George Brown - GoPro, Inc. Nicholas Woodman - GoPro, Inc. Brian McGee - GoPro, Inc..

Paul J. Chung - JPMorgan Securities LLC Timothy Young - Citigroup Global Markets, Inc. Andrew Uerkwitz - Oppenheimer & Co., Inc. Ryan Goodman - Bank of America Merrill Lynch Yuuji Anderson - Morgan Stanley & Co. LLC Joe H. Wittine - Longbow Research LLC.

Good day and welcome to GoPro's Second Quarter 2018 Earnings Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Jeff Brown, SVP Corporate Communications and Government Affairs. Please go ahead, sir..

Thanks, operator. Good afternoon, everyone, and welcome to GoPro's Second Quarter 2018 Earnings Conference Call. With me today are GoPro's CEO, Nicholas Woodman; and CFO, Brian McGee. Before we get started, I'd like to remind everyone that our remarks today may include forward-looking statements.

Forward-looking statements and all other statements that are not historical facts are not guarantees of future performance and are subject to a number of risks and uncertainties, which may cause actual results to differ materially. Additionally, any forward-looking statements made today are based on assumptions as of today.

We do not undertake any obligations to update these statements as a result of new information or future events.

Information concerning our risk factors is available in our most recent Annual Report on Form 10-K for the year ended December 31, 2017, which is on file with the Securities and Exchange Commission and in other reports that we may file from time to time with the SEC.

Today, we may discuss gross margin, operating expense, net profit and loss, as well as basic and diluted net profit and loss per share in accordance with GAAP and additionally on a non-GAAP basis. We believe that non-GAAP information is useful because it can enhance the understanding of our ongoing economic performance.

We use non-GAAP reporting internally to evaluate and manage our operations. We choose to provide this information to enable investors to perform comparisons of operating results in a manner similar to how we analyze them with our own operating results.

A reconciliation of GAAP to non-GAAP operating expenses can be found in the press release that was issued this afternoon. In addition to the earnings release, we posted slides containing detailed financial data and metrics for the second quarter 2018.

These slides, as well as a link to today's live webcast and replay of this conference call is posted on GoPro Investor Relations website for your reference. All income statement related numbers that are discussed today during the call, other than revenue, are not GAAP unless otherwise noted.

Now, I'd like to turn the call over to GoPro's Founder and CEO, Nicholas Woodman.

Nick?.

Thanks, Jeff, and good afternoon, everyone. Today, we will take you through some highlights of our second quarter performance and provide context on how GoPro is well positioned for the launch of three new products later this year.

We are on track, sell-through is solid in all regions indicating strong demand, and we believe GoPro will be profitable in the second half of 2018. And importantly, our plan is to exit the year with an improved margin profile we believe will translate into a profitable 2019. GoPro is executing.

Second quarter revenue was $283 million, up 40% sequentially. Sales were driven by the success of our flagship camera HERO6 Black as well as HERO5 Black.

After a two-quarter gap, in March, we reestablished our position at the entry-level with the launch of HERO, which has received the highest customer satisfaction scores for a new camera in several years. The combination of HERO, HERO5 Black and HERO6 Black represents our strongest good-better-best lineup ever.

According to the NPD Group, in the second quarter, GoPro held 97% of the action camera category in the U.S. by dollar volume. And the five top best-selling action cameras in the U.S. were all GoPros. Our spherical camera fusion even with limited distribution has captured roughly 48% of the U.S. market on a dollar basis.

We are proud to play a leadership role and plan to drive the category forward with future innovation. In both Europe and Asia according to GfK, GoPro held four of the top five selling action cameras in the second quarter. In Japan, GoPro's share of the action camera market increased to 58% by unit volume.

In Korea, sell-through grew 22% year-over-year by dollar volume. Finally, during the second quarter, we reached two notable milestones. First, GoPro sold its 30 millionth camera since the launch of our first HD Hero camera in 2009.

