Sonos Inc (SONO) Q2 2024 Earnings Call Transcript

Thank you for your patience. My name is Greg, and I will be your conference operator today. I want to welcome everyone to the Sonos Second Quarter Fiscal 2024 Conference Call. I will now hand the call over to James Baglanis, Head of Investor Relations. James, you have the floor.

Good afternoon, and welcome to Sonos Second 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 Sweets and Spices station, which is curated in collaboration with Sonos in recognition of Asian Pacific American Heritage Month. 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 the 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 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 second quarter fiscal 2024 results posted to the Investor Relations portion of our website. As a reminder, the press release, supplemental earnings presentation, and conference call transcript will be available on our Investor Relations website, investors.sonos.com. I would also like to note that for convenience, we have separately posted an investor presentation to our Investor Relations website, which contains certain portions of our supplemental earnings presentation. I'll now turn the call over to Patrick.

Thank you, James, and hello, everyone. I'm pleased to report that we did what we set out to do in the first half of our fiscal year. This performance sets us up nicely to deliver on our previously outlined fiscal 2024 guidance. As you've heard from us and others previously, our categories remain under pressure, so our ability to deliver these results is a testament to the strength of our team, our product portfolio, and our brand. We are holding our own and continue to gain market share in U.S. home theater and streaming audio versus last year. As you all know, we've been making healthy investments in innovation. Our investments remain focused on two things: the first is attracting new customers to Sonos, and the second is getting our existing customers to add more Sonos products to their lives. There are four things I want to highlight that stem directly from the investments we're making and how we're laser-focused on attracting new customers and getting existing customers to add more products. The first is the all-new Sonos app. This is our most extensive app redesign and re-architecture yet. Our original app was designed and architected over a decade ago when Sonos and our customers' needs were very different. We started from the ground up so we can build an app that would deliver our customers a great experience every day, allow us to more easily add new products and categories to it and move faster with new innovations and features going forward. Our new app brings services, content, and system controls to one customizable home screen, creating an unprecedented streaming experience. Best of all, our redesigned app is easier, faster, and better. It once again raises the bar for the home music listening experience and sets up our ability to expand into new categories and experiences. Our app is a proof point of what we have always said. We are the story of software eating audio. Our software truly differentiates our products from everything else in the market and is key to unlocking the opportunity ahead for us. Speaking of which, the second is that we are just weeks away from unveiling our newest product. This launch will give us a foothold into a new multibillion-dollar category, expanding the number of categories we play in from five to six and further diversifying our business. This has been a multiyear investment, and we expect it to pay off in spades in Q3 and beyond. This will also mark the beginning of new efforts on the marketing front to evolve the Sonos brand and reach new audiences. The third is expanding our distribution footprint. In March, we officially went live as a first-party seller on Amazon in the United States. The partnership is off to a great start and is a major milestone in our journey to ensure that we attract new customers to Sonos, particularly as we enter new categories. We continue to evaluate our distribution footprint with an eye towards reaching new customers and look forward to providing further updates in the quarters to come. And fourth, this quarter, we experimented with stimulating additional product sales in our installed base by delivering limited-time upgrade offers to some of our most loyal, longest-tenured customers. We are always exploring how we can better use our unique data and insights to deliver more personalized experiences for our customers. The results of the targeted promotion came in well ahead of our expectations, validating our ongoing investments in systems to better harness and utilize our data. Selling both new and existing products into our installed base represents a tremendous revenue opportunity. It's what gives us confidence in the success of the product we're about to launch in a new category, and it's what gives us confidence in our ability to scale this business in the years to come. For example, we've previously sized the opportunity of converting all single product households to the average multiproduct household to be over $6 billion in revenue. Switching gears, I wanted to briefly touch on our litigation with Google. Just last month, in early April, the Federal Circuit affirmed that Google had infringed five foundational Sonos patents. With this ruling in hand, we look forward to pursuing damages for Google's misappropriation of Sonos' innovations. I want to reiterate that we continue to be laser-focused on what we can control. We are at the onset of a multiyear product cycle as we harvest the benefits of our research and development investments to attract new customers and sell more to our existing customers. It's the flywheel that has powered Sonos for the past 20 years, and we're excited to add some more fuel to the flywheel this year. We are positioning the company to accelerate our growth while keeping expenses in check to deliver margin expansion in the years to come. The eventual recovery of our categories will only further fuel this reacceleration. The opportunity ahead remains large, as we have just 2% of the $100 billion global audio market and 9% share of the total households in our core market. Each year, our business is driven by both the acquisition of new households that enter our installed base and by our loyal customers who continue to make subsequent purchases over time. Our ability to capture a disproportionate share of the opportunity ahead of us will only improve from here. Great things are happening here at Sonos, and the best is yet to come. I'll now turn it over to Saori to take you through our financials.

