Sonos Inc Q1 FY2025 Earnings Call

Thank you for standing by. My name is Jale, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos First Quarter 2025 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask questions during this time, simply press star followed by the number one on your telephone keypad. I would now like to turn the conference over to James Baglanis, Head of Investor Relations. You may begin.

Good afternoon, and welcome to Sonos' first quarter 2025 earnings conference call. I am James Baglanis, and with me today are Sonos' interim CEO, Tom Conrad, 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 the Sonos radio 'Say it Loud,' which is curated in collaboration with Black at Sonos in recognition of Black History Month. Before I hand it over to Tom, 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 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 first quarter results posted to the investor relations portion of our website. As a reminder, the press release, supplemental earnings presentation, including our guidance, and a conference call transcript will be available on our investor relations website investors.sonos.com. I will now turn the call over to Tom.

Thank you, James, and thank you all for joining us today. I'm now in my fourth week as interim CEO. It's still early days, but it's not too soon to make a few observations. First, we have a lot of work to do. Despite recent progress, our core experience still needs significant improvement. Second, we must continue our effort to bring our expenses in line with our revenue. And third, I'm more convinced than ever that Sonos has a large market opportunity ahead of us, both in its current categories and in close adjacencies, and I know that we have the best team in the world to seize this opportunity. We're moving quickly and with purpose across all these interrelated fronts. As a board member, I started working closely with our software team this past fall, and I can tell you that they have an absolute dedication to improving the Sonos experience to a place that exceeds the expectations of all of our customers. I'm all in on reinvigorating and accelerating this essential work, helping with focus and priorities as we tackle what are frankly some very complex and longstanding software problems. As a longtime passionate customer myself, I know the magic of Sonos, but I also know the extreme disappointment of the company's recent app challenges. With respect to our expense base, I'm closely partnering with our CFO, Saori Casey, to drive operational efficiency and improve our financial performance. To accomplish this, I'm returning Sonos to a scrappier and more focused enterprise, drawing on the lessons I've learned from the successes and challenges I've navigated at companies of all stripes for over thirty years, from Apple to Pandora to Snapchat to Quibi. To this end, yesterday, we executed on a set of significant changes to the way we have reorganized our product and engineering staff into functional teams for hardware, software, design, quality, and operations, moving away from dedicated business units devoted to individual product categories. This allows us to bring together right-sized cross-functional projects that maximize our efficiency as we continuously evaluate, prioritize, and focus on the highest value market opportunities. These changes revealed organizational layers and redundancies that were not serving us. This means the difficult task of saying goodbye to about two hundred employees, including nearly fifty managers and executives. This is one more step in the structural transformation process that Saori has been describing on our last two earnings calls. This process began in our G&A function, and other parts of Sonos have followed suit. As I just mentioned, our focus is now on the total overhaul of the product organization, which houses more than half of our employees. While these actions represent a major milestone in our transformation journey, we are not finished. We will continue to carefully scrutinize the allocation of all dollars to ensure that they're being applied to the highest return opportunities. The leaner and more effective we are as a company, the better we can capitalize on the opportunities in front of us. It's a wonderful honor to be stepping into lead Sonos at this pivotal juncture. The board will be conducting a robust national search for the next permanent CEO, with the assistance of a leading executive search firm, and I will be a candidate. While that process plays out, there's no time to lose in pushing forward the vital work of fixing, restructuring, and innovating. Sonos today has the deepest, most innovative product lineup in its history. There's tremendous opportunity in front of us, and my job is to help Sonos take full advantage of it while running the company with a heightened focus on fiscal responsibility. We have a terrific team, and I look forward to the progress we're going to make together. Now let me turn things over to Saori to discuss our Q1 results.

