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Edited Transcript of SONO.OQ earnings conference call or presentation 7-Aug-19 9:00pm GMT

Q3 2019 Sonos Inc Earnings Call

Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Sonos Inc earnings conference call or presentation Wednesday, August 7, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brittany Bagley

Sonos, Inc. - CFO

* Michael Groeninger

Sonos, Inc. - VP of Finance & Global Liquidity

* Patrick Spence

Sonos, Inc. - CEO, President & Director

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Conference Call Participants

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* Adam Tyler Tindle

Raymond James & Associates, Inc., Research Division - Research Analyst

* Elliot Alper

D.A. Davidson & Co., Research Division - Analyst

* Kathryn Lynn Huberty

Morgan Stanley, Research Division - MD and Research Analyst

* Matthew John Sheerin

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

* Roderick B. Hall

Goldman Sachs Group Inc., Research Division - MD

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Presentation

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Operator [1]

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Good afternoon, my name is Camille, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos' Fiscal Third Quarter 2019 Earnings Conference Call. (Operator Instructions) I would now turn the call over to Mr. Mike Groeninger, Vice President of Corporate Finance.

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Michael Groeninger, Sonos, Inc. - VP of Finance & Global Liquidity [2]

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Thank you. Good afternoon, and welcome to the Sonos' Fiscal Third Quarter 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 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 third quarter fiscal 2019 results posted to the Investor Relations portion of our website.

I'll now turn the call over to Patrick Spence.

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Patrick Spence, Sonos, Inc. - CEO, President & Director [3]

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Thanks, Mike. And thanks to all of you for joining us today. I'm pleased to report our fourth consecutive record quarter with 25% year-over-year revenue growth and year-over-year improvement in our adjusted EBITDA, turning a $7 million profit compared to a $2 million 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 managing 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 the 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 1, 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, SYMFONISK, 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 sound 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, 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 Brittany to say a few words.

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Brittany Bagley, Sonos, Inc. - CFO [4]

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Thank you, Patrick. This has been my first full quarter as CFO of Sonos, and I'm delighted to share these strong results with you. Revenue grew 25% year-over-year with the strength across the board in terms of both geography and product. The Americas grew 18.4%; EMEA grew 16.6%; and APAC, including our per 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 sound bar; components grew 14%, continue -- helped by the launch of our new Sonos Amp; and other, which includes the IKEA modules in 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 onetime 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 impact. 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&D as we increase our software efforts to support our long-term road map. Investment in G&A helped 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 will 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 million to $88 million, 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 is 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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question comes from Rod Hall with Goldman Sachs.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [2]

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I guess, Brittany, I wanted to come back to the updated guidance. I know -- you guys call out the FX impact in the first 3 quarters. Could you help us understand it? I mean your new implied guidance for fiscal Q4 is $20 million, $21 million below consensus and at midpoint anyway. And I just wanted to see if -- do you -- is 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.

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Brittany Bagley, Sonos, Inc. - CFO [3]

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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 million 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 the 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.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [4]

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Okay. And then I just -- my -- on my follow-up, I just wanted to clarify the comments on tariffs. You've 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 tariffs impacts there.

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Brittany Bagley, Sonos, Inc. - CFO [5]

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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 '19.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [6]

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And could you say though for that month, like, what the impact looks like?

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Brittany Bagley, Sonos, Inc. - CFO [7]

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I'm not going to break that out. We are doing a lot 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 '19, and it's already included.

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Operator [8]

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And our next question comes from Katy Huberty with Morgan Stanley.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [9]

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Congrats on the quarter. I also wanted to ask clarification on guidance, then I have a question. On guidance, you talk about incremental R&D and marketing spend in the fourth quarter. 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?

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Brittany Bagley, Sonos, Inc. - CFO [10]

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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&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 investments again there, and that's really what you're seeing in Q4.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [11]

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Okay. And I know it's very, very early on the IKEA 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?

