Good afternoon. My name is Kelly and I will be your conference operator today. At this time I would like to welcome everyone to the Sonos Fiscal Second Quarter 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise.

[Operator Instructions] I would now like to turn the call over to Mike Groeninger, Sonos' VP of Corporate Finance. Please go ahead..

Thank you, Kelly. Good afternoon and welcome to Sonos' fiscal second quarter 2019 earnings conference call. I'm Mike Groeninger, VP of Corporate Finance and with me today are Sonos' CEO, Patrick Spence; CFO, Brittany Bagley; and former CFO, Mike Giannetto.

For those joining the call early, today's hold music comes from the Q2 playlist included in our shareholder letter. The playlist was created to celebrate our collaboration with the Google Assistant team.

Before I hand it over to Patrick I'd 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 dates.

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. 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 a complete information regarding our non-GAAP financial information and a quantitative reconciliation of those measures, please refer to today's shareholder letter regarding our second quarter fiscal 2019 results posted to the Investor Relations portion of our website. I'll now turn the call over to Patrick Spence..

Thanks, Mike, and thanks to all of you for joining today. It was another strong quarter for Sonos, 13% year-over-year revenue growth, 17% on a constant currency basis and a huge year-over-year improvement in our adjusted EBITDA, narrowing our loss in Q2 from $3 million – to $3 million from $15 million in the same quarter a year ago.

We're making great progress and nowhere is this more evident than in our new products growth driver. 24% of our revenue in Q2 came from new products like Beam, Amp and Architectural. In fiscal 2017, less than 10% of our revenue came from new products. We've accelerated our new product engine and its bearing fruit.

We have recently announced our first two products with IKEA to great reception from customers and media. So those will further help support this growth driver through the remainder of fiscal 2019 and beyond. That said, it's important to point out that even with this we're less reliant on new products alone than any company in our category.

Our existing portfolio continues to sell very well into new and existing customers. Sonos continues to set itself apart as customers come back and add more to their home. While unprecedented in our industry, this has been consistent over the last 15 years. The other growth driver I'd highlight is evolve the platform.

As we're making Google Assistant available on Sonos in the United States next week. Existing One and Beam customers will be able to download Google Assistant or if you have a Google Home device, you'd be able to use that to control your Sonos.

We think this will spur a new wave of growth with customers interested in freedom of choice and not being locked into one ecosystem. Sonos continues to get better over time. Lastly, I'm excited to have our new CFO, Brittany Bagley, here with us today.

I've had the pleasure of knowing Brittany for seven years as she was an integral part of the team that invested in Sonos when she was at KKR and has served on our Board for the past two years. She understands Sonos, the industry and the opportunity ahead.

I'm looking forward to working closely with Brittany to take advantage of the opportunities in front of us and to find new ones leveraging our amazing people and strong balance sheet. Of course she's just been at the helm for a little over two weeks, so we've got Mike Giannetto, our former CFO, here as well to help address Q2 specific questions.

I'll now turn it over to Brittany for a few words..

Thank you, Patrick. It's so good to be here to be a voice for the business and our plan for sustainable profitable growth. And I'm thrilled to be working in an operating level on what I see as an incredibly exciting strategy. It's a wonderful evolution for me personally from investor to Board member to a full part of the team.

As for this quarter, I have to say thank you to the team for giving me a nice straightforward results. We generated record Q2 revenue of $210 million, a 43% gross margin and $2.7 million in an adjusted EBITDA loss, which is a meaningful improvement year-over-year.

We continue to do what we said we do to demonstrate strong top line growth and to improve our profitability profile. I look forward to continuing to deliver on our promise over many quarters to come. With that, Patrick, Mike and I will take your questions..

[Operator Instructions] Your first question comes from the line of Rod Hall from Goldman Sachs. Please go ahead. Your line is open..

Yes, hi guys. Thanks for the question. Glad to see the Google Assistant rolling out next week and I wanted to just I guess circle back on that and I know you had commented that I think Patrick maybe you had said that not having that had probably affected European sales.

And I just wanted to see how you expect this to affect European sales as we look forward. And then I have a follow-up to that..

Yes, Rod, it's Patrick here. That's absolutely right. We saw a lot of strength from the Google Home products and the pickup of Google Assistant in the holiday quarter across Europe. And so, there's two things as you think about our European business.