Thank you, Tom. Hi, everyone. We delivered Q1 revenue towards the high end of our guidance at $551 million. On a year-over-year basis, revenue was down 10% versus our guidance of down 22% to down 9%. The decline was driven by softer demand due to market conditions and challenges resulting from our 2024 app rollout. As we've been talking about for some time now, our categories remain cyclically challenged and highly promotional. This was particularly notable in our portables category. Despite these headwinds, we saw stronger than expected demand for our new industry-leading soundbar, the Arc Ultra, which helped us achieve our highest ever quarterly market share in US home theater on a dollar basis. GAAP gross margin was 43.8%, plus 80 basis points above the high end of our guidance range, driven by better cost and product mix. As a reminder, we began amortizing the MIGHT intangible assets now that we're using its sound motion technology in Arc Ultra, which was a minus 40 basis point headwind year over year to GAAP gross margins. Non-GAAP gross margins were 44.7%. Q1 GAAP operating expenses were $193 million, and non-GAAP operating expenses were $169 million, down 5% and down 6% year over year, respectively. Both figures include $6 million of app recovery investments in the quarter. Non-GAAP operating expenses came in about $13 million below our guidance, due to both expense management efforts and timing of spend. Speaking of expense management, last quarter, I spoke about how we had begun our transformation efforts last year with our G&A functions. As a result, this quarter, we saw GAAP G&A expense decrease significantly to $25.8 million, down 35% year over year. This decline is attributable to four factors: one, lower personnel costs from the August 2024 reduction in force; second, lower litigation expenses; third, lower operational costs through facilities and vendor spend rationalization; fourth, timing shift of spending, which had an approximately $2 million benefit to G&A in the quarter. On a GAAP year-over-year basis, sales and marketing increased by 3%, in part due to app recovery investment. Research and development increased 2%, primarily due to a stock-based compensation expense related to retention of key personnel. On a non-GAAP year-over-year basis, G&A expenses decreased by 31%, research and development expenses decreased by 3%, and sales and marketing expenses increased by 1%. Adjusted EBITDA was $91.2 million, representing a margin of 16.6%. This was above the high end of our guidance range due to higher gross margin and lower operating expenses. We ended the quarter with $328 million of net cash, which includes $41 million of marketable securities as we hold excess cash in short-duration treasury bills. Q1 free cash flow was $143 million, down from $269 million last year, due to lower revenue as well as two unique factors that impacted last year's free cash flow. First, we were actively working down our excess owned inventory as we entered Q1 of fiscal 2024 with $82 million more finished goods inventory than this year's Q1. Second, Q1 of last year benefited from the implementation of new payment terms with our suppliers, which resulted in a large one-time benefit to free cash flow. Our period-end inventory balance decreased by 19% year over year to $141 million, primarily due to lower component balances. Sequentially, this was a decline of 39%. Our inventory consists of $117 million of finished goods and $24 million of components. After pausing share repurchases in fiscal Q4, we returned $27 million to shareholders in Q1, reducing our share count by 1.9 million shares, leaving us with $44 million under our current $200 million share repurchase authorization. Returning capital to our shareholders remains a key pillar of our capital allocation framework. Turning to our guidance, the Q2 outlook we're providing reflects our best estimates as of today. We expect Q2 revenue in the range of $240 million to $265 million, a year-over-year change of negative 5% to positive 5%. Our Q1 results and Q2 guidance imply our revenue in the first half of the year will be down between minus 9% to minus 6% versus the first half of fiscal 2024. Please note that while we are not providing guidance beyond Q2 at this point, I'd like to remind everyone that we've benefited from the launch and associated channel fill of Ace headphones towards the end of Q3 last year. As a result, we expect to have a very difficult year-over-year comparison in Q3. We expect Q2 GAAP gross margin in the range of 42% to 44%, down at midpoint from Q1 driven by deleverage, partly offset by product mix and seasonally lower discount. The decrease from last year's Q2 GAAP gross margin of 44.3% is driven by FX headwinds and the amortization of my intangible assets for the Sound Motion Technology and Arc Ultra. Non-GAAP gross margins are expected to be 44% to 45.8%, 180 bps to 200 bps higher than GAAP gross margins. You may recall we underwent a significant effort to diversify manufacturing of nearly all of our US-bound products, shifting to Malaysia and Vietnam. As a result, we expect tariffs to have a minimal impact on our gross margin in Q2 based on what we know today. We expect non-GAAP operating expenses to be between $140 million to $145 million compared to $157 million last year. As a result, we expect Q2 adjusted EBITDA to be in the range of negative $27 million to negative $6 million compared to negative $34 million last year. Our guidance contemplates that we will make another $4 million to $8 million of app recovery investments in Q2. Lastly, I want to summarize the actions from the art transformation journey that Tom and I mentioned on this earnings call. We expect the run rate savings of the announced actions from yesterday and those taken in FY24 to be in the range of $60 million to $70 million into FY26. While we're not providing fiscal 2025 expense targets, please note that our FY24 baseline OpEx normalized for variable compensation and restructuring expenses was around $770 million on a GAAP basis and around $680 million on a non-GAAP basis. We expect that the actions we have taken so far will fundamentally change and simplify the way we operate. We're flattening and evolving our organization structure as well as identifying areas to reduce our operational costs. These actions are intended to reduce our run rate expense base while improving our efficiency and effectiveness. We have made significant progress. Our transformation journey will continue as we work to identify other areas of operational improvements and spend rationalization. We believe that successfully executing on our efforts will allow us to invest in the most impactful, growth-oriented opportunities while structurally improving our profitability. We will continue to update you on our progress as we work through the year. With that, I'd like to turn the call over for questions.

