Sonos, Inc.
Q1 2020 Earnings Call Transcript

Published: 5 Feb 2020

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Sonos First Quarter Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today Ms. McLaughlin. Thank you. Please go ahead.

[Cammeron McLaughlin:]

Thank you. Good afternoon. And welcome to Sonos first quarter fiscal 2020 earnings conference call. I am Cammeron McLaughlin and with me today are Sonos', CEO, Patrick Spence; and CFO, Brittany Bagley.

[Patrick Spence:]

Thank you, Cammeron, and hello everyone. Our new fiscal year is off to a great start. Revenue for the quarter increased 13% or 15% on a constant currency basis to a record $562.1 million. Including the impact of tariffs during the quarter, gross margin increased to 44%, adjusted EBITDA increased 29% to $113 million, and adjusted EBITDA margin increased to 20.1%. Revenue growth during the quarter was driven by our Sonos speaker and Sonos system products led by Move, One SL, Amp and Port. A record number of new homes started with Sonos during the first quarter, and we continued to see strong growth in product registrations by both existing and new customers. Our IKEA partnership continues to be a strong contributor to growth in partner product and other revenue during the quarter. Furthermore, importantly, we continue to see that consumers who purchase a Sonos IKEA product the SYMFONISK product are returning and repurchasing additional products and continue to follow the same repurchase trend as customers who started with Sonos products. This trend is important, as we consider the lifetime value of these customers and consider future opportunities in this partner space.

[Brittany Bagley:]

Thank you, Patrick. Let me add some additional color on our strong first quarter results. Revenue growth was driven by strength across all product categories with the largest contribution coming from our Sonos speakers and our partner products and other revenue. Our planned promotions outperformed our expectations and we believe resulted in some pull forward of revenue from the second quarter. As we discussed with you last quarter, starting this quarter, we are now reporting our revenue in the following three categories

[Operator:]

And your first question comes from the line of Rod Hall with Goldman Sachs.

[Unidentified Analyst:]

Hi. This is RK on behalf of Rod. Thanks for taking my question. How do you know there was pull forward from promotions as opposed to just better demand? And could you also quantify the magnitude of the pull forward?

[Brittany Bagley:]

We're not going to quantify the magnitude of the pull forward. But if you look at the fact that we're maintaining our full year guidance, we have fully factored in what we think is pull forward.

[Unidentified Analyst:]

And how do you know it's not just better demand?

[Brittany Bagley:]

We look at a variety of factors and have conversations with our partners and look at sort of demand signals in the channel and are giving you our best view based on the information we have.

[Unidentified Analyst:]

Okay. Could you talk about what you mean by thinking about your products as more than just hardware and including additional business models?

[Patrick Spence:]

Yes. Hey, RK, it's Patrick here. I think you began to get an appreciation for the kind of things we're thinking about based on a couple of experiments that we were running over the last quarter something called Sonos Flex that we were running in the Netherlands where you could bundle certain sets of our products into a monthly fee that you pay, which better reflects really what we do as a business, because we're always bringing ongoing value to the customer in terms of new features and functions through our software. So we've been experimenting with that and -- so stay tuned on that one. We've also started something called Sonos for Business, where we think there's great opportunity to bring all the pillars of Sonos, the simplicity, the great sound, the freedom of choice to business customers as well. So we've begun some experiments there. And we've really -- as you've seen in our R&D investments we've been ramping up, we believe there's opportunity to bring new experiences to Sonos customers and get us into new Sonos customers by looking at other opportunities to bring services to the platform. And so just like we do with our hardware products, as those are ready and ready for scaling and public consumption, we'll be talking a lot more about those. But I'm very proud of the fact that the team is looking at and spending time not just on where we've been traditionally, but also thinking beyond that and thinking in new areas where Sonos can go.

[Unidentified Analyst:]

That makes sense. Thanks for all the color. Just one final question for me. You announced last month that you're not going to provide software updates to some older products. Could you talk about how that impacts replacement rates? And how the initial customer reaction has been?