We're excited for the introduction, actually I'd say three because we're excited about the introduction of Google Assistant and we expect that to be a driver in Europe. We also have IKEA which as we think about that later this year is a driver that I think will be relevant in Europe.

And the one thing I would flag is and you've heard it from a few companies is I think everybody's seen some macroeconomic weakness in Europe and so that is just the one thing that we are watching pretty closely at this point. But we do think Google Assistant and IKEA will help us return to growth in Europe..

Okay. Thanks, Patrick. And then my follow-up is on the margins. I guess I wanted to just – the margins were stronger than we expected at the gross level, 43.1%.

And I wanted to just check that that is mostly related to MLCC pricing or are there other dynamics in there? I just wonder, maybe Brittany if you can address what drove that margins strength and also why the EBITDA margin in the full year guide isn’t really changing..

Hey Rod. It's Mike. I'll take the first part of that on the gross margin. We actually even didn't thought ourselves and really it comes down to some excellent work from our operations team in terms of continuing to work on the supply chain and specifically around some of the component shortages and price premiums.

We’ve talked about for months now specifically around MLCC. The team did a really good job, kind of narrowing that exposure down and we definitely saw some of that benefit come through in Q2 and we've been able to reduce the headwind quite a bit from the MLCC shortages..

Great. Okay, Mike, thanks. Didn't mean to leave you out, by the way. Thanks for that..

No problem, Rod.

We'll make sure that doesn't happen this quarter. On your question on EBITDA going forward, we are not changing our guidance. I think the thing that you have to remember for the second half is we have some investments to make to support both the product road map going forward but also some of the Google launch initiatives.

And so we will see some investment in the second half of the year. Just keep that in mind..

Okay. Thanks, Brittany..

Your next question comes from the line of Katy Huberty from Morgan Stanley. Please go ahead. Your line is open..

Thank you, good afternoon.

Just going back to the geo segments, how is the ramp going in Japan and what other countries do you have in front of you that could drive significant growth?.

Yes, Katy, it's Patrick here. I'll take that. So, Japan is growing well. It is still a small part of the equation obviously at this point, but coming along and we've having done this a few times across different countries at this point we want to build it from a place of experience and strength and quality.

And so we're going deliberately pretty slow in terms of how we approach that with both our online efforts and then a few high-end retailers.

And I would say right now the way we're thinking about international is our IKEA partnership's going to take us into a number of new countries and that gives us a really interesting way to see which countries will pick up on the power of Sonos and allow us to – it kind of acts as a screen, if you will, into hey, where else should we invest? We have some ideas in terms of the other countries obviously, but I'm really liking the way it's come together with IKEA that will give us a bit of a head start and a good indicator of where we are seeing the most interest.

And it also means that we're building a customer care infrastructure to support a number of countries we haven't before. I think that's been a great kind of added benefit of the IKEA partnership. And so, we'll be watching that pretty closely and that'll help shape the other countries we go into full force as we think about fiscal '20 and beyond..

Okay. And then as a follow-up on gross margins, how should we think about the Sonos One redesign impacting gross margin as we think about modeling the June quarter. If I look at the last couple of years, gross margins are up sequentially by 100 or 200 basis points in June.

Should we think about that as the seasonal uptick this year and then layer on top of the some benefit from the redesign? Thanks..

Okay, Katy, it's Mike. There are a few things in there. First on Sonos One, as we did describe we did redesign and cost down the Sonos One. It's about a 10% or so reduction in the BAM cost which is pretty much in line with – our strategy has been we launch a product and we cost it down in future quarters and years.

So that's good, that's definitely a benefit going forward. There's other dynamics going on though. We also have different products and mix shifts in the quarter that we've seen in Q3. So I wouldn't necessarily say it's an uptick from what we've seen in Q2 based on history. Sonos One will help and then there will be some other mix coming into play too.

IKEA will start to ramp in the back half of the year, which overall has lower than our Company average gross margin, so that's something to consider as well..

Thank you. Congrats on the quarter..

Thank you..

Your next question comes from the line of Adam Tindle from Raymond James. Please go ahead. Your line is open. Adam Tindle from Raymond James, please go ahead. Your line is open. Your next question comes from the line of Tom Forte from D. A. Davidson. Please go ahead. Your line is open..