Second, since its launch in 2016, more than 4 million HERO5 Black cameras have been sold, making it the best-selling GoPro in record time. HERO5 Black achieved this three months faster than the previous bestseller HERO4 Silver which launched in 2014. These milestones reflect global demand and the enduring strength of our brand.

As Brian will explain, we are closely monitoring a well-known industry-wide shortage of passive components such as resistors and capacitors. While the shortage represents the risk to consumer electronics companies, we're fortunate to have an industry-leading operations team working closely with the large scale contract manufacturer to secure supply.

This is factored into the guidance Brian will provide shortly. Another issue we are watching closely is the trade impasse between United States and China. To-date, GoPro has not been impacted by the tariffs imposed on goods manufactured in China.

As noted on previous calls, we have significantly dialed up our second and third quarter marketing spend to drive consumer awareness and demand for GoPro ahead of the holidays, and it's having an impact. GoPro's overall digital presence is currently at levels we normally only see during the holidays.

Engagement is at a two-year high and our advertising has driven a steady increase in website traffic as well as double digit increase in organic conversion to sale. GoPro's social following has jumped more than 760,000 from last quarter, driven by strong increases on YouTube and Instagram.

And improved analytics are adding a sharp focus to our strategy. For instance, we've identified that roughly 50% of monthly active GoPro App users are using older HERO4 or HERO3 generation cameras. This represents a significant opportunity to drive upgrades.

Educating this engaged audience on the incredible innovation packed into our new cameras is a top priority for us. Understandably, there is a lot of focus on our Q4 execution.

It's important to note that the primary challenge related to sell-through in previous four quarters was attributable to premium products we left in the market for a second year at their original prices. This resulted in a significant drop in sell-through.

Now that we understand this pricing sensitivity and the need for a complete good-better-best product offering, we have confidence in a predictable fourth quarter. To summarize, GoPro is executing and looking forward to a profitable second half. Brand awareness, consumer engagement, and global sell-through are strong.

Channel inventories are tracking towards historic lows ahead of launch and our products are on track. We plan to continue to execute and exit the year with an improved margin profile that we believe will translate into a profitable GoPro in 2019. With that, I'll hand it to Brian..

as supply catches up, we will fill depleted channels meeting expected demand for the first quarter of 2019; gross margin to be similar to our exit rate of Q4 2018; operating expenses to be in a range of $400 million to $430 million to support our roadmap and global marketing; and we believe this translates into a profitable GoPro in 2019 along with improved cash flow.

With that operator, we are ready to take questions..

Thank you. We'll go first to Paul Coster with JPMorgan..

Hi, this is Paul Chung on for Coster. Thanks for taking our questions. So first (18:20). Thanks for that. So as OpEx continued to kind of come down, you mentioned you're on track to hit $400 million given your head count reductions et cetera.

The pickup in marketing expense, can you just talk about where your marketing expense has been targeted? And how do you ensure you get the best return on your investment?.

Hi Paul, thanks for that.

Our marketing spend has increased globally and we're running it multiplatform not just digital but out of home which includes billboards and train stations, public spaces, to really distribute and get people excited about GoPro's brand in many ways, and in many ways, this is leveraging experience that we gained during our big brand building years, pre-IPO and during that IPO period where GoPro's brand was much louder and prouder.

And so we've got proven experience in this area and we're seeing an impact. Digitally speaking, we've got exposure online at levels that we normally only see during the holiday period and yet it's only August.

So that's great in terms of driving exposure and awareness for GoPro in the lead up to the holidays and we're seeing significantly improved website traffic and conversion on sale on our website and as well we're seeing a lot of indications in our social performance that the marketing is working..

Okay, great.

And then if you could you talk about the regions in where you're seeing pockets of strength? Looks like EMEA was up pretty nicely, maybe some FX benefit there, but any color would be great?.

