Good afternoon. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos Third Quarter Fiscal 2023 Earnings Conference Call..

[Operator Instructions] James Baglanis, Head of Investor Relations, you may begin your conference. .

Thanks, Emma. Good afternoon, and welcome to Sonos Third Quarter Fiscal 2023 Earnings Conference Call. I am James Baglanis. And with me today are Sonos' CEO, Patrick Spence; and CFO and Chief Legal Officer, Eddie Lazarus. For those who joined the call earlier, today's hold music is a sampling from our Sunset Fuzz station..

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 certain non-GAAP financial measures. For information regarding our non-GAAP financials and a reconciliation of GAAP to non-GAAP measures, please refer to today's press release regarding our third quarter fiscal 2023 results posted to the Investor Relations portion of this website..

As a reminder, the press release, supplemental earnings presentation, and conference call transcript will be available on our Investor Relations website, investors.sonos.com.

I would also like to note that for convenience, we have separately posted an investor presentation to our Investor Relations website, which contains certain portions of our supplemental earnings presentation..

I will now turn the call over to Patrick. .

raising the bar in the existing categories where we play and entering new categories in innovative ways..

Speaking of raising the bar in existing categories, our new Era family of products is off to a great start. We have seen media and consumers alike embrace Era 100 for its detailed stereo sound and deep bass and Era 300 for its impressive out loud spatial audio listening with Dolby Atmos..

Each product has earned stellar reviews from both media and consumers with consumers rating both the Era 100 and the Era 300 at 4.8 out of 5 stars on sonos.com. A recent Forbes review of Era 300 noted it is nearly as perfect as any wireless speaker can be. The spatial audio performance is fantastic..

Last quarter, I outlined what changed between our Q1 and Q2 earnings and how that affected our guidance for the second half of this year. We are tracking to those revised expectations. And thus, today, we are maintaining the midpoint of the guidance we issued for the second half for revenue and adjusted EBITDA.

We saw a reduction in channel inventory in Q3, consistent with our expectation for registrations to outpace selling. We expect this to continue through Q4, particularly in Europe and Asia Pacific, where retailers continue to tighten up..

As for underlying demand, strength in the Americas helped offset the impact of the tough economic climate in Europe and Asia Pacific. Specifically, in the Americas, we saw steady registration trends through the quarter, followed by a strong response to our Father's Day promo in mid-June.

In both Europe and Asia Pacific, registration trends generally softened through the quarter, which we expect, to continue through Q4.

As I've repeatedly said, we would reduce our spending if necessary, to hit our EBITDA commitments, while staying on track to deliver our ambitious road map, because harder times require a renewed commitment to rigor, focus and efficiency. This commitment led us to announce a 7% reduction in force in mid-June..

This rightsizing our expense base will enable us to increase future profitability while making targeted investments in our exciting product roadmap. Our journey to drive more efficiency in the organization is never over.

We will continue to closely scrutinize our cost base and do whatever it takes to deliver on the kind of long-term profitability we've targeted..

Our focus remains on driving sustainable profitable growth over the long term as we continue to release products in our now 5 existing categories, Sonos Pro was added this year as well as 3 new categories we expect to enter.

We are in the early innings of our growth as our more than 14 million households represent just 8% of the 172 million affluent households in our core markets..

At the end of fiscal 2022, the average Sonos household had 2.98 products, up from 2.95 the prior year. This figure has steadily increased over the years, underscoring how the lifetime value of our customers continues to grow.

As we have noted in the past, 40% of our households are single product households, whereas our average multiproduct household has 4.3 products. In other words, we are starting to get into the range we have previously discussed 4 to 6 products for every mature Sonos households.

We estimate that converting our single product households; the average multiproduct household install size represents a $5 billion revenue opportunity. This highlights the long runway we have to further monetize our install base..

I remain confident that Sonos is on the right track to continue to deliver value for customers and investors over the long term.

There is no doubt in my mind that we will emerge from this challenging period as a stronger company and resume making progress toward delivering on our long-term targets of $2.5 billion in revenue and $375 million to $450 million in adjusted EBITDA..

Now, I'll turn the call over to Eddie to provide more details on our results and our outlook. .

Thank you, Patrick. Hello, everyone. Stepping back from the numbers for just a minute, I'd summarize Q3 as having 2 areas of intense focus. First, making sure that we deliver on the second half revenue guidance we gave on our Q2 earnings call.

And second, making sure that we deliver on our expense reductions, both to ensure that we meet the profitability guidance we gave last quarter and to put us in a position to deliver our stated intention in fiscal year '24 to grow revenue faster than expenses and expand our adjusted EBITDA margin. We are on track to do all these things..

