Ladies and gentlemen, thank you for standing by and welcome to the Sonos First Quarter Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ms. McLaughlin. Thank you. Please go ahead.

Thank you. Good afternoon and welcome to Sonos first quarter fiscal 2020 earnings conference call. I am Cammeron McLaughlin 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 a playlist that is included in our shareholder letter and was created by our Black @ Sonos employee resource group to celebrate Black History Month. 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 financial performance. These statements reflect our views as of today and should not be considered as representing our views of any subsequent date. They 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 several non-GAAP financial measures, including gross margin and adjusted EBITDA excluding the impact of tariffs, adjusted EBITDA, adjusted EBITDA margin, and free cash flow. For complete information regarding our non-GAAP financial information and a reconciliation of those measures, please refer to today's shareholder letter regarding our first quarter fiscal 2020 results posted to the Investor Relations portion of our website. I will now turn the call over to Patrick.

Thank you, Cammeron, and hello everyone. Our new fiscal year is off to a great start. Revenue for the quarter increased 13% or 15% on a constant currency basis to a record $562.1 million. Including the impact of tariffs during the quarter, gross margin increased to 44%, adjusted EBITDA increased 29% to $113 million, and adjusted EBITDA margin increased to 20.1%. Revenue growth during the quarter was driven by our Sonos speaker and Sonos system products led by Move, One SL, Amp, and Port. A record number of new homes started with Sonos during the first quarter, and we continued to see strong growth in product registrations by both existing and new customers. Our IKEA partnership continues to be a strong contributor to growth in partner product and other revenue during the quarter. Furthermore, importantly, we continue to see that consumers who purchase a Sonos IKEA product, the SYMFONISK product, are returning and repurchasing additional products and continue to follow the same repurchase trend as customers who started with Sonos products. This trend is important as we consider the lifetime value of these customers and consider future opportunities in this partner space. Our products consistently rank among the top home audio products, and we continue to gain market share amidst a rapidly evolving competitive environment. During the December quarter, we increased our market share dollars in the audio speaker category in many geographies, including the United States, United Kingdom, and Germany. When looking more specifically at premium price points in the categories we serve in the U.S., Sonos gained disproportionately more share compared to the rest of the market, further illustrating the power and premium nature of our brand and the strength of our products and platform. We had a very strong holiday selling period led by growth across all product categories. As you know, we limit regular promotions, keep our campaigns few and targeted throughout the year, and believe strongly in maintaining our premium position. We planned our marketing efforts to be deeper and broader this holiday as compared to last year, given how the holiday selling environment has evolved. Our communication and targeting were more effective than ever. Despite competitors offering significant discounts during the holiday season, we gained share, which we believe underscores the quality of our products, the uniqueness of our platform, and the strength and premium positioning of our brand. Given our strong execution in Q1 and exciting product pipeline, we remain on track to achieve the financial targets we set out for fiscal 2020. We intend to continue our cadence of launching at least two new products every year, and we are increasingly thinking about our products as more than hardware and look forward to being able to include additional business models as part of our future launches. I will now turn it over to Brittany to say a few words.