Yeah. Paul, this is Brian. Actually with less FX, EMEA has done a really good job of getting channel inventories down. They were actually one of the lowest. And so we needed to fulfill that demand on HERO6 and HERO5 products. APAC was also a bit low on channel inventory and we had to feed HERO6 and HERO5.

In North America, that's where we were probably most challenged from a channel perspective. Even their demand was up for HERO6 Black and HERO5 Black, and our kind of older products actually sold through nicely to help pull up (20:53) the overall channel.

So, we had strong demand across the board particularly for our flagship products, HERO6 Black and then HERO5 Black..

Okay. And the last question is on gross margins, you mentioned exiting 4Q of 2018 you expect 40s moving forward. How should we think about gross margins fluctuating between the quarters throughout the year? Thanks..

Well, we've been increasing margin as we kind of said back in February, right? We said it would be high-20s and I think we came out weighted about 28 or so percent and we said we'd be in the high 30s exiting second half of 2018, you saw it inch up to 34% in Q3, and that's due to a mixture of still selling some HERO6 and HERO5 Black product, but also channel selling some of the new products.

And then we're selling all new product in the fourth quarter, so you're seeing the full benefit of what we've been narrating for a while now that the new products we have that are coming, particularly at $199 and $299 price points, are at much better cost points than historically. So, that's why you're seeing the margin improvement..

Yeah, I'd like to add though that even though we're improving our margin profile on our new products this fourth quarter, each one of our good-better-best products is improving significantly for consumers. We're not gaining margin at the consumer expense, rather we're building a lot of innovation and capability into our new products.

So, I think that's just very important to note and we're very excited about the new products that we have on store for our customers this holiday season..

Okay, great. Thank you..

We'll take our next question from Jim Suva with Citi..

Hi. This is Tim Young calling on behalf of Jim Suva. Thanks for taking the question.

Can you talk about component shortages you mentioned in your prepared comments? Is the shortage getting better or worse compared to a quarter ago? And how should we think about the margin and revenue impacts from the shortage in the second half of 2018?.

Yeah. Thanks, Tim. I'll take this. We gave the component shortage a little bit of airtime on the call. It has actually gotten worse since the last call. I think you guys even put out a note a few weeks ago kind of talking about it. And so we wanted to frame this kind of properly.

Demand is very strong and supply is coming little bit later than we'd like in the fourth quarter. We have good supply pipeline going into 2019. So, we think we can catch up, but maybe not in time, although we're working on that for the fourth quarter. So that means we would have more sell-through than we would have sell-in.

But if we do get upside, it's fair to point out that about every 100,000 units that we would be able to ship would generate about $10 million of profit. So that's important to note. And I think on the 4.2 million, I think we have a pretty good line of sight on that and we're very comfortable achieving that for the year..

And all of this is factored into guidance of course..

And you actually asked another question in there, which was what was the impact on component cost on our margin, that's factored into our guidance and in the second half, its impact was about 1 percentage point. We think that actually goes away in the first quarter of 2019..

Okay. Thank you. That's all my questions. Thanks..

We'll go now to Andrew Uerkwitz with Oppenheimer & Company..

Hey, thanks, gentlemen. I just have two questions. One is, you may have mentioned this, I missed the very beginning of your call.

How can the supply shortage, the component shortage potentially affect your product mix? Or I guess, put it a different way, would it be favorable or unfavorable if the shortage kind of gets worse from here on product mix into the back half of the year?.

As I've just said, I think we have pretty good line of sight for where we are on a sell-in basis in the 4.2 million units. We don't see it worsening. We have pretty good visibility in with Jabil who is the biggest contract manufacturer.

So if anything what I mentioned is there's more timing about when we would get the product to be able to fulfill it in the fourth quarter, but we would have product to fill the pipeline and channel in Q1 of 2019..

Got you. Okay..

As we said, we're comfortable with how we've guided and so, if anything it was upside and not downside..

