Sonos, Inc.
Q4 2019 Earnings Call Transcript

Published: 20 Nov 2019

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to Sonos Fourth Quarter and Fiscal 2019 Conference Call. After the speakers' presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today, Ms. Cammeron McLaughlin, Sonos Investor Relations. Thank you. Please go ahead.

[Cammeron McLaughlin:]

Thank you. Good afternoon, and welcome to Sonos' fourth quarter and fiscal 2019 earnings conference call. I am Cammeron McLaughlin, and with me today are Sonos' CEO, Patrick Spence; and CFO, Brittany Bagley. For those joining the call early, today's hold music comes from a playlist inspired by the launch of Sonos Move, and is included in our shareholder letter today.

[Patrick Spence:]

Thank you, Cammeron, and thanks to all of you for joining us today, as we report on our first full fiscal year as a public company. As we get started, I want to ground us in the journey we've been on and what we set out to achieve this past year. When I took on the role of Sonos' CEO, almost three years ago, we set out to do two things. The first was to accelerate our pace of new product introductions, both in terms of new products extending our leadership in the home, and new products that take us into categories beyond the home. And the second was to deliver sustainable profitable growth on a consistent basis. As we exit 2019, I'm pleased to report major progress on both fronts, while continuing our run of record-setting results. Revenue for fiscal 2019 increased a 11% to a record $1.261 billion, and adjusted EBITDA increased 28% to $89 million. This marks the third consecutive year, we've exceeded the financial goals we set forth of 10-percent-plus revenue and 20-percent-plus adjusted EBITDA growth, as well as achieving the important milestone of positive free cash flow. We generated more than $97 million in free cash flow in fiscal 2019, ending the year with $339 million in cash. Moreover, we achieved these cash flow metrics, even as we increased our product velocity and investment in innovation to drive growth over the long term. We exited fiscal 2019 with over 9 million homes around the world using Sonos. This is a terrific milestone, and only reinforces our confidence about the opportunities in front of us. The quality of our products, the uniqueness of our platform, and the strength and premium positioning of our brand drove continued growth in purchases by both new and existing customers. In fiscal 2019, we added nearly 1.7 million new households, the most we've ever added in a year, and an increase of 9% from last year.

[Brittany Bagley:]

Thank you, Patrick. I'd also like to welcome Cammeron to her first earnings call with us. Since joining in August, she has been a wonderful addition to the team. Let me add some additional color on our strong 2019 results. We came in just above our revised guidance and ahead of average annual target pool. 2019 is another great example of us doing what we say we're going to do. In the fourth quarter, revenue increased 8% to $294.2 million. Gross margin declined 40 basis points year-over-year to 42.2%. Our adjusted EBITDA loss for the fourth quarter was $3 million compared to a $20 million profit last year. The loss was primarily driven by increased sales and marketing to support the launch of Move, and increased R&D headcount to support new hardware and software development. Turning now to our fiscal 2019 results. Revenue for the full year grew a 11% to a record $1.261 billion. This already impressive growth was even better on a constant currency basis at 13.4%. The Americas grew at 12.4% and EMEA grew at 1.3% or 5.8% on a constant currency basis. APAC grew significantly, up 78% on the strength of the IKEA module business.

[Operator:]

And your first question comes from the line of Rod Hall from Goldman Sachs. Your line is open.

[Unidentified Analyst:]

Hi, thanks for taking my question. This is Ashwin on behalf of Rod. Patrick maybe this question for you on holiday demand expectation. I wanted to get your thoughts on how you're thinking about demand particularly in Europe, where Google voice assistant was expanded during the year, and now that you have supported the other strength. Can you talk about your expectations of demand there? And I have a follow-up.

[Patrick Spence:]

We've obviously built that into the guidance that we provided. And we've certainly, I think it's been great like -- to your point about adding Google Voice -- Google Assistant across the countries in Europe, because it's much more relevant there in terms of what's happened. But nothing -- I wouldn't say anything in particular, that I would point out different or new really to that story. We expect growth and -- but we expect growth across all the regions, as we think about holiday.

[Unidentified Analyst:]

Okay. And my follow-up is on the Trade Up program. Can you give us more color on the reception there? Customer reception and kind of help us understand sort of the impact it would have on your margin profile, should the program see a significant uptake.

[Patrick Spence:]

It's really early days right now for the Trade Up program. This is a program where we're providing our long-standing customers with an opportunity to upgrade to the newest generation of products, and then to a responsibly be able to recycle their -- all their products. So right now, early days, we'll see how things develop over the next few months.

[Brittany Bagley:]

And we obviously have Trade Up built into our guidance for fiscal year '20. And I think you can see that, absent tariffs we're showing really nice gross margin results. So I wouldn't view that as a big drag.

[Unidentified Analyst:]

Understood. Thank you.

[Operator:]

Your next question comes from the line of Adam Tindle from Raymond James, your line is open.

