Hello, and welcome. My name is Suzanne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos Fiscal Second Quarter 2020 Earnings Conference Call. Instructions are provided for the operator’s assistance. Cammeron McLaughlin, Vice President, Investor Relations. You may begin your conference.

Thank you. Good afternoon, and welcome to Sonos Second 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 with music from many of the artists that Sonos has worked with thus far in 2020, including those featured on Sonos Radio. Before I hand the call 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 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 may 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 second 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. Thank you for joining us today. On behalf of everybody at Sonos, we sincerely hope you're managing your way through these challenging times, and our thoughts go to all those impacted by this global pandemic. Since the pandemic hit, our immediate priorities have been to support our people, serve our customers and ensure we weather the storm and emerge stronger. We transitioned to working from home in mid-March and have quickly seen how resilient, adaptable, and agile our people are. Our team has risen to the challenge and maintained an incredible level of productivity and teamwork despite the stresses of stay-at-home orders and life in general. This is evidenced by the fact we launched Sonos Radio on April 21 and are announcing three new products today. We have long instilled a learn-and-adjust culture, and that approach is resonating as we creatively and quickly solve for the needs of our customers, colleagues, and communities. As you can see from our Q2 results and the early Q3 trends, we are operating in volatile and unpredictable times. We're confident that we're well positioned for the long term, and we will emerge stronger from this crisis, but the short-term visibility is challenging, which is why we're withdrawing our prior fiscal 2020 guidance at this time. Our second quarter was challenging as we experienced a 17% year-over-year decline in revenue. Coming off a strong first quarter, we've been expecting some softness in the second quarter. Q2 is usually the quarter where retail partners rebalance their inventories after the holiday quarter. We typically see few orders early in the quarter, and then our partners replenish later in the quarter. This Q2, we saw one of our large U.S. retail partners and our German distributor doing this rebalancing, but we did not see the replenishments later in the quarter as the COVID-19 pandemic hit and everyone started to close stores and focus on health and safety. This led to a 23% year-over-year decline in revenue in March specifically. Despite this, we continued to gain share in the streaming home audio category in the U.S. and U.K. and maintained a leadership position during the quarter, which we attribute to the quality of our products and the strength of our brand. Our continued focus and investment in our direct-to-consumer efforts paid off as we saw a 32% year-over-year increase in our revenue through direct-to-consumer channels in Q2. In April, the first month of our Q3, direct-to-consumer revenue accelerated to approximately 400% year-over-year growth. Of course, most physical retail locations were closed in April, which made it a challenging sales environment to begin with, but we wanted to help make people's lives a little more joyful while they were spending more time at home. So we threw out our original plans. And on April 2, we launched a digital campaign, At Home with Sonos, with some tips on how to get the most of your Sonos and targeted promotional offers that ran through May 5. The other encouraging data point from April was that Move was one of our top-selling products, and it did not have a promotional offer associated with it. This underscores that our products are resonating with consumers and that our brand is premium positioned. Thanks to the success of our direct-to-consumer efforts, we expect that our total revenue in April will decline less than 5% year-over-year. We're pretty pleased with this given the physical retail is closed for the month. It is hard to know what the next few months will bring, and we don't view either March or April as indicative of our natural run rate, but it illustrates that our products and brands are resonating with consumers during this time. One of the most illustrative data points on how strong engagement was in April was listening hours. We experienced a 48% year-over-year increase in listening hours in the month of April. We're proud that we've been able to make life at home a little more joyful for the more than 10 million homes that we're in today. Innovation remains the core of Sonos, both in the products we build and the culture that fuels it. We design products and experiences that are easy to use, deliver brilliant sound, and give users the freedom of choice when it comes to voice and music services. Today, we are excited to announce the launch of Sonos Arc, Five, and Sub. Arc is our premium smart soundbar that brings immersive cinema-quality sound to your home with features like support for Dolby Atmos. Following the many years of success with our Playbar and category leadership, we are thrilled to bring a new premium soundbar to market. This is our best soundbar yet and really epitomizes what we're all about; it's the choice for anyone who loves movies and music. The Five is our most powerful speaker, delivering the same studio-quality sound as the beloved Play:5 and bringing increased memory, processing power, and a new wireless radio. It also features a stunning new front row. Our new Sub features the same iconic design and bold bass as its predecessor but upgrades it with increased memory, processing power, and more. Arc, Five, and Sub will be available this June. We continue to explore the role of services in the future of Sonos and continue to experiment with new business models like we have done in the past with Flex and Sonos for Business. We also continue to see long-term opportunities to expand upon our partnership model and remain pleased with our partnerships with IKEA and Sonance. As you saw in late April, we launched Sonos Radio. We had seen that our consumers are spending nearly half of all listening time on Sonos listening to radio content. Inspired by and built for Sonos owners, Sonos Radio is a free, ad-supported radio service available in the Sonos app. Streaming music, news, sports, and original Sonos programming, Sonos Radio integrates a growing list of 60,000 radio stations into one place. Since launch, a significant number of Sonos households have listened to Sonos Radio and has quickly risen up the ranks to become the sixth most used service on the Sonos platform. While the short term is unpredictable, I'm confident that we're well positioned for the long term, and we will emerge from this crisis well positioned to drive sustainable, profitable growth. I will now turn the call over to Brittany.

