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. [Operator Instructions]. 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 3 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…

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,…

[Operator Instructions]. Our first question comes from the line of Katy Huberty of Morgan Stanley.

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 changed 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 the -- in times like these, I think what happens is trends that were already underway accelerate in a big way. And as you know, in the last two years, we've -- our fastest-growing channel has been our DTC channel. And it goes to the type of product that we create but as well the importance that we see around our brand. And I think the day-to-day engagement through the system, the kind of listening hours we see and as well the engagement and why we're experimenting a bit with Sonos Radio is that ongoing engagement with our customers. And it all comes together, right, in terms of how people use the product and then, as well, how they add another Sonos product to their system. So I do -- we've invested in it. We're going to continue to. If you would have told me that we could grow DTC the way we did in April, and it wasn't without some bumps in terms of like a little longer hold times on the phone for people that were doing telesales and like we had some delayed shipments through there, but all in all, it was amazing to deliver that level of growth and be able to satisfy customer demand. It was just very encouraging for the future. And so I do think it's an important part of the future. And this is one of those times where you take stock of the strategy and how much more do you put your foot on the gas around these kind of things. And so it definitely makes me think this is going to be an even bigger part of our future. And it also points out that in these kind of times, we are the ones that ultimately made sure that we're getting people product quickly, and it's all about trying to deliver to the customers as best as possible. There were a lot of distractions from the other channels, right, in going through this. And so some are focused on essential goods and those kind of things, and so we -- it's something that we think is important. We think we can meet the customer demand and I think strengthens the brand for the long-term and is obviously good for the bottom line as well. So we are definitely thinking how we continue to build on this into the future.

That's great. And then a follow-up, Brittany, how should we think just 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 2 months that we really have, March and April, have behaved so differently. And so obviously, part of that was probably people were really getting their heads around what this meant in March. And in hindsight, there was probably some of this that even started in February as people started anticipating this given other things going on around the world. But with all of that, the sort of 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, the new products coming out. And as I mentioned, we're ending April in a much better inventory position. So when do we start to see some of those orders and replenishment orders coming into Q3. So with all of that, those are sort of the factors we're thinking through and one of the reasons it's really hard to guide or get a good handle on what the rest of Q3 or the year will look like.

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? And do you see it as cannibalistic of the other platforms or more of a complementary service?

Absolutely complementary. There's always been the radio service on Sonos. We hadn't touched it in 15 years. We've -- what we've done is use it as an opportunity to showcase what's possible in our app now. Obviously, there's the monetization benefits on advertising. And so we're putting our toe in the water on services, which we're excited about. But it also does present the opportunity for partners to showcase their certain playlists or stations and those types of things. And so I think it's going to be very complementary. And again, it allows us to showcase the best of Sonos and how an integrated solution can be and show our partners what's possible with our app inside the Sonos ecosystem. So I think it's good all around.

And our next question comes from the line of John Babcock of Bank of America.

Actually, I just want to follow up on the question on kind of the fiscal third quarter here. I know you're not really 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, so 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 I think we're pretty happy with that number given how much of physical retail has really remained closed. So we're just seeing a huge shift in demand to online in DTC. So that's really the best color we can give on Q3 because that's what we know. It's sort of -- it's less of an unwillingness at this point and more of it's just really hard to predict what the future will look like even a month from now.

Okay. That's fair. And then just with regards to the growth in the direct-to-consumer business, and I know we kind of already asked about this as well. But I mean, generally, where -- how large is that now as a percent of sales? Is that kind of 15%? Is that kind of in the ballpark? And also how sustainable do you believe that growth actually is as we kind of move beyond the pandemic here?

Yes, so 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 that's the last percentage of sales number we got. So you can triangulate a bit from there. In terms of sustainability, I think we're very pleased with the results. And as Patrick was talking about, we're going to work hard to make sure that we can keep some of that continued momentum in the DTC business. But part of that will depend on how permanently have consumer buying habits changed and when do they want to go back into the physical retail stores and is this a permanent trend for the consumer. And so I think we're going to have to wait and see a lot on how consumer buying behavior actually changes coming out of this environment.

And our next question comes from the line of Rod Hall with Goldman Sachs.

I guess, Brittany, I wanted to start with you and just see if you could answer -- I know that Patrick in his comments talked about the U.S. distribution channel, U.S. retail partner and then the German distributor not reloading on inventory. And I wondered if that inventory reload occurred in April or do you anticipate it to occur in the next couple of months, the end of this quarter? Or do you -- does not know? That's the first question. Then I have a follow-up to that.