[Unidentified Analyst:]

Good afternoon, this is Madison on for Adam, and thanks for taking my questions. I wanted to start on the household growth. You mentioned in the letter you added a record number of new households. Can you talk about the key drivers that have led to this acceleration, despite lower marketing spend? And how some business model innovation with partnerships like IKEA are impacting this?

[Patrick Spence:]

Yes, thanks, Madison. I think the new product velocity has certainly helped, right. So as we set out and have started to introduce new products, it keeps the -- it allows us to drive a lot of earned promotional dollars basically like through the -- through those two tempo moments, that two times a year when we have big press moments. And the world sees Sonos -- and see Sonos innovating. So that's been a key driver. I'd also point to the system. The Systemness and just like the continued loyalty of our customers to go out and tell their friends and family about Sonos continues to be a key driver. And the last point, would be finding new methods to actually drive more awareness of Sonos. So our efforts around digital and direct-to-consumer have allowed us to become more efficient on the sales and marketing side.

[Brittany Bagley:]

Madison, I'll just add, I think we're pretty excited about what IKEA could do for us longer term to continue driving down the new household acquisition cost. But I would remind you that they really would only have shown up in our household number since August, because they've been in stores in August and September. So they really are a pretty small contributor to this 1.7 million. So most of this 1.7 million is really being driven by our existing products and channels.

[Unidentified Analyst:]

Okay, that's good color. Thank you. And just for a follow-up. If I have my model right for fiscal year '20. It looks like gross profit dollars will still grow by high-single digits, including the tariff impact, but EBITDA will be down by mid-teens year-over-year. Can you just help me bridge the gap there? Is there anything outside of tariffs contributing to this, maybe related to the acquisition? And then what are the nature of these costs related to tariffs? Are they really one-time, meaning that we should get a $30 million tailwind in the fiscal year '20? Thanks.

[Brittany Bagley:]

Yes, great question. So as we think about it, we've done a lot of work to improve our gross margins in fiscal year '20, and absent tariffs, we would be both growing EBITDA 20% and investing back into the business. That's really critical for us in long-term to continue to grow, to continue to deliver new products, to continue to deliver software that differentiates Sonos. And so we are going to continue to do that. So absent tariffs, what you're really seeing is, we are investing back into the business and the majority of that is really in R&D. That said, the tariff costs really are one-time. What we're giving you is the net number of what it's costing us to actually pay the tariff. And so regardless of what happens to tariffs, when we got into fiscal year '21, we will be shipping our US-bound products from Malaysia, and that will get us out of the tariff impact.

[Unidentified Analyst:]

Okay. Thanks for taking the questions.

[Operator:]

Your next question comes from the line of Robert Muller from RBC Capital Markets. Your line is open.

[Robert Muller:]

I was wondering if you could just discuss the engagement from IKEA users in terms of how much time they're spending on the app. And then also, if you have any commentary about the popularity of the two products in which one has been performing stronger out there or kind of equal?

[Patrick Spence:]

Yes, we're not going to break out the unit sales. But I will tell you that I think the thing we've been watching and that's most important is how the customers that start with an IKEA product come back and repurchase. And so, so far we've seen that those customers follow the same trend as the Sonos branded customers, which is a huge thing as we think about the lifetime value that these customers will bring into. Brittany's earlier point, IKEA is going to be a great new household driver. And when you combine that with the fact that we're seeing that kind of behavior in return repeat purchase, I think we're in an excellent position. And we're very pleased with the start that we're off to with IKEA.

[Robert Muller:]

Okay. And then just along those lines. Are they returning for more IKEA or are they actually transitioning to the full Sonos branded product?

[Patrick Spence:]

We're seeing both in the mix right now, and we expect we probably will see both, and we'll continue to watch that over time, and see if any particular trends pop out. But at this point, we're seeing both.

[Robert Muller:]

Okay, that's great. Thank you very much.

[Operator:]

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

[Unidentified Analyst:]

Hi, this is David on for Brent. Thanks for taking the question. Could you comment on the early demand you're seeing for the Move as we head into the holiday season, especially with the $399 price point. It looks like you're calling it out as a big driver for 2020, so you must be feeling good about where you are in terms of how it's selling so far. And then you grew revenue 1% in Americas, 2% in EMEA on constant currency basis. Is there anything to call out as to why those regions didn't grow as fast? Is it competition or something to call out on the macro front? Thanks.

[Patrick Spence:]

I'll take the first one and let Brittany answer the second one. On the Move, we're pleased with the way we're off to start. It's a great product. I just look today and it's rated a 4.6 out of 5 on Amazon, which is pretty amazing for new products, and one of our best that's on there. All of our new products are great contributors to our growth, but so are our existing ones. And so, we're pleased and it absolutely plays a big part in our fiscal '20 growth story.

[Brittany Bagley:]

Yes. So the thing that you saw in Q4 is that both the Americas and EMEA were lapping the introduction of Beam in Q4 of last year, and so that's really the impact that you're seeing on the quarterly revenue growth. From a year-over-year standpoint, you can see we're continuing to really perform on our growth targets and that's much more what we look at.