Thank you, Patrick. As we have discussed over the last few quarters, Sonos has been focused on balancing strong top line growth and increasing profitability with the need to continue to invest in our business and future products. Despite the significant challenges this quarter and the potential long-term impact from the global pandemic, that is still our priority. Because of that sustainable profitable growth, we continue to be in a position of strength today where we can focus on what is best for the long-term business in addition to taking the necessary short-term actions. We also believe that a prudent balance sheet, along with M&A and share repurchases, is the right capital allocation strategy. And today, that philosophy is serving us well. We ended the second quarter with $283 million in cash and cash equivalents and very minimal long-term debt. We also have in place an $80 million undrawn revolver, providing even further flexibility. We have run a variety of scenarios, as you can imagine, and are confident in our cash position even if a weak economic condition persists. During the second quarter, we used $83.5 million in cash from operations, largely due to the timing of inventory payables following our holiday quarter. Q2 is typically a seasonal low quarter for cash. As we look at the rest of the year, we continue to focus on managing our cash and preserving our strong balance sheet. We also repurchased approximately $30 million of our stock early in the quarter. We currently have approximately $17 million remaining under the $50 million repurchase authorization. In March, we took action to review our planned investments for the year and made adjustments to preserve flexibility and liquidity while continuing to support our critical business needs. As you have seen, we have adjusted our marketing approach, both by reducing certain planned investments while also launching the At Home with Sonos campaign. We have taken steps to manage our inventory more tightly given the end market weakness and eliminated many discretionary expenses beyond just travel and typical in-office expenses. We are focused on having a lower operating expense run rate in the second half of fiscal 2020 as compared to the first half, which means we have also paused on some of the continuing hiring and investments we were making. You should expect some variability around sales and marketing given the timing of events in Q3, including our promotion and new product launches. We are confident that these are the right measures to take at this time, but we'll continue to review and adjust as we learn more over the coming weeks and months. Revenue in the second quarter decreased 17% or 16% on a constant currency basis to $175 million. Coming off a strong first quarter, we had highlighted that we were expecting some softness in the second quarter from demand pull-in. As Patrick noted, we also saw challenges, primarily from a large partner in the U.S. rebalancing inventory as well as weakness in our German market from inventory rebalancing with our distributor. Overall, across all of our markets, there was a significant impact in March from the weakened global demand environment and broad-based physical retail closures stemming from the COVID-19 pandemic. This impacted both end demand and replenishment orders from our partners in the majority of our end markets. As a result, our revenue in March declined 23%. Sonos speaker revenue represented 66% of total revenue during the second quarter and decreased to 27% from the prior year. We believe this category was more significantly impacted by inventory rebalancing measures and the effects of COVID-19 on consumer demand. In contrast, our Sonos system products revenue, which represented 27% of total revenue during the quarter, increased 22% year-over-year driven by