Thank you. The floor is now open for questions. If you would like to withdraw your questions, simply press star one again. If you are called upon to ask a question and are listening via loudspeaker on your device, please pick up your handset and ensure that your phone is not on mute when asking your question. Your first question comes from the line of Steve Frankel of Rosenblatt. Your line is open.

Good afternoon. Tom, the release today was a bit unconventional. The numbers came out before they opened, and then the call happened this afternoon. What drove that behavior?

Let me start by apologizing for the unconventional nature of this timing and take you through a little bit about how we ended up there. I've been here for three and a half weeks now, and I'm working to move the company forward quickly and with purpose. We've made a set of organizational optimizations. The related cost savings were among my top priorities coming in the door, which meant that the timing of the reorganization announcement and the earnings was sort of a delicate matter. I had to balance effectively communicating these complicated changes involving around two hundred departing colleagues and nearly a thousand product team members being reorganized with my responsibilities around the call. I decided that the best course was to announce the reorganization and related rift after the market closed yesterday and a day ahead of earnings, which gave me the time late yesterday to land these changes with the team. To minimize uncertainty with our investors today, we moved the release timing to before the market opened. We left the timing of the earnings call itself intact because it had been announced before I arrived, and we thought it would be too disruptive to move it. Thank you for your understanding about the late-breaking shifts to all of this.

Thank you for the insight. Maybe you can give us the top two or three most important changes you think the company has to make going forward?

As I said, I have a pretty strong bias to action. And in my first three and a half weeks, we've reorganized the company into a far more efficient structure. We've made concrete progress on rightsizing our expense base. We clarified our areas of focus to get the entire company working together in the same direction, which really sets us all up to begin operating the company much more efficiently and with a stronger shared sense of purpose. My focus now is getting Sonos back on track, which means improving the core experience for our customers, optimizing our business to drive innovation, and delivering operational and financial performance.

Okay. And you know, the last quarter the message was that the app was almost there. Where do we think we are today and how much longer is it going to take to get both the iOS and Android experience where they need to be to restore the brand?

So the team certainly made a lot of progress in Q4, and that allowed us to successfully launch Arc Ultra and Sub four, both of which are a hit with customers and reviewers. And now I would say that the team and I are just really focused on what I would call a return to excellence in the core experience, having moved beyond getting the app back to the place that we needed its core functionality to be. But, honestly, there remains a lot of work to do to meet my standards. And so we're focusing on three areas: performance and reliability, usability and design, and new experiences.

Okay. And any timetable for when you think you'll be satisfied?

I mean, as a product and engineer, great companies continue to invest in improving the experience day in and day out. Most of the work that we have in front of us falls into exactly that category.

Okay. And then one last quick one. Where are channel inventories today, and how does that compare with the desired level?

I can take that question. We ended the channel inventory at a comfortable place at the end of Q1. As you recall, last year, we were in a different place. So we're pleased with where we ended the quarter going into Q2.

Okay. Thank you. I'll go back into the queue.

