Mike Groeninger - Vice President of Corporate Finance Patrick Spence - Chief Executive Officer Mike Giannetto - Chief Financial Officer.

Katy Huberty - Morgan Stanley Rod Hall - Goldman Sachs Amit Daryanani - RBC Capital Markets Brent Thill - Jefferies Adam Tindle - Raymond James Matt Sheerin - Stifel.

Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos' Fiscal Third Quarter 2018 Earnings Conference Call [Operator Instructions]. I will now turn the call over to Mike Groeninger, VP of Corporate Finance. You may begin your conference..

Thank you, Mike. Good afternoon, and welcome to Sonos' Third Quarter 2018 Earnings Conference Call. I'm Mike Groeninger, VP of Corporate Finance. And with me today are Sonos' CEO, Patrick Spence; and CFO, Mike Giannetto. For those of you who joined the call early, your first question maybe about our selection hold music.

Breakthrough music experience is often debuted with signature songs. The first song played to the public on Sonos' first product, the ZP100, was No Sleep Till Brooklyn by the Beastie Boys. We thought it was appropriate to start our first earnings call as a public company the same way we started filling homes with music 13 years ago.

Before I hand it over to Patrick, I would like to remind everyone that today's discussion will include forward-looking statements regarding future events and our future financial performance. These statements reflect our views as of today only and should not be considered as representing our views of any subsequent date.

These statements are also subject to material risks and uncertainties that could cause actual results to differ materially from expectations reflected in the forward-looking statements. A discussion of these risk factors is fully detailed under the caption Risk Factors in our filings with the SEC.

During this call, we will also refer to non-GAAP financial measures, including adjusted EBITDA and adjusted EBITDA margin.

For complete information regarding our non-GAAP financial information and a quantitative reconciliation of those measures, please refer to today's shareholder letter regarding our third quarter fiscal 2018 results posted to the Investor Relations portion of our website. And with that, I'll turn the call over to Patrick Spence..

Thanks, Mike, and thanks to everybody for joining our first earnings call as a public company. Every quarter, we'll provide a lot of detail in our shareholder letter, so we'll primarily use these calls to take your questions. But I do have a couple of things I want to touch on today.

I talked a lot on our IPO road show about how important it is to all of us at Sonos to do what we say we will. And we're off to a good start with our Q3 results coming in at the high end of the preliminary ranges we provided.

One of the other things I took away from the IPO road show is that we still need to do a lot of education about our business model, as it's unique. I'm encouraged by the fact that investors are beginning to learn the power of building products that last for years, get better with software and customers buy more of those.

Since our products last for 5 to 10 years, the question is how do we get people to add another Sonos' product to their home? And we've done a good job of answering that over the last 16 years, as evidenced by the fact that last year, 38% of our registrations came from customers adding another Sonos to their system.

We are the only company I'm aware of where people add more to their system over time versus replacing previous purchases. We've made good progress on our growth strategies over the past few months.

We're delivering on our commitment to launch 2 new products a year with the introduction of Beam, our second product of fiscal 2018 after the One in Q1, and our announcement of Amp, which will start shipping in Q1 of fiscal '19.

In terms of global expansion, in August, we launched in Japan and are taking a tailored approach to that important market, the second-largest music market in the world. We continue to accelerate our direct-to-consumer business, with that channel continuing to be our fastest growing one.

We also continued to evolve the platform with the introduction of AirPlay 2, and we've seen increased engagement from Sonos homes that are using AirPlay 2. Just last week, we opened our platform to more developers with a set of APIs and are excited to see what gets developed as a result.

Finally, we continue to build the brand through activities like our reimagining of the NASDAQ opening bell, our Beam launch that drove a tremendous amount of earned media and our cultural marketing events at various physical locations.

I get opportunity to be at the CEDIA Expo last week and see also all of our installer partners, and there was a ton of energy around Amp, our APIs and our Sonos partnership, which was awesome to see. We're off to a great start as a public company.

And now I'll turn it over to Mike to provide some brief commentary before we open it up for your questions..

Revenue is expected to be in the range at the low end at $1.109 billion to a high end of $1.114 billion, representing an annual growth rate of 11.7% to 12.2% over fiscal 2017. Adjusted EBITDA, we expected the low end to be in $59 million to a high end of $62 million, representing an annual growth rate of 5.4% to 10.8% over fiscal year 2017.

One final note, we will provide our full year outlook for the fiscal year 2019 and our Q4 fiscal 2018 earnings call in November. With that, we'll open it up for questions..

[Operator Instructions] Your first question comes from Katy Huberty from Morgan Stanley..