the performance of Sonos Amp and the launch of Sonos Port in late fiscal 2019. Partner products and other revenue increased 4%, driven primarily by our IKEA and Sonance partnership, which launched in the second quarter of fiscal 2019. In April, as discussed, we launched our At Home with Sonos program. We thought it was important to get back in front of consumers with relevant messaging and opportunities during this challenging time. As Patrick mentioned, Sonos Move was one of our best-selling products even without a promotion. We have seen an increasing percentage of our sales shift to online purchasing during the quarter given the physical retail closures. Our direct-to-consumer revenue during the second quarter increased 32% year-over-year. We saw this further accelerate in April with approximately 400% year-over-year growth in our direct-to-consumer channel. Overall, April is showing meaningfully better trends compared to March. We expect total revenue in April to decline less than 5% year-over-year. We are very pleased with these results given physical retail remains mostly closed. This represents a significant shift in consumer-buying behavior for our products, primarily to the online channel. This is also improving our inventory position relative to Q2. Gross margin during the second quarter declined 130 basis points due to the introduction of tariffs in September 2019. Excluding the effect of tariffs, gross margin would have increased 230 basis points to 45.3%. Total tariff expenses through the first half of the year were approximately $26 million. We have not experienced any lasting impact due to COVID-19 as it relates to our manufacturing capacity. Currently, we still expect to complete our supply chain diversification into Malaysia by the end of the year. We have also submitted a request for exclusion from List 4A and are hopeful that we will obtain a positive outcome. As a reminder, since February 13, we have been subject to a 7.5% tariff on goods imported from China. Now for a little more color on OpEx. During the second quarter of fiscal 2020, GAAP operating expenses increased 11% on a year-over-year basis. While we made some significant reductions starting in March, we had also been investing for long-term growth. Overall, the majority of the increase is driven by higher headcount in our R&D organization as we continue to invest in new products and features. Research and development expenses increased 24% to $49.6 million. This includes the addition of the Snips team. Sales and marketing expenses increased 2% to $50.5 million, and G&A expenses increased 9% to $26.1 million, primarily due to an increase in legal fees related to our IP litigation. Excluding the $1.7 million in IP litigation fees during the quarter, G&A expenses increased 2%. Year-to-date, we have generated adjusted EBITDA of $64.8 million. Adjusted EBITDA for the quarter was a loss of $28.4 million. As we look forward to the rest of the year, we don't know what a normal run rate for our business looks like when physical retail will reopen or how the economy will recover. Given the uncertainty, unpredictability, and volatility, we are withdrawing our previously issued revenue, gross margin, and adjusted EBITDA guidance for fiscal 2020. Despite the challenging environment, we are excited about what we have seen from our 5-week At Home with Sonos campaign, the ongoing engagement from our customers, and the launch of Arc, Five, Sub, and Sonos Radio. We believe that the strength of our balance sheet allows us to continue making prudent investments, and the resiliency of our teams as they continue to operate from home allows us to continue delivering great experiences. We believe we are well positioned and capitalized to create value over the long term. And with that, we will open the line for questions.