Thank you, Patrick. Hi, everyone. Since joining Sonos as CFO a quarter ago, I've immersed myself in the details of the business and the exciting product roadmap. I see tremendous opportunity ahead for Sonos to drive sustainable, profitable growth over the long term, and I'm thrilled to be part of the team. Now on to our results. Q2 revenues came in slightly ahead of our expectations at $252.7 million. Our better-than-expected Q2 revenue was driven by a strong customer response to some promotions that we ran in the quarter. In particular, we saw great adoption to the targeted promotion to drive upgrade sales that Patrick referenced earlier. Revenue per product sold was $338, up 11% year-over-year. This increase resulted from favorable product mix, partially offset by increased promotional activity. This brings our first half revenue to $866 million, down 11% year-over-year. Digging in, performance varied significantly on a regional basis. Revenue in the Americas declined 5% year-over-year, whereas EMEA and APAC declined by 21% and 23%, respectively. Sales in our categories in both EMEA and APAC continued to be significantly impacted by the difficult macroeconomic environment. Overall, our first half performance puts us in a good position to deliver on our full year guidance. GAAP gross margin was 44.3%, up 100 basis points year-over-year and roughly in line with the guidance we gave last quarter. The year-over-year increase was due to lower component costs and favorable product mix, partially offset by additional promotional activity. Gross margin declined sequentially from our holiday quarter due to the seasonal deleverage from lower revenue in Q2. Our Q2 performance brings our first half gross margin to 45.6%, up from 42.7% in the first half of last year. This performance demonstrates the resilience of our underlying gross margins and underpins our confidence that we will meet our fiscal 2024 target of 45% to 46%. Adjusted EBITDA was negative $34 million, ahead of our guidance due to higher-than-expected revenue and lower product and marketing spend. This brings our first half adjusted EBITDA to $81.6 million, representing a margin of 9.4%. Non-GAAP adjusted operating expenses were $157 million in the quarter, down $22 million sequentially, primarily due to a seasonal decrease in sales and marketing spend. We ended the quarter with $292 million of net cash, which includes $46 million of marketable securities as we deployed some excess cash into short-duration treasury bills. Free cash flow in Q2 was negative $121 million due to typical seasonality, bringing our first half free cash flow to $148 million compared to $46 million in the first half of last year. This increase was primarily driven by working capital improvements, resulting from a focus on better managing our inventory through adjustments to our sourcing plans as well as the implementation of newly adopted payment terms with our suppliers. Our period-end inventory balance was $180 million, down 45% year-over-year and up 4% from last quarter. This consists of $114 million of finished goods and $65 million of components. We're working hard to keep inventory balances in check. And finally, we returned $53 million to our shareholders through stock repurchases in the quarter. We repurchased 2.5% of common shares outstanding as of Q1 at an average price of $17.32 per share. This brings our total year-to-date share repurchases to $76 million, leaving us with approximately $124 million remaining under our current $200 million share repurchase authorization. We continue to be balanced in our capital allocation strategy and expect to be active in the market repurchasing our stock. Turning to our outlook, we remain confident in our previous guidance for FY '24, which I will quickly recap. We expect our revenue in the range of $1.6 billion to $1.7 billion, roughly flat year-over-year at the midpoint. As previously noted, our guidance assumes that our products in the new multibillion-dollar category will generate a large portion of the over $100 million of revenue we expect from new products this year. We expect GAAP gross margin in the range of 45% to 46%, with non-GAAP gross margins in the range of 45.4% to 46.4% due to approximately $7 million of stock-based compensation and amortization of intangibles included in the GAAP cost of revenue. Adjusted EBITDA is expected to be in the range of $150 million to $180 million, representing a margin of 9.4% to 10.6%. As previously discussed, we're not providing formal guidance for free cash flow in fiscal 2024, though we continue to expect to significantly improve our free cash flow conversion versus last year. Turning to Q3, we expect the revenue to grow year-over-year in the range of $375 million to $405 million, which includes a sizable contribution from our launch of our highly anticipated new product. We expect GAAP gross margin to increase sequentially to 45% to 46%, primarily due to fixed cost leverage from higher revenue in Q3. Non-GAAP operating expenses are expected to be in the range of $147 million to $159 million, resulting in adjusted EBITDA in the range of $35 million to $40 million. With a solid first half in the books, we're in a good position to deliver on our fiscal 2024 guidance. We're laser-focused on our execution and accelerating revenue growth in the second half of the year while tightly managing our expenses to drive margin expansion. With that, I'd like to turn the call over for questions.