In your shareholder letter, you referenced media retailer and customer feedback and the Beam is in line with expectations.

Just curious whether we should think about that as in line with your internal expectations or in line with more conservative Street expectations? And then I wondered if you can comment on where Beam channel inventory levels are relative to the same point in the Sonos One product cycle?.

I'll take your first one and I'll let Mike talk to the inventory levels. So it's -- turning to our internal expectations, so we're feeling good about the way the product is tracking. And as we've talked about, we had made some assumptions around cannibalization of other products. And so we're feeling good about where that is.

And yes, feeling really good about this launch overall in the trajectory that we're on..

Yes, this is Mike, Katy. Your question about channel inventory. I mean, in comparison to Sonos One, it's a little difficult given that was the holiday period, which was a very high-volume period for us and different price points.

But in terms of channel inventory, I'd say it's in line with our expectations and very comfortable with the channel inventory levels as they are. We have the channel fill, which began late June and into this quarter. And we're very comfortable with channel inventory.

And as we said, we're feeling good about the performance in line with our expectations..

And if I can just one more, how should we think about Japan's contribution to revenue over the next year, given your focused on the direct-to-consumer and a few big retailers in that market?.

Yes. So I would say it will be minimal in terms of the impacts over the next few quarters. And we'll continue to give some more color on that, but we're just getting started and we want to make sure that we get off on the right foot there and these things build over time.

So it will be minimal as we think about the remainder of fiscal '18 and into fiscal '19..

Your next question comes from Rod Hall with Goldman Sachs..

I wanted to kick off with maybe an update on the MLCC situation in terms of supply and pricing, just to see if things are still as tight as you'd expected them to be pre the IPO and kind of how you see that playing out the rest of the year? And then I have a follow-up..

Yes, Rod. It's Mike again. From MLCC standpoint, we haven't seen a lot change. It's still tight. There's definitely an imbalance -- global imbalance between supply and demand. So the tightness is there. The premium pricing is there. We feel quite comfortable with our ability to procure the parts to meet our demand. Our teams are working daily on it.

We have some great supply relationships, so we feel very comfortable, very confident in terms of getting to the component supply we need. And from a premium pricing standpoint, it's pretty much as we have seen. We haven't seen dramatic changes there.

I'd say from our standpoint, we've made good progress in terms of lining up the supply to meet our demand going into next year. We will not see much of an impact this fiscal year in 2018. We'll start to see a little bit, but it will start to hit in fiscal '19 in terms of the premium pricing..

I also wanted to follow up on this new Amp product that you guys just launched at CEDIA and see whether -- I think our expectation had been that the unit volumes there wouldn't get material until March.

I'm just wondering whether you have any hope to maybe have more of a material contribution in the December quarter from that or how you see that playing out from a demand point of view?.

We're obviously not providing guidance for next year right now. But from a volume standpoint because of the availability for a channel, we would expect to see why it come through in our Q1 fiscal '19, and then general availability later in calendar 2019. So we'll start to see some flow in Q1..

And then I just -- one last one is on the API, and kind of what the plan is there. You guys didn't say too much in the opening remarks, but that was a big change at CEDIA as well.

And I'm curious to know what the reception that's been, and maybe give us -- I don't know, Patrick, if you can give us a little bit of philosophy behind those changes, but I think that would be interesting as well..

one, fundamentally kind of tie into everything that's happening in the smart home space and allow us to take advantage of that trend; and then secondly, really also create a platform, you may see Product Hunt has done a big push just recently around those APIs.

It allows developers that may have ideas around what to do for sound in the home that we may not think of and new services that have yet to be invented, which I think is pretty exciting. And so it will be fun to see what gets created on top of Sonos as a result of the API.

But this is a new and exciting area for us, and the software teams work super hard to make sure of it. They're also ones that allow people to build experiences yet don't take away from the reliability that we're renowned for and make sure that we keep customers listening to their music in a rock-solid fashion..

Your next question comes from Amit Daryanani with RBC Capital Markets..

I guess a couple from me as well. First off, when you talk about the direct channel model that you guys have, the direct to consumer, I think the shareholder letter talked about business is up 20% year-over-year.

Could you just touch on what percent of sales are done direct today? And either qualitatively or quantitatively, what's the margin profile in the direct versus indirect model for you guys?.

So direct is about 12% of our sales year-to-date as we look at it, and the margin tends to be about 10 points better than our traditional in terms of where it fits..

Perfect. That's pretty helpful.

And I guess just as a follow-up, when you talk about new products enabling growth as you go forward, can you just touch on what markets or areas you would be focused on with these new products? And at least recently, I think about lifting of Sonos One and Beam, new products have also meant lower ASPs versus the prior products for the same category.