Yes. So we're characterizing it as a bit of rebalancing from -- so it's 2 things. There was inventory rebalancing that went on, which I think we had called in our Q1 that we did think there was some demand pull-in, and we were trying to get a view on some softness in Q2. And so we did see some inventory rebalancing from those 2 partners. What we then saw was COVID-19 hit and a real drop-off in demand so that the end markets were much weaker. And then with the closure of physical retail and everyone being much more careful about how much inventory they hold, we saw a lack of replenishment orders. And with weaker demand, there was also enough inventory that everyone had. So as we come through April, we think we're in a much better inventory position. We think that, that sets us up well to start getting replenishment orders. But it's kind of anyone's guess on when those will really come in. It will depend on the retailers, the channel, when does physical actually reopen, how well is each retailer doing with their online sales, how are they seeing demand. So there's a bunch of factors that make it hard for us to call when that will happen.

Okay. All right. And then I wanted to come back to this point of direct distribution, Patrick. And see -- I mean, obviously, this is -- it's unfortunate, this has all happened but, in a way, lucky from a direct distribution point of view, I guess. And I wonder if you have any ideas, or how you might keep people on that platform in the future since it's such an attractive distribution methodology for you, both I think from a brand point of view as well as a financial point of view.

Yes. Thanks, Rod. And I think the thing that we've learned is people are willing to purchase audio products in a big way online. So they're not having to listen necessarily as we go through it. So people found -- and we saw through the data, people were comparing like the shipment times, too, right, through this period. So it's kind of -- it's a -- I think the proposition has to be, in this day and age, how quickly are you going to get it from a partner. And when were in a position where it was quickest to get it from Sonos for sure, obviously, in terms of going through this. We -- as well our customers, we communicated a lot in terms of how Sonos could help in your home office, how it can help you enjoy all that -- all of the video streaming that you're watching and how Beam plays into that, the home cinema side, all of these things. And we communicated like never before in the month of April as well. And I hear from a lot of our customers, and I did not hear that we overcommunicated. And so I think that ongoing communication about what we're doing is actually a really important learning from the month of April as well. And our product was born at the home and built for this time. And so we're -- I'm very proud of the fact that we're bringing joy to people's homes in this time. And so I think we've learned that we can engage even more with our customers. The other thing that we had and we saw was people trading up, right, to get to the new products, I think, as people were home and saying, you know what, now is…

Our next question comes from the line of Matt Sheerin of Stifel.

Yes. Patrick, just a follow-up regarding your comments about the upgrade program. You've got 3 new products coming out. You also have your new app and operating system unveiling next month, which would also appear to be a catalyst 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 or will be helpful there?

Yes. Matt, I think it will be. And you know from our history, like we haven't really been through these cycles, I think, because we try to build products that last for a long, long time. And probably the best example right now we're going through are with Amp and Port, right, in replacing products from 12 to 15 -- that we launched 12 to 15 years ago. And so I think the -- given the -- the thing I would point you to is the level of engagement, the listening on Sonos over these 2 months has been incredible. The quick jump-up the charts of Sonos Radio shows the engagement level there and then with the DTC brand and engagement and trade-up. And so that is something we've just started the journey on. We launched the program late last year. In terms of where we tested it, we made sure we could go and deliver it. We made some adjustments, right? We didn't get it right with recycle mode when we first launched the program. So we changed that up, and listened to customers and changed that up. And then through this period, I think we're learning there is appetite there. And it's a little early to really build that in as we think about the future, but it will be interesting to see what we learn because we won't be pushing on people to replace their Playbar with an Arc. But we have so many avid fans, and I can tell you from having done it in my own home, it is night/day difference, right? The Arc just takes it to a whole new level. It will be really interesting to see what we learn on how that drives over time and what our customers really want to do here. But I'm pleased with where we are on the trade-up cycle. And S2 that you referenced, the S2 that we're rolling out our new OS and app, just sets us up well for the future and to be bringing more innovation to the platform through high-res audio and some of those other things that I think will help us over time bring even more customers up to the newer products. And so I'm excited about what we're doing on that front.

Okay. That's helpful. And just a question on the gross margin. I know there's a lot going on here. You had that promotion in the month of April, which sounds like it was very successful. You also have still some headwinds on tariffs and your manufacturing shifting out of China. So could you talk about how we should think about gross margin?