[Patrick Spence:]

Sure. That is something that I think we certainly saw how passionate our Sonos customers are from any communication and with the news that we put out there. I mean we didn't get it right in terms of our initial communication hence by follow-up. And so, I think everybody understands now that the intent was to talk about the fact our products launched anywhere from 10 to 15 years ago are no longer capable of supporting the new features that are going to be coming out in May, but they will continue to be supported with bug fixes and software updates and those kind of things. And we see that continuing into the future.

[Unidentified Analyst:]

Great. Thanks -- congrats on the good results guys.

[Patrick Spence:]

Thanks, RK.

[Operator:]

Your next question -- line of Adam Tindle with Raymond James.

[Adam Tindle:]

Okay, thanks. Good afternoon. Brittany, I just wanted to start on revenue guidance. Obviously congrats on very strong December quarter. Just hoping on what you -- that you can touch on a little bit on what you're seeing here early in the March quarter given the commentary around the pull in, I'm just anticipating some debate tomorrow. On one hand, we could fully understand not wanting to model normal seasonality up a strong quarter due to prudence and conservatism. On the other hand, sure you can sympathize with the fact that this was the quarter last year where there was a channel inventory problem that needed to be corrected. I think there's some speculation that that could be bubbling up again. So just hoping that you can help us understand conservatism versus channel inventory issue based on what you've seen thus far in the March quarter?

[Brittany Bagley:]

Yes. I think we're comfortable with our inventory position in terms of where we are and you're -- we're very happy with our Q1 results. And we're not changing our guidance for the year in any way. So I think that's sort of the best color I can give in terms of how we're seeing Q2.

[Adam Tindle:]

Okay. And maybe just on that point, cash flow was up nearly I think 30% year-over-year despite the incremental tariff impact. Can you just touch on what's driving such strong trends in cash flow? And how we can think about cash flow as the year progresses?

[Brittany Bagley:]

Yes. Q1 is always our strongest cash flow quarter. We have incredible benefits of scale in Q1. That said, we also had strong working capital management. And of course, because we're really not a taxpayer yet, we had another great quarter where our free cash flow was actually higher than our EBITDA. So that are -- those are some of the contributing factors. I think if you looked last year, Q1 would also have been our highest cash flow quarter. And so I think you can think about similar trends throughout the year.

[Adam Tindle:]

Okay. And one quick one for Patrick. It looks like you're keeping the EBITDA guidance which -- for the year which would imply a net loss for the remaining three quarters of the fiscal year, which is pretty atypical based on the past few years, usually a couple million positive. And you mentioned investments and that's what I wanted to ask about. If you could just maybe touch a little further on the investments that you mentioned? And ultimately, what got you comfortable with making them and what you expect to see from them?

[Brittany Bagley:]

Yes, I'll take this one, Adam. I think what we are really doing as you have seen even starting in the second half of 2019 and then what we are expecting through this year is that we're making pretty significant investments predominantly in our R&D and product organization. This is to continue to support our long-term product road map, our diversification outside of the home. Patrick, spend a little bit of time on how to think about our new potential revenue initiatives that we have been experimenting with. And so we really see this as an important investment for our long-term future and the overall strength of the business for many years to come. Obviously, we are trying to balance that along with strong gross margins this quarter and continuing to deliver on our promise on an average annual 20% EBITDA growth. So we really are balancing the investments we're making with the overall health of the business. But feel really good about the opportunities in front of Sonos as a company and where we can take it and the fact that we really are leaders in our products both on the hardware and software side of the business.

[Adam Tindle:]

Thanks, and congrats on a strong start.

[Brittany Bagley:]

Thank you.

[Operator:]

Your next question line of Katy Huberty with Morgan Stanley.

[Katy Huberty:]

Yes. Thank you. My congrats on the quarter as well. Brittany, as you think about 2Q historically revenue is down 50% to 60% sequentially. Should we think about a trend that is in that range, but maybe towards the high end of the decline historically given the pull in? Or is there a scenario where revenue in 2Q this down -- year is down more than we've seen in the past?

[Brittany Bagley:]

Yes. I mean I don't think we're going to start giving real quarterly guidance or shaping the quarter. So the best I can do is to advise looking at last year as a guide and then taking into account our comments about pull in.

[Katy Huberty:]

Okay. Thank you. And then you mentioned as it relates to gross margin dynamics up 140 basis points to 240 basis points margin expansion and some of that is product mix. Can you talk about what is the mix shift that's going on in the business that is allowing you to expand gross margins at that rate?

