For three years, GoPro, Inc. (NASDAQ:GPRO) has been talking a big game about how it's going to turn its business around. Growth stalled around 2015 and product missteps led to a rash of financial losses. GoPro stock is now down more than 90% from its all-time high. There have been fits and starts for the company, but losses are still mounting, and after shutting down the Karma drone business, there aren't a lot of growth options left for GoPro.
One way to return to profitability is to get consumers excited about the next-generation action camera and sell the product for a price that will drive decent margins. Management says a new product is on its way this quarter and it will boost GoPro's profit margin in the second half of the year. Investors better hope that's true, or else the company could be in dire straits by the end of the year.
GoPro's stellar balance sheet has taken a turn for the worse
I think it's worth taking a step back to look at how well-positioned GoPro was a few years ago compared to where it is today. After the second quarter of 2015, GoPro had $517 million in cash and marketable securities on the balance sheet and zero debt. At the time, it appeared that GoPro's balance sheet would be a point of strength through any challenges that might be coming.
Less than three years later, GoPro's balance sheet has turned into a liability and gives it very little cushion to absorb losses if they continue. After the first quarter of 2018, net cash was just $12.6 million, including $132.2 million of debt that's been taken out in recent years.
To make matters worse, GoPro expects to lose money in the second quarter, just as it's building inventory for the critical holiday season sales push. It may have to stretch the balance sheet to its limits just to make it through the year.
GoPro can't afford another bad holiday season
There are three numbers that investors should look at to see how GoPro's recovery is going: revenue, gross margin, and operating expenses. Management says operating expenses will be "sub-$400 million" in 2018, so let's fix that number for now. For GoPro to make an operating profit and stop burning cash it will need to generate at least $400 million in gross profit.
To hit breakeven operationally, GoPro will have to boost either revenue or gross margin this year. The chart below shows the company's history and some simple calculations show how hard it will be to generate $400 million in gross profit.
Let's go through a couple of scenarios for GoPro to reach breakeven on operations. If GoPro can boost its gross margin to 35%, it could live on about $1.15 billion in revenue, near what it's generated in the past year. But that's an optimistic margin assumption given historical margin trends.
If gross margin stays at around 30%, GoPro would need to sell about $1.33 billion of product, which it hasn't done consistently since 2015. Here's the problem: GoPro dropped the Karma drone a little over a year after it hit the market, which will be a drag on revenue going forward. It also lowered camera prices, leading to a 7% drop in revenue in the first quarter of 2018, despite a 3% increase in units sold. To grow revenue to $1.33 billion, or about 15%, it may have to increase units sold by 25% or more. That's a tall task for GoPro today.
GoPro has few options if 2018 is a flop
In 2017, GoPro lost $163.5 million from operations and burned through $80 million of cash. With cash levels already low, the company doesn't have the leeway it once did to make costly mistakes with products. It needs 2018's lineup of action cameras to be a hit, both from a unit sales basis and from a margin perspective. That's a tall order for a company that has been disappointing investors for three years, but it's necessary for GoPro to survive.