Thank you, Patrick. Let me add some additional color on our strong first-quarter results. Revenue growth was driven by strength across all product categories with the largest contribution coming from our Sonos speakers and our partner products and other revenue. Our planned promotions outperformed our expectations and we believe resulted in some pull forward of revenue from the second quarter. As we discussed with you last quarter, starting this quarter, we are now reporting our revenue in the following three categories: Sonos speakers, which increased 7% and include Play:1, Play:5, Sonos One SL, Playbar, Playbase sub and our voice-enabled Sonos One, Move, and Beam products; Sonos system products up 17% year-over-year include Sonos Port, Amp, and Boost; and our partner products and other revenue, which increased 333%, includes revenue generated through our IKEA and Sonance partnership accessories and other revenue. You will find our historical product revenue based on these new categories in the reports and filings section of our Investor Relations website. Gross margin increased 120 basis points to 40.5% during the quarter. Excluding the $20 million in China-U.S. tariff duties recognized this quarter, gross margin would have increased over 460 basis points to 44%. Our strong gross margin expansion during the quarter was driven by volume and mix shift into higher-margin products as well as material cost reduction. As we discussed last quarter, we continue to invest in the business to support our long-term growth. This spend is predominantly showing up in R&D to support our product roadmap, software capabilities, and services. Our adjusted EBITDA for the quarter was $93.2 million compared to $87.4 million last year. Excluding the impact of tariffs, adjusted EBITDA increased 29% to $113 million, with adjusted EBITDA margin increasing 246 basis points to 20.1%. Turning to our balance sheet and cash flow, we ended the quarter with $408 million in cash and cash equivalents and $23 million in long-term debt. We generated over $100 million of free cash flow in the quarter. We also completed the acquisition of Snips for approximately $36 million in cash. In September 2019, our Board authorized a $50 million share repurchase program, which we started to execute on during the quarter and we continue to see tremendous value in our stock. The strength of our balance sheet enables us to take a thoughtful approach to capital allocation. As a reminder, we are investing in our long-term roadmap through R&D while also looking at inorganic growth opportunities as we demonstrated with Snips. We are also focused on returning value to shareholders through share repurchases. We will continue to manage these each quarter while also maintaining a strong balance sheet. Looking ahead, we are excited for continued execution on a strong fiscal 2020. We have great products and partnerships including those launched at the end of 2019 and look forward to additional new products and services that we will announce this year. We are pleased to reconfirm our fiscal 2020 guidance. We continue to expect revenue in the range of $1.365 billion to $1.4 billion. This represents growth of 8% to 11% for the year and at the midpoint is consistent with our average annual target of 10% revenue growth. We had a strong first quarter, but do believe there was some pull forward of revenue from the second quarter given the effectiveness of our promotions, which is reflected in this guidance. As a reminder, our gross margin and adjusted EBITDA guidance takes into account approximately $30 million of one-time impact from China tariffs. Sonos products manufactured in China and shipped to the U.S. were subject to a 15% tariff through February 13, and after that date will be subject to a 7.5% tariff. Given that the first quarter is our largest quarter and we have already begun transitioning to Malaysia, the reduction in the tariff is expected to have little impact on our fiscal 2020 tariff expense. We expect Malaysia to be fully operational by the end of the year and therefore will have largely eliminated the impact of tariffs by the end of the fiscal year regardless of rate. We are also closely monitoring developments related to the coronavirus and are focused on supporting our people and partners during this challenging time. Currently, we think any impact to our operations is minimal and at this time do not anticipate any impact to our fiscal 2020 outlook. Our fiscal 2020 GAAP gross margin outlook remains in the range of 41.2% to 42.2% excluding tariff-related costs. GAAP gross margin would be in the range of 43.2% to 44.2% in fiscal 2020, representing 140 to 240 basis point improvement from fiscal 2019. Fiscal 2020 adjusted EBITDA remains in the range of $72 million to $82 million including tariffs. Excluding tariffs, which we view as one-time, adjusted EBITDA would be $102 million to $112 million, representing growth at the midpoint in line with our average annual 20% target. We look forward to continued execution and believe we are on track to deliver our fourth consecutive year of strong revenue and adjusted profitability growth. We are very proud of the Q1 results we have been able to deliver. And with that, we will open the line for questions.

Your first question comes from Rod Hall with Goldman Sachs.

Hi. This is RK on behalf of Rod. Thanks for taking my question. How do you know there was pull forward from promotions as opposed to just better demand? And could you also quantify the magnitude of the pull forward?

We're not going to quantify the magnitude of the pull forward. But if you look at the fact that we're maintaining our full year guidance, we have fully factored in what we think is pull forward.

And how do you know it's not just better demand?

We look at a variety of factors and have conversations with our partners and look at sort of demand signals in the channel and are giving you our best view based on the information we have.

Okay. Could you talk about what you mean by thinking about your products as more than just hardware and including additional business models?