Now for the Q3 results. We reported revenues of $373.4 million, up 23% sequentially and roughly flat year-over-year on both the reported and constant currency basis. Americas grew 8% year-over-year to be 67% of total revenue, driven by resilient consumer demand as well as a strong reception to our Father's Day promotion in June..

EMEA and APAC each declined year-over-year to be 28% and 4% of total revenue, respectively. This was due to soft consumer demand consistent with the challenging economic climate in each region. We expect this softness in EMEA and APAC to continue through Q4. Though the shape of the second half is a bit different than we had anticipated.

In aggregate, our expectations are unchanged from what we outlined last quarter. I'll discuss this further after I finish recapping this quarter's results..

Quarterly registrations declined 2% year-over-year, while products sold declined 11%. This divergence with registrations outpacing selling is consistent with what we outlined last quarter about reducing channel inventory in the second half of the year.

Favorable product and channel mix as well as focused price increases caused revenue to be roughly flat year-over-year despite the 11% decline in products sold..

Q3 gross margin expanded 270 basis points sequentially from Q2 to 46% or 45.9% excluding the impact of FX, consistent with last quarter's guidance.

This expansion was driven by a full quarter of some targeted price increases, lower cost of components and favorable mix, partially offset by promotional activity and the reserves and expenses we have taken related to our component inventory that we currently deem to be excess.

These reserves are included in our cost of revenue and thus hit our gross margin. This is a temporary consequence of sourcing components during a period of COVID-induced scarcity, followed by a period of slower demand. We expect to work the rest of the way through this gradually diminishing COVID overhang in mid-fiscal year '24..

On a year-over-year basis, gross margin declined by 130 basis points due to lack of typical promotional activity in Q3 of fiscal '22, partially offset by favorable product mix and fewer spot component purchases in Q3 of this year.

Adjusted EBITDA was $34.3 million, ahead of our expectations due to the combination of higher revenue and lower operating expenses. Foreign exchange was an approximately $0.7 million tailwind to adjusted EBITDA..

Total non-GAAP adjusted operating expenses of $149.6 million declined by $4.4 million or 3% from Q2 due to delayed program in advertising spend and lower bonus accrual..

Please note that the mid-June rev had little impact on our Q3 expenses. And that this expense figure excludes the $10 million restructuring charge we recorded associated with the rev..

We ended the quarter with $268 million of cash and no debt. Free cash flow was negative $7.8 million in the quarter, largely driven by a $31 million increase in accounts receivable, an $18 million decrease in accounts payable and accrued expenses and $15 million of share repurchases, partially offset by a $23 million decrease in inventories.

Within inventories, finished goods were $240 million, down 13% sequentially. Looking ahead, our typical seasonality has its building inventory in fiscal Q4 ahead of the holidays. Our component balance of $58 million was up 12% sequentially. Over the last year, we moved swiftly to adjust our sourcing plan and our component purchase commitments..

While we have made good progress, we still expect our component balance to continue to increase in the near term before reaching a peak sometime next fiscal year. As I said previously, managing our owned inventory and improving cash conversion remains a top priority..

And finally, before turning to guidance, we repurchased $15 million of stock in the quarter at an average price of $16.10 a share, representing 0.7% of common shares outstanding as of Q2. As a reminder, we have approximately $55 million remaining of our previous $100 million share repurchase authorization..

Turning to guidance. As I previously mentioned, our expectations for the second half of fiscal 2023 are largely unchanged from last quarter. Today, we are adjusting guidance ranges to reflect being 3 quarters of the way through fiscal '23, while maintaining the midpoint for revenue and adjusted EBITDA.

We now expect to report full year revenues between $1.64 billion and $1.66 billion, down approximately 6% year-over-year..

At the midpoint, our guidance of $1.65 billion is unchanged from last quarter. We expect Q4 revenue between $290 million and $310 million, down between 2% and 8% year-over-year. Our Q4 guidance assumes that our Q3 promo overperformance pulled in some demand from Q4.

And while overall demand in the Americas is resilient, we expect EMEA and APAC to weigh on our results..

Taken together with our Q3 revenue of $373 million, second half revenue at the midpoint of our revised guidance is $673 million, unchanged from last quarter. We now expect gross margin will be in the range of 44% to 44.2%. The entirety of this revision is driven by higher excess component provisions.

As a result, we now expect Q4 gross margin between 45.9% and 46.9%. At the midpoint, this outlook implies a second half gross margin of approximately 46%, modestly below the midpoint of our prior guide of 47%. Absent this excess component provision in Q4, our gross margin outlook would be in line with the prior guide.