Yes. It's a great question. So I would say we have been providing it with and without tariffs to start. So that's sort of the biggest delta in terms of how we've been talking about it. From a manufacturing standpoint, we still think that we will diversify for our U.S.-bound production into Malaysia by the end of the year. Now I say that's sitting where we are today, there's a lot that has to go into the world getting back to normal at some point to make sure we can make that a smooth transition. But from where we sit today, we still see that happening by the end of the year. And then if that happens, we will not be subject to tariffs anymore unless the tariff program shifts. We're at a 7.5% tariff now, so it went down as of February 13 from the 15% we were paying before. And then we have also applied for an exemption. And so optimistically, we would hope to get that exemption, and then that would be another mitigant on the tariff factor, but there are sort of multiple ways where we're working to remove tariffs from the mix from a gross margin standpoint. Without tariffs, we were at a 45.3% gross margin for the quarter. That is higher than our general long-term guidance of 42% to 44%. And what you're seeing here is really how we're doing from a product mix standpoint. And then we have some benefit from channel mix in the quarter as well. So going forward, where we land on that margin framework will really depend on the mix of the products we're selling, the channels we're in, how good a job we're doing at negotiating down our material costs. Obviously, the higher our volume, the more leverage we have on some of those negotiations. And so those are the things that we're looking at as we go forward. Obviously, we're pulling guidance. So we're not really providing any updated guidance for gross margin in this point either, but those are the factors that are worth thinking through as you think through what could happen to our gross margin in future quarters.

Understood. And just one last question, I can sneak in here. Just regarding the Sonos Radio, which sounds like that's been also successful to begin with. Could you talk about sort of the P&L model there? And what should we think about in terms of contributing to profitability? Or is that more sort of a marketing customer engagement type of model that we should be maybe thinking about?

Probably too early to talk about that one. We really just launched it. And so as we scale the model and see what kinds of reactions we get and how our customers react and all of that, then I think we'll be more prepared to talk a little bit about that very reasonable question in later quarters, but it's just too early in terms of our launch.

And your next question comes from the line of Adam Tindle of Raymond James. .

Okay. Patrick, I just wanted to start on the shift in consumer buying behavior to online channels. I just want to touch on kind of the opportunities and threats that it brings. I think you touched on some of the opportunities in the prepared remarks. Specifically on the threat, you do have one competitor that dominates online search, you've got another competitor that dominates e-commerce. It doesn't look like it's impacting now as you talked about gaining share in the quarter, you can still see it's up significantly. But I just wanted to give you a chance to maybe address that longer-term big picture concern on those 2 major competitors.

Yes. Thanks, Adam. I think the -- there's a couple of angles on that, right? One is what they're doing on the product side. And we've always talked about the fact that, from a product perspective, they're trying to achieve something very different than we are. And through Q1 and Q2, it's been interesting because they haven't been as active in the marketplace like even at the -- even for the pops as much. And so as I mentioned, and I think as we said in our letter, too, fiscal Q1 and fiscal Q2, in the streaming audio category, we've gained share in our major markets across both quarters. And so it's been interesting to see that because there hasn't been as much focus, and I would say, from them. And so it's kind of interesting at the end of the day. And I think we have to be prepared, and we are prepared that they come back at it a little bit more focused in the fall, right, when the usual launch things happen. But we'll see, right, in terms of that front. And then I think when it comes to e-commerce, we've been very thoughtful about the way that we've created our channel mix and, over the last 2 years, our investments in DTC. So I am not -- I do not think that we are unduly tied to any one partner in all of this, online or off-line, in terms of where we are. We value all of the relationships and the work and the value that our channels add. I think one of the channels that probably gets underappreciated, quite frankly, is our installed solutions channel that does a lot of the Amp and support work and a lot of the installations. And so I think…

Okay. That's helpful. And Brittany, just as a follow-up, I wanted to circle back to the comment about less than 5% year-over-year decline in April. If I heard you correctly, it doesn't sound like that was driven by some onetime baked replenishment boost or something like that. The environment isn't getting worse in May incrementally. I know it's challenged. You have 3 new products hitting in June. Are there offsets that I'm not thinking about here to where the June quarter could be worse than that 5% year-over-year decline that you're already experiencing in April?

I think the big thing that went on in April, and it was really the first 5 weeks that we ran our At Home with Sonos promotion campaign, and so I think the question will be that did a great job of getting us back in front of consumers with really compelling offers. And so as that campaign is over as of yesterday, what does that look like for a normalized run rate in May and June. If it hadn't -- if we had had an April where we weren't running a campaign, I think we might have been able to say, okay, this might be a good sort of run rate base, but we really need to see how the reaction is when we're off the At Home with Sonos promotion campaign.

Okay. The one thing I just -- the one thing I'd throw on there or 2, Adam, is just that everyone was at home, right? So it was -- there were 2 kind of factors. One was promotion, we upped the level of communications in how people get the most of their Sonos. But let's not forget as well, millions of people were stuck at home, and so we don't know as some of these things begin to lift to like do people -- what's the behavioral change that we're going to see to. So I'd just flag that.

