Sonos, Inc. (NASDAQ:SONO) Q3 2023 Earnings Call Transcript

Sonos, Inc. (NASDAQ:SONO) Q3 2023 Earnings Call Transcript August 9, 2023

Sonos, Inc. beats earnings expectations. Reported EPS is $0.16, expectations were $-0.2.

Operator: Good afternoon. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos Third Quarter Fiscal 2023 Earnings Conference Call. [Operator Instructions] Thank you. James Baglanis, Head of Investor Relations, you may begin your conference.

James Baglanis: Thanks, Emma. Good afternoon, and welcome to Sonos Third Quarter Fiscal 2023 Earnings Conference Call. I am James Baglanis. And with me today are Sonos’ CEO, Patrick Spence; and CFO and Chief Legal Officer, Eddie Lazarus. For those who joined the call earlier, today’s hold music is a sampling from our Sunset Fuzz station. 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 2023 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 like to also 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 will now turn the call over to Patrick.

Patrick Spence: Thanks, James. And hello, everyone. Earlier this afternoon, we reported strong fiscal Q3 results. We are winning in the categories in which we play and I am proud of the team’s execution as we outperformed the competition. The categories of consumer electronics that we participate in remain challenged, as conditions have not yet returned to what we would consider normal and we continue to see unprecedented levels of discounting by our competitors. Despite this, our brand and product portfolio continue to perform well. Consistent with past quarters, we have continued to gain significant market share in home theater in both the United States and Europe. This is a testament to our continued investment in research and development, which remains focused on two things, raising the bar in the existing categories where we play and entering new categories in innovative ways.

Speaking of raising the bar in existing categories, our new Era family of products is off to a great start. We have seen media and consumers alike embrace Era 100 for its detailed stereo sound and deep bass and Era 300 for its impressive out loud spatial audio listening with Dolby Atmos. Each products are in stellar reviews from both media and consumers with consumers rating both the Era 100 and the Era 300 at 4.8 at a five stars on Sonos.com. A recent Forbes review of Era 300 noted it is nearly as perfect as any wireless speaker can be, the spatial audio performance is fantastic. Last quarter, I outlined what change between our Q1 and Q2 earnings and how that affected our guidance for the second half of this year. We are tracking to those revised expectations and thus today, we are maintaining the midpoint of the guidance we issued for the second half for revenue and adjusted EBITDA.

We saw a reduction in channel inventory in Q3 consistent with our expectation for registrations to outpace selling. We expect this to continue through Q4, particularly in Europe and Asia Pacific where retailers continue to tighten up. As per underlying demand, strength in the Americas helped offset the impact of the tough economic climate in Europe and Asia Pacific. Specifically, in the Americas, we saw steady registration trends through the quarter, followed by a strong response to our Fathers’ Day promo in mid-June. In both Europe and Asia Pacific, registration trends generally softened through the quarter, which we expect to continue through Q4. As I have repeatedly said, we would reduce our spending if necessary to hit our EBITDA commitments, while staying on track to deliver our ambitious roadmap, because harder times require renewed commitments to rigor, focus and efficiency.

This commitment led us to announce a 7% reduction in force in mid-June. This rightsizing in our expense base will enable us to increase future profitability, while making targeted investments in our exciting product roadmap. Our journey to drive more efficiency in the organization is never over. We will continue to closely scrutinize our cost base and do whatever it takes to lever on the kind of long-term profitability we have targeted. Our focus remains on driving sustainable profitable growth over the long-term as we continue to release products in our now five investing categories. Sonos Pro was added this year, as well as three new categories we expect to enter. We are in the early innings of our growth as our more than 14 million households represent just 8% of the $172 million affluent households in our core markets.

At the end of fiscal 2022, the average Sonos household had 2.98 products, up from 2.95 in the prior year. This figure has steadily increased over the years underscoring have a lifetime value of our customers continues to grow. As we have noted in the past, 40% of our households are single product households, whereas our average multi-product households has 4.3 products. In other words, we are starting to get into the range we have previously discussed of 4 to 6 products per every mature Sonos household. We estimate that converting our single product households, the average multi-product household install size represents a $5 billion revenue opportunity. This highlights the long runway we have to further monetize our install base. I remain confident that Sonos is on the right track to continue to deliver value for customers and investors over the long-term.

There is no doubt in my mind that we will emerge from this challenging period as a stronger company and resume making progress toward delivering on our long-term targets of $2.5 billion in revenue, and $375 million to $450 million in adjusted EBITDA. Now, I will turn the call over to Eddie to provide more details on our results and our outlook,

Eddie Lazarus: Thank you Patrick. Hello everyone. Stepping back from the numbers for just a minute, I’d summarize Q3 is having two areas of intense focus. First, making sure that we deliver on the second half revenue guidance we gave on our Q2 earnings call. And second, making sure that we deliver on our expense reductions, both to ensure that we meet the profitability guidance we gave last quarter and to put us in a position to deliver our stated intention in fiscal year ‘24 to grow revenue faster than expenses and expand our adjusted EBITDA margin. We are on track to do all these things. Now, for the Q3 results. We reported revenues of $373.4 million, up. 23% sequentially and roughly flat year-over-year on both a reported and constant currency basis.