To size this for you, the full year impact of the provision is expected to be at least 100 basis points headwind to gross margin. And as a reminder, we've also faced significant FX headwinds this year, adversely affecting gross margin by over 100 basis points as well.

Excluding FX and the provision, gross margin would be well within our normal annual target of 45% to 47%. We now expect adjusted EBITDA to be in the range of $148 million to $158 million, representing a margin of 9% to 9.5%..

At the midpoint, our guidance of $153 million is unchanged from last quarter. We expect Q4 adjusted EBITDA to be between 0 and $10 million, representing a margin of between 0% to 3%.

Embedded in this Q4 adjusted EBITDA guide is non-GAAP adjusted operating expense of approximately $147 million in Q4, down modestly from Q3 due to realized risk savings and lower bonus, partially offset by timing of program spend. Full year non-GAAP adjusted operating expenses are expected to be approximately $623 million..

Taken together with our Q3 adjusted EBITDA of $34 million, second half adjusted EBITDA at the midpoint of our revised guidance is $39 million, again, unchanged from last quarter. As Patrick mentioned, in Q3, we took the painful but necessary step of reducing our workforce by approximately 7%.

We have other expense reduction initiatives underway as well. For example, continuing the process of reducing our leased office space..

We recently amended our long-term lease in Boston, reducing our footprint by almost 50%. And in Santa Barbara, we will be giving up our 2 current office locations and moving to a new consolidated office space early in the second quarter of 2024..

We will continue to review our expense base in search of further areas of savings, managing expenses and improving efficiency is of critical importance. We are in the throes of planning for fiscal '24. And while it's too early to provide guidance, I do want to double down on our commitment to delivering operating leverage in fiscal '24.

We will provide further detail on this on our Q4 earnings call..

Last but not least, let me touch briefly on our Google litigation. In our Northern California case against Google, the jury awarded us $32.5 million based on Google's infringement of one [ of our 2 ] patents. Post-trial motions are currently pending.

In Google's 2 pending cases against Sonos at the ITC, a hearing was held in one case with an initial decision expected in September. In the second case, the judge delayed the expected July hearing and indicated that she would be issuing an order finding the Google patents at issue there to be invalid. We expect a written ruling shortly..

With that, I'd like to turn the call over for questions. .

[Operator Instructions] Your first question comes from the line of Erik Woodring with Morgan Stanley. .

Awesome, and nice work in the quarter. Maybe Patrick or Eddie, I'm not sure which one -- I defer you to one of you. But just to confirm, I guess, the fiscal 3Q beat and fiscal 4Q guide down, that's largely -- it seems like a product or a result of strong promotional activity. So you pulled forward some demand.

There's also some incremental weakness in international markets.

So one, just making sure those -- are the kind of the 2 key factors to think about for 4Q? And the follow-up to that is just like how should we think about product registration growth or declines, I guess, as we then think about the September quarter? Should we think about the trajectory we're assuming just given the guide down? And maybe if you could just share some color on how to think about that for the September quarter.

That would be helpful. And then I have a follow-up. .

Thanks for that question. So we've been intensely focused on hitting our revised second half top and bottom line targets. And obviously, we're very happy that we're going to be meeting those goals. As to the balance between Q3 and Q4, I think you hit it. We had a very successful Q3 promo, which no doubt pulled forward some revenue from Q4.

We're also expecting some further channel tightening in EMEA and APAC and you touched on that. Overall, we see the Americas holding steady with continued weakness in those other regions, consistent with the economic conditions in those other areas. For the whole year, I just want to emphasize this because you asked about registration.

But the whole year registrations have been outpacing selling. So the underlying demand is actually a bit stronger than the headline revenue numbers. Now, our goal is to continue to compete effectively, which we've been doing as we wait for our categories to recover, which they definitely will in time.

And so -- but I think you summarized things pretty well there, Erik. .

Perfect. And then maybe, Patrick, you continuously kind of talked about these 4 new categories. Obviously, now it's 3 new categories after the launch of Sonos Pro. Can you help us maybe think about the time line to entering those new product categories? And I know you don't want to give away any trade secret.

So maybe if I phrase the question as you've set a long-term target for $2.5 billion of revenue, $375 million to $450 million of EBITDA.

Do you need to enter those 3 new categories to reach that goal? Or do you think you can reach that goal with kind of the exposure that you have and any subsequent product launches in existing categories already?.

Thanks, Erik. We -- entering the new categories, you know, that our strategy is both raising the bar in the existing categories, which is important to driving growth. And then the second element of that is entering new categories.

