GoPro’s Quarterly Results: They Have to Create Other Revenue Sources. How?

GoPro released the 10-Q for their quarter ended March 31^st last Thursday.  The company’s net income dropped from a profit of $16.8 million in last year’s quarter to a loss of $107.5 million in this year’s.  The balance sheet remains very solid, though not quite as solid as a year ago.

We’ll have our usual fun with the numbers, but let’s start with a discussion of the market and strategic situation GoPro finds itself in.  That’s ultimately what will determine the numbers after all.

A Little Strategic Food for Thought

GoPro is the only brand of “capture device,” to use their excellent term, I can name off the top of my head.  I know there are many others.  If you search Amazon for sports cameras, you’ll find them.  Interestingly, none on the first two pages (there are 400 pages) are GoPro.  But if you search “GoPro” on Amazon, most of the first page is GoPro, but the bottom of that page already has a couple of cameras for brands other than GoPro.

Let’s go one step further.  Search Amazon for “capture device.”  There are 400 pages, but none of the first three pages have a camera (GoPro or another brand) on them.  I don’t quite know if that’s a problem or an opportunity for GoPro.  That is, in some way can being a capture device be a point of differentiation (in a positive way) from other brands’ cameras?  Can it suggest a higher usability or better reliability or features or something?  Or is it a bad thing because everybody thinks it’s a camera?

Remember that consumer electronics have pretty much always turned into commodity products, and I’d love to hear from somebody who can explain why I’m wrong about that.  Arguably, it’s even starting to happen to Apple’s iPhone.

And so, I find myself returning to my old mantra that it’s hard to be a specialty brand and a public company in our current environment.  To be very clear, GoPro knows it can’t just be a device company- at least, as I see it, not and be a successful public company.  I’ll tell you what it’s trying to do about that after we review the numbers.

The Numbers

Revenues for the quarter dropped 49%, from $363.1 to $185.5 million.  They fell in all geographic areas.  In the U.S., revenues fell 52.6% from $155.3 to $73.6 million.  Total units shipped declined 48% from 1.342 million to 701,000.  The decline was due to “…global sell-in that was seasonally lower than the prior year and the lack of a major new product launch in the fourth quarter of 2015.”

The gross profit margin declined from 45.1% to 32.5%.  The decline was due to “…charges related to legacy products of approximately $8 million (380 bps) for excess purchase commitments, inventory write-downs and marketing development funds. These charges resulted from lower sales estimates for our end-of-life HERO products. In addition, the year-over-year decrease in gross margin was attributable to the allocation of fixed overhead costs across less units shipped in 2016 and sales mix. We do not have further material financial exposure remaining from either purchase commitments or our inventory related to our end-of-life HERO camera line.”

I would note that inventory, at $140 million, was down just 14.6% from $164 million at the end of last year’s quarter with sales down 49% in this year’s quarter.

Total operating expenses rose 28% from $141.5 to $181.5 million.  There was a restructuring charge of $6.5 million in January for a global workforce reduction of 7%.  General and administrative expense was down 32.6% from $34.7 to $24.7 million.  R & D expense, on the other hand, rose 59.1% from $49.4 to $77.0 million.  As a percentage of revenues, that’s an increase from 14% to 42%.

The R&D increase “…was primarily attributable to higher cash-based personnel-related costs of $10.8 million, resulting from a 49% growth in global headcount from March 31, 2015 to March 31, 2016, as well as increases in material and equipment costs of $4.4 million, increases in allocated facilities, depreciation and other supporting overhead expenses of $4.4 million and increases in consulting and outside professional service costs of $4.0 million. The growth in R&D expense in absolute terms, and as a percentage of revenue, was primarily driven by investments to support the development of our next generation HERO5 cameras, drone-related products, content-management software solutions, and entertainment related initiatives.”

My reading of the above quote is that they are going for it.  They believe they can be competitive in cameras, but also recognize the need to be more than a device company to differentiate their brand and the cameras.  They have the balance sheet to support the effort.

Sales and marketing was up 40.8% from $56.4 million in last year’s quarter to $79.4 million in this year’s.  It rose from 16% to 43% as a percentage of revenue.

“The…growth of $23.1 million…was primarily attributable to higher advertising and promotional activity costs of $10.6 million associated with expanded branding and product marketing efforts that began during the fourth quarter of 2015, as well as increases in cash-based personnel-related costs of $6.0 million, resulting from a 33% growth in global headcount from March 31, 2015 to March 31, 2016 , and increases in allocated facilities, depreciation and other supporting overhead expenses of $2.6 million.”