Yeah, I think that point about the importance of us covering the supply shortage is really to help explain the gap between total demand for GoPro and our top line revenue and ability to meet that demand. I'd just like to be on record of saying GoPro does not have a demand problem, full stop.

It really comes down to pulling in the supply of some of these components so that we can build them early enough in Q4 and recognize them as sell-in revenue to potentially recognize upside that our current demand is showing exists. It's not as much that we see significant downside risk and thus we were confident in guiding towards that..

No, I appreciate that. Because the way I was thinking about it, it seemed like if there is component shortages it means you're not making the newer cameras with the higher ASP.

So, it sounds like you're appropriately thinking about that with your guidance and leaving upside on the table effectively what you're (27:20) doing here?.

We are actually only building new cameras with higher ASPs. So, we're no longer building our older cameras..

Yeah..

And as we mentioned, our channel inventory of those units is heading towards historic lows. We're looking at a very good transition from our old product to our new product. So, you won't have much of our older product on shelf and we'll be primarily selling-through as well as selling-in our newer products during the fourth quarter..

Excellent. I appreciate that color. And then if I could just do one follow-up.

With the kind of the new operating kind of expense structure, how has that changed the focus of R&D product development? What's some of the tangible things you can share about how that's either improved or got more focused and in what areas you are kind of thinking about?.

Well, we've spent a lot of effort on getting to know our customer better, understanding through analytics as well as consumer outreach through focus groups to learn about their sensitivities, their interests.

And being a much more focused company primarily targeting a great camera app and cloud experience for our customers, it's really narrowed the amount the work that there is to do.

So even though, we've reduced operating budget, we've still been able to maintain healthy R&D and product innovation and development budgets to continue to deliver exciting products for our consumers every year.

Now, we also understand the importance of delivering new products to our customers every year, as we shared that's a very important focus for us moving forward.

Because new products – nothing excites consumers more than new products and that's why we're really excited for this holiday season where we've got three new cameras at the good-better-best price points for the first time since 2012.

So, when you factor in our thinning out inventory in the channel coupled with these exciting new products priced appropriately, we're looking forward to a strong fourth quarter..

Great. Thank you. Appreciate the time gentlemen..

Thank you..

Thanks..

We'll go now to Ryan Goodman with Bank of America Merrill Lynch..

Hey, guys. Thanks for the questions. First one is just on the fact that you're coming out with three new products. I just want to ask on that. So I was under the impression it was going to be a mid and high end refresh.

So I guess, can you walk me through the decision to do a refresh on the entry level as well? And should we be thinking that this is just going to fill in the gap for HERO? So, yeah, just curious on color on why you're doing that just maybe six months into the launch or less?.

Sure. The decision to launch HERO back in March was because the data was clear that we had a gap at the $199 price point. We did not have a HERO camera there, we had a Session camera. And as we've shared numerous times consumer really wants a HERO camera more than they want a Session camera.

And so we saw an opportunity to release a HERO camera that would drive sell-through at the $199 price point globally and HERO has done that. I want to call out it is not cannibalize the higher price GoPros as was of concern to some investors.

We have years of selling $199, $299, $399 HERO cameras, so we felt confident in our ability to forecast sell-through rates and those forecasts have come to be. So that's terrific.

And as we look forward to the new products that we're going to launch this holiday having all of the cameras of a same generation, sharing many of the same user experience advancements is really important. We want to have a consistent user experience across all of our products.

We also saw opportunities to lower the manufacturing cost related to the HERO camera and benefit in terms of margin as well. So launching a new entry level camera this holiday season is a benefit to the consumer and to GoPro's margin as well..

Okay, great. And then just one follow-on, another one on the shortage.

So, I guess, can you help me understand how much of this is going to be a unit factor in getting to that 5 million number and how much of it is a margin factor? Because you mentioned there's like a 1% hit to the margins in the near term which should go away in the first half of 2019, but you're also talking about exiting at 40%.