[Brittany Bagley:]

Yes, I think, that all of our different products have different gross margins associated with them. And so there is variability for us in any given quarter in terms of how that mix will fall out from a gross margin standpoint. So I would say in Q1 we happen to sell a lot more of our high-margin products. You can look at where we were running promotions and think about how that probably contributed to it. And then it's really that and then some continued improvement in our material costs which led to a very nice quarter.

[Katy Huberty:]

Okay. And then just one last one maybe for Patrick. You talk about in the investor letter the idea of realizing the value of your IP that may mean patent licensing or other accretive financial arrangements. Can you talk about how many of those type of arrangements you have in place today? And do you see this as a year where there could be an inflection in the number of those arrangements? Thanks.

[Patrick Spence:]

Hi, Katy, it's Patrick. I'm going to pass you to Eddie, our General Counsel and Lead on IP to answer that one.

[Eddie Lazarus:]

Hi, everyone. Thank you, Patrick. So as we've noted we think that quite a few players in the space are currently infringing on our patented inventions and we're in discussions with many of those companies. We hope that those discussions will bear fruit in a substantially accretive way. Exactly when that's going to happen we can't say. We view this as really a long-term proposition for the company. It's not something that we have a clock on. But as we've shown now we're also willing to litigate when necessary if discussions completely break down. So for us it's -- every single one of these circumstances is a little bit different and I wouldn't want to prejudge where we're going to come out. But we are very actively pursuing getting value for what we consider to be extremely valuable inventions.

[Katy Huberty:]

Eddie, do you have existing licensing arrangements? And Brittany where does that show up in the revenue segmentation I assume in other?

[Brittany Bagley:]

Yes. That would be in our other category.

[Katy Huberty:]

Thank you.

[Operator:]

Your next question line of Matt Sheerin with Stifel.

[Matt Sheerin:]

Yes. Thank you. And thanks for taking question. Just regarding the promotional activity you had in the quarter it sounds like that's been very successful. And as you look through the fiscal year not just the seasonally strong quarters how has that strategy changed in terms of reaching out to customers? And what should we expect through the year?

[Brittany Bagley:]

Yes, I think you should really expect that we continue to be a premium brand and that we are very selective in terms of when we run promotions and that we are looking at it holistically. But what we have seen from Black Friday, Cyber Monday is that that is an increasingly promotional time of year and customers really expect that companies are getting promotional. We were by no means the most promotional company in our category on Black Friday, Cyber Monday. But to some extent, you really have to make sure that you're ready to play and show up at that time of year. And so, what you saw from us this year was that we planned that that we went a bit deeper this year than we did last year and that really paid off for us as a result. I think we'll see what that means next year. We're not going to get into 2021 at this point. But for the rest of 2020 everything is already planned into our guidance, and we will be continuing to focus on being a premium brand and very selective in our promotions.

[Matt Sheerin:]

Okay. And then -- and you mentioned Patrick that you saw a nice increase in the number of registered users. Could you tell us what that number was? And then in terms of the percentage of customers that buy additional products, particularly with this IKEA program, could you give us that number as well?

[Patrick Spence:]

Yeah Matt, we give those on an annual basis. So, we're not providing any on the quarter, but it was a record quarter in terms of the number of new homes. The other thing that was important was IKEA was a significant contributor to that. So, our push for partnerships and the work that we've done there, which again is very different from where we've been in the past has been something that's really helping expand the Sonos system and the software platform into many, many new homes. And so, that's something which we're very proud of and we think has a lot of opportunity for the future.

[Matt Sheerin:]

Got it. Okay. Thank you.

[Operator:]

And your next question line of Thomas Forte with D.A. Davidson.

[Thomas Forte:]

Great. Thanks for taking my question. So as you move your supply chain into Malaysia for products sold in the U.S., how should we think about the potential for your supply chain that stays in China as far as potential disruption from a prolonged coronavirus? Thank you.

[Brittany Bagley:]

Hey, thanks for the question. Look, coronavirus is obviously a very fluid situation. So, it is hard for us to predict with certainty what the impact is going to be there. But for what we see now, based on the information that we do have, we are saying there will be minimal impact and no change to our fiscal year 2020 guidance.