And so both of those -- both parts of our strategy, just like acquiring new homes and as well getting our existing homes to purchase additional are part of the strategy, it's all part of getting to our $2.5 billion in revenue. And as you alluded to, stay tuned, because we definitely don't foreshadow the product roadmap for competitive reasons.

So thank you. .

Your next question comes from the line of Brent Thill with Jefferies. .

This is [ David ] on for Brent. Eddie, I wanted to start on the litigation. I appreciate the color you just gave.

I'm curious just on kind of the go-forward path from here, how you guys are thinking about this? Maybe one, I guess, what are the next mile markers that we should -- as investors should be watching for? And 2, how are you guys thinking about -- I know you guys have in the past said that you think Google is infringing on more than just the 5 patents you guys have gone with kind of reloading that and coming with more patents down the road, just curious to get an update on that.

.

Well, the next milestone is going to be the post-trial motions in the case that we so far have prevailed in, in Northern California. The judge is holding hearing actually tomorrow. And we should get, I would think, a decision on that in relatively soon after the hearing. So that's step one.

Step 2 is going to be the oral argument in the Federal Circuit of the appeal from the case that we won at the ITC finding 5 Google patents to be both valid that Google was infringing 5 of our valid patents. And once that appeal -- first of all, that appeal could benefit us significantly if we prevail in any respect there on our cross appeal.

And the second point there is that once that appeal is decided, the damages case for those 5 patents will begin in the Central District of California. And those are foundational patents that Google has been infringing for a very, very long time and that we have already withstood the test of litigation. So that's probably the next big event.

And then, we'll be getting a decision in their remaining case against us at the ITC initial decision in September, final decision in January. And we're cautiously optimistic that that will come out well for us. .

That's helpful. And then maybe just on the promotional activity. I know you guys have in the past talked about competitors being a little bit more aggressive on promotion activity. Obviously, you guys weren't promoting as much as you -- last year as much as you are this year.

Just curious have you guys found yourself maybe promoting a little bit more than you would like, just curious around that trend. .

I think we -- what I'd say is that our promotional strategy overall really hasn't changed. We're promoting in very particular moments in time when we think the consumers are really focused on our product context. And that's proven very, very successful.

So while we have, in some sense, promoted more this year, because we've been so successful with our promotions, it hasn't been because we've been on sale all the time. And I think that strategy has proven successful.

And I expect that we're going to continue much the same way because we are gaining in market share, as Patrick described, very significantly in home theater, both here and abroad.

And so it just -- I think we've hit the right notes with a brand that's really, really strong right now and plays with these occasional moments as opposed to being on sale all the time. .

Your next question comes from the line of Jason Haas with Bank of America. .

Thought the commentary on what's going out the second half shift has been really helpful. I'm curious if that changes your thinking at all for the holiday period? I know it falls into the next fiscal period. But just curious as we're getting a little bit closer to the holidays, if there's any change in your thinking there. .

No change in our thinking. We think we have a great product line-up and a good strategy that we're setting in place. But we can't tell exactly when that kind of cyclical issues in our space will turn. But we're going to be ready to excel at the moment that happens.

And Q1 is always a strong quarter for us and we're looking forward to going through that again. .

That's great to hear. And in terms of -- just curious to get a little bit more commentary on inventory levels, both your own. I appreciate all the commentary you gave on what's going on with the components.

But just more broadly speaking, how you feel about your inventory levels? And then also to the extent that you could see into your retail channel inventory levels if we're closer to getting to the end of the destocking that needs to happen.

And again, just given how important the holidays for you? If there's any risk that, retailers are having order to reorder?.

Sure. So look, we've brought inventory levels down by more than $100 million since the beginning of the year and we feel good about that. But with a bit of a slowdown of demand, they're somewhat elevated still. And we'll be building a little bit more into Q1 as typical for the holiday season.

With respect to finished goods, we expect to return to a normal level exiting Q1. On the component side of things, we'll be taking a bit more onto our balance sheet as we exit from certain CM relationships and also due to the aging of some inventory purchase during COVID and now held by some third parties.

It's going to take us a little longer to work through that temporary spike in our own inventory, but we expect to do so in fiscal year '24. So a little bit elevated right now, a little bit of seasonality at work. But we will expect to be in very good shape next year on that..

Now in terms of our retail partners, a little bit of tale of 2 cities. In EMEA, our distribution pattern is much more diffuse but we're definitely seeing some tightening there. We've already experienced a lot of tightening here in the U.S. BestBuy has got many fewer weeks of cover than they used to hold. That's fine. We have a great relationship there.

But we've already seen a lot of the squeeze in that system. And as I said, that's why registrations have been outpacing selling all you along. .

