Good afternoon. My name is Camille and I will conference operator today. At this time, I would like to welcome everyone to the Sonos' fiscal third quarter 2019 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will a question-and-answer session. [Operator Instructions].

I will now turn the call over to Mr. Mike Groeninger, Vice President of Corporate Finance..

Thank you. Good afternoon and welcome to Sonos' fiscal third quarter 2019 earnings conference call. I am Mike Groeninger, VP of Corporate Finance and with me today are Sonos' CEO, Patrick Spence and CFO, Brittany Bagley. For those joining the call early, today's hold music comes from the Q3 playlist included in our shareholder letter.

The playlist was inspired by our exciting collaboration with IKEA. 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 2019 results posted to the Investor Relations portion of our website. I will now turn the call over to Patrick Spence..

Thanks Mike and thanks to all of you for joining us today. I am pleased to report our fourth consecutive record quarter with 25% year-over-year revenue growth and year-over-year improvement in our adjusted EBITDA turning a $7 million profit compared to a $2 million loss last year.

Given such a strong quarter, I think it's a good time to remind everyone that we think about our business on a long term basis. I would encourage you to continue measuring our progress on an annual basis against our stated goals of 10%-plus annual revenue growth and 20%-plus annual adjusted EBITDA growth.

I am very pleased we continue our progress towards another fiscal year delivering on that, thanks to our Q3 performance.

As you all know, our business is not always smooth quarter-to-quarter, given new product release timing and seasonal buying trends along with other factors, but we continue to feel very good on delivering consistent and steady growth over the course of the year, while improving our profitability.

We continue to look at the whole year and multi-years forward as we think about our business. As I mentioned previously, accelerating new product philosophy has been a primary focus area as well as thinking more expansively about new addressable markets and how to monetize the Sonos technology platform.

Our collaboration with IKEA, which launched in stores August 1 with some fantastic press reviews, is the perfect example of Sonos delivering against these ambitions. This collaboration represents a new business opportunity for Sonos where our technology powered speakers manufactured and sold by our partner IKEA.

The new product line SYMFONISK is the result of close collaboration between Sonos and IKEA and is an innovative way to bring the Sonos experience to new customers at a global scale. IKEA has unparalleled reach and offers a completely new distribution footprint to Sonos' existing network.

We are in approximately 300 IKEA stores across 18 countries with more countries launching through 2020. The collaboration brings the Sonos sound experience to new unique form factors at new price points and to new countries.

The $99 price point is particularly interesting as we believe it has the potential to significantly expand our audience by bringing Sonos into millions of new homes. Once introduced to the simplicity of the Sonos experience, we anticipate many customers will consider adding additional Sonos products to their homes.

You will see this revenue show up in our results as our module revenue as we are selling IKEA hardware with embedded software. In Q4, we look forward to consumers experiencing the two new innovative products we have developed with IKEA and to sharing something new, we know customers will love. I will now turn it over to Brittany to say a few words..

Thank you Patrick. This has been my first full quarter as CFO of Sonos and I am delighted to share these strong results with you. Revenue grew 25% year-over-year with strength across the board in terms of both geography and products. The Americas grew 18.4%, EMEA grew 16.6% and APAC including our module sales to IKEA grew 168.1%.

Our wireless speaker category grew 11%. Our home theater speakers grew 34%, largely due to the continued success of our Beam soundbar. Components grew 14% continuingly helped by the launch of our new Sonos Amp. And other, which includes the IKEA module and other accessories, grew 220.8%.

In addition to new product and the lunch with IKEA, it has been great to have the Google Assistant available this quarter. Q3 also had strong gross margin performance at 45.1%. We are up sequentially from Q2 due to the benefit of cost reductions and a one-time rebate from a contract manufacturer.

We are down 70 basis points from last year, primarily due to a reduction in licensing revenue and unfavorable foreign currency exchange impact. Overall though, this was a strong gross margin quarter but consistent with variability we expect within a year.