Is that something that just happened -- is just an anomaly of those two products or is that something we should expect that new products would have lower ASPs as we go forward?.

We don't really have a range. Our products range in price from $149 to $700 today, and we think that's a great range to have our products. Certainly, this year, different than any other. You've seen 2 that are in the more entry-level parts of the segments that they play. And so we don't think in terms of ASP.

We think in terms of the portfolio we're building for customers at a variety of price points. And I don't expect it will change in terms of the way we distribute kind of our products over time between that $150 to $700 price points.

So as I think about it over the long term, I think you'll see us in those price points, and certainly this year, we happen to have done 2 that are more of the entry level for those segments, but that's not going to be an indicator of anything we do every year..

I would only add that we just announced the Sonos Amp 2, which has a $599 list price. So it's not a particular direction we're going. It really depends on the product solution that we're offering our customers..

Your next question comes from Brent Thill from Jefferies..

Just as it relates to Asia, I think that has been tracking somewhere in the single-digit percent of your overall revenue. I think when you look at what you mentioned in the letter that Japan is the second-largest music market, but you're still kind of expecting the minimal short-term impact.

Can you just talk about kind of maybe why it takes so long to ramp up there kind of your expectations of when you would expect to see a ramp? And is that just maybe a reflection of the U.S.

and Europe markets, just still being massively underpenetrated?.

Yes, Brent. We definitely think there's huge opportunities in all of the existing markets that we're in. And so even as we think about investments and resources, we think about that.

But I think with Japan in general, we want to make sure we get it right for the long term, which is why we're taking a measured approach in terms of how we approach it with sonos.com and then our high-end retail partners like Beam.

And so when we're thinking about these new markets, we're thinking how do we make sure that we get in, we establish the brand in the right place and we learn as well. So from consumers there, we know they have very discerning taste when it comes to their audio experience.

And so we want to make sure that we're doing everything in terms of local services, audio fidelity, everything around our product range to make sure that we've got it nailed, right? And so we're big believers in getting in there, starting to learn and then really ramping it up as soon as we have the formula.

And you'll know from us -- I mean, the other thing that we want to do is be prudent about getting ahead of expectations on some of these things. And so we'll want to make sure that we see the traction there before we start to count on it for too much in the future.

But really, it's about thinking how do we make sure that we've got the formula nailed for any country that we're going into. Japan is one we want to make sure that we get right before we scale it up..

And then quickly for Michael, just on the guidance, I realize you have only 20 days left in the quarter. And so I would assume given -- you've only given a 5 million delta from the low to high that you fairly get visibility going into the back half of this month..

Yes, that's correct, we do have good visibility. We have a full 2 months behind us. So yes, we do have good visibility. So we're quite confident with the range we've provided, top and bottom line..

And as we're just thinking about Q1 models, Michael, just given it's your seasonally strongest quarter, anything to think about just as we're looking at models for early next year, or is it too early to call?.

I'd say it's too early to call. Stay tuned. We will provide guidance in our next earnings call. So in -- our Q1 will continue to be our largest quarter. I won't go beyond that, but you'll be hearing more from us on next year at the Q4 call..

Your next question comes from Adam Tindle from Raymond James..

Matthew, as Chief Commercial Officer; and then combining the marketing and commercial organization.

So on the combination, can you just maybe talk about what you've learned in doing that? And then Matthew as Chief Commercial Officer with his background in digital commerce, can you just talk about what his marching orders are?.

Yes. So I think we've learned that we can move a little faster. And by -- we've taken down some of the walls to get the teams closer aligned. And I think that's making us more effective. You see it in the results as well and in terms of some of the efficiency we've been able to gain in the sales and marketing area.

And I think as everybody knows, it's an area that we expect to gain even more efficiency over time. And Matthew does have the experience around digital, run direct to consumer from Nike that has really helped in terms of making sure we shift our focus there.

And at the same time, we're to build and continue to build on things like our longstanding relationship with the installer channel, right? And so this has also been a big push as you've seen over the past couple of weeks around Amp, the APIs, our Sonance partnership.

And so I think Matthew has been really focused on how do we continue to drive growth in those channels that we're in today and really drive as much as we can through direct to consumer.

It's why you've seen the new facility in the app to be able to communicate directly with our customers and be able to make sure that we're educating and letting them know about what's available. So he's definitely helped accelerate, I would say, the pace of change and our focus on digital..

