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Edited Transcript of GPRO earnings conference call or presentation 27-Apr-17 9:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 GoPro Inc Earnings Call

Half Moon Bay May 4, 2017 (Thomson StreetEvents) -- Edited Transcript of GoPro Inc earnings conference call or presentation Thursday, April 27, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian T. McGee

GoPro, Inc. - CFO

* Charles J. Prober

GoPro, Inc. - COO

* Nicholas D. Woodman

GoPro, Inc. - Founder, Chairman and CEO

* Peter M. Salkowski

GoPro, Inc. - Head of IR

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Conference Call Participants

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* Charles L. Anderson

Dougherty & Company LLC, Research Division - VP and Senior Research Analyst

* James David Medvedeff

Cowen and Company, LLC, Research Division - Associate

* Jason Mitchell

BofA Merrill Lynch, Research Division - Research Analyst

* Joseph Eric Wolf

Barclays PLC, Research Division - MD and Deputy Head of United States Equity Research

* Paul Coster

JP Morgan Chase & Co, Research Division - Senior Analyst, Alternative Energy, and Applied and Emerging Technologies

* Simona Kiritsov Jankowski

Goldman Sachs Group Inc., Research Division - MD and Senior Equity Research Analyst

* Stanley Kovler

Citigroup Inc, Research Division - VP and Analyst

* Tavis Christian McCourt

Raymond James & Associates, Inc., Research Division - Research Analyst

* William Verity Power

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Yuuji P. Anderson

Morgan Stanley, Research Division - Research Associate

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Presentation

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Operator [1]

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Good day, and welcome to the GoPro's First Quarter 2017 Results Conference Call. Today's call is being recorded.

At this time, I'd like to turn the call over to Mr. Peter Salkowski, Head of Investor Relations. Please go ahead, sir.

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Peter M. Salkowski, GoPro, Inc. - Head of IR [2]

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Thank you, operator. Good afternoon, everyone, and welcome to GoPro's First Quarter 2017 Earnings Conference Call. With me today are GoPro CEO Nicholas Woodman; COO, CJ Prober; and CFO, Brian McGee.

Before we get started, I would 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 any of 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, 2016, 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 press release, we have posted slides containing detailed financial data and metrics for the first quarter of 2017. These slides and a link to the webcast for today's earnings conference call are posted on the Events & Presentation page of the GoPro Investor Relations website for your reference. A link to the live webcast and a replay of today's conference call is posted on the Events & Presentation page of the GoPro Investor Relations website for your reference. All income statement-related numbers that are discussed today during the call other than revenue are non-GAAP, unless otherwise noted.

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

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [3]

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Good afternoon. Our first quarter performance marks a major step in GoPro's turnaround, and demonstrates our commitment to achieve full year non-GAAP profitability. When we last spoke on March 15th, GoPro affirmed first quarter revenue would be at the high end of guidance. Today, I'm happy to report that year-over-year first quarter revenue grew by 19% to $219 million, handily beating the high end of our guidance. With full year non-GAAP operating expenses targeted below $495 million, a $200 million reduction from 2016, we remain on track towards full year non-GAAP profitability without sacrificing our product road map.

I'm also happy to report that we have strengthened our balance sheet. Earlier this month, we completed a convertible debt offering that put net proceeds of $92 million on the balance sheet, providing what we believe to be sufficient capital to fund our growth plans moving forward. And both brand recognition and demand for GoPro remain strong. According to NPD, in the United States, GoPro has the 3 top-selling cameras on a unit basis in the digital imaging category. And our premium-priced HERO5 Black was the best-selling camera on both a unit and dollar basis.

Here, I'd like to take a moment to explain how average selling price, or ASP, is driving our 2017 revenue plan. While we estimate that the unit sell-through was down year-over-year, our ASP in the first quarter was up 25% sequentially and 13% year-over-year. The increase in ASP is driven by the reduction of lower price SKUs; the introduction of new premium products, like Karma and Karma Grip; and customers' preference for our premium camera, HERO5 Black. The net result is that higher ASPs are driving higher revenue.

Next, our brand. Social media metrics show that interest in GoPro is growing. GoPro's social channels are up over 25% year-over-year with nearly 32 million followers. This includes more than 10 million followers on Facebook and more than 12 million on Instagram. Today, the combination of our own channels plus the reach of our advocates and athletes touches nearly 200 million consumers.

And according to Google, YouTube videos attributed to GoPro are up 67% year-over-year in the first quarter. Google also recently published a study of teens aged 13 to 17 that placed GoPro as the 6th coolest brand out of 122 companies. Our brand is strong and remains one of our greatest assets.

In our last call, we explained that GoPro is now focused on 5 key priorities for driving revenue and returning the company to full-year profitability in 2017. In a few minutes, CJ will take you through our progress on each of these, but I'd like to briefly cover 2 of them and how they are influencing our decision making.

First, making the smartphone central to the GoPro experience. We believe that to grow our business, we must make it easy for consumers to seamlessly transfer content from their GoPro directly to their phone. There, the GoPro App can create a great video for them automatically. We are making significant advancements towards this game-changing experience, which we plan to share later this year.

The second priority I want to speak to is expanding GoPro's product line for advanced users. While we remain focused on capturing new users, we are also developing leading-edge solutions for our advanced customers. In 2016, we introduced Karma, an aerial handheld and wearable stabilization system we refer to as Hollywood in a backpack. Our research indicates that in 2017, the U.S. drone market will generate more than $900 million and close to $3 billion worldwide. Karma represents our entry into this important market, and we are very happy with its initial sales performance.