OpEx continues to show investment in R&D as we increased our software efforts to support our long term roadmap. Investment in G&A helps us continue to scale as a public company. And sales and marketing continued to show leverage even with the launch of Google in Q3. We will continue to make investments in Q4 as we prepare for the holiday quarter.

In September, we will be excited to share the details of our lineup with you. Obviously with the announcement of tariff last week, we are focusing on managing that impact. The good news is that we have been preparing for this potential and have been moving towards diversifying our supply chain outside of China.

We believe this is a good business decision for Sonos longer term and we will continue to pursue this regardless of the vicissitudes of the tariff discussions. For fiscal year 2019, the minimal impact of tariff starting September 1 at 10% is already included in our updated guidance.

With all of this, we are pleased to reconfirm and tighten our revenue guidance for the year in the range of $1,250 million to $1,260 million of revenue.

This represents 10% to 11% year-over-year growth, which is consistent with our long term annual target, even including the impact of challenging FX trend and a difficult environment in Europe with Brexit.

We are also confirming our EBITDA at the high end of our range of $86 million to $88 million or 25% to 28% year-over-year growth above our long term target of 20% growth in EBITDA annually. We are excited for what we feel was a great quarter and what is shaping up to be a very strong year for us. With that, I will open it up for questions..

[Operator Instructions]. Our first question comes from Rod Hall with Goldman Sachs..

Hi guys. Thanks for the question. I guess, Brittany, I wanted to come back to the updated guidance. I know you guys called out the FX impact in the first three quarters.

Could you help us understand it? I mean your new implied guidance for fiscal Q4 is $20 million, $21 million below consensus at midpoint anyway and I just wanted to see, is most of that currency? Or can you break that down at all, that deviation from consensus to just help us understand that? And then I have a follow-up..

Yes. Sure. So I think our prior guidance was $1,250 million to $1,275 million. So we are within our prior guidance range and I would view the fact that we are coming in sort of at the lower end of that prior guidance range really to be attributable to FX. We quantify FX to be about a $20 million headwind for us so far this year.

So that is a big part of it for us. And then obviously, we had a nice quarter in EMEA this quarter. But Q1 and Q2 had some fairly challenging trends in EMEA that we are working to recover from.

And so while we continue to see really excellent performance in the Americas, I think it's a couple of those pieces that land us where we are landing for the year. And again while it is at the low end of guidance, it's 10% to 11% growth, which is really what we target for the year.

And so we are feeling pretty good about where we think we are landing the year..

Okay. And then just on my follow up, I just wanted to clarify the comments on tariffs. You said it's contemplated in the guidance.

I wonder if you could just help us understand, is there any material impact from tariffs here? Or there is not really very much impact because you are able to move the supply chain around? Just kind of help us understand what's under the covers on the tariff impacts there?.

Yes. So because of our fiscal year-end and when tariffs are contemplated going into effect, it's really a one-month impact for us. And so it really has very minimal for fiscal year 2019..

Could you say, though, for that month like what the impact looks like?.

I am not going to break that out. We are doing a lot of things including moving the supply chain to mitigate the impact of tariffs. This fully went into effect last week. So we are working quickly and we are comfortable saying that it's pretty minimal for 2019 and it's already included..

Okay. Great. Thank you..

And our next question comes from Katy Huberty with Morgan Stanley..

Thank you. Good afternoon. Congrats on the quarter. I also wanted to ask a clarification on guidance and have a question on guidance. You talk about incremental R&D and marketing spend in the fourth quarter.

Was all of that baked into your original guidance? Or are you spending more given your outlook for the products or given the outperformance on margins?.

Yes. I would say, we really focused on annual guidance so that we have some flexibility quarter-to-quarter. So it was largely contemplated but it really is coming together where we have been able this year to continue to support that spend in R&D and we have gotten some excellent leverage out of sales and marketing.

And so it's been contemplated but what we are really signaling is that it's time for us to make some investments again there. And that's really what you are seeing in Q4..

Okay.