Next question comes from the line of Logan Katzman of Raymond James. Your line is open.

Hi, guys. This is Logan on for Adam. Just two quick ones for me. Tom, maybe first for you. With all the changes you're implementing, can we still expect two product launches a year? Or has that been put on pause?

We're certainly committed to continuing to ship many great products each year. I think I'm probably going to hold off on making specific commitments about the product roadmap.

Yeah. Makes sense. Thank you. And then just one last question from me. Any changes to capital allocation or anything you guys want to talk about around that?

I can take that question. We continue to focus on our capital allocation strategy. As you recall, we paused the buyback in Q4 while we were focused on the app recovery progress to make sure that it was stable enough. But we have resumed the buyback, as we mentioned, and we continue to be judicious about our capital allocation, and returning capital to our shareholders remains a pillar of our strategy.

Great. Thanks, guys.

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

Great. Thank you so much for taking my question. And nice to meet you, Tom. You know, in the letter you sent to employees yesterday, you referenced Sonos becoming mired in too many layers that have made collaboration and decision-making harder than it needs to be. Can you maybe just expand upon exactly what you mean by that and help us understand how the actions you're taking are going to help on the product front or if it's more beyond the product front? Just help us understand what exactly you mean by that, and then I have a quick follow-up. Thank you.

Sure. So the product organization in particular had a sort of business unit organization strategy where there were separate organizations for different elements of our product line, such as a professional category, a portable category, a home category, and so on. What that meant was that we had many redundancies across those teams. For example, we had a head of mechanical engineering in each one and team members underneath that. As we seek to have flexibility in how we apply our resources to our roadmap, having that particular set of products hard-coded into the organizational structure creates a lot of overhead and a lack of flexibility around being able to react and adapt to market conditions. By moving to a functional organization with a hardware team, software team, operations team, design team, and QA team, we can put together what I would call right-sized projects with the minimal necessary people to address a market opportunity. This enables us to move more quickly and collaborate much more efficiently. That's what I was alluding to in the email yesterday.

Okay. That's helpful. And maybe now I have a different follow-up, which is just, you know, if I could double-click on that, it seems like that's been the kind of the Sonos MO for years, if not decades now. I guess what has really changed now? I mean, you've been on the board; I'm just wondering why make the change now if you look back beyond the last three years, you guys were going through multiple years of 10% growth. Obviously, it's been a very challenging market, but you've had that structure while you were successful. So why is that not the successful structure going forward? Or is this really just about making sure you're being more efficient going forward?

The business unit structure was put into place about eighteen months ago, replacing a previous model that I would describe as hardware top-heavy in its earlier form. The previous structure had some of the same product line dimensions, but the hardware group was complemented by a functional group for software and for design, among others. What we're doing here is a return to a model that worked well previously, but we are also refining the model by emphasizing the idea that everything we do doesn't have to start with a hardware new product. This change allows us to navigate much more efficiently and effectively in regard to the core experience initiatives that our customers care about.

Okay. That makes a ton of sense. Thank you for that clarification. Super helpful. And then, you know, last question for me, Saori. I know you don't guide beyond the quarter out. If you look back, and I appreciate the comments you made on the product launch last June quarter, if you look back in history and just exclude the June 2024 quarter, your seasonality in fiscal Q3 revenue seasonality has been anywhere between down 7% sequentially and up 42% sequentially. It just leaves a very wide range for consensus to fall in. I'm just wondering if you have any comments to help us on the call, to make sure that we're thinking about where the boundaries might be, based on what years we could look to in history to maybe set the proper bar for the June quarter. I realize there's a lot of moving pieces, but I'm just wondering if we could have any more detail to help us narrow the scope of how we should be thinking about the June quarter. That's it for me. Thank you.

Hi, Erik. Thanks for that question. It certainly is challenging. Even if I were looking back for patterns, there's a wide range. At this point, we're only able to provide color relative to last year's view that the pattern will look different than last year due to the Ace launch and the channel fill we had at the end of the quarter. So we're leaving it at that for now. Thank you.

Your next question comes from the line of Alex Fuhrman of Craig Hallum. Your line is open.