According to NPD, for the month of March, Karma bundled with HERO5 Black was the number 2 best-selling drone priced over $1,000 in the U.S. on a unit basis. We estimate this represents 19% market share for this price band. And last week, GoPro announced the development of Fusion, a 5.2K spherical camera designed to capture professional-quality content for both virtual reality and non-VR productions.

In just a few days, we received more than 3,000 applications for the Fusion pilot program. To ensure that Fusion delivers an optimal user experience, we are working closely with technology and content leaders like Adobe, FOX Sports and Facebook. While the spherical market is in its early days, we believe Fusion, coupled with our brand, will help position GoPro as a leader in this important category.

To summarize, GoPro is executing a turnaround. We are a considerably more efficient and effective company than we were just 6 months ago, and you're seeing it in our first quarter results. We have improved communication, collaboration and decision-making with a sharply focused set of priorities. We have improved execution by doing fewer things better.

We've secured our balance sheet and we have dramatically reduced spending without compromising our product road map. We feel good about the first quarter, about our strong guidance for the second quarter and about our goal of returning to full year non-GAAP profitability in 2017.

With that, I'll turn it over to our COO, CJ Prober.

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Charles J. Prober, GoPro, Inc. - COO [4]

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Thanks, Nick. Today, I'm going to provide an update viewed through the lens of our 5 key priorities for 2017. Our #1 priority is to drive profitability through improved efficiency, lower costs and better execution. We feel great about the progress we're making here. First, we drove down our Q1 operating expenses lower than expected, putting us in great position to achieve our full year goal.

Second, in Q1, we reduced channel inventory sequentially by over 13%, a trend we hope to accelerate with the scheduled price drop on HERO Session. Beginning this weekend, the MSRP on the nearly 2-year-old HERO Session will be reduced by $50 to $149.

Third, we're on track with a number of initiatives aimed at improving the efficiency of our resources. For example, we're on schedule with staffing up our Bucharest, Romania office to support our initiatives in software engineering. And in Manila, we're building out our office for customer support, IT and administrative services.

Fourth, we have a number of initiatives in process to simplify and reduce costs in our supply chain, small changes in packaging, assembly and shipping of our products that will show significant savings over time. So we feel great about the progress we've made to date against our #1 priority, and we recognize there's a lot of opportunity for further improvement.

Next, I'll shift to our second priority: Making the smartphone central to the GoPro experience. While smartphones don't offer the versatility and durability of a GoPro camera, they do serve as a convenient tool for managing and sharing the content shot on a GoPro. While many of our consumers are still learning about our existing software, I'm happy to note that the investments we've make to date are working. Specifically, in Q1, there were 5.2 million installs of our QuickMobile editing app, more than 3x the number of installs in the first quarter of last year. In addition, first quarter monthly active users are up 160% year-over-year.

Content sharing from our Capture App grew 43% year-over-year. We recently launched GoPro Plus, our subscription service, in EMEA and APAC, and we continue to see better-than-expected conversion from trial to paid with lower-than-expected churn. Pretrial and subscriber growth remains strong and we're excited to implement initiatives later this year that will improve the funnel into GoPro Plus.

These data points strongly corroborate our thesis that removing the pain points between capture and sharing result in deeper engagement by our consumers. As Nick noted, this year, we're developing an exciting new software experience that makes it even easier for consumers to share their content.

Our third priority is to market the improved GoPro experience to our extended community. Since the advent of HD HERO in 2009, GoPro sold more than 25 million cameras. However, many of our early consumers are not aware of our improved software experience, which sets up a big opportunity for GoPro to reengage our existing community.

One initiative to address this is the trade-up program we launched in the U.S. earlier this month. The program offers discounts of up to $100 to consumers who swap an older GoPro for a cloud-connected HERO5. In just 2 weeks, the program stimulated thousands of trade-ins and approximately 90% of the cameras we've received back are HERO3 cameras from 2012 and '13. Introducing these consumers to the superior quality and simplicity of HERO5 is a win-win for them and for us.

Our fourth priority is to grow GoPro's international business. Here, we are proud to say that 60% of our revenue in the first quarter was generated in markets outside of the U.S. This is particularly impressive when you consider that we opened our first international sales and marketing office in Europe just 3 years ago. The international data also validates our strategy of entering new markets by putting small teams on the ground with a local approach. In Japan, we saw a big jump, with revenue up 83% year-over-year, and our category dollar share grew from 1.4% to 3.4%. In China, quarterly revenue was up 59% year-over-year and our unit share grew from 1.7% to 3.1%.

The investments we've made in improving our software are also helping our international business. In the past 7 months, we've gone from 0 localizations on our Capture App and camera firmware to a total of 10 languages, including French, German, Korean and simplified Chinese. One point of validation is that between 70% and 90% of consumers in these countries are using our cameras in their local language.

Also, in February, one of the world's top manufacturers of smartphones, Huawei, announced that GoPro's editing software will be preinstalled on its new smartphone, starting with the Huawei P10 and Honor 8 flagship models. Huawei's impressive market share in Asia and Europe present us with an opportunity to introduce millions of new consumers to GoPro's brand and software tools.

Our fifth key priority is to expand the GoPro product line for advanced users. Once again, we're showing great progress. In February, GoPro rereleased our drone, Karma. Sales are tracking above expectations in the U.S. We just lunched Karma in Europe. And next month, Asia.