And I know it's very, very early on the IKEA product but any color around feedback around expectations for demand versus original expectations that IKEA had for that product? And then how should we think about the timing and the pace of IKEA coming back and adding to the orders for those products?.

Hi Katy. It's Patrick here. I will take that one. So we are six days in, to your point about being very early in terms of where we are. It's been great to see, I think the media reaction and the reviews just starting to hit just before they launched. Even today I saw the Guardian did a five star review on SYMFONISK lamp product which is awesome to see.

We have seen a lot of customers on social media raving about the products. So are feeling good about where it is, as is IKEA. But it's way too early to speculate on what this might mean to the forecast or anything else in that regard.

And I would also say, it is a new way of doing business for us and like a whole new area in terms of the way that we conduct our business here in terms of selling them the hardware and embedded software. And so that's a little bit different. I want to make sure that we go through that, that we get right.

So at this point, excited about what we have seen so far, feeling good about that, but it's too early to know, does it change anything that we have in our plans today..

Katy, I was just going to add that because of the way we do the relationship with IKEA, we really know where that's going to land for fiscal year 2019. So any variability that we talk about, we will start to talk about in November when provide guidance on 2020. But I would view it as being pretty locked for fiscal year 2019..

Okay. That's helpful.

Can I just ask one more question on the recovery and growth in Europe? How much of that is tied to adding Google Assistant which has become the number one voice assistant in the European market lately?.

Yes. At this point, I wouldn't attribute it to that. I think we called out that we had a promotional program that we tried in Europe and that went very well in the quarter. It's still early in the Google Assistant front. And we have obviously built that into our plan as we thought about the year.

So nothing on that front that has -- well, everything on that front has made us help reconfirm our guidance for the year and is in line with what we are expecting at this point..

Okay. Thank you so much..

And our next question comes from Adam Tindle with Raymond James..

Okay. Thanks and good afternoon. Patrick, I just wanted to start with the R&D investments picking up to maybe revisit the outside the home initiative that you have alluded to in the past. I know it's hard to get into specifics, so hoping to ring fence it a little bit.

So I guess where would you kind of set the boundaries on the markets that you will choose to attack? How can we think about you guys competing with potentially a different set of competitors in that? And then also any sort of a timeline that you can give us for that initiative?.

Obviously, we see a lot of opportunity in the future in a variety of markets that are there in the audio space. When we came into home audio, there were a lot of competitors that were incumbents that had well-established positions and we think we bring something unique to the table.

And I think as I have mentioned before, any of the new categories we enter, we will bring a unique perspective to and the unique Sonos attributes around things like freedom of choice and great sound and easy experience. And so we are being thoughtful about how and when we enter those categories and approach that.

And we just are excited about the investments we are making there to make that happen. But I also want to make sure that we don't tip our hands in terms of when we are going into particular new product categories but we are very excited about the product roadmap that we have right now.

And I think it's the best one we have had in my 7.5 years at Sonos, for sure..

Okay. That's helpful. And then maybe one for Brittany, just on the operating model. You have had, I think four quarters of revenue growth meaningfully outpacing OpEx growth on a year-over-year basis. But based on guidance, it looks like that trend is going to reverse in Q4.

So I am just hoping that you can maybe touch on an OpEx metric that you are targeting because it is increasing as a percent of revenue in Q4. So just wondering if that continues? And you sound committed to the 10% revenue growth, 20% EBITDA though.

So in light of this OpEx increase, is that still something that you think is achievable for the near term future?.

Great question. Yes, we absolutely do. You have seen a lot of OpEx leverage from some of the restructuring that we did in the sales and marketing team and that's given us a pretty significant benefit.

But we are still going to be smart about where we invest behind supporting new launches, building our brand and then, to Patrick's point, we are excited about where we are investing in R&D. But that's also to help us drive long term future growth. And so we are very committed to the 10% topline and then the 20% EBITDA.

