activities in the first six months of 2015 was a positive $132 million.  It was negative $79 million in the first six months of 2016.

We also see big declines in inventory from last year ($219 down to $90 million) and in receivables ($119 to $65 million).  These declines are consistent with the reduction in revenues.  Management notes that there were no further inventory write-offs during the quarter.  Three customers represented 59% of accounts receivables at the end of the quarter.  That total is pretty much the same as a year ago.

There are essentially no long term liabilities.  Current liabilities also fell consistent with the reduced level of business.  Equity took a big hit, falling from $783 to $597 million.  Total liabilities to equity was more or less unchanged at 44%.

GoPro is maintaining its revenue guidance for the whole year of $1.35 to $1.5 billion.  They expect to be profitable again in the fourth quarter, and project their gross profit margin in the second half to be around 40%.  That’s lower than they’ve had historically, and I wonder if competitive pressures aren’t responsible for some of the decline.

In the 10-Q GoPro states, “Our long-term growth will depend in part on our ability to expand our consumer base and our presence in international markets.”  And Nick Woodman, responding to analyst’s question says, “…as it relates to expanding the market and the new products that we have slated for back half of the year, yes, we are definitely expanding the market by creating better user experiences that make it easier for our customers to capture, create and share engaging personal content.”

He talks later about shifting the brand from “…a very aspirational image-based presentation…” to “…more product-centric.”  “By the end of the year,” he says, “GoPro is going to be much more of an ecosystem company and an end-to-end solution for our consumers.”

I see the vision.  GoPro as an ecosystem as well as a trendy, aspirational brand makes sense to me- but only for a part of the market.  How big is that market?  Does it support public company required growth while maintaining the brand positioning?  What determines the line between people who want to be part of an ecosystem and those who just want to create some content or maybe just take some pictures on their phones or using a cheaper camera?

I’m guessing GoPro’s team is busy trying to figure out if the ecosystem part of the market will support them as a public company and is scurrying to diversify its revenue sources.