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spk07: My name is JL and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos third quarter fiscal 2024 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. I would now like to turn the conference over to James Boglanis, head of investor relations and treasury. You may begin.
spk01: Good afternoon, and welcome to Sonos' third quarter fiscal 2024 earnings conference call. I'm James Viglanis, and with me today are Sonos CEO Patrick Spence, CFO Sayori Casey, and Chief Legal and Strategy Officer Eddie Lazarus. For those who joined the call early, today's hold music is a sampling from our Sonos radio station, Backyard Barbecue. 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 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 2024 results posted to the investor relations portion of our website. As a reminder, the press release, supplemental earnings presentation, and a conference call transcript will be available on our investor relations website, investors.sonos.com. I will now turn the call over to Patrick.
spk02: Thank you, James. And hello, everyone. It was the magic of the Sonos experience that brought me to the company 12 years ago. We pour our heart and soul into everything we do, and we're proud of what we build and the way Sonos brings joy to our customers' lives. That's why it's so painful to let customers down the way we have with our new app. I am committed to making this right with our customers and partners. It's the company's number one focus right now, and I will not rest until we're in a position where we've addressed the issues and have customers raving about Sonos again. A few years ago, we decided to embark on a complete ground-up rewrite of our app. One reason was to address the performance and reliability issues that had crept in over the last 20 years and were negatively affecting our customers' experience. This would have been reason enough, but as important, we viewed re-architecting the app as essential to the growth of Sonos as we expand into new categories and move ambitiously outside the home. In addition to its more modern user interface, the new app has a modular developer platform based on modern programming languages that will allow us to drive more innovation faster and thus let Sonos deliver all kinds of new features over time that the old app simply could not accommodate. Some of these new features are already on our drawing boards and could represent our entry into new categories. Others are still to be imagined. But without a modern app, they would have remained beyond our reach. For Sonos, a company built on innovation at the intersection of software and hardware and the delivery of joyful experiences, we needed the new app to set ourselves up for the future. While the redesign of the app was and remains the right thing to do, our execution, my execution, fell short of the mark. Since I took over as CEO, one of my particular points of emphasis has been the imperative for Sonos to move faster. That is what led to my promise to deliver at least two new products every year, a promise we have successfully delivered on. With the app, however, my push for speed backfired. It's important to note that this was really a redesign of the entire system, not only the app, but also the player side of our system, as well as our cloud infrastructure. And this was an enormously complex undertaking. As we rolled out the new software to more and more users, it became evident that there were stubborn bugs we had not discovered in our testing. As a result, far too many of our customers, especially those with some of our older products in their systems, are having an experience that is worse than what they previously had. For some, this meant existing speakers missing from their Sonos systems, while others saw latency issues or errors while setting up new products. Regardless of the issues experienced, our customers deserve better from us. The app situation has become a headwind to existing product sales, and we believe our focus needs to be addressing the app ahead of everything else. This means delaying the two major new product releases we had planned for Q4 until our app experience meets the level of quality that we, our customers, and our partners expect from Sonos. While this has the painful effect of reducing our Q4 sales expectations, we believe it will set our future products up for greater success over the medium to long term. We have been working tirelessly on fixing the bugs in the new app, adding back certain features and exploring every option for improving the customer experience. Since launch, we've introduced nine new software updates that address these issues. We expect the app will get better