And as Nick mentioned, last week, GoPro unveiled a pilot program for Fusion, a 5.2K spherical camera for shooting virtual reality and OverCapture videos and photos. OverCapture is a unique feature that allows users to punch out high-definition video and photos from the spherical captured angles. You can see a demonstration of Fusion on GoPro's blog, The Inside Line.

So to summarize, we have a clear set of priorities, we're focused on doing fewer things better and we're now seeing the payoff in our execution and results.

With that, I'll hand it over to our CFO, Brian McGee.

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Brian T. McGee, GoPro, Inc. - CFO [5]

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Thanks, CJ. Today, I'll provide an overview of our first quarter performance and provide some guidance for the second quarter and full year of 2017.

I'll start with our higher-than-expected first quarter revenue, which was up 19% year-over-year, $219 million. Our revenue growth was driven by a year-over-year increase in camera revenue, growing accessory revenue and a relaunch of Karma. We shipped 738,000 camera units in the first quarter, with our $399 and above cameras accounting for over 60% of the camera units shipped and total first quarter revenue.

Unit sell-through outpaced sell-in as a result of channel inventory declining 13% sequentially, with HERO5 Black channel units down nearly 30% from the end of the fourth quarter of 2016. We also expect channel inventories to decline sequentially for the second quarter of 2017. Excluding the first quarter shipment of 129,000 previously discontinued cameras, we estimate channel inventory would have been down over 20% sequentially.

On a reported basis, first quarter's street ASP, defined as total reported revenue divided by camera units shipped, was up 13% year-over-year and 25% sequentially, driven by Karma, HERO5 Black and accessory revenue.

Looking at revenue by geographic location, the Americas accounted for 44% of Q1 revenue, with EMEA and APAC accounting for 31% and 25%, respectively. Revenue in absolute dollars increased year-over-year across all geographies. Direct channel revenue of $115 million accounted for 52.5% of Q1 revenue and was up 37% year-over-year benefiting from Karma, HERO5 Black and accessories.

Gross margin for the first quarter of 2017 was 32.3%, which compares to 33% in the first quarter of 2016. The margin benefit from shipping previously-discontinued cameras, which were written down in prior periods, was largely offset by charges related to a price reduction for the HERO Session camera, that we'll do in Q2 as well as other product-related costs. This performance was in line with our guidance despite Karma being a larger-than-expected percentage of our revenue mix.

First quarter operating expenses of $131 million were down $51 million sequentially or 28%. The reduction in operating expenses reflects the impact of our restructuring actions. Headcount at the end of the first quarter was 1,327, down 14% from the end of the year and 23% since the end of the third quarter of 2016. Sequentially, research and development expenses and sales and marketing expenses were down nearly 20% and 40%, respectively.

We incurred non-GAAP tax expense in the first quarter of $2 million versus a tax benefit of over $10 million in the first quarter of 2016. We reported a net loss per share in the first quarter of $0.44. This compares to a net loss per share in the year-ago period of $0.53.

GAAP net loss for the first quarter was $111 million or $0.78 per share. This compares with a GAAP net loss of $107.5 million or $0.78 per share for the first quarter of 2016. The company's negative GAAP tax rate of 25% for Q1 results from a higher proportion of pretax losses in the U.S. and pretax profits in foreign jurisdictions. Due to our full valuation allowance in the U.S. and the company generating taxable income in foreign jurisdiction, the result is a negative effective tax rate.

Turning to the balance sheet. Accounts receivable at March 31 were $55 million, down from $165 million at the end of the 2016. DSOs came in at 23 days. First quarter inventory increased $40 million, sequentially to $208 million, reflecting increases in HERO Session and HERO5 Black cameras as well as Karma. We expect our inventories to be approximately $130 million by the end of second quarter.

At the end of the first quarter, we had cash of $75 million. The sequential decline in cash was due primarily to the first quarter net operating loss, coupled with cash payments for accounts payable, other liabilities and severance. These payments were partially offset by strong collections of accounts receivable.

On a pro forma basis, total capital available for the company was approximately $250 million, which includes cash on hand of $75 million, borrowing availability through our credit facility of $82 million and net proceeds from our convertible debt offering of $92 million.

I will now move on to guidance. We expect revenue for the second quarter of 2017 to be between $260 million and $280 million. We expect our HERO5 Black camera to remain our top-selling product and for Karma to become an even larger percentage of our second quarter revenue.

We expect gross margins to be 33.5%, plus or minus 1 percentage point. Operating expenses for the second quarter are expected to be in the range of $122 million to $126 million. We expect adjusted EBITDA for the second quarter to be in a range of negative $15 million, plus or minus $5 million.

Regarding 2017 guidance, we continue to target double-digit year-over-year revenue growth, operating expenses below $495 million, positive adjusted EBITDA, and we continue to work towards our goal of achieving full year non-GAAP profitability.

We expect GAAP and non-GAAP tax expenses for the full year of between $13 million to $15 million and $6 million and $8 million, respectively. For the second quarter, we expect GAAP and non-GAAP tax expense of approximately $5 million and $1.5 million, respectively. We expect our second quarter basic share count to be approximately 136 million shares.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question, this will be from Paul Coster with JPMorgan.

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Paul Coster, JP Morgan Chase & Co, Research Division - Senior Analyst, Alternative Energy, and Applied and Emerging Technologies [2]

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I've got 2, really. The first one is to do with the ASPs which are higher, welcome. But gross margins look like they're stuck in the low 30s at the moment. Is this what we should expect moving forward? And what has to happen for the gross margins to improve from here given the ASP shift? My second question is, you refer to under $495 million of pro forma operating expenses, that kind of leaves room for interpretation. What are the factors that cause you to go well under $495 million versus just sneaking under that target?

