Shares of GoPro (GPRO 3.32%) have been in free fall the past three months after the company disappointed investors with its fourth-quarter guidance. Wall Street had originally expected the action-camera maker to end 2017 with a bang, driven by strong demand during the holiday quarter.
But things started going south thanks to improper inventory management and a bad pricing strategy. Sales of its older HERO5 action camera took a hit following the launch of the new HERO6 toward the end of the fourth quarter. As a result, GoPro's third-quarter inventory shot up 40% from the previous quarter.
This has forced GoPro to discount its older inventory, reducing the average selling price of its products. So even though the company expects inventory levels to drop around 29% in the fourth quarter, its top line is on track for a massive hit. But this isn't where the company's troubles end.
GoPro is going to shrink this year
The company dropped a bomb in January when it announced its exit from the drone business, as well as a plan to downsize the workforce. As Fool.com's Travis Hoium rightly said, GoPro "is now in a fight for its own survival," as giving up on a fast-growing market like drones raises big red flags about its future.
The move away from drones and discounts in prices will leave a deep hole in its finances. It will now report $340 million in fourth-quarter revenue according to the preliminary results, a massive drop from the prior-year period's sales of $540 million. And the margin erosion is even more alarming.
GoPro expects a non-GAAP gross margin of 26% for the fourth quarter, a huge drop over the year-ago quarter's 39.5% figure. These negative effects will spill into the company's 2018 performance, with Yahoo! Finance analysts projecting a 4.4% drop in annual revenue. This is a far cry from the 37% year-over-year jump GoPro reported during the third quarter of fiscal 2017.
So if investors expect any good news from the company's fourth-quarter report on Feb. 1, they are likely to be disappointed because CEO Nick Woodman is going for major damage control.
A rocky road ahead
Woodman has tried to drum up optimism about his company:
GoPro is committed to turning our business around in 2018. We entered the new year with strong sell-through and are excited with our hardware and software road map. We expect that going forward, our road map coupled with a lower operating expense model will enable GoPro to return to profitability and growth in the second half of 2018.
This will be easier said than done, as the promised $80 million cut in operating expenses might not be enough to get it back to profitability. GoPro estimates 2017 non-GAAP operating expenses at $490 million, which puts its 2018 outlay at $410 million. But the company will have to rack up close to $1.6 billion in sales to cover this level of operating expense, assuming the 26% non-GAAP gross margin level that it is forecasting for the fourth quarter holds steady throughout 2018.
This means that GoPro will have to increase its revenue by 35% in fiscal 2018, which looks like a long shot right now after its exit from the drone market and potential competition in action cameras.
The GoPro Karma was the No. 2 selling drone in the U.S. from April to September last year in the $1,000-plus price category. GoPro hasn't revealed the exact sales numbers for the Karma, but it was definitely a big contributor to its top line as the massive cut in the company's fourth-quarter guidance indicates. More specifically, GoPro lowered its revenue guidance by $130 million (from the original $470 million issued in November last year) when it announced its exit from drones.
It won't be surprising, then, if GoPro reveals a tepid guidance once again because of the absence of drone-related revenue, denting investor confidence further. And it won't be easy for the company to regain this confidence as its drone exit clearly shows that GoPro doesn't have the stomach for a fight.
The company had explained that the drone market is extremely competitive and comes with a set of margin challenges. Simply put, GoPro was finding it difficult to go up against market leader DJI Innovations, which reportedly holds half the drone market in North America.
A similar scenario might emerge in action cameras, with the emergence of cheaper, equally capable products from rivals. There are many alternatives at way lower prices, so the company could be forced into a price war if consumers don't buy its current offerings at their premium prices.
It will be extremely difficult for GoPro to deliver the required revenue growth this year to achieve profitability. Investors shouldn't hope for a turnaround when the company releases its quarterly results, as its struggles are far from over.