every two weeks with each subsequent release, and we're committed to continuing to improve the experience on that same cadence and even faster where we can. We are able to rapidly deliver these major software updates because of the modular developer platform of our new app. I want to highlight three important areas where we're taking action. First, fixing the app. I've asked Nick Millington, the original software architect of the Sonos experience, to do whatever it takes to address the issues with our new app. We've identified the key bugs, have a plan to fix them, and are improving our processes and staffing to ensure we successfully execute our action plan. One of our board members, Tom Conrad, has over 30 years of experience in software engineering, and Tom is helping us ensure our software efforts are on the right track, as well as providing another expert perspective. Because we expect that our app will continue to get better every two weeks, we're making more and more customers happy with each release. We're doing everything we can to put all of these issues behind us in time for the important holiday season. The second is supporting our customers. We are increasing our investment in customer support to be able to engage with more of our customers and partners and do it faster. Our customer support has always been something that has set us apart and we need to ramp this faster to help our customers navigate in the near term. And finally, winning back our customers and partners. We are enacting programs this quarter to both support and thank our customers and partners for sticking with us through this period and turn their dissatisfaction to delight. These programs will run across Q4 and Q1. We expect these investments will come at a cost in the range of $20 to $30 million in the short term, but are necessary to right the ship for the long term. And given we've been at this for 20 years, we know it's needed to win in the long term. Now turning to the other important launch from the quarter, I'm pleased to share that even with the challenges of the app, our first headphones, Ace, are off to a good start. As you may have heard me say before, this is our most requested product ever. Headphones is a very exciting category for us to play in as the premium over the ear headphone category is a 5 billion addressable market growing by double digits annually, which stands in contrast to the cyclical downswing we continue to navigate in our existing categories. Our goal of participating in more and more categories is to continue to diversify our revenue streams and headphones are a great opportunity to do just that. The customer reviews have been outstanding as Sonos ACE is rated 4.6 of five stars on Sonos.com and 4.5 of five stars on Best Buy. In its first month, ACE gained a meaningful share in the premium over the year category in our key countries, despite competitors dropping their prices and offering unprecedented promotions in tandem with our launch. We take those competitor actions as a compliment to the quality of our offering. To support the launch of ACE, we signed a number of new distribution partnerships. Last quarter, I mentioned we went live as a first-party seller on Amazon in the United States. We have since expanded this partnership to Europe. Additionally, you can now find Sonos Ace on the shelves of InMotion stores in many major airports around the world. InMotion is a premier airport electronics retailer, and we are delighted to build upon this partnership over time. Ace represents an evolution of the role that Sonos can play in your life. With our categories, we are very well established in the home, and we will continue to innovate there. For the first time, ACE enables us to be with you all day long, to be a part of the major moments in your day, whether at home, in the office, on a plane, or out for a walk. This is integral to our mission of being everywhere our customers experience sound. To recap, it is deeply disappointing for me personally and for all of us at Sonos to be on track for the first three quarters of the year and to have a successful new product launch in an exciting new category. only to revise our expectations for the fourth quarter due to the challenges with our new app. Of all the reasons that could have taken us off track, knowing that it is because we failed our customers and partners is perhaps the most painful. I want to reiterate again that the entire team and I are committed to making this right with our customers and partners. It's my number one focus, and I will not rest until we're in a position where we've addressed these issues and have customers raving about Sonos again. I'll now turn it over to Sayori to take you through our financials.
