Earnings Call: Q3 2019

Aug 7, 2019

Good afternoon. My name is Kavitha, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Sonos Fiscal Third Quarter 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and Thank you. I will now turn the call over to Mr. Mike Greninger, Vice President of Corporate Finance. Thank you. Good afternoon, and welcome to the Sonos fiscal Q3 2019 earnings conference call. I'm Mike Groeninger, VP of Corporate Finance and with me today are Sonos' CEO, Patrick Spence and CFO, Brittany Bagley. For those joining the call early, today's hold music comes from the Q3 playlist included in our shareholder letter. The playlist was inspired by our exciting collaboration with IKEA. Before I hand it over to Patrick, I'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 our expectations reflected in the forward looking statements. A discussion of these risk factors is fully detailed under the caption Risk Factors in our filings with the SEC. During this call, we will also refer to non GAAP financial measures, including adjusted EBITDA and adjusted EBITDA margin. For complete information regarding our non GAAP financial information and a quantitative reconciliation of those measures, please refer to today's shareholder letter regarding our Q3 fiscal 2019 results posted to the Investor Relations portion of our website. I'll now turn the call over to Patrick Spence. Thanks, Mike, and thanks to all of you for joining us today. I'm pleased to report our 4th consecutive record quarter with 25% year over year revenue growth and year over year improvement in our adjusted EBITDA, turning a $7,000,000 profit compared to a $2,000,000 loss last year. Given such a strong quarter, I think it's a good time to remind everyone that we think about our business on a long term basis. I'd encourage you to continue measuring our progress on an annual basis against our stated goals of 10% plus annual revenue growth and 20% plus annual adjusted EBITDA growth. I'm very pleased we continue our progress towards another fiscal year delivering on that, thanks to our Q3 performance. As you all know, our business is not always smooth quarter to quarter given new product release timing and seasonal buying trends along with other factors, but we continue to feel very good on delivering consistent and steady growth over the course of a year while improving our profitability. We continue to look at the whole year and multi years forward as we think about our business. As I mentioned previously, accelerating new product velocity has been a primary focus area, as well as thinking more expansively about new addressable markets and how to monetize the Sonos technology platform. Our collaboration with IKEA, which launched in stores August 1st with some fantastic press reviews, is the perfect example of Sonos delivering against these ambitions. This collaboration represents a new business opportunity for Sonos where our technology power speakers manufactured and sold by our partner, IKEA. The new product line, Symphonisk, is the result of close collaboration between Sonos and IKEA and is an innovative way to bring the Sonos experience to new customers at a global scale. IKEA has unparalleled reach and offers a completely new distribution footprint to Sonos' existing network. We are in approximately 300 IKEA stores across 18 countries with more countries launching through 2020. The collaboration brings the Sonos ad experience to new unique form factors at new price points and to new countries. The $99 price point is particularly interesting as we believe it has the potential to significantly expand our audience by bringing Sonos into millions of new homes. Once introduced to the simplicity of the Sonos experience, we anticipate many customers will consider adding additional Sonos products to their homes. You'll see this revenue show up in our results as our module revenue, as we are selling IKEA hardware with embedded software. In Q4, we look forward to consumers experiencing the 2 new innovative products we have developed with IKEA and to sharing something new we know customers will love. I'll now turn it over to Britney to say a few words. Thank you, Patrick. This has been my 1st full quarter as CFO of Sonos, and I'm delighted to share these strong results with you. Revenue grew 25% year over year with strength across the board in terms of both geography and products. The Americas grew 18.4%, EMEA grew 16.6% and APAC, including our module sales to IKEA, grew 168.1%. Our wireless speaker category grew 11%. Our home theater speakers grew 34%, largely due to the continued success of our Beam soundbar. Components grew 14%, continuing helped by the launch of our new Sonos Amp and other, which includes the IKEA modules and our accessories grew 220.8%. In addition to new products and the launch with IKEA, it has been great to have the Google Assistant available this quarter. Q3 also had strong gross margin performance at 45.1%. We are up sequentially from Q2 due to the benefit of cost reductions and a one time rebate from our contract manufacturer. We are down 70 basis points from last year, primarily