And I think in our guidance, even with some additional investment in Q4, we are still expecting to outperform that 20% EBITDA growth for the full year, 24% to 28%. So we feel pretty good about the metrics and the balance and we really do look on it on an annual basis rather than trying to time anything in a specific quarter..

Okay. That's helpful. Thank you..

And our next question comes from Elliot Alper with D.A. Davidson..

Great. Thank you for the questions.

So how should we think about the rollout of the IKEA locations and the revenue contribution for that effort heading into the next year?.

So you will see IKEA disclosed in APAC and other for us. We are not going to break it out in more detail than that on until it gets to be a more significant portion of our revenue. We are in 300 stores, 18 countries. Six, seven days into it.

We like the press coverage we are getting and we are pretty locked for the year on where we are to come out on IKEA. And as I mentioned earlier, any improvement or performance or anything that you would see in that would be included when we come back and give 2020 guidance..

Okay. Great. And then just a follow-up. Prime Day was longer this year than it's ever been.

Did you notice any material difference in sales in July?.

So Prime Day and July fall in Q4 for us. And so we look at Q4 as a whole inclusive of that and look forward to providing an update on that, whether or not it was meaningful when we release our Q4 results..

Okay. Thank you..

And our next question comes from Matthew Sheerin with Stifel..

Yes. Thanks and good afternoon. Just another question regarding the improvement in gross margin and the guide up on that. I know you talked about some cost cutting. I know one of the headwinds for that business or that margin has been higher component cost and I know a lot of these components are now easier to get.

So how much of that is relative to the lower component cost? And then that contract manufacturer credit that you talked about, could you tell us how many basis points that might have benefited other gross margin?.

Lots of good questions in there. So I will start with, we are not sort of changing our long term guide on gross margin and this is all baked into the updated guidance we provided for 2019. So it was a really nice quarter on gross margin, but I wouldn't necessarily extrapolate that out.

We are not going to break out the impact of the contract manufacturer, but it was a nice help in that quarter. And then overall, our operations team has done a very nice job of mitigating some of the component cost increases.

So those have come in much better for the year than I think we were all expecting at the beginning of the year and has been a meaningful help for us on a gross margin basis generally..

Okay.

And looking at the IKEA business and other businesses or business relationships that you may have similar to that, is the margin profile of that business similar to your own direct business? Or is it different?.

The margin on our module business is different. It's a different product for us. And you know, again we don't break it out. But I think we have talked about how the fact that our module gross margin is a bit lower than our general product. On the other hand, we don't have some of the other OpEx costs associated with our normal Sonos product line.

And so overall, we consider it to be very beneficial to our bottomline performance..

Okay. Great. And just last question, if I may, regarding the IKEA launch and those products and particularly the $99 speaker, which appears to be selling well.

Is there any concern about cannibalizing your low-end speakers, the Play:1? Or is that a different audience that you are trying to reach?.

That's a different audience that we think we are reaching in a different form factor as well. And so we are excited because, well as you know, Matt, this gets into somebody's home and they end up buying more. And so we really see this as a great way to establish ourselves in millions of new homes.

And they use the Sonos app, they get a beginning of an understanding the Sonos system and from there add a Sonos 1 or add a Beam over time and we will have to see what that looks like. But we are confident that that trend will play in time. So we see it as net accretive..

Okay. Thanks very much..

[Operator Instructions]. And there are no further questions at this time. And I will turn it back over to the presenters..

Thank you. Thanks again for everybody's time today. To close, I would like to reiterate that the strength of our Q3 earnings keeps us right on track to deliver our planned revenue and EBITDA growth for this year.

We are delivering against promised new product velocity as well as expanding the reach and scope of our platform introducing the Sonos experience to millions of new customers.

With IKEA's SYMFONISK in market in Q4, we look forward to consumers enjoying the first fruits of this strategy and we also look forward to sharing something new later this quarter that we know customers are absolutely going to love. We hope you will take some time to enjoy the playlist we included in the shareholder letter.

This one was inspired by our collaboration with IKEA and features some of our favorite Swedish artists. Thank you and have a great day..

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