spk00: Thank you, Patrick. Hi, everyone. Q3 revenues came in slightly ahead of our expectations at $397 million, up 6% year-over-year. Our positive year-over-year growth was driven by the introduction of our first over-the-year headphone, Ace. This brings our year-to-date revenue to $1,262.7 million, down 6.5% year-over-year. Though our financial results over the past three quarters have put us on track to meet our annual expectations, the challenges from the launch of our app requires us to adjust our Q4 expectations, as Patrick mentioned earlier. I'll come back to this after I finish recapping our Q3 performance. GAAP gross margin was 48.3%, up 230 bps year-over-year, considerably better than our guidance we gave last quarter. This overperformance was primarily due to a one-time benefit from improved inventory management. Gross margin increased sequentially from our second quarter due to fixed cost leverage from higher revenue in Q3 and inventory management. Our Q3 performance brings our year-to-date gross margin to 46.4%, up from 43.6% in the comparable period last year. Non-GAAP adjusted operating expenses were $155 million in the quarter, down $2 million sequentially. Adjusted EBITDA was $48.9 million, representing a margin of 12.3%, ahead of our guidance driven by higher gross margins and, to a lesser extent, higher revenue. This brings our year-to-date adjusted EBITDA to $130.5 million, representing a margin of 10.3%. We ended the quarter with $277 million of net cash, which includes $50 million of marketable securities, as we hold some excess cash in short-duration treasury bills. Free cash flow in Q3 was $40.3 million, bringing our year-to-date free cash flow to $188 million, compared to $38 million in the comparable period last year. This increase was primarily driven by working capital improvements resulting from focus on better managing our inventory through adjustments to our sourcing plans as well as implementation of newly adopted payment terms with our suppliers. Our period in inventory balance was $155 million, down 48% year-over-year, and down 14% from last quarter. This consists of $102 million of finished goods and $53 million of components. We are working hard to keep inventory balances in check. And finally, we returned $52.5 million to our shareholders through stock repurchases in the quarter, representing 2.6% of common shares outstanding as of Q2. We have $71 million remaining under our current $200 million of share repurchase authorization. We expect to continue to be active in the market purchasing our stock. Turning to our guidance, the Q4 outlook we're providing reflects our best estimates as of today. As previously mentioned, we're reducing our expectations for the fourth quarter fiscal 2024 as a result of challenges stemming from the rollout of our new app. We expect Q4 revenue in the range of $240 to $260 million. The challenges with our app have had a twofold impact to our Q4 revenue expectations. One, lower sales across our portfolio due to app launch issues. Two, the decision to delay the launch of two major new products until our app experience meets the level of quality that we, our customers, and our partners expect from Sonos. As a result of the reduction to Q4, we expect a revenue in the range of $1.503 to $1.523 billion for the full year. We expect Q4 GAAP gross margins in the range of 40% to 42%, down sequentially from Q3, driven by deleverage resulting from lower revenue. For the full year, we expect GAAP gross profit dollars in the range of $682 to $696 million, representing a gross margin of 45.4% to 45.7%. We expect non-GAAP gross margins to be approximately 40 bps higher due to approximately $6 million of stock-based compensation and amortization of intangibles included in GAAP cost of revenue. We expect Q4 adjusted EBITDA to be in the range of minus $37 million to minus $14 million, resulting in full year adjusted EBITDA in the range of $93 to $117 million, representing a margin of 6.2% to 7.7%. The reduction in our expectation for adjusted EBITDA is primarily due to lower revenue. As Patrick mentioned, from now through the holidays, we're investing approximately $20 to $30 million in fixing the app, supporting our customers, and regaining their trust. We expect that this will come in the form of revenue and gross profit reductions, as well as operating expense increases. A portion of this investment that will be incurred in Q4 has not been factored into our guidance range. Despite the reduction in our expectations for Q4, we still expect to show significantly improved free cash flow conversions versus last year due to our efforts to improve working capital. We have spoken in the past about our focus of expense management driving efficiencies across the organization. In the spring, it became clear that we needed to do more structurally and evolve how we operate. As a result, we began working on a transformational cost initiative that we will provide an update in November. With that, I'd like to turn the call over for questions.
spk06: Thank you.
spk07: The floor is now open for questions. If you have dialed in and would like to ask a question, please press star 1 on your telephone keypad to raise your hand and join the queue. If you would like to withdraw your question, simply press star 1 again. If you are called upon to ask a question and are listening via loudspeaker on your device, please pick up your handset to ensure that your phone is not on mute when asking your question. We do request for today's session that you do limit yourself to one question and one follow-up. Thank you. And again, to join the queue, it's star 1. Just a moment for your first question. Your first question comes from the line of Adam Tindall of Raymond James. Your line is open.
spk05: Okay, thanks. Good afternoon. I wanted to start, Patrick, on the two products that are being pushed and appreciate you taking responsibility and I think have garnered a lot of trust from customers over time. On those two products that are pushed, how can you give us a sense of how far along those products were? And as we think forward to a time where, you know, these near-term headwinds are through us and into fiscal 25, would that be, you know, a potential year where you might envision, you know, if that stuff gets behind us, we'd have, you know, something like four product increases, sorry, introductions or are those kind of indefinitely pushed?
