Earnings Labs

GoPro, Inc. (GPRO)

Q3 2018 Earnings Call· Thu, Nov 1, 2018

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Transcript

Operator

Operator

Good day, everyone and welcome to the GoPro Third Quarter 2018 Earnings Results Conference. Today’s call is being recorded. And now I’d like to turn the conference over to Christopher Clark, Director of Communications. Please go ahead sir.

Christopher Clark

Management

Thanks, operator. Good afternoon, everyone and welcome to GoPro’s third 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 obligation 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 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 have posted slides containing detailed financial data and metrics for the third quarter 2018. These slides as well as a link to today’s live webcast and a replay of this conference call is posted on the 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?

Nicholas Woodman

Management

Good afternoon. Today we will provide highlights of our third quarter performance including an update on the launch of our HERO7 line of cameras. Third quarter revenue was $286 million and we increased our cash to nearly $150 million. We remain on track to be profitable for the second half of 2018 and expect to exit the year with low channel inventory, putting us in a good position for Q1, 2019. GoPro made significant market share gains internationally in Q3. According to GfK in Europe, in the $150 and above action camera market GoPro held 84% unit share and 85% dollar share up from 78% and 80% respectively year-over-year. GoPro also grew share in APAC during Q3. According to GfK in Japan, GoPro held 58% unit share and 71% dollar share of our category. And in Korea, GoPro held 47% unit share and 61% dollar share. This represents GoPro’s highest dollar share in Japan and Korea since the beginning of 2016. In the U.S. according to NPD Group in the third quarter, GoPro held 87% unit share and 96% dollar share of our category. And the top six action cameras sold in the U.S. were all GoPro’s. And for the 19th straight quarter, GoPro was the best selling camera of any type in North America. And you can bet that we’re focused on making it 20 quarters for five years straight in Q4. The biggest news coming out of the third quarter was the successful launch of our new flagship HERO7 Black, which has achieved the strongest month one unit sell-through of any new camera in our history. HERO7 Black was announced on September 20 and gained immediate international momentum from a wave of positive press, including several Editor’s Choice Awards and while we’re happy to receive such strong recognition…

Brian McGee

Management

Thanks, Nick. During our second quarter earnings call, we outlined our expectations for the third quarter and second half of 2018. The second half of the year is largely playing out as expected and continues to be on track to meet our financial objectives. I’ll now recap key points from our Q2 call and provide an update on how Q3 results came in relative to that outlook. We suggested sell-through of 5 million units for the full year, which represents 16% annual growth with sell-through of 3 million units in the second half of 2018. We believe sell-through was 1.1 million units in Q3 up slightly year-over-year, which tracks to our expectation. In particular, Asia-Pacific and Latin America continued to be regional growth drivers. In addition, we continue to expect to Q4 sell-through to be 2 million units. We expect to sell-in to be approximately 4.3 million units for 2018. We expect to exit the year with low channel inventory, which sets us up well for the first quarter of 2019. We expect to be profitable on both a GAAP and non-GAAP basis for the fourth quarter. Now I'll provide more detail on our performance in the third quarter and then offer guidance for the fourth quarter of 2018 and a qualitative outlook for the first quarter of 2019. Our solid third quarter performance was attributable to better than expected demand for our cameras, in particular, our newly launched HERO7 Black as well as continued management of our expenses. For the third quarter of 2018, revenue was $286 million. Gross margin for the quarter was approximately 33%, up two percentage points sequentially. Our GAAP and non-GAAP operating expenses were $112 million and $99 million in the third quarter. A reduction of $10 million compared to the year ago quarter, despite…

Operator

Operator

Thank you. [Operator Instructions] And we'll go first to Paul Coster. Excuse me, at JPMorgan.

Paul Chung

Analyst

Hi, thanks. This is Paul Chung on for Coster. Thanks for taking my question. So first off, on product mix, so I assume the HyperSmooth features skewing more sales towards the Black. I'm judging by your highest monthly sell-through in history, and of course, so that you mentioned, so. Now as we think that 4Q model higher HERO Black mix relative to other year launches?

Brian McGee

Management

Hi, Paul. This is Brian. Yes, we expect the mix to shift more to HERO7 Black, when historical and we expect that trend to continue into the first quarter of 2019. And what comes with that is an increase in – an expected increase in ASPs both in the fourth quarter, we said, it'd be up slightly and I'll continue to drive up into the first quarter of 2019.

Nicholas Woodman

Management

Yes, I would add to that. Our production builds also allow us to adjust for this beneficial skew mixture.

Paul Chung

Analyst

Okay. And then my second question is on channel. So I noticed your indirect sales slightly bigger portion than past quarters. Is this function of maybe more international mix? Can you just talk about the dynamics going on there? And how should we think about kind of longer term impacts on both gross and operating margins if this continues? Thanks.