[Unidentified Analyst:]

Got it. Thank you.

[Operator:]

Your next question comes from the line of Sean Henderson from DA Davidson. Your line is open.

[Sean Henderson:]

Thank you for taking my question. So to start, similar to your IKEA efforts, to what extent does your team looking to grow its retail partnership strategy?

[Patrick Spence:]

Yes, we're just getting started with the IKEA one. We're off to a good start and we have more plan with them. But it's certainly something we're considering for the future, nothing to announce today, but something we're considering for the future.

[Sean Henderson:]

Okay, thank you. And then just one quick follow-up. So how should we think about your future product strategy, including any potential new verticals that you guys can move into.

[Patrick Spence:]

Yes. We're committed to continuing to deliver the kind of pace of new product introduction that you've seen from us over the last -- almost three years now. So we've accelerated that. I think we feel good about that. We are -- you will see a balance of both extending -- products that extend our leadership in the home, and then also products that help us expand into categories we're not in today, and those can come both from Sonos branded efforts and also from partnerships. So you'll see a mix of both. And you can continue to expect to see us making sure that we're delivering on both of those fronts.

[Brittany Bagley:]

As we mentioned in the shareholder letter, you should expect a few more product introductions this year, and will be really excited to talk about those when those happen.

[Sean Henderson:]

Got it. Thank you very much.

[Operator:]

Your next question comes from the line of Matt Sheerin from Stifel. Your line is open.

[Kurt Swartz:]

Yes, hi, this is Kurt Swartz on for Matt Sheerin. Thank you for taking my questions. First question, I know you aren't providing specific quarterly guidance, but just hoping maybe you could provide any more color on how Q1 sales are currently trending perhaps relative to historical seasonality. I think you said you've expected growth in all regions, but any other color there would be helpful.

[Brittany Bagley:]

Yes. So we don't provide quarterly guidance, and we are still early in Q1. But I would say, that the best way to look at that would be a growth rate that is roughly consistent with the growth rates that we saw last year.

[Kurt Swartz:]

Understood. And then, just another question, going back to the tariffs. Sort of a two-pronged question here. For one, are you using -- do you plan on using the same contract manufacturers in Malaysia that you've been using previously? Or are you sort of branching out to new ones? And also have you considered passing along the tariff costs? Or was that really not in the strategy once the tariffs were actually implemented? Thank you.

[Brittany Bagley:]

Yes. Both great questions. We have diversified our contract manufacturers over time, but in Malaysia we are using contract manufacturers that we're already working with. So this is really about diversifying to Malaysia out of China. In terms of passing along the cost, I mean, we certainly thought about it, but that was not what we determined to be the best plan. And because this really is a one-year impact for us, we need to do what's best for the business and our consumers. And what's best for our business and our consumers is, to diversify as quickly as we can, and get out of having to pay these tariffs, while also delivering what we need to deliver on from a brand and Company perspective, and continue to invest in our business for the long-term.

[Kurt Swartz:]

Understood.

[Operator:]

And your next question comes from the line of Katy Huberty from Morgan Stanley. Your line is open.

[Erik Woodring:]

Good evening, guys. It's Erik Woodring on for Katy. So just touching more on the 1Q dynamics here, realizing you don't give specific guidance. So I imagine that you've incorporated this into your guidance, but just curious how you guys think about the timing of the holiday season being six days shorter this year than last year, and kind of how that affect -- how you think about 1Q? And then secondly, as it relates to 1Q, historically call it just shy of 100% of your annual EBITDA comes through in fiscal 1Q. Is that how we should think about it kind of ex-tariffs and then later on the incremental tariffs impact after. And then I have a follow-up.

[Brittany Bagley:]

So yes, we have incorporated holiday timing into our guidance and into my commentary. So yes, we've thought about that. And I think all were really going to say, on EBITDA is that we think about half of that cost of tariff will get impacted in Q1. So we'll be adding back about 15 of the 30 in Q1.

[Erik Woodring:]

Okay, great, thanks. And then just as it relates to tariffs. Obviously, you've talked about expanding to Malaysia. Just how far along are you on in that process? Do you plan on only moving US non-capacity? Or are you taking kind of a broader view towards diversifying your manufacturing base, kind of call it over the longer term?

[Brittany Bagley:]

Over the long-term, we are looking to diversify, and have a solid and flexible manufacturing strategy. But right now, because of tariffs, we are prioritizing US-bound manufacturing. So that's our priority for fiscal year '20.

[Erik Woodring:]

Okay. Thank you very much.

[Operator:]

And there are no further questions at this time. Mr. Patrick Spence, I turn the call back over to you for some closing remarks.

[Patrick Spence:]

Fantastic. Thanks to everybody for joining today. I think, we've got our first year as a public company in the books, and it was a good one. And we're looking forward to what we have planned in fiscal '20. And I would also point out in our letter, you will find a playlist inspired by Sonos Move. So I hope you'll all take a moment to enjoy that. Thanks, and we'll talk to you next quarter.

[Operator:]

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