due to a reduction in licensing revenue and unfavorable foreign currency exchange impacts. Overall though, this was a strong gross margin quarter, but consistent with variability we expect within a year. OpEx continues to show investment in R and D as we increase our software efforts to support our long term roadmap. Investment in G and A helps us continue to scale as a public company. And sales and marketing continued to show leverage even with the launch of Google in Q3. We will continue to make investments in Q4 as we prepare for the holiday quarter. In September, we'll be excited to share the details of our lineup with you. Obviously, with the announcement of tariffs last week, we are focusing on managing that impact. The good news is that we have been preparing for this potential and have been moving towards diversifying our supply chain outside of China. We believe this is a good business decision for Sonos longer term and we'll continue to pursue this regardless of the vicissitudes of the tariff discussion. For fiscal year 2019, the minimal impact of tariffs starting September 1 at 10% is already included in our updated guidance. With all of this, we are pleased to reconfirm and tighten our revenue guidance for the year in the range of $12.50 to $12.60 of revenue. This represents 10% to 11% year over year growth, which is consistent with our long term annual target, even including the impact of challenging FX trends and a difficult environment in Europe with Brexit. We are also confirming our EBITDA at the high end of our range of $86,000,000 to $88,000,000 or 25% to 28% year over year growth above our long term target of 20% growth in EBITDA annually. We are excited for what we feel was a great quarter and what is shaping up to be a very strong year for us. With that, I'll open it up for questions. And our first question comes from Rod Hall with Goldman Sachs. Yes. Hi, guys. Thanks for the question. I guess, Brittany, I wanted to come back to the updated guidance. I know you guys called out the FX impact in the 1st three quarters. Could you help us understand that I mean your new implied guidance for fiscal Q4 is $20,000,000 $21,000,000 below consensus and at midpoint anyway. And I just wanted to see if most of that currency or can you break that down at all that deviation from consensus? Just kind of help us understand that and then I have a follow-up. Yes, sure. So I think our prior guidance was $12.50 to $12.75 So we're well within our prior guidance range. And I would view the fact that we are coming in sort of at the lower end of that prior guidance range really to be attributable to FX. We quantify FX to be about a $20,000,000 headwind for us so far this year. So that is a big part of it for us. And then obviously, we had a nice quarter in EMEA this quarter, but Q1 and Q2 had some fairly challenging trends in EMEA that we are working to recover from. And so while we continue to see really excellent performance in the Americas, I think it's a couple of those pieces that land us where we're landing for the year. And again, while it is at the low end of guidance, it's 10% to 11% growth, which is really what we target for the year. And so we're feeling pretty good about where we think we're landing the year. Okay. And then I just on my follow-up, I just wanted to clarify the comments on tariffs. You said it's contemplated in the guidance. I wonder if you could just kind of help us understand, is there any material impact from tariffs here or there's not really very much impact because you're able to move the supply chain around? Just kind of help us understand what's under the covers on the tariff impacts there. Yes. So because of our fiscal year end and when tariffs are contemplated going into effect, it's really a 1 month impact for us. And so it really is very minimal for fiscal year 2019. And could you say though for that month like what the impact looks like? I'm not going to break that out. We are doing a of things, including moving the supply chain to mitigate the impact of tariffs. This fully went into effect last week. So we're working quickly and we are comfortable saying that it's pretty minimal for 2019 and it's already included. Okay, great. Thank you. And our next question comes from Katy Huberty with Morgan Stanley. Thank you. Good afternoon. Congrats on I also wanted to ask a clarification on guidance, then I have a question. On guidance, you talk about incremental R and D and marketing spend in the Q4. Was all of that baked into your original guidance? Or are you spending more given your outlook for the products or given the outperformance on margins? Yes. I would say we really focus on annual guidance so that we have some flexibility quarter to quarter. So it was largely contemplated, but it really is coming together where we have been able this year to continue to support that spend in R and D. And we've gotten some excellent leverage out of sales and marketing. And so it's been contemplated, but what we're really signaling is that it's time for us to make some product, but any color around feedback around expectations for demand versus original