Yes. Hey, RK, it's Patrick here. I think you began to get an appreciation for the kind of things we're thinking about based on a couple of experiments that we were running over the last quarter, something called Sonos Flex that we were running in the Netherlands where you could bundle certain sets of our products into a monthly fee that you pay, which better reflects really what we do as a business, because we're always bringing ongoing value to the customer in terms of new features and functions through our software. So we've been experimenting with that and so stay tuned on that one. We've also started something called Sonos for Business, where we think there's great opportunity to bring all the pillars of Sonos, the simplicity, the great sound, and the freedom of choice to business customers as well. So we've begun some experiments there. And we've really, as you've seen in our R&D investments, we've been ramping up; we believe there's opportunity to bring new experiences to Sonos customers and get us into new Sonos customers by looking at other opportunities to bring services to the platform. And so just like we do with our hardware products, as those are ready and ready for scaling and public consumption, we'll be talking a lot more about those. But I'm very proud of the fact that the team is looking at and spending time not just on where we've been traditionally, but also thinking beyond that and thinking in new areas where Sonos can go.

That makes sense. Thanks for all the color. Just one final question for me. You announced last month that you're not going to provide software updates to some older products. Could you talk about how that impacts replacement rates? And how the initial customer reaction has been?

Sure. That is something that I think we certainly saw how passionate our Sonos customers are from any communication and with the news that we put out there. I mean we didn't get it right in terms of our initial communication, hence by follow-up. And so, I think everybody understands now that the intent was to talk about the fact our products launched anywhere from 10 to 15 years ago are no longer capable of supporting the new features that are going to be coming out in May, but they will continue to be supported with bug fixes and software updates and those kinds of things. And we see that continuing into the future. So I would say we got lots of comments, I got lots of emails and I would say that was probably 70% to 80% of kind of the volume in terms of people asking about that, and most are reassured in terms of the message there. But I think we've always stood for product longevity, it's very different than anybody else in the industry, and we plan to continue to lead in product longevity. Right now, we think that we introduced the Trade Up program which helps our long-time customers be able to move into the latest and greatest products. So that's something we've just started. We're starting to learn from that. So we'll see how that impacts replacement rate over time as we go through that. But at this point, we've been just learning in terms of going through that and we continue to expect that we'll see similar kind of repurchase rates from existing customers as well.

Great. Thanks and congratulations on the good results everyone.

Thanks, RK.

Your next question comes from the line of Adam Tindle with Raymond James.

Okay, thanks. Good afternoon. Brittany, I just wanted to start on revenue guidance. Obviously, congrats on a very strong December quarter. Just hoping on what you, that you can touch on a little bit on what you're seeing here early in the March quarter given the commentary around the pull in. I'm just anticipating some debate tomorrow. On one hand, we could fully understand not wanting to model normal seasonality up a strong quarter due to prudence and conservatism. On the other hand, sure you can sympathize with the fact that this was the quarter last year where there was a channel inventory problem that needed to be corrected. I think there's some speculation that that could be bubbling up again. So just hoping that you can help us understand conservatism versus channel inventory issue based on what you've seen thus far in the March quarter?

Yes, I believe we are confident in our inventory position and we are pleased with our Q1 results. We are not altering our guidance for the year. This provides a clear perspective on how we view Q2.

Okay. And maybe just on that point, cash flow was up nearly I think 30% year-over-year despite the incremental tariff impact. Can you just touch on what's driving such strong trends in cash flow? And how we can think about cash flow as the year progresses?

Yes. Q1 is always our strongest cash flow quarter. We have incredible benefits of scale in Q1. That said, we also had strong working capital management. And of course, because we're really not a taxpayer yet, we had another great quarter where our free cash flow was actually higher than our EBITDA. So those are some of the contributing factors. I think if you looked last year, Q1 would also have been our highest cash flow quarter. And so I think you can think about similar trends throughout the year.

Okay. I have a quick question for Patrick. It seems you're maintaining the EBITDA guidance for the year, suggesting a net loss for the remaining three quarters, which is unusual compared to previous years when it was typically positive by a couple million. You mentioned investments, and I'd like to hear more about those. Can you elaborate on the investments you referred to and what made you confident in making them and what you expect as a return?