Nicholas Woodman

Management

Yes. No problem, Paul. Part of the reason international was higher this quarter as we actually launched first with the HERO7 line up internationally. So they actually got more product in the quarter versus North America. As we look to the fourth quarter, we expect actually all three geographies to grow year-over-year and obviously, sequentially, and the mixed shift a bit more to America’s versus Europe and APAC.

Brian McGee

Management

And I just like to give a big shout out to the GoPro's operations team for coordinating the first ever international launch for us. This is the first time we've ever launched international markets. Before the U.S., we launched several days early, internationally, and that in a year where we launched three new cameras for the first time since 2012. Just a really big shout out to that team on it and it's a great sign of GoPro’s improving execution and efficiency.

Paul Chung

Analyst

Great. And then my last question is on GoPro Plus. So you got some nice growth there. So how big do you envision this business can become and what are kind of the steps you’re taking to increase more adoption? Thank you very much.

Nicholas Woodman

Management

Thank you. Yes, GoPro Plus is growing steadily. And as I shared in my remarks, we’re focused on testing new pricing tiers and new benefits to provide the increased value proposition and differentiated value proposition to consumers. And we're very focused on increasing refining and increasing our marketing efforts to drive awareness. Our internal research shows that we only have approximately 25% awareness of GoPro Plus amongst our community, which points to a real opportunity to grow the subscription service further at an increasing rate.

Paul Chung

Analyst

Thank you.

Operator

Operator

We’ll move next to Andrew Uerkwitz at Oppenheimer.

Andrew Uerkwitz

Analyst

Hey, thanks gentlemen for taking my call. Two questions, the first one on the Silver and White discounting. Could you just walk through kind of the thought process there? Is it different? Because you're seeing something in the channel is made you want to do this to the conversation you had with your partners kind of any additional color there on the discounting? That'd be great.

Nicholas Woodman

Management

Sure. Yes, we've received feedback from our retailers that this was going to be a very promotional holiday. And they encouraged us to be more promotional and we took their advice and decided to be promotional on both Silver and White in addition to HERO7 Black, which we already had planned promotions for. HERO7 White and Silver are selling in line with our expectations and together with these promotions that we've got planned for the heart of that holiday buying period, we expect them to play their part in our good, better, best strategy. And it's important to note again, that we're seeing a mix shift to the high end due to the strength of HERO7 Black. And again, I'm going to give another shout out to our operations team – for ensuring that we've got the inventory to support this mix shift. And as well manage it with future builds, so they can support it, if the shift continues into 2019, which we expect it will.

Andrew Uerkwitz

Analyst

Got it. And then on the near term parts shortages, component shortages, does the mix shift change your thoughts there at all as far as your major…

Brian McGee

Management

Andrew, this is Brian. I think, as we kind of shared last quarter and our prepared remarks today, we continue to see 5 million units of global sell-through demand for GoPro in 2018. And our sell-through trends are remaining consistent with kind of the guidance we've given. We obviously, over perform in Q3 with revenue that was $16 million above the midpoint of a previous guide and that shifted revenue to Q3 from Q4. We mentioned being more promotional, which we just talked about on Silver and White. That will definitely impact a little bit revenue and margin versus what we had guided previously. But then we'll still be profitable in the fourth quarter, and the second half and grow cash balances towards the end of the year. As we looked forward to Q1, we believe sell-in, sell-through will be at least 1 million units, and we expect to see this sequential increase in the ASPs. So hopefully that answers your question. We'll see more of a shift up to HERO7 Black, both in the fourth quarter and in the first quarter, as Nich had mentioned.

Nicholas Woodman

Management

Yes. And the components constraints should not affect our ability to build more HERO7 Black.

Andrew Uerkwitz

Analyst

Got it. Okay. Yes, it's – and then if you breakeven your profitability – profitable in Q1 next year, that seems like it could bode well for the entire year. How are you thinking about marketing sales strategy, or even R&D, as you start to have a little bit more cash flexibility in 2019?

Nicholas Woodman

Management

Yes. We shared that could be an area, where we increase spending. On our last call, we shared that we could see OpEx going up to potentially $420 million next year. And that the areas of where we would increase spending would be in R&D and in marketing, if we were to do so. We are going to be increasing marketing in Q1 2019, when compared to first quarter 2018. We've learned that it's important to take in always on-approach to our marketing as we had done in our brand building years, as opposed to being off and on, as we had done in other years post IPO as far more effective to stay on, to keep driving awareness, keep the drum beat of loud and proud as it does have a significant impact on our ability to drive sell-through. Also, it's important to note, in my prepared remarks, I covered quite a bit of time covering the performance of our marketing since launch. We've got significant increases in engagement and overall, we're very pleased with the initial results of our more feature centric marketing campaign. That's doing a much better job of driving awareness of HERO7’s new features and why, both new customers and upgraders alike maybe interested. Now we're seeing it in sell-through. So you can expect that approach to continue at amplified levels in the first quarter and to a certain degree throughout 2019.