And then maybe just a quick follow-up for Mike. I just wanted to clarify the $14 million in annualized savings, I think that gives you in the neighborhood of 100 basis points or so of adjusted EBITDA margin benefit.

Is that fully reflected in Q3 results? And maybe just help us with how we can think about the timing of the 13% to 15% adjusted EBITDA margin target relative to 90 days ago or so, how you're feeling about that?.

Yes. So first on the restructuring, the annualized savings, the restructuring occurred in Q3. So we had about $4.5 million operating expense charges onetime in nature related to the restructuring. So that was an incremental cost in Q3.

Beyond Q3, we'll start to see the savings, and we've estimated that to be about $14 million from an annualized point of view from an operating expense savings. The second part was, I think, on the long-term EBITDA target.

Is that what the question was?.

Correct. How you're feeling about the 13% to 15% relative to 90 days ago, given you've got digital commerce accelerating. You've got savings happening right now, you would think that there are some things that are happening that are improving profitability on a forward basis..

Yes. So I got you. So this is -- I mean, just so everybody knows, our long-term adjusted EBITDA margin, we're confident we can deliver is 13% to 15%. In terms of how I feel, how we feel about it, nothing has changed really. We -- it's where we see us growing the business and getting to overall -- the next several years.

If anything, I think our confidence increases as we continue to make progress, but it's a long-term target that we've established. We took a lot of time thinking about it, so nothing has changed over the last 90 days. We feel very confident we would get to that level of EBITDA margin..

[Operator Instructions] The next question is from Matt Sheerin with Stifel..

So Patrick, you were just talking a little bit about the Sonance partnership. And I wanted to just ask about that partnership, in addition to Ikea, and other revenue streams that you're looking at that are more on the licensing and royalty side. I know the other category is going up.

So could you talk a little bit more about how much of a driver that will be to forward revenue and margin contribution?.

It's something that we're early days in. So for sure, obviously, just having announced the Sonance's partnership. And just for everybody's edification, that's really a collaboration because Sonance provides, really, the best architectural speakers, that's in-wall, in-ceiling and some outdoor as well.

So we're partnering with them in the same way we're partnering, to some degree, with Ikea in terms of the products that we're building with them. And so this is to explore other ways to help build out really the Sonos system, right, and the fact that the software is at the core.

And so it's something that we're going to continue to keep looking at with a few brands that we feel fit with our mission and what we're trying to do. And I think, Matt, over time, we'll figure out as we see these develop, we don't want to get too far ahead of ourselves. So we're being conservative in terms of where those are right now.

But I'm super excited about both and what we're seeing on both. And I've got a chance to spend a little time with Sonance team last week. So I heard there's going to be some exciting stuff there. But we are not yet building that in a big way into our financials. And we'll want to see how those pan out before we get that into our model..

And then just back to the product portfolio, I know you've got the 2 products out now. But if you look beyond the Amp, I did notice that the PLAY:3 is no longer available on your website, and I'm not sure if that would be sort of next in line. But I know you have 2 higher-end speakers without the voice function yet.

So I would assume that, that would be one area.

But could you give us some read into what you'd be thinking about in terms of new products in the next year or 2?.

We feel really good about the product road map that we have. I think we've got the farthest kind of outlook that we've ever had from a product road map perspective, and I think everybody are actually very excited about the products we have.

You'll understand that for competitive reasons, I'm not going to go into which ones come next as we go through it, but we're looking at the home, right? We still feel we have a huge opportunity there being in over 7 million homes today.

But thinking about that, those 176 million people that are paying for streaming music today, so massive opportunity remains in the home, and that's kind of job one. Job two is really the outside the home work. And we've talked about areas like outdoor and personal and some of the others, and so that's an area we continue to explore.

And so those are really on our mind and things that we have considered in our product road map, but I want to be cognizant of the fact that, competitively, we want to be careful about what we share..

There are no further questions at this time. I will turn the call back over to the presenters..

All right. Thanks, Mike, and thanks to all of you for joining. Appreciate the questions. Very excited about the momentum that we've been developing. The past few months have been fantastic in terms of getting Beam out, AirPlay 2, the IPO, obviously, and then as well the announcements we've had around Amp and the APIs and as well as Sonance partnership.

So we're building good momentum. We're excited to be public, and we look forward to talking to you further on the Q4 earnings call in November. And it wouldn't be a Sonos call without leaving you with something to listen to. So I'd point you in direction of Jade Bird, a great new artist on the Glassnote label.

My friend Daniel Glass had pointed me, introduced me to her. Her music is very unique, and I hope you'll find it enjoyable. So thank you very much, and have a great day..

This concludes today's conference call. You may now disconnect..