I think that's a little bit higher than you've talked about in the past? So just any color there would be helpful..

Sure, Ryan. So let's parse this a little bit. So the 5 million number is sell-through. So between what is already in the channel by HERO5, HERO6 et cetera, that sales plus what we fill in is new on the new product.

So the combination of all products through the year we think, the total demand on a sell-through basis is about 5 million units, okay? Our ability to supply is at the moment we think limited to 4.2 million with hopefully some upside.

And so we think we'll exit in the fourth quarter based on guidance about 40% plus or minus one percentage point on exiting into 2019, right. And I also mentioned, within the guidance for what we're going to sell in the second half, the impact on component cost because of the shortage is about one percentage point.

Right? But again what this means is we will end up with channel inventories that are basically at historical lows for 2018 or exiting the year, but we have a solid pipeline of product ready to go into 2019..

Okay. Thank you..

We'll now take a question from Yuuji Anderson with Morgan Stanley..

Great. Thanks for taking my question. I think this is the first time that you're providing some explicit guidance on the sell-through that you're expecting this year.

So just kind of high level curious to hear what drives the confidence in that now that you're providing that?.

Yeah, thanks Yuuji. A couple of points. One is we're 40% in, so that's good. We've got two down, two to go. Historically, Q3 has – we're very consistent there so that comes down to Q4.

And if I compare Q4 and I look at last year where we didn't have an entry level camera, that's the biggest difference in absolute units increase in the fourth quarter from a sell-through perspective. We just didn't have a product.

And so if I compare against the prior two years, that did sell-through of more than 2 million units and we did about 1.3 million units in the fourth quarter of 2017. The reason is we didn't have an entry level product.

And then we also think that given the new products we have all with displays versus selling against the Session that we're going to see a lift in demand, which we're already seeing quite frankly, and we see it in HERO6, HERO5 Black and HERO. So we're already seeing that demand lift.

And in my prepared remarks we talked about the fact that if I exclude all the EOL cameras, our mainline cameras are up 32% year-over-year on the sell-through basis. That's what's giving us the confidence that we can actually deliver on these numbers..

Got it. Appreciate the color, makes a lot of sense. And then, just a quick question on the Q2 gross margins, I believe that also came in slightly higher than expected.

So can you just walk through a little bit just that bridge between what you guided going into the quarter and what led to that outperformance there?.

The outperformance was really demand for HERO6 and HERO5. HERO6 did exceptionally well. Channels were depleted particularly in Europe. I think I gave that commentary earlier. We had to fill channels there, North America was strong on HERO6 as well as Asia.

As a matter of fact, Asia, that region actually had higher sales of HERO6 and HERO5 versus the other region. So very strong HERO6 Black in Asia and then EMEA..

And Yuuji, I would just add that the sell-through rates that we're forecasting for Q4 are in line with historical rates that we've achieved in years where we have had newer products and where we did not leave older flagship products out at their one year old price in the second year.

So we don't need to achieve any heroic sell-through levels or anything like that to achieve our targets for this fourth quarter. The sell-through that we need to achieve is supported by historical levels that we've seen before..

Got it. Thanks so much for the color..

And our last question will come from Joe Wittine with Longbow Research..

Thanks for squeezing me in. HERO5 Black and HERO6 Black were 60% of units. So I think the remaining 40% is mostly entry level HERO.

I understand there's some Karma too, but can you give us any comparison of that call it high 30s or 40% of units to what your entry level has previously represented?.

Hey, Joe this is Brian. I think historically the $299 and $399 price point has held the lion's share of the dollar mix. This quarter Q2 was 75% and 60%. We've held that pretty tightly over the last two years. And we expect that to be consistent.

In terms of the other 40%, it's a combination of a little bit of HERO5 Session and then HERO product, right, with demand at the low-end. But again the mix is very consistent, and Nick, as he'd alluded to, on a historical basis we're running right at the mix levels we would expect..