Hey, guys. Thanks very much for taking my question. I wanted to ask about the workforce reduction and just, more broadly, if you think about the company going forward as a leaner, more streamlined operation. How much of the organization today is focused on hardware development versus software development versus things like sales and marketing? Can you give us a sense of just the biggest shifts in how the company is different today compared to how it was just a year ago?

I'll start by discussing the product organization. So much of what we do that people perceive as hardware is actually software. Our software organization is today, in fact, quite a bit larger than our hardware organization. The rough numbers are about 150 people in hardware and more than double that in software. Of course, we have a talented team around design, QA, operations, and so forth that complements all of that in our product organization. Saori, do you want to talk about how that relates to our expenses?

From an operating expenses standpoint, you'll see the ratio among R&D, sales and marketing, and G&A. There are cyclicality to the marketing spend, particularly for holiday seasons and so forth, so in general terms, the aggregate structure reflects that focus but, from a headcount perspective, the biggest part of the company is R&D headcount, followed by G&A headcount and then sales and marketing headcount. Marketing would have a significant portion of expenses related to the non-headcount spending with G&A more leaning towards headcount, as is R&D. It's probably best to consider this on a dollar basis due to the way we spend our operating expenses and our investments, but that's the general lineup in relative terms concerning headcount resources.

Okay. That's really helpful. And then, Saori, I think you mentioned some baseline OpEx numbers from this year. Should we be thinking about the opportunity for a step function lower in the future in OpEx, or is it more about an opportunity to grow sales faster than expenses in future years? Can you help us understand that?

Thanks for that question. While we've announced this reduction in force specifically around headcount, we're continuing to explore many cost optimization opportunities. I know we've been somewhat less concrete about what changing cost structures mean, but it really is about looking at every dollar and how we're able to spend that dollar more efficiently. This could involve everything from reassessing our real estate footprint to potentially negotiating better fees. It's a journey beyond what we've announced so far. We're not providing guidance on OpEx beyond what we're presenting today, but we will continue to evaluate opportunities as we progress through our transformation.

I'll just add that, looking at my background, you'll see instances where I've helped take young startup companies through their growth phase and into being newly public. A crucial skill developed in that process is the ability to scrutinize all expenses as they arise. I'm particularly focused on ensuring that we're making investments where we'll see the highest possible returns.

Okay. That's really helpful. Thank you both.

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

Thanks. Tom, just on the 12% reduction in force, can you discuss whether that was across all functional areas or focused on a couple of bigger areas? And perhaps you could discuss some of the changes that you made in the software development team. Have you made changes in leadership? What are you doing there to ensure that consumers have a cleaner, simpler experience?

Yeah. A lot of great work had been done by Saori to bring our operating expenses in line in the G&A lane in previous quarters. This set of changes was particularly focused on the remaining dimensions of the company, with a special emphasis on changes in the product organization. As I've described, the reorganization itself revealed redundancies across the product organization and opportunities for us to step into a smaller but more effective team. One truth from my career in the startup world is that the size of a team is not always correlated with its output. We've found a successful path to creating a smaller but more efficient and powerful product and engineering organization. I'm confident we have the right team in place to enhance the core experience that I'm fully committed to.

Okay. And just on the software side, have you made changes in the leadership team to ensure they're on the right track?

That's correct. Across the product organization, we exited about half a dozen vice presidents and reorganized teams around our most effective leadership for the go-forward plan. It's a great group, and I know we're going to make significant progress.

We have a follow-up question from the line of Steve Frankel of Rosenblatt. Your line is open.

I just wondered if you might give us any insight into how Ace did in the important holiday season.

Hi, Steve. From a revenue results perspective, certainly Ace was incremental to our year-over-year and to our quarter, and it continues to receive great reviews from our customers. As we mentioned on our earnings call, it was off to a slow start, and so as we continue to recover our brand, Ace launched at the worst possible time from an app launch perspective. We're making progress and, while we cannot disclose exact results, we are pleased with Ace receiving positive reviews from our customers and contributing incrementally to our revenue.

Alright. Thank you.

With no further questions, that concludes our Q&A session for the conference call. We thank you for your attendance. You may now disconnect.