I hope you all are staying healthy and safe. A couple of questions from me. Does the incredible success of the direct channel in the month of April change your thinking about the path to market for your business over the long run? And how do you think about the advantages of having that direct customer relationship versus the advantages of having a larger third-party store network?

Katy, it's Patrick. I'll take that one. Yes, I think that in times like these, what happens is trends that were already underway accelerate in a big way. In the last two years, our fastest-growing channel has been our DTC channel. It relates to the type of product that we create but also the importance that we see around our brand. The day-to-day engagement through the system, the kind of listening hours we see, and the engagement in why we're experimenting with Sonos Radio shows that ongoing engagement with our customers. We've invested in it, and we're going to continue to. If you had told me that we could grow DTC the way we did in April, there were some bumps in terms of a little longer hold times on the phone for people doing telesales, and we had some delayed shipments, but all in all, it was amazing to deliver that level of growth and satisfy customer demand. It was very encouraging for the future, and I do think it's an important part of our future. This makes me think about how much more we put our foot on the gas regarding these kind of things. It definitely validates this will be an even bigger part of our future. We are the ones ensuring our customers get product quickly, which ultimately strengthens the brand for the long term and is obviously good for the bottom line as well. So we are definitely considering how we continue to build on this in the future.

That's great. And then a follow-up, Brittany, how should we think qualitatively about the remainder of the quarter? Obviously, the promotions ended May 5, but then you have three new products shipping for the second half of June. Do you think there will be enough sell-in that we could see some strength off those new products?

It's a great question, Katy. I mean, I think one of our challenges in looking forward, even for the rest of the quarter, has been that the two months, March and April, have behaved so differently. Obviously, part of that was probably people were really getting their heads around what this meant in March. In hindsight, there was probably some of this that even started in February as people began anticipating this given other things going on around the world. The drastic difference we saw in April makes it really hard for us to predict what else we think is going to happen in Q3. So we've got the headwinds of physical retail continuing to be closed, who knows when that's going to reopen, and then you've got the balance from us of this strength in our DTC channel and the new products coming out. We're ending April with a much better inventory position, so we'll need to see when we start receiving some of those replenishment orders in Q3. It's just tough to call when that will happen.

Okay. And Patrick, can I just squeeze one more in, high level? How would you describe the differentiation of Sonos Radio versus other music streaming services? Do you see it as cannibalistic of the other platforms or more of a complementary service?

Absolutely complementary. There's always been a radio service on Sonos, but we hadn't touched it in 15 years. What we've done is use it as an opportunity to showcase what’s possible in our app now. Obviously, there are monetization benefits on advertising. We are cautiously entering the services space, which we’re excited about. It also presents the opportunity for partners to showcase certain playlists or stations. I think it's going to be very complementary. It allows us to showcase the best of Sonos and how an integrated solution can be and demonstrate to our partners what's possible with our app inside the Sonos ecosystem. It's good all around.

Actually, I just want to follow up on the fiscal third quarter here. I know you're not willing to provide guidance, but I thought maybe you might be able to provide us some sense as to how revenues kind of trended through April and into the first part of May here. And then also, I think you mentioned that your inventories have kind of rebalanced but also want to get a sense for where they stand right now.

Yes. John, as we look at revenue in April, it's down less than 5% year-over-year. So that's a pretty big contrast to our down 23% in March. And yes, it's still down, but we're pretty happy with that number given how much of physical retail has really remained closed. We're seeing a huge shift in demand to DTC in online sales. That's the best color we can give on Q3 because it’s what we know. It’s less about unwillingness at this point and more about how challenging it is to predict the future right now.

Okay. That's fair. And then just with regards to the growth in the direct-to-consumer business, how large is that now as a percent of sales? Is that kind of 15%? Is that in the ballpark? And also how sustainable do you believe that growth will be as we move beyond the pandemic here?

Yes, we didn't disclose it as a percentage of sales for this quarter. We just gave you the growth numbers. It was last at 12% of sales in fiscal year '19, so you can triangulate from there. In terms of sustainability, I think we're very pleased with the results. As Patrick mentioned, we're going to work hard to keep that momentum in the DTC business, but part of that will depend on how permanently consumer buying habits have changed and when they want to return to physical retail stores. So we'll have to see how consumer buying behavior evolves after this environment.

I wanted to start with you, Brittany, and see if you could address whether the U.S. distribution channel and U.S. retail partner, along with the German distributor, have restocked their inventory. Did that restocking happen in April, or do you expect it to happen in the next few months? Or is that uncertain?

Yes. So we're characterizing it as a bit of rebalancing. There were inventory rebalancing measures that we had called in Q1, and we did see some inventory rebalancing from those two partners. However, COVID-19 hit and caused a drop-off in demand so that the end markets significantly weakened. With physical retail closures, everyone has been more careful about how much inventory they hold, leading to a lack of replenishment orders. I think we're in a much better inventory position now, which sets us up well to start receiving replenishment orders. However, it depends on the retailers, the channel, when physical retail opens, and how each retailer is managing demand.