Americas grew 8% year-over-year to be 67% of total revenue, driven by resilient consumer demand, as well as a strong reception to our Father’s Day promotion in June. EMEA and APAC each declined year-over-year to be 28% percent and 4% of total revenue respectively. This was due to soft consumer demand, consistent with the challenging economic climate in each region and we expect this softness in EMEA and APAC to continue through Q4. So the shape of the second half is a bit different than we had anticipated, in aggregate, our expectations are unchanged from what we outlined last quarter. I will discuss this further after I finish recapping this quarter’s results. Quarterly registrations declined 2% year-over-year, while products sold declined 11%.

This divergence with registrations outpacing selling is consistent with what we outlined last quarter about reducing channel inventory in the second half of the year. Favorable product and channel mix, as well as focused price increases caused revenues to be roughly flat year-over-year despite the 11% decline in product sold. Q3 gross margin expanded 270 basis points sequentially from Q2 to 46% or 45.9% excluding the impact of FX, consistent with last quarter’s guidance. This expansion was driven by a full quarter of some targeted price increases, lower cost of components and favorable mix partially offset by promotional activity and the reserves and expenses we have taken related to our component inventory that we currently deem to be excess.

These reserves are included in our cost of revenue and now hit our gross margin. This is a temporary consequence of sourcing components during a period of COVID-induced scarcity, followed by a period of slower demand. We expect to work the rest of the way through this gradually diminishing COVID overhang in mid-fiscal year ’24. On a year-over-year basis, gross margin declined by 130 basis points due to lack of typical promotional activity in Q3 of fiscal ‘22 partially offset by favorable product mix and fewer spot component purchases in Q3 of this year. Adjusted EBITDA was $34.3 million, ahead of our expectations due to the combination of higher revenue and lower operating expenses. Foreign exchange was an approximately $0.7 million tailwind to adjusted EBITDA.

Total non-GAAP adjusted operating expenses of a $149.6 million declined by $4.4 million or 3% from Q2 due to delayed program and advertising spend and lower bonus accrual. Please note that mid-June rev had little impact on our Q3 expenses and that this expense figure excludes the $10 million restructuring charge we recorded associated with the rev. We ended the quarter with $268 million of cash and no debt. Free cash flow was negative $7.8 million in the quarter, largely driven by a $31 million increase in accounts receivable and $18 million decrease in accounts payable and accrued expenses and $15 million of share repurchases, partially offset by a $23 million decrease in inventories. Within inventories, finished goods were $240 million down 13% sequentially.

Looking ahead, atypical seasonality has its building inventory in fiscal Q4 ahead of the holiday. Our component balance of $58 million was up 12% sequentially. Over the last year, we moved swiftly to adjust our sourcing plan and our component purchase commitment. While we have made good progress, you still expect our component balance to continue to increase in the near term before reaching a peak sometime next fiscal year. As I’ve said, previously managing our own inventory and improving cash conversions remains a top priority. And finally, before turning to guidance, we purchased $15 million in stock in the quarter at an average price of $16.10 a share, representing 0.7% of common shares outstanding as of Q2. As a reminder, we have approximately $55 million remaining of our previous $100 million share repurchase authorization.

Turning to guidance. As I previously mentioned, our expectations for the second half of fiscal 2023 are largely unchanged from last quarter. Today we are adjusting guidance ranges to reflect being 3/4 of the way through fiscal ‘23, while maintaining the midpoint for revenue and adjusted EBITDA. We now expect to report full year revenues between $1.64 billion and $1.66 billion, down approximately 6% year-over-year. At the midpoint, our guidance of $1.65 billion unchanged from last quarter. We expect Q4 revenue between $290 million and $310 million, down between 2% and 8% year-over-year. Our Q4 guidance assumes that our Q3 promo overperformance, pulled in some demand from Q4, while overall demand in the Americas is resilient. We expect EMEA and APAC to weigh on our results.

Taking together with our Q3 revenue of $373 million, second half revenue at the midpoint of our revised guidance is $673 million, unchanged from last quarter. We now expect gross margin will be in the range of 44% to 44.2%. The entirety of this revision is driven by higher excess component provisions. As a result, we now expect Q4 gross margin between 45.9% and 46.9%. At the midpoint, this outlook implies the second half gross margin of approximately 46%, modestly below the midpoint of our prior guide of 47%. Absent this excess component provision in Q4, our gross margin outlook would be in line with the prior guide. To size this for you, the full year impact of the revision is expected to be at least, 100 basis, points headwind to gross margins.