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Brian T. McGee, GoPro, Inc. - CFO [3]

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Paul, this is Brian. On the gross margin guidance, we've talked about annual long-term model of 40% plus or minus 1 percentage point. What drives our margins -- we have a seasonal business, we have lower first half volumes versus the second half. In particular, cameras will be up much more in the second half.

Our camera business is very good on margin. Karma is a much higher percentage. Fortunately, it's selling well in the market. But it has kind of a meaningful differential in margin relative to our cameras. Karma will be lower as a percentage of our overall business in the second half. As CJ mentioned in his prepared remarks, we have some efficiency in supply chains, which means we'll get some product-related cost reductions as well in the second half, and we have some new product introductions that will also be more profitable. So that addressees the margin point, I think.

The under $495 million, we'll be below $495 million. As you recall in the kind of prepared remarks, we wanted to make sure that we were doing things that really drive to our product road map, and the reductions we took don't impact that product road map. I think going below that could impair our long-term ability to drive into new markets. And so I think that's the answer to the OpEx.

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Charles J. Prober, GoPro, Inc. - COO [4]

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Yes, the only thing I would add, Paul, in the OpEx as we talked about before, we kind of are adopting a new culture around cost. And so we're always looking for efficiencies and ways to do things differently to get costs out of our -- out of both OpEx and COGS. And so that's an ongoing effort, we're not done there. But as Brian said, we're still shooting for our target of below $495 million.

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Paul Coster, JP Morgan Chase & Co, Research Division - Senior Analyst, Alternative Energy, and Applied and Emerging Technologies [5]

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Okay. My last -- just a quick follow-up. And that is that you appear to be really focused on your core customer base: buy fewer things better, as Nick said. And you appear to be creating higher-value solutions for that segment. Can you -- is this how it's going to be moving forward, and we're not really sort of focused on the mass market at this stage? Or am I misinterpreting things?

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [6]

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Paul, Nick here. When we develop storytelling solutions with a bias towards the GoPro community, that doesn't just include people that own a GoPro, that includes consumers who are look-alikes to consumers who have already purchased a GoPro. And the market for our products is far from saturated, we believe. I know there's some concern over that. But when we look at data indicating whether new customers -- or whether HERO5 Black customers, for example, that's owned a GoPro before or not, it's clear to us that we're getting a lot of new customers that have never owned a GoPro.

So we're finding that solutions that worked really well for our greater GoPro community are appealing to entirely new customers as well. And so we also have a strategy around the development of products for our more advanced customers that also serve as meaningful solutions for prosumers as well as professionals. We're not developing products specifically for the professional market per se. But rather, traditionally, GoPro products for consumers have always been good enough, if not market-leading products for the professionals.

So don't focus too much on are we just narrowing our road map to be focused specifically on the existing GoPro community. We're developing solutions that we believe will be a hit with that community. But for sure, they'll still be designed to be attractive to new customers and a broad range of customers, to pull them in and ultimately grow that community.

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Operator [7]

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We'll now take a question from Joe Wolf with Barclays.

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Joseph Eric Wolf, Barclays PLC, Research Division - MD and Deputy Head of United States Equity Research [8]

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First, I'm curious about going a little bit deeper into this trade-in program, where you -- I guess you can get a little bit of data on, I guess, a refresh cycle. How does that work exactly? What is -- is there any economics for GoPro at this point? Or what's -- how does that work exactly with the customer? And similarly, on the monetization front, the Huawei smartphone activity sounds interesting, but is that a revenue driver or a customer experience driver as you look at that right now? And then I've got a couple of others.

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Charles J. Prober, GoPro, Inc. - COO [9]

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Yes, good questions. This is CJ, I'll take that. On the trade-up program, the way that that works is consumers with an existing pre-HERO5 GoPro can send us in their camera and they can get a discount off the HERO5 cloud-connected solution. And what's really driving that is the experience that we offer through our HERO5 products are significantly simpler and better to our earlier-generation products. And many of those early consumers in fact aren't aware of that.

And so this was -- the trade-up program was designed to incentivize consumers who haven't perhaps used their GoPro in a while to trade that in for the superior HERO5 experience. And again, as I said in my prepared remarks, we're seeing thousands of consumers take advantage of that. And most of the cameras that we're getting back, 90% or so, are HERO3 vintage, so 2012 and 2013 cameras. And we're doing this directly with the consumers as a -- really a pilot program and not through our retail partners. So the economics are through our direct business.

On the Huawei relationship, it's really an opportunity for us to expose the software that we've built and grow the GoPro brand in markets that we're still driving a lot of awareness. So Huawei is incredibly strong in Asia, of course, and also in EMEA. And by having GoPro software preinstalled on their smartphone devices, it just exposes their consumers to GoPro and allows us to bring them into our ecosystem and, in the future, introduce them to our hardware as well. But there's no direct monetization from that partnership.

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Joseph Eric Wolf, Barclays PLC, Research Division - MD and Deputy Head of United States Equity Research [10]

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Okay, that's helpful. A question on the other -- on the -- I think the 360 Fusion and I guess, also, the Karma related. Am I understanding that the Fusion is more of a professional kind of camera and that's sort of a pilot?

And then on the Karma, can you give us a little bit more detail -- you sort of beat your expectations. But as I hear the commentary about the second half, when you talk about Karma sales, are you thinking about that as the hardware or are you thinking about a sale with the camera? How should we be thinking about units and drones in terms of the actual camera? And as you think about the second half, why would you already not fully -- I don't quite understand that dynamic of Karma being lower in the second half, wouldn't that be a great holiday gift?