spk02: Thanks for the question, Adam. These products were ready to be shipped in Q4, but as we've mentioned, we felt like it would be that we had to address the app issues first because we hold a high bar on the experience we want customers to have. So that is the number one focus at this particular point in time. And so I don't want to get too far into fiscal 25, but I will say these products were ready to ship in Q4.
spk05: Got it. Okay. And understand, obviously, all the near-term pain that we're enduring on the app. But as you kind of think about the longer-term vision, once we get through this, you talked about being with customers all day long. I wonder if you might just expand on that vision over time, what that could bring. From a Sonos perspective, could there be a time where this app, given the modular development that you're talking about, could introduce new monetization streams? Anything that you could give us from an investor standpoint as help as to what the long-term vision would be as we endure some of the short-term pain.
spk02: Yeah, thanks, Adam. I think that's a good one. You know, we remain confident that over the long term, we can take more and more of that hundred billion dollar audio market. We're only two percent, less than two percent of it today. And definitely the work that we've done on the app was the right work as we position ourselves for the future and build more. You know, kind of build what we need from a future proofing and allowing us to be outside the home in all of those areas. And so we feel we have a lot of opportunity ahead in new categories. But also right now, the number one thing for our customers is to make sure that we address the app and earn back that trust so we can extend into all of those new categories we have plans for.
spk07: Your next question comes from the line of Steve Frankel of Rosenblatt. Your line is open. Thank you.
spk06: Good afternoon, Patrick. Obviously a lot to work through here. When we look at the magnitude of the revenue reduction in Q4, maybe give us some help parsing through how much of that is to the products that aren't going into the channel and how much is the app issues causing a significant slowdown in sell-through, and to the extent that's the case, where are channel inventories relative to where you want them to be for Q4?
spk00: Hi, Steve. This is Sigori. I can take that. And so the way we characterize the impact, the Q4 reduction to our expectation in two folds. One, first, in the larger of the two is the lower sales across our portfolio due to the uptrend. issues. And second, material enough to mention, and certainly is the delay in the launch of our two major new products that were ready to go, as Patrick just mentioned. And so those were sort of in order of magnitude to the impact of the guidance reduction. As far as channel inventory for Q, at the end of Q3, knowing our Q4 revenue now that we're continuing to monitor very carefully, you know, that would put us a little bit higher than we would have liked now knowing our trend currently. But certainly that impact is comprehended in our Q4 guidance that we gave today, best we know as of today.
spk06: Okay. And then on the $20 to $30 million number of If a portion of that is price protection in the channel, is that already reflected in gross margins or might gross margins end up lower if you end up putting more price protection into or discounts into effect to goose sales?
spk00: Yeah, the Q4 guidance that we gave out does not fully comprehend the $20 to $30 million that we mentioned today. That has impact, as I mentioned, to multiple line items of the P&L, revenue, gross profit, and operating expenses, and also the timing in which it would hit between Q4 and Q1. And so some actions are already underway. But there are others that are a little bit more in progress in determining exactly how to position that to your point about whether that's a price protection type of activity that we would hit in Q4 versus Q1. We believe more will hit in Q1 than Q4 at this point, best we know.
spk07: Thank you. Your next question comes from the line of Brent Phil of Jefferies. Your line is open.
spk03: Hi, this is Rayana Matraji on for Brentsville. Thanks for the question. Could you speak a bit more to the issues from the app rollout and the impact it could have on purchase intent for hardware going forward?