Yes, I'll take this one, Adam. I think what we are really doing, as you have seen even starting in the second half of 2019 and then what we are expecting through this year, is that we're making pretty significant investments predominantly in our R&D and product organization. This is to continue to support our long-term product roadmap, our diversification outside of the home. Patrick, spend a little bit of time on how to think about our new potential revenue initiatives that we have been experimenting with. And so we really see this as an important investment for our long-term future and the overall strength of the business for many years to come. Obviously, we are trying to balance that along with strong gross margins this quarter and continuing to deliver on our promise on an average annual 20% EBITDA growth. So we really are balancing the investments we're making with the overall health of the business but feel really good about the opportunities in front of Sonos as a company and where we can take it and the fact that we really are leaders in our products both on the hardware and software side of the business.

Thanks, and congrats on a strong start.

Thank you.

Your next question comes from the line of Katy Huberty with Morgan Stanley.

Thank you. Congratulations on the quarter as well. Brittany, when you look at the second quarter historically, we typically see revenue decline by 50% to 60% sequentially. Should we anticipate a trend within that range, perhaps leaning towards the higher end of the decline given the current pullback? Or is there a possibility that revenue in the second quarter this year will decline more than what we've observed in the past?

Yes. I mean I don't think we're going to start giving real quarterly guidance or shaping the quarter. So the best I can do is to advise looking at last year as a guide and then taking into account our comments about pull in.

Okay. Thank you. And then you mentioned as it relates to gross margin dynamics up 140 basis points to 240 basis points margin expansion, and some of that is product mix. Can you talk about what is the mix shift that's going on in the business that is allowing you to expand gross margins at that rate?

Yes, I think that all of our different products have different gross margins associated with them. And so there is variability for us in any given quarter in terms of how that mix will fall out from a gross margin standpoint. So I would say in Q1 we happened to sell a lot more of our high-margin products. You can look at where we were running promotions and think about how that probably contributed to it. And then it's really that and then some continued improvement in our material costs which led to a very nice quarter.

Okay. And then just one last one maybe for Patrick. You talk about in the investor letter the idea of realizing the value of your IP that may mean patent licensing or other accretive financial arrangements. Can you talk about how many of those type of arrangements you have in place today? And do you see this as a year where there could be an inflection in the number of those arrangements? Thanks.

Hi, Katy, it's Patrick. I'm going to pass you to Eddie, our General Counsel and Lead on IP to answer that one.

Hi, everyone. Thank you, Patrick. So, as we've noted, we think that quite a few players in the space are currently infringing on our patented inventions and we're in discussions with many of those companies. We hope that those discussions will bear fruit in a substantially accretive way. Exactly when that's going to happen we can't say. We view this as really a long-term proposition for the company. It's not something that we have a clock on. But as we've shown now, we're also willing to litigate when necessary if discussions completely break down. So for us, every single one of these circumstances is a little bit different and I wouldn't want to prejudge where we're going to come out. But we are very actively pursuing getting value for what we consider to be extremely valuable inventions.

Eddie, do you have existing licensing arrangements? And Brittany where does that show up in the revenue segmentation I assume in other?

Yes. That would be in our other category.

Thank you.

Your next question comes from the line of Matt Sheerin with Stifel.

Yes. Thank you. And thanks for taking the question. Just regarding the promotional activity you had in the quarter it sounds like that's been very successful. And as you look through the fiscal year, not just the seasonally strong quarters, how has that strategy changed in terms of reaching out to customers? And what should we expect through the year?

Yes, I think you should really expect that we continue to be a premium brand and that we are very selective in terms of when we run promotions and that we are looking at it holistically. But what we have seen from Black Friday and Cyber Monday is that that is an increasingly promotional time of year and customers really expect that companies are getting promotional. We were by no means the most promotional company in our category on Black Friday and Cyber Monday. But to some extent, you really have to make sure that you're ready to play and show up at that time of year. And so, what you saw from us this year was that we planned that we went a bit deeper this year than we did last year, and that really paid off for us as a result. I think we'll see what that means next year. We're not going to get into 2021 at this point. But for the rest of 2020, everything is already planned into our guidance, and we will be continuing to focus on being a premium brand and very selective in our promotions.

Okay. You mentioned, Patrick, that there was a nice increase in the number of registered users. Could you share that number with us? Also, what percentage of customers are purchasing additional products, especially with the IKEA program?