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [11]

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Yes. For Fusion, the spherical camera market is still in its infancy. If you track sell-through of spherical cameras that are out there, the units sold through at retail is still quite low despite that some of these cameras have been in the market for more than a couple of years now. And it's still a heady experience for consumers to capture spherically, whether it's for VR, consumptive viewing or whether it's to produce traditional content from the spherical-captured content, like you can with Fusion and the OverCapture experience.

And so we believe that the strongest segment for Fusion initially is going to be the professional and the prosumer tip-of-the-spear consumer market. Fusion, the product itself, the experience is -- it's like using a GoPro. It's very straightforward. And we think that our more advanced customers will find it appealing. But we just think that the market is more professionally focused at the moment. And that, combined with Fusion's technical specifications and overall capabilities, we believe it's going to be a category leader when we make it more broadly available. And so that's our thinking around that, why we are positioning it from the outset as more for a professional and prosumer solution.

And then in terms of Karma, we expect our overall camera unit volume to grow over the second half of the year and certainly in the fourth quarter. And as we've shared, we have HERO6 planned for this year. And so we believe that that as a percentage of our business is going to increase over the course of the year. And as a result, we expect Karma to be a smaller percentage of our business and be less impactful to gross margin.

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Brian T. McGee, GoPro, Inc. - CFO [12]

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And this is Brian, gentlemen. I'll follow up on that, adding to what Nick is saying. The camera piece of our business is very good margin and profitable, much more so than Karma. So the mix aspect of this as we get in -- so from the first half to the seasonally stronger second half, just makes the math work better on margin.

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Joseph Eric Wolf, Barclays PLC, Research Division - MD and Deputy Head of United States Equity Research [13]

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But when you sell a Karma, are you -- I'd like a little bit more clarity on how you're defining that. You're selling a Karma, are most of them being bought with a camera? Are most of them being bought without a camera?

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Brian T. McGee, GoPro, Inc. - CFO [14]

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At the moment, most are being bought with a camera, actually.

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Joseph Eric Wolf, Barclays PLC, Research Division - MD and Deputy Head of United States Equity Research [15]

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So when you say that the margins -- are you just splitting between the hardware and the camera in that comment?

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Brian T. McGee, GoPro, Inc. - CFO [16]

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So I look at it as the bundle as being Karma and a separate camera sale as being unique. And therefore, that particular sale is higher. And we expect to sell, proportionally, a lot more cameras in the second half than the first half. And therefore, that's what's driving the margin.

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Joseph Eric Wolf, Barclays PLC, Research Division - MD and Deputy Head of United States Equity Research [17]

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Understood. And then just one last question, Brian. Cash, what is the comfort level you have? Do you expect to generate some cash towards -- toward the end of the year to build that cash above the $75 million in absolute cash? Or are you very comfortable with your availability and liquidity right now?

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Brian T. McGee, GoPro, Inc. - CFO [18]

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So obviously, I'm very comfortable with the availability that we've got. As I mentioned, $250 million on a pro forma basis. The cash will be flat, maybe down slightly in Q2 just because we guided for an EBITDA loss, but then working capital will make up some of that because of inventory reduction. And we grow it into Q3 and Q4.

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Operator [19]

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We'll now move to Jason Mitchell with Bank of America.

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Jason Mitchell, BofA Merrill Lynch, Research Division - Research Analyst [20]

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Just to start with a couple of balance sheet questions. I guess, can you help me understand why inventory was up so much in Q1? Because you kind of entered with a little excess channel inventory on Black. Is that just related to the Karma? And then on accounts payable, that was a bit higher than it usually is in Q1. Is that also related to the inventory build? And is that going to kind of trend down in 2Q?

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Brian T. McGee, GoPro, Inc. - CFO [21]

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So on the 8 assets related to inventory, and I've mentioned we'll bring inventory down to below $130 million, so basically that helps pay for the accounts payable, right? Yes, actually, what we're missing in the fourth quarter is there was actually more channel inventory of Session than there was of HERO5 Black. And HERO5 Black we depleted at the highest percentage sequentially, which was nice. And as we mentioned, part of the increase was Session, part of it was HERO5 Black, is the stronger selling product, as we go into the kind of [dev growth] for Q2 and then Karma was up a little bit as well.

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Jason Mitchell, BofA Merrill Lynch, Research Division - Research Analyst [22]

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Okay. And then, I guess, on just the 2Q guidance. Can you kind of help a little bit more with understanding the puts and takes for the driver of the upside to the guidance? I mean, how much of that is Karma versus kind of the cameras?

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Charles J. Prober, GoPro, Inc. - COO [23]

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The way I think about our Q2 guidance -- this is CJ, is that we're seeing a strong performance in our core business, which I would attribute to great products. I mean, HERO5 is being very well received by consumers. And demand for our $399 product is really strong. And then as we said, we've launched Karma in the U.S. this quarter and it's performing better than expected. We've just gotten into EMEA and APAC next month, and so that's a contributor as well. But it's not just Karma. I mean, our core business is performing really well.

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Operator [24]

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We will now move to Simona Jankowski with Goldman Sachs.

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Simona Kiritsov Jankowski, Goldman Sachs Group Inc., Research Division - MD and Senior Equity Research Analyst [25]

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I think you mentioned sell-through was down year-over-year. Could you help quantify that? And I think if I did the math right, it was actually up year-over-year last quarter. So just curious to what you attribute the return to year-over-year declines in sell-through. And then I was curious if you're able to parse out for us what ASPs did for the cameras without including Karma or the accessories.