spk02: Yeah, thanks, Rihanna. So, you know, we, a few years ago, we embarked on a complete roundup rewrite of the app. We wanted to address the performance and reliability issues. And we also wanted to create something that would allow us to expand into new categories and bring a lot of new features to the system. So, you know, redesigning the app was definitely the right move for Sonos. But we, you know, we fell short on our execution of this one. And, you know, I think we're seeing the short-term pain that we're having right now in that rollout, but it's our number one priority right now to address this. And so I believe we will be able to address this, determined that we will address it in the short term and be able to make sure that we keep our flywheel intact for the future.
spk03: Okay, cool. And then what are you seeing in the demand environment in general? Has a weaker macro evolved? further impacted consumer spend, or is that hard to tell with the app problems as well?
spk02: You know, our categories have really been under pressure for the last two years. So we continue to believe that they will recover at some point. But what we are focused on is best positioning for what we see today, right now. Part of this is also why we are undergoing the cost transformation initiative that Sayuri had mentioned, and also why it's so important that we entered the premium over the ear headphone category, as that is a $5 billion market and growing double digits.
spk07: Thank you. Your next question comes from the line of Eric Woodring of Morgan Stanley. Your line is open.
spk04: Hey, guys. Thanks so much for taking my questions. Patrick, I know you guys are alluding to, you know, the 20 to 30 million of costs in the near term. I'm just wondering if you take a step back and think about, you know, the potential reputational damage that you could have from this app update. You know, could that be longer lasting and more kind of cost intensity you know than just 20 to 30 million i mean you know if you go through i'm sure you have a number of message boards um there's a lot of backlash and so i'm just wondering if there's a longer term plan here in place outside of you know fixing the app and promoting you know what else you have in store to to try to get those customers that have either been loyal customers or new customers that were potentially considering sonos products to actually come back after this, and then I will follow up.
spk02: Thanks. Yeah, thanks, Eric. So I think the key is to address the pain points that we have right now and those customers that are having issues with the new app. For sure. But remember, we're not standing still on the innovation front. So we have two major new products that we're pushing out again to make sure that we're in a position where the app issues are behind us. As we do that and as we launch those, we launch other products we have planned, we do our day-to-day execution in the channels and in marketing and all our other areas, people will, you know, be able to see the products, they'll experience our products. And I'm confident that, you know, with the roadmap we have, with the innovation we have coming, that this will be, you know, just one chapter in our long history. And so we do feel like the 20 to 30 million is what it takes to, you know, address the short-term pain and that with everything we have coming, we'll be able to ultimately address that pain and then get back to a place of customers raving about Sonos.
spk04: Okay, understood. And then just maybe as my follow-up, I wanted to make sure I was fully understanding, Sayori, some of your comments. So the 4Q guide does not incorporate those $20 to $30 million of costs? I'm just trying to understand if you flagged them for us, but then you're not including it in the guide. Does that mean we need to include $20 to $30 million of costs in 4Q, or are you saying that those are likely to come in fiscal year 25? Thanks.
spk00: You're correct that the 2030 is not comprehended in our Q4 guidance. Part of it is because the $20 to $30 million will be incurred over Q4 and Q1. And majority of it, we expect it to be incurred in Q1. There are some activities that are already in progress, but there are others that we're still vetting through the details. And so we did not want to detail that out in our guidance until we have a better clarity for Q4 specifically.
spk07: Thank you. There are no further questions at this time, thus concluding our Q&A session. We'll now turn the conference back over to CEO Patrick Spence for closing remarks.
spk02: Thanks, JL, and thanks to all of you for your time today. Just three things I want to hit in closing. First, building a new software foundation was the right investment for the future of Sonos, but our rollout in May has fallen short of the mark. We will not rest until we've addressed the issues with our app and have delivered new versions that materially improve our customers' experiences. Second, while our app setback is regrettable, it is one chapter in our over 20 years of delighting customers. I speak for everyone at Sonos when I say that our number one priority is to make this right and ensure that the next chapter is even better than the previous ones. And finally, our entry into headphones, Ace, is off to a good start and presents a great opportunity for us in a new, large, and growing category. Thank you, and we'll talk to you again next quarter.
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