It looks like our first question comes from Steve Frankel with Rosenblatt.

I'd like to start with a couple of the new initiatives that happened during the quarter. Maybe give us some feedback on early learnings from the direct presence on Amazon? And any more details you could give us on the installed base promotion and what you might do going forward around that.

Yes. Thanks, Steve. It's Patrick here. On Amazon, we're very pleased with our start there, as I mentioned, very focused on how we find new customers, and that is something that we've been able to deliver on, just getting started, but something we think is going to be even more important going forward given some of the new categories that we're going into. So I think that's been helpful in terms of our overall plan and positioning ourselves for growth. And then on the installed base, this is one that, as you know well, is a large opportunity for us over time. If we can get more of the single-player homes to the multiproduct average, that's a $6 billion opportunity. And we continue to invest in the systems and the tools to allow us to go after this opportunity even more. And so we're very excited about the opportunities there. I feel like we're getting well positioned, particularly through our direct-to-consumer channel to really tap into that as well, which I think really helps particularly as we think about as well, some of the new products that are coming into play because they're going to help as we tap into our existing base, too. So excited about both. I think we have lots of opportunity in both, and we're going to continue working on those and there are other ones we're working on to - again, with that real focus of trying to find other partners that can help us get into new homes because as everyone knows, we're only in about 9% of the total homes we think we can address. And so finding new homes is the name of the game.

Great. And then one last question, some characterization of channel inventories. And if you can give us some insight geographically how that may differ as well.

Yes. On the channel inventory, we ended with a very comfortable level. We don't usually break it down into the geographic or channel details further on the call, but we're comfortable with where we ended.

And our next question comes from the line of Erik Woodring with Morgan Stanley.

So Patrick, maybe you first, clearly, still banking at a pretty significant product launch in fiscal 3Q. Can you maybe help us understand what you've learned about consumer demand over the last 3 months? And I say that because we see most consumer companies flagging real caution and kind of the spending environment. Your outlook for this new product has been unwavering. So can you maybe just help us connect the dots? What's driving the confidence as we see maybe some of the macro outlook, especially as it relates to consumer spending remain kind of unchanged, negative, maybe deteriorate? I'm not sure how to characterize it, but maybe you could share some color with us, and that would be helpful.

Certainly, Erik. I would say that in our categories, the last three months have been consistent with what we've experienced previously. Our categories have faced challenges for some time, and last year we noted that overall it was quite weak. Currently, we don’t see indicators suggesting a decline or any improvement. Therefore, we are concentrating on what we can control, which reflects positively on our brand and product portfolio, allowing us to perform well in the first half of the year. We’ve learned a lot from this experience. Additionally, we have made significant efforts to understand the new category we are entering, which is substantial and boosts our confidence. We believe we offer a distinct perspective. We have engaged in numerous discussions with our channel partners and recognize that this new category is expanding. This situation differs from our existing categories, as it is showing year-over-year growth. All these factors, along with our success in the first half, give us confidence in maintaining our guidance for fiscal 2024.

Great. And then I'm not sure if this is for you, Patrick, or for you, Saori. But obviously, a lot going on investment-wise this year, which is great to see. How much of this is kind of run-rate operating expenses or investments as we think about the forward look beyond just this year versus how much is a bit of what I would call heavy lifting that you need to do and maybe a bit of pull forward in spend that some of it potentially doesn't repeat as we look again beyond this year. Can you just help us understand some of that, that would be really helpful.

Thanks, Erik. Certainly, what our investment approach is embedded in our guidance range, the FY '24 guidance that we've confirmed. We are continuing to invest to optimize for profit growth over the long term at the same time, making sure that we're optimizing for future growth as well. So it is embedded in our guidance, and we will share more as we go through the new product launches and as we continue to monitor the market, the market continues to be challenging, and we realize that we need to stay pulse on the market. But at the same time, we will continue to control what we can control.

Our next question comes from the line of Jake Norrison with Raymond James.

Perfect. I just wanted to start and double-click on the promotional focus on getting new homes. Could you just speak to the levers here that you'd be able to pull? Obviously, this is high level, it's early days, but maybe just compare and contrast to previous partnerships like the IKEA one that weren't as successful in gaining new customers.