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Brian T. McGee, GoPro, Inc. - CFO [26]

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Yes. Simona, this is Brian. Sell-through was down, excluding the EOL products, about 20%. We mentioned on the February call, we expected channel inventory to decline. And we expect them to also decline in the second quarter, and that's largely related to EOL products we sold in Q1. The biggest driver of the reduction sequentially was HERO5, right? And so that product is doing well in the market.

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Simona Kiritsov Jankowski, Goldman Sachs Group Inc., Research Division - MD and Senior Equity Research Analyst [27]

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And on the ASPs?

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Brian T. McGee, GoPro, Inc. - CFO [28]

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And on ASPs, you'd expect -- well, we have ASPs going up as part of mix year-over-year. And I'd expect as the retailers start to sell through the same mix of products we're selling in, that they're going to see an ASP lift as well.

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [29]

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And the question, specifically, if you were to strip out Karma and accessories...

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Brian T. McGee, GoPro, Inc. - CFO [30]

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Yes. No, ASPs are up just on cameras as well. Year-over-year, they're up; and sequentially, they're up.

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [31]

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Yes. Part of what the answer to both questions is that this time, in the first quarter of 2016, remember we were selling through that channel a lot of lower-priced inventory in the form of our HERO, HERO+ and HERO+ LCD products that were all priced in the $129 to $249 range. And while those products were selling well, they were heavily discounted. And as a result, you had those higher sell-throughs that now, as a comp, we're down from that year-over-year. But also you're seeing ASPs up, which is terrific.

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Brian T. McGee, GoPro, Inc. - CFO [32]

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Simona, just one other comment, we've said this on the last call. We expect ASP in 2017 as a year to be above 2016. And that's in aggregate as well as camera.

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Operator [33]

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We will now move to Stanley Kovler with Citi.

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Stanley Kovler, Citigroup Inc, Research Division - VP and Analyst [34]

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I was wondering, and it seems like within your mix portfolio if you can parse out if this is just a function of the general inventory Or also, on the demand side, the mix of HERO5 going up. And then how you think about the mix of your higher-end products as we move throughout the year? And then just on the expenses, it seems like the Q2 guidance is already implying that you're operating at the full year OpEx number. So curious how we should think about the opportunities you have in the second half of the year to maybe get further below that bogie that you have for OpEx.

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Brian T. McGee, GoPro, Inc. - CFO [35]

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Yes. I think on the -- even in the prepared remarks and guidance, we expect the HERO5 Black to continue to be the top-selling product both this quarter, and it should do well throughout the year. So the mix is definitely going to help there on -- from a margin perspective and ASP. In terms of OpEx, yes, we did $131 million guided for -- at midpoint, I guess, it'd be $124 million. And I think the second half would be -- well, we're not guiding for it, but if you do the math against $495 million, it'd be less than the $124 million by a bit.

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Stanley Kovler, Citigroup Inc, Research Division - VP and Analyst [36]

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And then just as a follow-up. I wanted to ask you what kind of progress you're making on the chip development of the new chip as you move away from your previous partner. If you can update us on that situation.

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Charles J. Prober, GoPro, Inc. - COO [37]

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Yes, Stanley, it's CJ. So we don't really discuss the -- our future products and road map. But I will say that there's no change of plans in terms of launching HERO6 in 2017.

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Operator [38]

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We'll now move to Yuuji Anderson with Morgan Stanley.

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Yuuji P. Anderson, Morgan Stanley, Research Division - Research Associate [39]

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Most of them have been answered. But just one on Karma, like how we should just think about the retail footprint there? And what stage are we in? How are you feeling about channel? And if we're not there yet, like when do you think you'll be fully distributed?

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Charles J. Prober, GoPro, Inc. - COO [40]

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Yes. It's CJ. So in the U.S., we're still reaching new doors. In EMEA, because we've just launched there, we're continuing to roll out Karma. In Asia, we haven't started. So we still have a ways to go in terms of getting Karma in -- across the retail footprint that we have planned.

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Operator [41]

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Will Power with Baird has the next question.

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William Verity Power, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [42]

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A couple of questions. Maybe just -- first, just to follow up on channel inventory, I know it was down in Q1. And it sounds like, Brian, you expect further reduction in Q2. Is that expected, to be clear, to be in balance as you exit Q2? Or do you expect further channel inventory reductions in Q3? And then just -- I'm just also curious, just the Session, the price reduction, is that the biggest piece of that you're trying to drive down? I'll start with that.

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Brian T. McGee, GoPro, Inc. - CFO [43]

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Yes, channel inventory reductions in the first quarter were across every product, actually, not just limited to one. In Q2, it's coming down largely due to the EOL products we sold in Q1. We expect those to actually clear in Q2. I think some of the other products will also be down. Like Session, we'd expect to be down [as the price moves,] that we're planning to do on in a couple of days.

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William Verity Power, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [44]

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Okay. And so do you think that you'll have that in balance kind of as you exit the quarter? Or are there further reductions coming out of Q2?

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Brian T. McGee, GoPro, Inc. - CFO [45]

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Well, I'd say it's actually pretty balanced now. I mean, most of the cameras I think are going to be in line to where they need to be in Q2. It's just the EOL's going to come down. And then Session, we would expect to drive down just because of the product moves, okay? But we also expect the biggest demand to be in HERO5 Black.