expectations that IKEA had for that product? And then how should we think about the timing and the pace of IKEA coming back and adding to the orders for those products? Hey, Katy, it's Patrick here. I'll take that one. So we're 6 days in, to your point about being very early in terms of where we are. There's been it's been great to see, I think, the media reaction and the reviews that started to hit just before they launched. And even today, I saw The Guardian did a 5 star review on the Symphonix lamp product, which is awesome to see. We've seen a lot of customers on social media raving about the products. So we're feeling good about where it is as is IKEA, but it's way too early to speculate on what this might mean to the forecast or anything else in that regard. And it is I would also say it is a new way of doing business for us and kind of like a whole new area in terms of the way that we conduct our business here in terms of selling them the hardware and embedded software. And so that's a little bit different. I want to make sure that as we go through that, that we get that right. So at this point, excited by what we've seen so far, feeling good about that, but it's too early to know, does it change anything that we have in our plans today? And what's the I think that's right. Katie, I was just going to add that because of the way we do the relationship with IKEA, we really know where that's going to land for fiscal year 2019. So any variability that we talked about, we'll start to talk about in November when we provide guidance on 2020. But I would view it as being pretty locked for fiscal year 2019. Okay. That's helpful. Can I just ask one more question on the recovery in growth in Europe? How much of that is tied to adding Google Assistant, which has become the number one voice assistant in the European market lately? Yes, it would at this point, I wouldn't attribute it to that. I think we called out that we had a promotional program that we tried in Europe and that went very well in the quarter. It's still early on the Google Assistant front. So, we and we've obviously built that into our plan as we thought about the year. So nothing on that front that everything on that front has made us help reconfirm our guidance for the year and is in line with kind of what we were expecting to this point. Okay. Thank you so much. Our next question comes from Adam Tindle with Raymond James. Okay. Thanks and good afternoon. Patrick, I just wanted to start with the R and D investment picking up to maybe revisit the outside the home initiative that you've alluded to in the past. I know it's hard to get into specifics, but hoping to ring fence it a little bit. So I guess where would you kind of set the boundaries on the markets that you'll choose to attack? How can we think about you guys competing with potentially a different set of competitors in that? And then also any sort of timeline that you can give us for that initiative? Obviously, we see a lot of opportunity in the future in a variety of markets that are there in the audio space. The when we came into home audio, there were a lot of competitors that were incumbents that had well established positions and we think we bring something unique to the table. And I think as I've mentioned before, any of the new categories we enter will bring a unique perspective to and the unique Sonos attributes around things like freedom of choice and great sound and easy experience. And so we're being thoughtful about and when we enter those categories and approach that. And we just are excited about the investments we're making there to make that happen. But I also want to make sure that we don't tip our hand in terms of when we're going into particular new product categories. But we're very excited about the product roadmap that we have right now, and I think it's the best one we've had in my seven and a half years at Sonos for sure. Okay, that's helpful. And then maybe one for Brittany just on the operating model. You've had, I think, 4 quarters of revenue growth meaningfully outpacing OpEx growth on a year over year basis. But based on guidance, it looks like that trend is going to reverse in Q4. So I'm just hoping that you can maybe touch on an OpEx metric that you're targeting as it because it's increasing as a percent of revenue in Q4. So just wondering if that continues. And you sound committed to the 10% revenue growth, 20 percent EBITDA growth. So in light of this OpEx increase, is that still something that you think is achievable for the near term future? Great question. Yes, we absolutely do. You've seen a lot of OpEx leverage from some of the restructuring that we did in the sales and marketing team and that's given us a pretty significant benefit. But we are still going to be smart about where we invest behind supporting new launches, building our brand. And then to Patrick's point, we are excited about where we're investing in R and D, but that's also to help us drive long term future growth. And so we are very committed to the 10% top line and then the 20% EBITDA. And I think in our guidance, even with some additional investment