Got it. Everyone's asking three questions, so I might as well, as well. I was a little bit confused on April getting better, but then the decision to do the OpEx reduction. So maybe just talk about how you went through that. If you've kind of gotten past the worst, April is getting better, why do we need to take actions on the cost structure right now?

So we took our cost actions in the beginning of March. So when this hit, we tried to react pretty quickly to take some cost actions and those were really -- I mean there are things that sort of everyone has done, including people aren't traveling, we've been able to significantly reduce our in-office expenses. And then we've also looked at ways we can bring down discretionary spending in all of that. We're really trying to strike the balance between taking cost actions where we think it's prudent for the business. While also continuing to invest in R&D and product and our future road map so that we come out of this pretty strongly. And I think the only sort of comment on future OpEx would be we don't have guidance to give. We don't know where Q3 will land. We don't know that it will land at that April number of less than 5%. So we need to keep watching and being flexible and nimble and balancing sort of the right decisions for the business from both a long-term investment standpoint and OpEx profitability cash flow standpoint.

[Operator Instructions]. Your next question comes from the line of Brent Thill of Jefferies.

Great. It's James on for Brent. Just to -- could you touch on the strength of Sonos Move that you saw in April? Is there anything in particular that you'd call out that's driving that strength? Is it most of the DTC business? Just any color there would be helpful.

James, I think it is -- as we've thought about it, I think it wasn't on promotion. So I flagged that, which is pretty interesting. But the -- obviously, the other side of this is it is becoming springtime. And people are going outside around their home and that kind of thing. And so I think the -- we are watching it closely, but that probably has something to do with it. It's been a very well rated and reviewed product throughout. We had seen some really good strength in Australia when we launched it there last fall when it was heading into Australian summer. And so I think that seasonality is an interesting aspect of it. I also think the versatility as we had new homes come in and be thinking about which product they're going to choose, Move is obviously one which has a degree of versatility that other products do not. So I think the reasons we built the product are starting to really prove out now, which is pretty exciting for us. And so we'll see how it trends through the rest of this spring and into summer period, but it's a really good green shoot right now.

Yes, that's really helpful. Just another one, just curious how your supply chain is holding up given the shift to Malaysia. I believe that they're still on lockdown. So just -- would just be curious to hear some color on what you're hearing from suppliers there and how we should think about that going forward.

Yes. I mean I think we're calling out that we don't think that there is a material or lasting impact to our supply chain from this. China is already back up and running. And then we are diversifying between China and Malaysia. And so we are continuing to go through that process. They are on lockdown right now, but they're, I think, expected to open up again in the middle of May. And so from what we can see now, we would be on track for our diversification into Malaysia by the end of our fiscal year, sort of consistent with our plans. If they do end up in lockdown for much longer, then we'll come back and update that view, but that is our best view based on current information.

And our next question comes from Elliot Alper of D.A. Davidson. .

Wafer [ph] called out yesterday, adoption sales of stimulus checks came through. I was curious if you had all saw this as playing a role in better month in April.

I wouldn't call that out for our business specifically, but of course, it can be hard to tell.

Okay. And then you spoke about cash preservation, still have some left on the repurchase authorization. How are you guys thinking about buybacks for the rest of the year?

Yes. I mean I think, in any environment, we don't really talk about the timing of when we plan to execute against our authorization. So we're very focused on liquidity and our cash balance right now. We continue to think that our stock is at an attractive valuation level, and we're not pulling or suspending our repurchase program. And so we will see what makes the most sense for us as we continue to work through that authorization.

I'd now like to turn the call back to Patrick Spence for closing remarks. .

Thanks, Suzanne, and thanks to all of you for joining. I know it's a strange times, challenging time. So I really appreciate you taking the time given everything that's going on in the world right now. I want to say thank you to our team who has stepped up in an incredible way to make sure we could launch Radio and all the products today. It's just been incredible to see our people just persevering through this, the creativity. We've had people doing lab testing at home and make-shift labs in their kitchens, bathrooms. I mean it's just been incredible to see. And I think that creativity and spirit sets us up well for the long term. And I'm just really proud that we've been able to bring a little joy to people in their homes during this period of time, and that's what we plan to continue to do. We've got some great new products as we go forward. We've got some experiments we're trying like Radio, so I think we're well set up for the future in the short term. A little hard to know what's going to pan out, but I'm very optimistic and think we're well positioned for the long term. So thank you again, and we'll talk to you soon. Take care.

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