I pretty much have the same comment I had about the R&D spending increase.  I’d be curious to see some information on where this marketing spend is focused.

Operating income went from a profit of $22.3 million to a loss of $121.4 million.  There was a tax benefit of $14.3 million compared to a tax expense of $3.3 million in last year’s quarter.  I reported the net income at the start of the article.

Cash and cash equivalents on the balance sheet fell, but it was from $492 million a year ago $389 million.  Guess that’s enough to get them by for a while.  The decline isn’t a surprise given the loss, the investments they are making, and an acquisition (discussed below).  Net cash provided by operations was $66.3 million in last year’s quarter.  It was a negative $33.3 million in this year’s quarter.

Receivables declined by half from $106 to $47 million.  Three customers represented, respectively, 36%, 23%, and 14% of total receivables.  That’s 73% of receivables in total.  I’ve already mentioned inventory.  They expect a further decline during the current quarter.  CFO Brian McGee put it this way:

“I think we would expect to see inventories come down pretty substantially in the channel in Q2, order of magnitude, I think in the range of 35% to 50% down on the weeks of inventory basis in the channel, which is pretty substantial, and our inventory will come down as well.”

Back to Strategy 

GoPro announced in its filing that it had, on March 9 and April 11, completed the acquisition of two “privately-held mobile editing application” companies.  It paid cash of $45 and $59 million for them, but only the first was completed during the quarter.  There’s also some potential deferred compensation of up to $37 million payable.  These companies have apps called Replay and Spice.

GoPro intends “…to combine these two apps to simplify mobile content creation for not only GoPro customers, but for smartphone users as well.”

A smartphone, with or without certain accessories, is a direct competitor to GoPro’s capture devices for certain customers and potential customers.

In the conference call, GoPro also discussed “…GoPro for Desktop, a tool that simplifies the offload, access and sharing of GoPro content.”  It was released in early March.  They also talked about “…additional software advancements with our new GoPro VR app, which further establishes GoPro as a leader in virtual reality… When combined with our new VR capture rigs, Omni and our Odyssey and our stitching software, Kolor, it’s clear that GoPro has created one of the world’s most comprehensive platforms for capturing, stitching, sharing and enjoying VR content.”

The VR app works with both the Apple and Android operating systems.

GoPro also announced that its quadcopter drone, Karma, would be delayed.  It was supposed to be launched in the first half of 2016, but has been pushed back to the holidays.  I am not making a comparison here, but I did notice that Fry’s had a quadcopter with a camera on sale in its weekend ad for about $99.  That’s not the market GoPro wants to be in, and they tell us Karma will contain “…revolutionary features that differentiate it from other drones.”

I’m guessing the drone introduction might have been pushed back because of the advancement of drones in the market in general.  I’ve said in a previous article that introducing a drone seems pretty defensive so this one, when introduced, better be great.

It also says something to me about the market GoPro is competing in.  There are very functional cameras, drones, and software from other brands that are competitive with GoPro.  I took a look at GoPro’s discussion boards and found capture device customers talking about using a couple of other types of editing software on GoPro footage.

GoPro got itself into some trouble by being a bit too optimistic on its projections and overpricing some product.  To some extent that’s a tactical issue they are resolving.  Lesson learned, I’d say.

Strategically, they have to make the company into something more than a camera company in a very competitive market.  Chairman and CEO Nick Woodman said, “…we’re now positioning GoPro as a content enabling solution for smartphone users and casual users, as well as our existing core customer base. And you’re going to see that approach continue in our hardware design as well.”

President and Director Anthony Bates responded to an analyst’s question about monetizing GoPro’s software products this way.

“…we have a much broader portfolio, including mobile now. I wouldn’t say that you should focus heavily on a monetization strategy at this stage. What we’re really trying to do is put the best possible portfolio of products across an ecosystem ranging from desktop to mobile, both for our traditional capture devices as well as VR. There is a small amount of revenue that does come from the VR side of it. As you know, we acquired Kolor, but I wouldn’t say it’s going to be material in this year.”

Though they don’t release revenue by source, I’m sure it’s safe to say that most of GoPro’s revenues come from their capture devices. Anthony Bates pretty much just told us that above.

GoPro has a balance sheet which allows CEO Woodman to project a positioning for the company in an area where they don’t make any money right now and President Bates to tell an analyst not to worry about it.  But GoPro’s future as a public company can’t be exclusively in consumer electronic products.  Should be fun to watch as they work to evolve their revenue sources.