Hi, thank you for taking my question. So, since we have biggest growth perception on your stock, it's your relationship with Amazon, so can you talk a little bit about how you leverage Amazon both selling on the retail platform and also your relationship with Alexa and as an AWS customer and then also how you compete against Amazon. Thank you..

Yes, sure Tom, it's Patrick, I'll take that. So we have a deep and long-term partnership with Amazon, started with our work with them around AWS for sure. So they are the cloud partner that we use but has expanded well beyond that. Amazon Music, we have had support for a long time, actually we just talked to Steve Bloom over Amazon Music this week.

And I'd say we've been on Amazon.com as a retailer for a number of years as well, so that's another part of the relationship we've had and we really over the last couple of years have established a strong relationship with Dave Lynch and the Alexa team over there.

And it's been something where you can clearly see that Amazon and Google have invested ahead of anybody else in the industry around these voice assistants and their strategic intent, both companies is to get their voice assistant on as many products as possible, regardless of who those products are built by.

And us having millions of the most desirable homes on earth has really motivated Amazon and Google to want to work with us to put their assistants on our platform. And so, we have a great relationship with Amazon. They are one, they are multi-faceted, as you said.

I talked to Dave last week, so we continue to work very closely with Amazon and Google, Apple as well as we go through this.

And so, certainly we expect that to continue and we'll take advantage of any services that any of these companies are bringing out that we think help customers, right, at the end of the day because what we want to do is give customers freedom of choice.

And so, regardless of who the service comes from we want Sonos to be able to present that to customers whether it's Amazon or Google, Apple, you name it..

Great. Thank you so much for taking my question..

Your next question comes from the line of Matt Sheerin from Stifel. Please go ahead. Your line is open..

Hi, good afternoon. This is Kurt Swartz on for Matt Sheerin. Thanks for taking my question. First off, just wondering if you could offer any color as to whether these IKEA product launches and any other product launches coming up may have any sort of material impact on seasonality going forward..

Yes. So I would say for this year, keep in mind that IKEA is launching in August. So we have really good visibility for this year and it's already baked into our annual guidance and our annual forecast.

So I wouldn't expect anything differently this year and then we can certainly talk about what that might look like going forward once it's launched and we have a little visibility into how it's doing..

Understood. And then just a follow-up, looking more at I guess, any products in the pipeline, wondering if you've given an additional consideration to perhaps rolling out a product that may incorporate a display going forward.

I know last time you were asked about it, that was still something that you haven't really been considering too seriously at that time.

But just wondering if there's any update there?.

We're always looking, Kurt, at kind of what's happening in the marketplace, for sure. I think there's been something from Strategy Analytics saying I think the display power kind of smart speakers, smart displays has been about 10% of the market over last six months or so. So we'll continue to watch this space.

Haven't seen it pick up in the same way that we did as voice initially picked up or some of our products have along the way, smart soundbar and those kind of things. So I feel like the jury is still out, as we think about, the Facebook portal doesn't seem to have got much traction from any of the market data that we've been able to see at this point.

So obviously we have the Nest Home Hub that launch this week, so we'll see how that does as well in the marketplace, but at this point, I'd say our strategy is still to produce and connect easily to existing displays, right, like a television and make those sound greater, you could do the same with AirPlay for iOS devices as well.

So we will continue to watch for sure..

Understood. Thank you very much for the time..

Your next question comes from the line of Brent Thill from Jefferies. Please go ahead. Your line is open..

Hi, this is John Streppa on for Brent. Thanks for the question. You've seen very nice leveraging the sales and marketing line as you kind of pivoted more towards digital. Just curious if you could highlight a little bit about the go-to-market strategy with the Google Assistant rollout and your partnerships with IKEA and Sonance..

Yes. We do – we have seen some great leverage that's from both the push to digital as well as some of the changes that we made in consolidation on the team.

We've got some great activities lined up to really push the launch of Google Assistant, so we're feeling good about those activities, but they very much fall in line with the kind of activities that we've been moving forward with around digital and some outdoor and kind of the effectiveness levels you've seen.