in Q4, we're still So we feel pretty good So we feel pretty good about the metrics and the balance and we really do look on it on an annual basis rather than trying to time anything in a specific quarter. Okay. That's helpful. Thank you. And our next question comes from Elliot Alper with D. A. Davidson. Great. Thank you for the questions. So how should we think about the rollout of the IKEA locations and the revenue contribution for that effort heading into the next year? So you'll see IKEA disclosed in APAC and other for us. We're not going to break it out in more detail than that until it gets to be a more significant portion of our revenue. We're in 300 stores, 18 countries, 6, 7 days into it. We like the press coverage we're getting. And we're pretty locked for the year on where we're going to come out on IKEA. And as I mentioned earlier, any improvement or performance or anything that you see in that would be included when we come back and give 2020 guidance. Okay, great. And then just a follow-up, Prime Day was longer this year than it's ever been. Did you notice any material difference in sales in July? So Prime Day and July fall in Q4 for us. And so we look at Q4 as a whole inclusive of that and look forward to providing an update on that whether or not it was meaningful when we release our Q4 results. Yes. Thank you. And our next question comes from Matthew Sharon with Stifel. Yes, thanks and good afternoon. Just another question regarding the improvement in gross margin and the guide up on that. I know you talked about some cost cutting. I know one of the headwinds for that business or that margin has been higher component costs and I know a lot of those components are now easier to get. So how much of that is relative to the lower component costs? And then that contract manufacturer credit that you talked about, could you tell us how many basis points that might have benefited the gross margin? Lots of good questions in there. So I'll start with we're not sort of changing our long term guide on gross margin and this is all baked into the updated guidance we provided for 2019. So, it was a really nice quarter on gross margin, but I wouldn't necessarily extrapolate that out. We're not going to break out the impact of the contract manufacturer, but it was a nice help in that quarter. And then overall, our operations team has done a very nice job of mitigating some of the component cost increases. So those have come in much better for the year than I think we were all expecting at the beginning of the year and has been a meaningful help for us on a gross margin basis generally. Okay. And looking at the IKEA business and other businesses that or business relationships that you may have similar to that. Is the margin profile of that business similar to your own direct business or is it different? The margin on our module business is different. It's a different product for us. And again, we don't break it out, but I think we have talked about how the fact that our module gross margin is a bit lower than our general products. On the other hand, we don't have some of the other OpEx costs associated with our normal Sonos product line. And so overall, we consider it to be very beneficial to our bottom line performance. Okay, great. And just last question, if I may, regarding the IKEA launch and those products and particularly the $99 speaker, which appears to be selling well. Is there any concern about cannibalizing your low end speakers, the PLAY 1 or is that a different audience that you're trying to reach? That's a different audience that we think we're reaching in a different form factor as well. And so we're excited because, well, as you know, Matt, this gets into somebody's home and they end up buying more. And so we really see this as a great way to establish ourselves in millions of new homes. And they use the Sonos app, they get a begin to get an understanding of the Sonos system and from there out of Sonos 1 or out of Beam over time and we'll have to see what that looks like, but we're confident that that trend will play out in time. So we see it as net accretive. Okay. Thanks very much. And there are no further questions at this time. And I'll turn it back over to the presenters. Thank you. Thanks again for everybody's time today. To close, I'd like to reiterate that the strength of our Q3 earnings keeps us right on track to deliver our planned revenue and EBITDA growth for this year. We're delivering against promised new product velocity as well as expanding the reach and scope of our platform, introducing the Sonos experience to millions of new customers. With IKEA's Symphonisk in market in Q4, we look forward to consumers enjoying the first fruits of this strategy, and we also look forward to sharing something new later this quarter that we know customers are absolutely going to love. We hope you'll take some time to enjoy the playlist we included in the shareholder letter. This one was inspired by our collaboration with IKEA and features some of our favorite Swedish artists. Thank you and have a great day. This concludes today's conference call. You may