[Patrick Spence:]

The only thing I would add on that is just that China also isn't a material market for us. So, I know many companies have been talking about this, but I think it's important to note that from a revenue perspective it's not material for Sonos.

[Thomas Forte:]

Great. Thanks for taking my question.

[Patrick Spence:]

Thanks, Tom.

[Brittany Bagley:]

Thank you.

[Operator:]

Your next question line of Robert Muller with RBC Capital Markets.

[Robert Muller:]

Hi. Can you talk a little bit about the integration of the Snips team on how the development of voice assistance is coming along? And are there any kind of targets or goals that you're looking towards in terms of when we actually might see integration into the new products?

[Patrick Spence:]

The integration is going well, and we're excited by it. I think we found people that share a lot of the beliefs that we have in terms of how to build amazing customer experiences. And I would say stay tuned in terms of the rest.

[Brittany Bagley:]

Yeah, I would say you're going to see them fully integrated in our P&L. So, you're not going to see any call outs related to the Snips acquisition. And like we do with everything on our product road map when we're ready to announce something, we'll be really excited to share it with everyone. But we're not putting out time lines on specific product features.

[Robert Muller:]

Sure. And then just -- I know it's small, but on tariffs can you expand just a little bit more on why there wasn't a reduction to your expectation? I mean just kind of backed on math, it seems like it might be a few million at least. So, I'm just wondering why to have another rate is not changing your expectations.

[Brittany Bagley:]

It is really because of how much of the tariff came through for us in Q1, which is well behind by the transition time line. And then, we are already in production in Malaysia. So, we moved very quickly on that and are executing there. And so, as we talked about last quarter, our tariff impact is really front-end weighted for the year. And so as we get into the back half of the year, we have largely mitigated that. And that's why you really don't see a material call out for the reduction in the tariff rate.

[Robert Muller:]

Okay. Appreciate it. Thank you.

[Patrick Spence:]

Thanks.

[Operator:]

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

[Brent Thill:]

I think Patrick you mentioned strong growth in Americas, EMEA was only up 1% constant currency. I'm just curious, what you think the cause was and what kind of gets that back elevated to where you see the U.S. level that?

[Patrick Spence:]

Yes, I think the important thing to understand there that we referenced a little bit is, what's going on in the market as well. And we were able to actually gain share in the key markets there in U.K. and Germany. And so, we feel good about the work that we're doing there as well. And with some of the work that we're doing with IKEA, I think we're in an excellent position. And so, we obviously want to see that continue to grow over time. But at the same time, we feel good about our positioning and being a premium brand like in the categories, we play in, we're in a good position in that market.

[Brent Thill:]

And I know the -- your e-mail about the software updates maybe sent the wrong signal, but I've just anecdotally had some friends that have already moved to upgrades and get moving. Have you seen any upgrades ahead of that that you see already in the system? Or is it just too early to call?

[Patrick Spence:]

The program that we offered as a choice right to customers, again this is a choice to customers and so they get to -- if they choose upgrade because, they're excited by the features and functions that are there, they can choose to do it has really just got started at this particular point in time, so too early at this point to see. This is the first time in what 16, 17 years now we've gone through anything like this. So, we'll learn and be factoring that in. But right now, it's early in terms of going through that. And I think we also clarified that message pretty quickly. So people understood that their existing products will continue to work. So, I think the -- again this is -- while I understand the questions from like a revenue perspective and how it impacts the flow, it really is an effort to make sure that we're building on the brand that we've created and that customer loyalty and everything that we're doing for customers. So, we'll see over time how that trends.

[Brittany Bagley:]

Yes. The only thing I would add is, as you can imagine, we didn't make this decision lightly or quickly. And so, to the best that we can estimate these impacts, they are included in our fiscal year '20 guidance.

[Brent Thill:]

Great. Thank you.

[Operator:]

And turning back over to Patrick Spence for closing remarks.

[Patrick Spence:]

Great. Well, thank you everybody. We're very excited with the strong start to fiscal '20 and are looking forward to an exciting year. As you can see, we're making a lot of investments, primarily in research and development. And so, we're excited for what lies ahead. And thank you for your support.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.