Okay. All right. And then I wanted to come back to this point of direct distribution, Patrick. I mean, obviously, it's unfortunate this has all happened, but it seems fortunate for direct distribution. I wonder if you have any ideas on how you might keep people on that platform in the future since it's such an attractive distribution methodology for you, both from a brand perspective and a financial perspective.

Yes. Thanks, Rod. I think what we've learned is people are willing to purchase audio products online without necessarily needing to listen to them first. We're seeing data showing that people are comparing shipment times. We were in a position to quickly deliver our products, making it an attractive option for customers. Our communication throughout this period was focused on how Sonos products can enhance their home experience, and we found people appreciated that. It’s essential to ensure ongoing communication about our products and understand our customers' needs. Customers are willing to engage with us, and many have chosen to trade up their older products. We’ll continue to invest in our DTC channel and capitalize on this momentum.

Yes. Patrick, just a follow-up regarding your comments about the upgrade program. You've got three new products coming out, and you also have your new app and operating system unveiling next month, which would appear to be catalysts to prompt people to upgrade. So could you talk about what you're seeing there in terms of that upgrade program and whether the new app will be a catalyst?

Yes. Matt, I think it will be. We haven't typically seen these cycles because we try to build products that last for a long time. The engagement and listening hours on Sonos have been incredible. The quick rise of Sonos Radio shows high engagement levels with our brand. The DTC growth supports ongoing trade-up activity as we try to bring more innovation to customers. In terms of the upgrade program, early results have shown significant appetite, and we expect that to increase as we launch our new products and features.

Yes. It's a great question. We've been providing margin information with and without tariffs. The manufacturing shift to Malaysia is on track, and we are still aiming for completion by the end of the fiscal year. We're also optimistic about our request for an exemption from tariffs, which could mitigate that impact on gross margins. Currently, our margins sit at 45.3%. From a product mix perspective, we’ve been doing well in terms of sales channel mix. As a result, the mix of products we sell impacts our gross margin.

Understood. And just one last question I can sneak in here. Regarding Sonos Radio, could you discuss its contribution to profitability? Or is it more about marketing and customer engagement in the initial stage?

Probably too early to talk about that one. We really just launched it, and as we scale the model and see reactions from our customers, we can discuss it in later quarters. For now, it is too early to determine its impact on profitability.

Okay. Patrick, I just wanted to start on the shift in consumer buying behavior to online channels. Can you touch on the opportunities and threats this shift brings? Specifically, what do you see long-term concerning your competitors who dominate online search and e-commerce?

Yes, thanks, Adam. There are a couple of angles here. One is what our competitors are doing on the product side, which is different from our approach. Our data shows we've gained share across both quarters in the streaming audio category. As for e-commerce, we've been thoughtful about our channel mix, and we're not overly dependent on any one partner. We're excited about our continuing investments in DTC, and we prioritize quality relationships with all our channels. The crisis has accelerated some macro-level trends in physical retail. While there will always be a place for physical stores, our strong DTC channel indicates a positive outcome for our brand's future growth.

Yes. In April, we saw a decline of less than 5% year-over-year, which contrasts with March's 23% fall. While it’s still a decline, we’re pleased considering physical retail closures. We're witnessing a shift to online and DTC. The full impact of our ongoing promotions in April makes it hard to predict normalized performance for May and June. The results we've seen support our direct-to-consumer strategy.

Thanks, Suzanne, and thanks to all of you for joining. I know it's a strange, challenging time, but I appreciate you taking the time given everything happening in the world right now. I want to thank our team for stepping up incredibly to launch Radio and all the products today. It's been inspiring to see our people persevere through this and showcase their creativity. Our teams setting up testing at home has been amazing. It's that spirit and creativity that sets us up well for the long term. We’re proud to bring a little joy to people's homes during this time, and that’s what we intend to keep doing. We have exciting new products coming, and we're optimistic about our future. Thank you again, and we’ll talk soon. Take care.

And this concludes today's conference call. You may now disconnect.