Andrew Uerkwitz

Analyst

Awesome. Thank you, guys for all the additional color. I appreciate it.

Nicholas Woodman

Management

Thank you very much.

Operator

Operator

[Operator Instructions] Moving next to Joe Wittine at Longbow Research.

Joe Wittine

Analyst

Hey guys. Nick, so Black looks great. But I'm still struggling with the promotions. Just because, as you said before, when showing your dad you are the market, you have no competition domestically at least. So I'm struggling to understand, why retailer would say GoPro needs to be promotional because other categories presumably are? On top of that you always partaken in holiday promotions, so maybe a little bit more detail on this advice on why you’re choosing to go this way?

Nicholas Woodman

Management

Sure. It's for share of wallet. So consider a consumer may be really excited to buy a GoPro, but they're also really excited to buy, say a pair of Beats headphones and maybe the Beats headphones are $100 bucks off and they may decide, hey, I got to take advantage of this promotion on headphones during this Christmas period and I’ll wait to save up and buy a GoPro in February. It's not that retailers or GoPro per se are necessarily worried about losing a sale to a direct competitor.Although, we take all competition seriously and the promotion, certainly don’t hurt. It’s about competing for share of wallet and also when you are participating in retailer promotions over the holiday period, you get included in their advertising. Retailers pitch in for the cost of the promotion. The cost of promotion is not solely born by GoPro. So that’s an opportunity to get leverage out of our retailers holiday marketing spend and get GoPro’s name and the HERO7 line into the limelight if you will during the holiday season. So it’s really important on many levels to participate in those promotions. So that’s why we’re doing that. And I believe that answered. Was there a part of your question I left out?

Joe Wittine

Analyst

No, that’s fair. Maybe similar topic and I appreciate that. Do you envision any scenario based on the early sell-through that you’re seeing where the company puts in a permanent price reduction to Silver and White kind of similar to what you are seeing with other products that have been sort out of the gate?

Nicholas Woodman

Management

No. We’re not seeing any signs that we would need to do that. The only reason that we needed to price protect in 2015 and 2017. I know it’s easy to think that GoPro always price protects because we had in a couple of fourth quarters in 2015, 2017, in all other fourth quarters, we never priced protected. So this price protection is not the norm for GoPro. We’ve only had to do that when we did not sell-through enough of our products over the holiday and we were looking at having too much inventory in the channel and we had to help our retailers sell-through that inventory, so we had the lower price. And that’s the reason for price protection. When we see sell-through like we’re seeing so far this fourth quarter combined with the sale sell-through that we expect to see during the promotional period, we do not think that we are going to have too much inventory in the channel. And that would allow us to maintain the intended retail price, which would make price protection unnecessary. So that’s why I am emphatically saying that, no, we do not believe that we are going to have to price protect this holiday. We are quite confident in our ability to have a strong holiday quarter.

Joe Wittine

Analyst

Okay. That’s helpful context. Every year’s a little bit different here obviously. And then last for me. As far as the discontinued cameras go or I don’t know if that’s the right way to put it, but the five, the six, the last year’s HERO, and then the sessions. Can you address Brian, what you have of those on your 9/30 balance sheet as well as what’s in the channel. Because we’re seeing some of these cameras still on the bestseller list and they seem to be taking demand from some of the new cameras. So I’m wondering when that maybe kind of evaporates? Thanks.

Brian McGee

Management

Yes, no worries. Actually in the channel, we ended the HERO6, HERO5 and HERO going into a launch at the lowest level we probably ever had in the history of the company. And it was – I think less than 200,000 units globally. We expect all of those to be sold out by end of November. So we’re in actually really good shape going into the selling season where those are out and then the new cameras takeover fully. And we have very, very little in the way of – in our inventory of HERO6 and HERO5 very small.

Nicholas Woodman

Management

And it’s important to note that those units that are selling-through in the channel those are taken into account when we do our forecasting and the sell-through of our own new HERO7 products. So everything is in line with our expectations for the quarter.

Joe Wittine

Analyst

Great. Thanks guys.

Nicholas Woodman

Management

Thank you.

Brian McGee

Management

Thank you.

Operator

Operator

We’ll go next to Yuuji Anderson at Morgan Stanley.

Yuuji Anderson

Analyst

Great. Thanks for taking my question. Two if I may, on the gross margins for Q3, I believe it was a little bit light versus the forecast. Would appreciate any color behind that one. And then on sell-through, I know you called out global sell-through and you saw particular strength in a couple of the international markets there. Could you comment on what the sell-through trend look like in the United States?