Okay got it.

And somewhat related, after going away the Sessions were Amazon bestsellers for about half of July, it looked like you were participating in Prime Day, so do I have that right and I was wondering, it didn't sound like it was an extra production round, so was that inventory in your balance sheet or lingering inventory at the retailers?.

It was inventory on our balance sheet that we got to Amazon for Prime Day..

Okay.

And then with respect to tariffs, understand you're not included in the affected HS codes on the $200 million list, but it's a fluid situation, so what is the plan if more codes do get added and these actually do go into effect?.

Yeah. Interesting, I was at Jabil just a couple of weeks ago and talking about supply but also talking about this issue. We're actively looking at how would we source outside of China.

They have two locations that may fit the bill for GoPro and I think if that comes down that way, I think we can move pretty quickly into two locations that wouldn't be impacted by tariffs..

And frankly, there may even be reasons to go to these regions even for cost benefits outside of protecting ourselves against tariffs. So as we continue to look for ways to operate our business more efficiently and drive costs down, this is something that the team is looking at..

Okay, great. Since I'm last I'm going to do one more. Of the 2019 commentary, obviously the gross margin comment was the biggest surprise to me.

I'm just curious what you view is the biggest risk to hitting that number, because GM has historically been accosting the model so far in advance, it's such a big step up that the question kind of begs to be asked?.

Well, what we talked about is we're exiting with the products we have at 40% in the fourth quarter. I think we have a pretty darn good handle on what the cost points are. We know what the price points are. So from that perspective, I think our modeling from margin has been pretty good over historical perspective.

And then you have the second half, we have pretty good visibility into what I think our roadmap is going to be and then the cost of those products. So that gives us the ability to say, I think we have some better visibility maybe than maybe previously..

And Joe, just to add a little color to that. The only reason that GoPro had a margin problem Q1, Q2 and Q3 of this year is because of the fact that we left premium products out for a second year in a row of their original price last fourth quarter in 2017.

We suffered significant drop in sell-through when we did that that taught us a lot about our customers' pricing sensitivity as it relates to our products. And that forced us to lower the price of HERO5 Black and HERO5 Session by $100.

We saw sell-through snapback, which was terrific, but really that pricing sensitivity and our not lowering those prices during the fourth quarter led to inventory overage in the channel, which forced us to lower price and erode margin.

Now that we will not do that again, we will introduce all new products at the $199, $299 price points this holiday season. History has shown that consumers' that drives purchase intent.

So we think that we can hit our sell-through targets, which will allow us to exit the year with low channel inventory, which of course won't require us to lower prices and won't erode margin.

So, I think that that's the single biggest reason why we're confident in our ability to maintain margin going into and through 2019 is because we've got great new products that are going to excite consumers and won't force a price drop..

Thanks, guys..

Okay. Thank you very much..

And that concludes today's question-and-answer session. I'd like to turn the conference back to management for any additional or closing remarks..

Thank you, operator. Well, thanks everybody. To close, I'd like to address what we recognize is certainly of concern to our investors and that is our Q4 execution.

As you've heard, we're executing and our performance is a result of the fact that we spent the last couple of years learning about our customers pricing sensitivity and their desires to see new products from us every year. And the data is clear.

We've only seen sell-through challenges in Q4 when we've left year old premium products out for a second year at their original prices. We've learned that we need to launch new products to excite consumers. In this year, as we've shared, we're launching three new cameras at the good, better, best price points. Something we haven't done since 2012.

We believe this will allow us to deliver a more predictable Q4, and importantly, set us up for a strong entry into 2019, where we believe we will be able to maintain gross margin. The last two years have been a recovery period for GoPro.

And I believe our recent performance indicates we're exiting this recovery phase, and executing on our plan to return to growth and profitability. Thank you very much for joining today's call everyone. This is team GoPro signing off..

This concludes today's call. Thank you for your participation. You may now disconnect..