Yeah Matt, we give those on an annual basis. So, we're not providing any on the quarter, but it was a record quarter in terms of the number of new homes. The other thing that was important was IKEA was a significant contributor to that. So our push for partnerships and the work that we've done there, which again is very different from where we've been in the past, has been something that's really helping expand the Sonos system and the software platform into many, many new homes. And so, that's something which we're very proud of and we think has a lot of opportunity for the future.

Got it. Okay. Thank you.

And your next question line of Thomas Forte with D.A. Davidson.

Great. Thanks for taking my question. So as you move your supply chain into Malaysia for products sold in the U.S., how should we think about the potential for your supply chain that stays in China as far as potential disruption from a prolonged coronavirus? Thank you.

Hey, thanks for the question. Look, coronavirus is obviously a very fluid situation. So, it is hard for us to predict with certainty what the impact is going to be there. But from what we see now, based on the information that we do have, we are saying there will be minimal impact and no change to our fiscal year 2020 guidance.

The only thing I would add on that is just that China also isn't a material market for us. So, I know many companies have been talking about this, but I think it's important to note that from a revenue perspective it's not material for Sonos.

Great. Thanks for taking my question.

Thanks, Tom.

Thank you.

Your next question line of Robert Muller with RBC Capital Markets.

Hi. Can you talk a little bit about the integration of the Snips team on how the development of voice assistance is coming along? And are there any kind of targets or goals that you're looking towards in terms of when we actually might see integration into the new products?

The integration is going well, and we're excited by it. I think we found people that share a lot of the beliefs that we have in terms of how to build amazing customer experiences. And I would say stay tuned in terms of the rest.

Yeah, I would say you're going to see them fully integrated in our P&L. So, you're not going to see any call outs related to the Snips acquisition. And like we do with everything on our product roadmap when we're ready to announce something, we'll be really excited to share it with everyone. But we're not putting out timelines on specific product features.

Sure. I know it's a small point, but could you elaborate on why there wasn't a reduction in your tariff expectations? Based on the calculations, it seems it could be a few million at least. I'm curious why an additional rate hasn't changed your expectations.

It is really because of how much of the tariff came through for us in Q1, which is well behind by the transition timeline. And then, we are already in production in Malaysia. So, we moved very quickly on that and are executing there. And so, as we talked about last quarter, our tariff impact is really front-end weighted for the year. And so as we get into the back half of the year, we have largely mitigated that. And that's why you really don't see a material call out for the reduction in the tariff rate.

Okay. Appreciate it. Thank you.

Thanks.

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

I think Patrick you mentioned strong growth in Americas, EMEA was only up 1% constant currency. I'm just curious, what you think the cause was and what kind of gets that back elevated to where you see the U.S. level that?

Yes, I think the important thing to understand there that we referenced a little bit is what's going on in the market as well. And we were able to actually gain share in the key markets there in the U.K. and Germany. And so we feel good about the work that we're doing there as well. And with some of the work that we're doing with IKEA, I think we're in an excellent position. And so, we obviously want to see that continue to grow over time. But at the same time, we feel good about our positioning and being a premium brand like in the categories, we play in, we're in a good position in that market.

I understand that your email about the software updates may have sent a mixed message, but I’ve heard from some friends who have already made the switch to upgrades and are moving forward. Have you noticed any upgrades in the system already, or is it still too early to tell?

The program we've introduced as an option for customers is still in its early stages, so it's too soon to assess its impact. This is the first time in about 16 or 17 years that we've launched something like this, so we'll learn as we go. We also communicated clearly that existing products will continue to function, ensuring customers understand that. While I recognize the concerns regarding revenue and its implications, our focus is on strengthening the brand and fostering customer loyalty. We'll monitor how this evolves over time.

Yes. The only thing I would add is, as you can imagine, we didn't make this decision lightly or quickly. And so to the best that we can estimate these impacts, they are included in our fiscal year '20 guidance.

Great. Thank you.

And turning back over to Patrick Spence for closing remarks.

Great. Well, thank you everybody. We're very excited with the strong start to fiscal '20 and are looking forward to an exciting year. As you can see, we're making a lot of investments, primarily in research and development. And so, we're excited for what lies ahead. And thank you for your support.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.