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Patrick Spence, Sonos, Inc. - CEO, President & Director [12]

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Katy, it's Patrick here. I'll take that one. So we're 6 days, 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. Even today I saw The Guardian did a 5-star review on the SYMFONISK's 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 about 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.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [13]

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And what's the structure...

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Brittany Bagley, Sonos, Inc. - CFO [14]

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I think that's right, Katy. 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 '19. So any variability that we talk 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 '19.

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Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [15]

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Okay. That's helpful. Can I just ask one more question on the recovery and growth in Europe? How much of that is tied to adding Google Assistant, which has become the #1 voice assistant in the European market lately?

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Patrick Spence, Sonos, Inc. - CEO, President & Director [16]

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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 it -- 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 as -- well, 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.

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Operator [17]

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And your next question comes from Adam Tindle with Raymond James.

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Adam Tyler Tindle, Raymond James & Associates, Inc., Research Division - Research Analyst [18]

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Patrick, I just wanted to start with the R&D investments picking up to maybe revisit the outside the home initiative that you've alluded to in the past. 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 you -- how can we think about you guys competing with potentially a different set of competitors in that? And then also, any sort of time line that you can give us for that initiative?

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Patrick Spence, Sonos, Inc. - CEO, President & Director [19]

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We -- 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 too and the unique Sonos attributes around things like freedom of choice and great sound and easy experience. And so we're being thoughtful about how 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 a particular -- new product categories. But we're very excited about the product road map that we have right now, and I think it's the best one we've had in my 7.5 years at Sonos for sure.

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Adam Tyler Tindle, Raymond James & Associates, Inc., Research Division - Research Analyst [20]

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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 may be touch on an OpEx metric that you're targeting? Is -- as -- is 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 grew, 20% EBITDA growth. So in light of this OpEx increase, is that still something that you think is achievable for the near-term future?

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Brittany Bagley, Sonos, Inc. - CFO [21]

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Great question. Yes, we absolutely do. You've seen a lot of our 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&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 expecting to outperform that 20% EBITDA growth for the full year, 24% to 28%. 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.

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Operator [22]

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

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Elliot Alper, D.A. Davidson & Co., Research Division - Analyst [23]

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So how should we think about the rollout of the IKEA locations and the revenue contribution for that effort heading into the next year?

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Brittany Bagley, Sonos, Inc. - CFO [24]

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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 would see in that would be included when we come back and give 2020 guidance.

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Elliot Alper, D.A. Davidson & Co., Research Division - Analyst [25]

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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?

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Brittany Bagley, Sonos, Inc. - CFO [26]

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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 released our Q4 results.

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Operator [27]

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And our next question comes from Matthew Sheerin with Stifel.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [28]

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Yes. Just another question regarding the improvement in gross margin and the guide of -- 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 cost? And then that contract manufacturer credits that you talked about, could you tell us how many basis points that might have benefited the gross margin?

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Brittany Bagley, Sonos, Inc. - CFO [29]

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Lots of good question in there. So I'll start with -- we're not sort of changing of our long-term guide on gross margin, and this is all baked into the updated guidance we've 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.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [30]

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Okay. And looking at the IKEA business and other businesses that -- or business relationship that you may have similar to that. Is the margin profile of that business similar to your own direct business? Or is it different?

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Brittany Bagley, Sonos, Inc. - CFO [31]

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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 to be very beneficial for our bottom line performance.

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Matthew John Sheerin, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [32]

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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?

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Patrick Spence, Sonos, Inc. - CEO, President & Director [33]

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That's a different audience that we think we're reaching and 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 -- are beginning to get an understanding of the Sonos system and from there, add a Sonos One or add a 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.

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Operator [34]

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(Operator Instructions) And there are no further questions at this time. And I'll turn it back over to the presenters.

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Patrick Spence, Sonos, Inc. - CEO, President & Director [35]

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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 SYMFONISK in market in Q4, we look forward to consumers in joining 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 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 our favorite Swedish artists. Thank you and have a great day.

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Operator [36]

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