Sonos, Inc. (NASDAQ:SONO) Q2 2024 Earnings Call Transcript May 7, 2024

Sonos, Inc. misses on earnings expectations. Reported EPS is $-0.56331 EPS, expectations were $-0.27. SONO isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. My name is Greg and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos Second Quarter Fiscal 2024 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. [Operator Instructions] Thank you. I would now like to turn the call over to James Baglanis, Head of Investor Relations. James, you have the floor.

James Baglanis: 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 Officer 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 API at 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 as 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 will now turn the call over to Patrick.

Patrick Spence : 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 strengths 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 life.

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 bring 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 on 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 multi-billion dollar category, expanding the number of categories we play in from five to six and further diversifying our business. This has been a multi-year 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 install 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 install 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 multi-product 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 multi-year 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 re-acceleration. 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 install 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.

Saori Casey : 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 onto our results. Q2 revenues came in slightly ahead of our expectations at $252.7 million. Our better than expected Q2 revenue was driven by 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 base 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 continue 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 decline 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 a 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 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 repurchases 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 multi-billion dollar category will generate a large portion of the over $100 million 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 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 a 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.

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