Your next question comes from the line of Mark Cash with Raymond James. .

This is Mark on for Adam. Patrick, if I can start with you since you brought up Sonos Pro, it would be great if you can give an update on that. I understand its early days.

But how its interest and have you learned anything since introduction that could help catalyze demand for Sonos SaaS offerings?.

Yes, it is early days, like you mentioned, Mark. I think we're pleased with the customers that have adopted it and the interest that we've received. We haven't even really started to promote it yet, because we want to make sure that through marketing efforts because we want to make sure that it's meeting the mark with the customers.

It feels pretty good in terms of doing so. We think we have opportunity there. We think we have some work to do as well to make it easy for customers to really adopt it even faster. But I think we're on the right path for addressing the needs of the customers we've targeted with that offering.

And we are going to continue to look for opportunities to add recurring revenue flows to our business wherever we can in a way that benefits customers. And so we recognized the value of those types of offerings, and we'll continue to work on that. .

Okay. And then Father's Day strength has called out with promotional activity. So I was wondering if you could give a sense of linearity in the quarter.

Are things better now versus if you look back in April? I understand that the Father's Day maybe skewed the middle of June somewhat, but if you kind of give us a sense of how things progressed throughout the quarter that would be great. .

I don't really have any more color for you on that other than to say what I said earlier, which is we do think that that did pull forward some revenue from Q4. So you can read into that. But that effect over time will dissipate. .

Okay. And then I just wanted to circle back to the inventory topic.

With our installer channel and retail partners tightening, can you give us a sense of what kind of inventory levels they're holding now versus what you consider historical norms by these different go-to-market avenues?.

We don't actually give out those numbers. But what I would say is that by historical standards, the retail partners here in the States, for example, have definitely tightened.

So it's to the point where we're very comfortable with where those inventory levels are now and that over time, registrations and sell-in will now balance out as opposed to registrations outstripping selling as it has all year long. .

Okay. If I could just ask one more for Eddie. The gross margin headwinds you mentioned from the increased reserve. I was -- I think you mentioned you're getting through this in fiscal year '24, if that was right.

And then so if that's right, when do you see the headwind subsiding? And would it still be 100 bps impact for some of the year?.

It's -- I think the phrase I used is it's gradually diminishing and we should be all the way through it in '24. .

Your next question comes from the line of Tom Forte with D.A. Davidson. .

This is Sean on for Tom. I have one question and one follow-up.

So for my first question, how should investors think about the refresh rate for consumer electronics in general and your products in particular? It's our understanding that your products have longer refresh rates given the relative build quality and the integrated software components?.

Yes. Thanks, Sean. I think this is where we differ from pretty much every other company that participates in consumer electronics.

Our model stands alone because the premise is ultimately that the products will last a long time, which I think from an investor standpoint should be viewed as a higher return on investment from the investment we make in bringing a new product to market.

And from a -- I think everybody would recognize it's also better for the world since we're not creating stuff that ends up in a landfill or recycled as well. .

And then the part of our model that's important is that people will add more over time. And we know from our cohort model that this continues to be the case and has been for 20 years.

This is why we're always focused more on the long-term value as opposed to that onetime purchase or some of the cyclical refreshes that so many other companies are because -- as I mentioned, we believe we have a $5 billion revenue opportunity alone simply from being able to take our single product households to multiproduct.

And so the way to think about it, I would say, is we're playing the long game and playing the -- adding more and more products over time and getting higher ROI from our products. .

And for my follow-up, how, if at all, have you been impacted by consumers focusing their discretionary income on travel? So some recent examples, including a focus on international travel and live events which are best exemplified by the Taylor Swift Arrow Store?.

Yes. So I think we -- I think we've all seen and heard some of the services and travel versus good spending on a macro level. And that shift definitely isn't just new in Q3. I think we've been encountering that throughout the year, and we talked about that a little bit.

But what I think is most important on that is that it's impacting the audio market overall as opposed to Sonos specifically. And so when we look at the category share, we think about market share, in times like these, it's really important to understand how you're competing and how you're winning. .

And we're pleased to say that we are holding or gaining share in the categories that we play, despite not discounting to the levels that our competitors are. And so we feel very good about our position, our product portfolio and our brand positioning in a difficult market right now.

And I think we look forward to the day that the, spend on goods normalizes a bit from where it is today and swings back from services. So we are -- that's why we're investing for the long term. We'll be in the best position of any company in audio to take advantage of that when things normalize. .

[Operator Instructions] There are no further questions at this time. Patrick, I turn the call back over to you. .

All right, thanks, Emma, and thanks to all of you for joining. We look forward to updating you again in November. .

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