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William Verity Power, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [46]

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All right. Okay. And then I just had a follow-up with respect to some of the mix comments at the open, I think alluding to some mobile phone ease-of-use improvements expected in the second half of the year. I guess I was just trying to understand, is that tied to some of the new apps that have been enhanced -- or I guess, not as new anymore, the Plus product? Or is there something new entirely that you think is going to help improve that usability experience?

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [47]

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We've shared that some of our software objectives -- well, one of our primary objectives for the year and beyond is to make the smartphone central to the GoPro experience. We've also shared that we are in the process of collapsing our multiple apps into a simplified single GoPro App for our customers. And as far as the experience that I alluded to of helping -- making it easier for our customers insofar as their GoPro's auto-offloading their content to a phone for the app to make the edit, that's an experience that we're building into our existing app experience.

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William Verity Power, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [48]

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Okay. All right.

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Charles J. Prober, GoPro, Inc. - COO [49]

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Will, the one other thing I'd add to this is that -- and I kind of touched on this in my prepared remarks, it's CJ -- is that the enhancements that we've made to date are actually showing great progress. I shared some steps around Quik, and the sharing increase that we're seeing on Capture. And we obviously have lots of other data that we look at to gauge engagement around camera usage and HERO5 versus prior models, and we're very happy with the progress that we're seeing there. And the fact that we're making enhancements is just going to help accelerate that.

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Operator [50]

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James Medvedeff with Cowen and Company has the next question.

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [51]

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Yes, I'd like to -- like a couple of the last guys, most of mine has been answered. But can you spend -- I just want to make -- just for housekeeping purposes, the guidance for full year profit -- non-GAAP profitability, is that at the operating line or at the net income line?

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Brian T. McGee, GoPro, Inc. - CFO [52]

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Yes, so we talked about being EBITDA positive for the year. And we're working our plan and we're working towards being full year profitability, and that profitability would be at the bottom line, after tax. That's the goal.

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [53]

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After tax and after interest expense?

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Brian T. McGee, GoPro, Inc. - CFO [54]

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Correct.

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [55]

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Okay. And is it about $1.3 million, $1.4 million a quarter of interest on the convert?

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Brian T. McGee, GoPro, Inc. - CFO [56]

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Well, the convert is $175 million times 3.5% for the year. So dividing that by 4 will make it $6 million, so $1.5 million roughly.

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [57]

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Okay. And then my final question for now is, what is the strategic thinking or what is the thought behind the price cut on the Session?

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Charles J. Prober, GoPro, Inc. - COO [58]

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James, I can take that. So Session's a 2-year-old product at this point, so it's a natural time to make that move. It also doesn't offer the same experience that our HERO5 Session offers or HERO5 Black, of course, in terms of being cloud connected. And so it's the -- an added benefit of this is that in EMEA, where we see lower-priced competitors bring Session more in line with that and also accelerate the channel inventory reductions that Brian highlighted. But it's really just it's a 2-year old product and it's the right time for that.

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [59]

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How many of them do you have in inventory?

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Brian T. McGee, GoPro, Inc. - CFO [60]

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Well, we're not going to split it out, but it's not too many that we can't sell them throughout the balance of the year.

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [61]

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So that should be finished by the end of this quarter?

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Brian T. McGee, GoPro, Inc. - CFO [62]

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No. It'll be finished by the end of the year.

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Operator [63]

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We'll now move to Charlie Anderson with Dougherty & Company.

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Charles L. Anderson, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [64]

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I'm hopping between calls here, so sorry if this has been asked. But just maybe kind of big picture views on the drone market. You mentioned how it's lower gross margin for you. Is it the type of thing where you're going to be pretty modest in your distribution until you can get a product that's at a higher gross margin or a margin more in line with what you're looking for? And just generally, how you're feeling about that market in general, how it's trending, what are table stakes, that sort of thing.

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [65]

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We're growing distribution for Karma strategically through retailers that we believe are well suited to sell it and -- that's internationally as we've shared. And we're feeling good about the category. We're feeling good about Karma. Karma is exceeding our expectations as we shared. In North America, according to NPD, as I shared in my remarks, it was the #2 best-selling drone in the $1000 and up price band for drones, which is something that we're very happy with.

And we believe that that represents roughly 19% market share for that price band, which is impressive given the admittedly rocky start that we were off to with Karma. And our retailers are very positive about the product. Our customers are very positive about the product. So we are feeling very good about it. And it's going to serve as a terrific platform for us to build upon with future models. So overall, we're quite optimistic about the category and about our ability to succeed in it.

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Charles L. Anderson, Dougherty & Company LLC, Research Division - VP and Senior Research Analyst [66]

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Great. And then a follow-up for me on the growth that we're seeing in China and Japan. How much of that is distribution based versus you're seeing solid growth on the kind of the same-store sales retailers you were already at?

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [67]

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The latter. We're seeing the benefits of having small effective teams in region who are helping to localize our marketing. And not just in terms of our advertising, but also our marketing at retail. We've made some changes in how we present the product to the retail customer that have made significant improvements in same-store sell-through. And I would say that there is distribution expansion as well. But it's more biased towards the latter, your latter statement, which is improving same-store sell-throughs.

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Charles J. Prober, GoPro, Inc. - COO [68]

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Yes. And Charlie, I don't know if you caught the prepared remarks, it's CJ. The -- GoPro has become a global brand, and we did that without localizing our products up until Q4, which is quite amazing, right? Like if you bought our product in China or Japan, you were using it in English. And so in Q4, we localized the product into 10 languages, the camera and our associated software. And we're seeing that pay off. So 90% of our consumers in China are using the product in their native language. And that's obviously paying dividends for us.

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Operator [69]

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We'll now move to Tavis McCourt with Raymond James.