And as a reminder, we’ve also faced significant FX headwinds this year adversely affecting gross margin by over 100 basis points, as well. Excluding FX in the provision, gross margin would be well within our normal annual target of 45% to 47%. We now expect adjusted EBITDA to be in the range of $148 million to $158 million representing a margin of 9% to 9.5%. At the midpoint our guidance of $153 million is unchanged from last quarter. We expect Q4 adjusted EBITDA to be between zero and $10 million, representing a margin of between 0% to 3%. Embedded in this Q4 adjusted EBITDA guide is non-GAAP adjusted operating expense of approximately $147 million in Q4, down modestly from Q3 due to realized rift savings and lower bonus, partially offset by timing of program spend.

Full year non-GAAP adjusted operating expenses are expected to be approximately $623 million. Taking together with our Q3 adjusted of $34 million, second half adjusted EBITDA at the midpoint of our revised guidance is $39 million, again unchanged from last quarter. As Patrick mentioned, in Q3, We took the painful, but necessary step of reducing our workforce by approximately 7%. We have other expense reduction initiatives underway, as well. For example, continuing the process of reducing our leased office space. We recently amended our long-term lease in Boston reducing our footprint by almost 50%. And in Santa Barbara, we will be giving up our two current office locations, and moving to a new consolidated office space early in the second quarter of 2024.

We will continue to review our expense base in search of further, areas of savings. Managing expenses and improving efficiency is a critical importance. We are in the throes of planning for fiscal ‘24. And while it is too early to provide guidance, I do want to double down on our commitment to delivering operating leverage in fiscal ‘24. We will provide further detail of this on our Q4 earnings call. Last but not least, let me touch briefly on our Google litigation. In our Northern California case against Google, the jury awarded us $32.5 million based on Google’s infringement of one of our Sonos themed patents. Post-trial motions are currently pending. In Google’s two pending cases against Sonos at the ITC, a hearing was held in one case with an initial decision expected in September.

In the second case, the judge delayed the expected July hearing and indicated that she would be issuing an order finding the Google patents at issue there to be invalid. We expect a written ruling shortly. With that, I’d like to turn the call over for questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Erik Woodring with Morgan Stanley. Your line is open.

Erik Woodring: Awesome. Thank you guys and nice work in the quarter. Maybe Patrick, already I’m not sure which one I defer either one of you, but just to confirm, I guess, the fiscal 3Q beat and in fiscal 4Q guide down that’s largely it seems like a product or result of strong promotional activity. So you pulled forward some demand. There’s also some incremental weakness in international markets. So one, just making sure those are the kind of two key factors to think about for 4Q. And the follow-up to that is just like, how should we think about product registration, growth or declines I guess as we then think about the September quarter? Should we think about the trajectory worsening just given the guide down? Or maybe if you could just share some color on how to think about that for the September quarter. That would be helpful. And then I have a follow-up. Thank you.

Patrick Spence :

Eddie Lazarus: Erik, thanks for that question. So we’ve been intensely focused on hitting our revised second half top and bottom-line targets. And obviously we’re very happy that we’re going to be meeting those goals. As to the balance between Q3 and Q4, I think you hit it. Well, we had a very successful Q3 promo, which no doubt pulled forward some revenue from Q4. We’re also expecting some further channel tightening in EMEA APAC and you touched on that. Overall, we see the Americas holding steady with continued weakness in those other regions consistent with the economic conditions in those other areas. For the whole year, I just want to emphasize this because you asked about registration, but the whole year registrations have been outpacing selling.

So, the underlying demand is actually a bit stronger than the headline revenue numbers. Now our goal is to continue to compete effectively, which we’ve been doing as we wait for our categories to recover, which they definitely will in time. And so, but I think you summarized things pretty well there.

Erik Woodring: Awesome. Perfect. Thank you, for that. And then, maybe Patrick, you continuously kind of talk about these four new categories. Obviously, now it’s three new categories after the launch of Sonos Pro. Can you help us make you think about the timeline to entering those new product categories? And I know you don’t want to give away any trade secrets. So maybe if I phrase the question as, you’ve set a long-term target for $2.5 billion of revenue, $375 million to $450 million of EBITDA. Do you need to enter those three new categories to reach that goal? Or do you think you can reach that goal with kind of the exposure that you have in any subsequent product launches in existing categories already? And that’s it for me. Thank you.

Patrick Spence : Thanks, Erik. We entering the new categories, that that our strategy is both raising the bar in the existing categories, which is important to driving growth. And then the second element of that is entering new categories. And so, both of those both parts of our strategy just like acquiring new homes, and as well getting our existing homes to purchase additional are part of the strategy. It’s all part of getting to our $2.5 billion in revenue. So, and as you alluded to stay tuned, because we definitely don’t foreshadow the product roadmap for competitive reasons. Thank you.

Erik Woodring: Thank you, Patrick.

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