Brian McGee

Management

So to answer the first question on the Q3, as we looked at doing promotions for the holiday season for some of the units we’ve sold in Q3 were those would actually hit in the promotions. We had to take a revenue reserve in margin reserve for those products. And so that lower the margin from 34% to the 33.2%. So it’s all attributable to promotions. On the U.S. side and the European side, on a year-over-year basis on sell-through for Q3, they’re actually down. But they were down because they were competing against $149 session camera from the prior year. As we look right now, we’re actually trending well up across every geography on sell-through. So that’s in line with the guidance we have because we estimate we’re going to lift 50% to 2 million units in Q4.

Nicholas Woodman

Management

Yes. We’re seeing very positive effects from the strength of HERO7 Black helping us grow our business globally.

Yuuji Anderson

Analyst

Yes. And then just on the shipments for the new products going in. For the Silver and the White, is it such that there’s a little bit more channel still going to come in Q4? Or was the timing roughly the same as the HERO7 Black?

Nicholas Woodman

Management

Well, we launched those products concurrently, all three at once in internationally and then a few days later in United States. But we’ll continue to sell in all three skews throughout the course of Q4, if that’s what you’re asking.

Yuuji Anderson

Analyst

And then my last question, as part of the promotions to finish off the year, will you be doing some kind of trading program?

Nicholas Woodman

Management

Trade off is something that we’ve been experimenting with. To learn how effective it is from a CRM perspective that driving upgrade within our community. We tested this a bit at launch. It was very successful. We got a bunch of good data. You’ll see us turn it on and off periodically as we’re gathering data, testing different offers and really learning about what triggers upgrade within our community. So that’ll help explain you why sometimes you see it, sometimes you don’t. We’re learning a lot from it.

Yuuji Anderson

Analyst

All right. Thank you so much.

Nicholas Woodman

Management

Thank you.

Operator

Operator

And we’ll take our final question today from Jim Suva at Citi.

Tim Young

Analyst

Hi. This is Tim Young calling on behalf of Jim Suva. Thanks for taking the question. Can you maybe just a little quick follow-up on the trading program? Can you provide some color on your progress in terms of monetizing and doing installment base, especially with the new product launch?

Nicholas Woodman

Management

We’re not sharing information as to what degree were driving upgrade amongst our existing users and frankly, it’s a little bit early for us to get a good read on that. Anecdotally, you can learn a lot by reading a user – by watching user reviews on Instagram and on YouTube for example and then reading the audience – the viewer comments below those video posts. And we shared some of our favorites on gopro.com/news. You can watch several user reviews. These reviewers bought HERO7 Black with their own money and you’ll see thousands of viewer comments below their videos that give you a really good read on customer sentiment around our new products. And you’ll note that in those comments, there are countless mentions of people saying, GoPro finally gave me a reason to upgrade GoPro – I’m finally going to upgrade from my HERO3. I just sold my HERO5 and got my HERO7 Black in the mail. And I love it, no regrets. So it’s only anecdotal, but we did not see this during HERO6 launch or HERO5 launch. So anecdotally it looks like HERO7 Black is really resonating with our community and driving a lot of upgraded intense, which is great to see. And then in terms of upgrading – sorry, monetizing our community further, it’s great to see GoPro Plus grow 16% sequentially to 185,000 subscribers. And as I mentioned, we see a lot of opportunity to grow that at a faster rate given awareness is quite low at 25%. And we’re going to be testing additional pricing tiers and benefits globally to do everything we can to grow that number because it’s clear there’s a significant opportunity there.

Tim Young

Analyst

And then my last question is on the tariffs. Are you seeing any impact so far? And how large is it?

Brian McGee

Management

On the tariff other companies have successfully sort of exclusion on the tariff and we believe there are reasons for our cameras to also be excluded if we’re ever included in a tariff list in the future. But we’re being very proactive on this topic. We also believe we have an option to move our U.S. bound production out of China in the first half of 2019 if necessary. And I want to reiterate, however, we are not moving production out at this time, but we’re preparing to do so if necessary.

Tim Young

Analyst

Got it. Thanks.

Operator

Operator

And I’ll now turn the conference back to management for any additional or concluding remarks.

Nicholas Woodman

Management

Thank you, operator. I’d like to extend a big, big thank you to all 900 GoPro employees around the world for their ongoing execution this year, it’s been phenomenal. And thanks to their creativity and capability. HERO7 Black is an unquestionable hit in each of our markets globally. So much so that we’re seeing a skew mix shift towards our $399 flagship. HERO7 White and HERO7 Silver are selling in line with our expectations. And when we combine this with the promotions we have planned for the heart of the holiday buying season, we are confident in a successful holiday quarter for GoPro positioning as well for Q1 2019 as well. So thanks very much for joining today’s call everyone. This is team GoPro signing off.

Operator

Operator

And once again, ladies and gentlemen, that does conclude our conference for today. Again, thank you all for joining us.