Thank you for standing by. My name is Dale, 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. [Operator Instructions]. I would now like to turn the conference over to James Baglanis, Head of Investor Relations and Treasury. You may begin.

Good afternoon, and welcome to Sonos' third quarter fiscal 2024 earnings conference call. I'm James Baglanis and with me today are Sonos CEO, Patrick Spence; CFO, Saori 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.

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 #1 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 rearchitecting 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…

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-ear headphone, Ace. This brings our year-to-date revenue to $1.2627 billion, down 6.5% year-over-year. Though our financial results over the past 3 quarters had 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 onetime 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 and 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…

[Operator Instructions] Your first question comes from the line of Adam Tindle of Raymond James. Your line is open.

I wanted to start, Patrick, on the 2 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 2 products that are pushed, can you give us a sense of how far along those products were? And as we think forward to a time where these near-term headwinds are through us and into fiscal '25. Would that be a potential year where you might envision, if that stuff gets behind us, we'd have something like 4 product introductions? Or are those kind of indefinitely pushed?

Thanks for the question, Adam. These products were ready to be shipped in Q4. But as we've mentioned, we felt like 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 #1 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.

Got it. Okay. And understand, obviously, all the near-term pain that you'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? Just 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.

Yes. Thanks, Adam. I think that's a good one. We remain confident that over the long-term, we can take more and more of that $100 billion audio market. We're only less than 2% 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 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 #1 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.

Your next question comes from the line of Steve Frankel of Rosenblatt. Your line is open.

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 new 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?

Hi, Steve. This is Saori. I can take that. And so the way we characterize the impact of the Q4 reduction to our expectation in two-folds. One, first and the larger of the 2 is the lower sales across our portfolio due to the app issues. And second, material enough to mention and certainly, it's the delay in the launch of our 2 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 at the end of Q3, knowing our Q4 revenue now that we're continuing to monitor very carefully. 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.

Okay. And then on the $20 million to $30 million number, 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 or discounts into effect to boost sale?

Yes. The Q4 guidance we gave out does not fully comprehend the $20 million 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.

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

This is Rayyana Matraji on for Brent Thill. 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?

Yes. Thanks, Rayyana. So 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 redesigning the app was definitely the right move for Sonos, but we fell short on our execution of this one. And I think we're seeing the short-term pain that we're having right now in that rollout, but it's our #1 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.

Okay. Cool. And then what are you seeing in the demand environment in general? Has a weaker macro further impacted consumer spend, or is that hard to tell with the app problems as well?

Our categories have really been under pressure for the last 2 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 Saori 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.

Your next question comes from the line of Erik Woodring of Morgan Stanley. Your line is open.

Patrick, I know you guys are alluding to the $20 million to $30 million of costs in the near term. I'm just wondering if you'd take a step back and think about the potential reputational damage that you could have from this app update. Could that be longer lasting and more kind of cost intensity than just $20 million to $30 million? I mean if you go through, I'm sure you have a number of message boards, there's a lot of backlash. And so I'm just wondering if there's a longer-term plan here in place outside of fixing the app and promoting. What else you have in store 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 have a follow-up. Thanks.

Yes. Thanks, Erik. 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 2 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 be able to see the products, they'll experience our products. And I'm confident that with the roadmap we have, with the innovation we have coming, this will be just one chapter in our long history. And so we do feel like the $20 million to $30 million is what it takes to 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.

Okay. Understood. And then just maybe as my follow-up, I wanted to make sure I was fully understanding, Saori, some of your comments. So the 4Q guide does not incorporate those $20 million to $30 million of cost. I'm just trying to understand, if you flag them for us, but then you're not including it in the guide, does that mean we need to include $20 million to $30 million of cost in 4Q? Or are you saying that those are likely to come in fiscal year '25? Thanks.

You are correct that the $20 million to $30 million is not comprehended in our Q4 guidance. Part of it is because the $20 million 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 better clarity for Q4 specifically.

Thank you. There are no further questions at this time, thus concluding our Q&A session. I will now turn the conference back over to the CEO, Patrick Spence, for closing remarks.

Thanks, Dale, and thanks to all of you for your time today. Just 3 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 #1 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.

This concludes today's conference call. You may now disconnect.