So as we think about that, IKEA is obviously pushing in a big, big way on the products that we co-developed. And I think one of the benefits of that relationship is they get 1.3 billion shoppers a year through their stores. So they will get to see Sonos in a homelike environment which is something that we're really, really excited about.

And so, we think we are going to continue to – we think fiscal 2019 is where we're getting to the kind of sales and marketing leverage that we think is the right thing and we feel pretty good about where we landed for this year. And then – so we think it's reflective of the way sales and marketing will be going forward, if you will..

Great. Thanks. And then maybe just a housekeeping one. Last quarter, you highlighted elevated channel inventory exiting the first quarter heading into the second. Just curious kind of how that played out throughout the quarter and how you stand heading into the third. Thank you..

Yes. This is Mike. Actually it played out quite well. I think we mentioned in the February call that January looked pretty good in terms of sell-through registrations and it continued throughout the quarter. So, from a channel inventory standpoint, we're in really good shape.

We have mentioned we're a couple of weeks higher than we would've liked at the end of December, but that's all – so we're thrilled and we're in good shape..

Great. Thank you..

You're welcome..

Your next question comes from the line of Adam Tindle from Raymond James. Please go ahead. Your line is open..

Okay, thanks and good afternoon. Sorry about that, just bouncing between calls. So I'll start with a softball as a penalty for myself. Brittany, you've got an interesting view coming from the private side.

I guess, what do you think is the most misperceived by the public markets about Sonos and what are the things that you can do to help bridge that gap?.

I don't know if that's a softball, but it's a great question. Look, I think that everyone recognizes rightly that consumer electronics can be a difficult business and we understand that too.

And so I think what we're out to prove and what I'm how to help the Company prove is that we can actually do a really good job of it, that we can be consistent, that we can execute, that we can hit the targets from a long-term perspective that we have laid out for all of you and that Sonos is a really a different kind of consumer electronics company.

So that's what has gotten me excited to come over to this side of the table and really be part of the team and try and demonstrate that. And what we recognize it's on us to just go show you all of that quarter-after-quarter and hit what we said we're going to hit..

All right. Well, then maybe in that vein just want to touch on the full year revenue guidance. If we look at Q3 seasonal trends are normally up low double-digit on a sequential basis, ex the launch of Playbase in 2017. And if we kind of assume that sort of seasonality we need like a 30% sequential uplift in Q4 take it to the full year revenue number.

That is something that you achieved last year but that was with Beam being one of the most successful product launches ever.

So I guess, the question that we’ll probably get tomorrow is what underlies the confidence that this will be a Beam-like finish to the year and why bake in such successful launch into guidance and hope that full year revenue guidance..

Yes. So I'll take that and of course Patrick and Mike can jump in. Look I think as we think about the second half of the year.

And I am going to talk about the second half of the year rather than individual quarters as we tie it into our full year and – guidance, our guidance was really designed to hit the promise of what we’ve said that we can do, which is 10-plus percent revenue growth.

And so as we look at the second half of the year, we feel good about our ability to deliver that. Remember that a couple of the things that we are talking about on this call really haven't hit our financials yet. So, Google hasn't launched yet. Patrick talked a little bit about how we are optimistic that that has some good traction in Europe.

Our architectural speakers with Sonance really have not hit in Q2 yet. Those are just out the door. And we have good visibility on IKEA as they build to their launch in August. So those are the pieces that we are looking at as we reconfirm that guidance number for the year..

Okay. Thanks and congrats on the new role..

Thank you..

And that concludes the questions..

All right, thank you. Thanks again for everybody's time today. And I'd like to take a moment to thank Mike Giannetto as this is the last earnings call he'll join. Mike has done a tremendous job over the last seven years playing a critical role and helping us scale from $200 million in revenue to over $1 billion.

He took a small finance team and built it into a strong finance and facilities team that we have today. It's a testament to Mike and the team he built that we're able to successfully IPO last year and that we're in a strong financial position today. He's been a great colleague and a great friend to me through thick and thin.

And for that, I and all of Sonos will be forever grateful. So thank you, Mike..

Thank you..

We hope you also take some time to enjoy the playlist we included in the shareholder letter. We had some fun putting this one together to mark the introduction of Google Assistant on Sonos. Thanks and we'll talk to you soon..

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