Yes. So it's not promo-related. This is more structural and long-term oriented. So if we're going to add any channel partner, it really is about assessing who they're reaching and who they're talking to and how does that fit with today's product portfolio and the one we're building for the future. And so this is much more strategic in nature in terms of identifying how else do we tap into the 91% of homes that we believe we can address but aren't in yet. And so that's what's guiding really our push for the expanded distribution that you've seen, and we'll continue to see.

Okay. Great. I appreciate the color there. And then last one for me. I'm hoping you could just dive a little deeper on international trends. Of course, we've seen the weakness. But can you just maybe speak to your market share versus the broader audio segment in those regions?

Yes. So this is one we watch very closely because we want to know how we're doing relative to the other players that are there. As I mentioned, we continue to, in fact, gain or hold share in the U.S. home theater and the streaming audio, even though those are down year-over-year, which is what we're looking at. Similarly, we're seeing significantly down year-over-year, anniversarying negative year-over-year last year as well across EMEA and then as well into Australia, which is our biggest APAC market at this point. And so those are ones where we are holding our own, we feel like. And so from everything we can see at this point, we continue to hold up well relative to what's happening in the industry more broadly. And I think when you look at our results in terms of the geographies, I think they're very representative of what you're seeing across the industry as opposed to anything Sonos unique.

And our next question comes from Alex Fuhrman with Craig-Hallum.

Just from a high level, wondering if you can explain to us a little bit. It seems like your business today is roughly the same size as it was about 3 years ago when there was a lot more housing activity, and now it's been kind of a multiyear slump in housing velocity. Can you talk to us a little bit about what that's done to your customer profile, who you have coming into the brand, how many products they're buying, maybe what their first products they might be buying are? And what steps are you taking to be ready for demand to come back if presumably we do see some type of an uptick in the housing market at some point in the future?

Yes, thanks, Alex. We've been concentrating on what we can control. In the first quarter, we focused on bundles, and we had our highest proportion of new homes starting with multiple products during that time. We've demonstrated our ability to attract customers as we have only tapped into a small segment of the market. By putting together appealing packages for our customers and making the buying process straightforward, as we did during the holiday season, we can counter the prevailing trends to some extent. While our categories face challenges, we believe housing will ultimately provide us with a beneficial boost. We are preparing for better times by improving our execution and investment strategies during these tough periods. We're focusing on bundling and looking at promotions for our existing customers. The innovations from our product team and our new marketing strategies will greatly benefit us if we receive some favorable trends from the housing market. The efforts we're putting in now will yield positive results when the market rebounds. We're committed to navigating these challenging times efficiently and profitably.

And our next question comes from the line of Brent Thill with Jefferies.

Patrick, you get the magic wand and you can kind of wave it. What are the things that you think could really help get the environment back to where you'd want to be? What are the two or three things you'd wave that wand over?

That's an excellent question, Brent. I believe that if we see a shift in investments toward audio products, it would greatly benefit us. That would be the most significant factor. In addition, as Alex mentioned, we do expect the housing market to contribute positively. However, we're not going to dwell on that too much since there are no quick fixes. Instead, our focus is on leveraging our existing customer base and capitalizing on the $6 billion opportunity. We're looking for new channels and countries where we can expand our reach to homes we haven't yet penetrated. Our efforts will include enhancing distribution, advancing our product innovation pipeline, and finding new ways for our current customers to enjoy more Sonos products and share their experiences with others.

I apologize if I missed this earlier, but regarding the promotional pricing you implemented, I understand some of it appears to be effective. Can you clarify how much you're planning to utilize that in the future? Will you need to rely on it more heavily, or given your premium product positioning, are you hesitant to pursue that strategy further? What should we consider in this regard?

We are carefully considering our promotions. Our primary objective is to increase profit margins rather than just revenue. Certain markets have become quite promotional and competitive, and we are closely monitoring the business dynamics to ensure we can enhance our profit to the bottom line.

It appears there are no further questions. I will now hand it back to CEO Patrick Spence for closing remarks. Patrick, the floor is yours.

Thank you. I just want to hit two quick things in closing. First, we did what we set out to do in the first half of the fiscal year, and this puts us in a great position to deliver on our fiscal 2024 guidance. Second, we are on the cusp of an exciting launch that takes us into a new multibillion-dollar category that is growing. We look forward to sharing this new product with the world soon. And of course, there's a lot more in the pipeline that we're excited about. Thanks for your time today, and we look forward to speaking with you again next quarter. Take care.

Thank you, Patrick, and thank you all for joining. You may now disconnect.