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Tavis Christian McCourt, Raymond James & Associates, Inc., Research Division - Research Analyst [70]

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Brian, a couple of clarifications first. I think you said sell-through on a unit basis was down 20% year-over-year in the first quarter. And then I think you said, excluding end-of-life products, I'm assuming you're excluding the end-of-life sales in both quarters. Did I hear that right?

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Brian T. McGee, GoPro, Inc. - CFO [71]

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That's correct. Yes, it was comparable.

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Tavis Christian McCourt, Raymond James & Associates, Inc., Research Division - Research Analyst [72]

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Okay. And then I think you also said cash would be down slightly in Q2. I imagine that's before the convert is taken into consideration. Or do you expect us to be down despite the fact that you've got the convert coming on the balance sheet?

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Brian T. McGee, GoPro, Inc. - CFO [73]

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The question was around the $75 million that we have not counting the convert, which we just parked in the bank. So we guided for negative EBITDA in Q2, so we've had -- that would be a cash use because we have working capital, so we'll deplete inventory in the quarter by quite a bit, actually, and then use the assets to make payables. And so the net is kind of a flat to down on cash in Q2, but we build it up in the second half as we drive higher regional revenue.

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Tavis Christian McCourt, Raymond James & Associates, Inc., Research Division - Research Analyst [74]

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Okay. And then the cash flow from operations for Q1, obviously, inventory was a big drag. But you also mentioned some other items like severance. Could you break out if there was -- what the materiality of some of the non-recurring cash flow items were in Q1?

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Brian T. McGee, GoPro, Inc. - CFO [75]

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They weren't that material. The severance piece was small. And as a reminder, we had the $75 million at the end of the Q1. And in April, we added $92 million to the balance sheet and we have $82 million available against the borrowing capacity. So we're pretty well capitalized.

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Tavis Christian McCourt, Raymond James & Associates, Inc., Research Division - Research Analyst [76]

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Yes. And then one product question for you, Nick or CJ. So on -- how does the Fusion differ from the Omni? Both spherical cameras, kind of what is kind of the product difference there?

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [77]

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They're completely different products in that regard. Omni is a chassis to receive 6 GoPros, whereas Fusion is a single GoPro in and of itself. You don't combine multiple GoPros to build Fusion. It is a self-contained spherical camera that you can use for spherical capture for virtual reality application. Or, thanks to OverCapture, which is capturing every angle at once, capturing over what you need, more than you need, you can then reframe your shot during postproduction editing to produce a traditional fixed perspective video, just as though you'd shot it with a single camera, but you had perfect aim of the camera at all times. So Fusion is a very versatile capture solution for traditional content creators as well as for leading-edge content creators for virtual reality.

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Operator [78]

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We'll now move to Joe Wittine with Longbow Research.

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Unidentified Analyst [79]

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This is [Nick Todorov] in behalf of Joe. So in the last earnings call, you compared the HERO4 sell-through with the HERO5, that's 4Q of '16 versus 4Q of '14. Can you do like a similar comparison for the first quarter of '17, HERO5 sell-through versus HERO4 sell-through in the first quarter of '15? How would that compare?

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Brian T. McGee, GoPro, Inc. - CFO [80]

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Sell-through. I don't have that actually in front of me. But knowing that the HERO5 Black on a percentage basis is higher than both the HERO4 and HERO5, and we were up revenue wise year-over-year, the HERO5 would have outpaced the HERO4.

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Unidentified Analyst [81]

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Versus Q1 of '15?

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Brian T. McGee, GoPro, Inc. - CFO [82]

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Oh, Q1 of '15?

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Unidentified Analyst [83]

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Yes, because you were...

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Brian T. McGee, GoPro, Inc. - CFO [84]

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Q1 of '15. I don't have that. Actually, I don't have that in front of me.

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Unidentified Analyst [85]

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Yes, because you were comparing the launch versus the launch last quarter, but that's okay. So if I can follow-up. Given the Q1 numbers and the guidance, if we assume that second quarter OpEx is going to be down sequentially, that still implies that your 4 quarters sales and marketing has to be down at least 40% year-over-year. I mean, do you believe that having several new products, we're assuming that, that level of marketing will be sufficient? And I'm assuming that you're not going to guide a 4-quarter OpEx, but just generally speaking.

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Charles J. Prober, GoPro, Inc. - COO [86]

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Yes. I think the important thing to note, [Nick], is that most of our entertainment expenses were in the marketing line. So when we made the decision to move away from our entertainment business, the biggest impact there was in our marketing line.

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Unidentified Analyst [87]

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Okay. Okay. And the last one to squeeze in. Is the trading program dilutive to gross margin?

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Brian T. McGee, GoPro, Inc. - CFO [88]

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No.

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Operator [89]

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That will conclude the Q&A session. At this time, I will turn it back over to CEO, Nick Woodman, for closing remarks.

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Nicholas D. Woodman, GoPro, Inc. - Founder, Chairman and CEO [90]

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Thank you very much for joining today's call, everybody. I'd just like to close by saying that since founding GoPro in 2002, I've really never had the privilege of working with such a strong and capable team. What you're seeing in our first quarter results is a direct result of the much-improved communication, collaboration and culture that we have within the company. And it's never been better. And with this in mind, I believe we're entering a new and exciting era for GoPro where, once again, we're aligning the strength of our business with the strength of our brand.

And with that said, on behalf of all of our employees around the world, this is team GoPro signing off.

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Operator [91]

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And again, that does conclude today's conference call. Thank you all for your participation.