Sonos Q3 2024 Earnings Call Transcript

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August 7, 2024

There are 8 speakers on the call.

Operator

you for standing by. My name is Jaylen, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos Third Quarter Fiscal 20 24 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.

Speaker 1

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Operator

would now like to turn the conference over to James Boglanis, Head of Investor Relations and Treasury. You may begin.

Speaker 2

Good afternoon, and welcome to Sonos' Q3 fiscal 2024 earnings conference call. I'm James Baglanis, and with me today are Sonos' CEO, Patrick Spence CFO, Saori Casey and Chief Legal and Strategy Officer, Eddie Lazarus. For those who joined the call early, today's hold music is sampling from our Sonos radio station, Backyard Barbeque. 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.

Speaker 2

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 Q3 fiscal 2024 results posted to the Investor Relations portion of our website. As a reminder, the press release, supplemental earnings presentation and a conference call transcript will be available on our Investor Relations website, investors.

Speaker 2

Sonos.com. I will now turn the call over to Patrick.

Speaker 3

Thank you, James, and hello, everyone. It was the magic of the Sonos experience that brought me to the company 12 years ago. We pour our heart and soul into everything we do, and we're proud of what we build and the way Sonos brings joy to our customers' lives. That's why it's so painful to let customers down the way we have with our new app. I am committed to making this right with our customers and partners.

Speaker 3

It's the company's number one focus right now and I will not rest until we're in a position where we've addressed the issues and have customers raving about Sonos again. A few years ago, we decided to embark on a complete ground up rewrite of our app. One reason was to address the performance and reliability issues that had crept in over the last 20 years and were negatively affecting our customers' experience. This would have been reason enough, but as important, we viewed re architecting the app as essential to the growth of Sonos as we expand into new categories and move ambitiously outside the home. In addition to its more modern user interface, the new app has a modular developer platform based on modern programming languages that will allow us to drive more innovation faster and thus let Sonos deliver all kinds of new features over time that the old app simply could not accommodate.

Speaker 3

Some of these new features are already on our drawing boards and could represent our entry into new categories, others are still to be imagined. But without a modern app, they would have remained beyond our reach. Versonos, a company built on innovation at the intersection of software and hardware and the delivery of joyful experiences, we needed the new app to set ourselves up for the future. While the redesign of the app was and remains the right thing to do, our execution, my execution, fell short of the mark. Since I took over as CEO, one of my particular points of emphasis has been the imperative for Sonos to move faster.

Speaker 3

That is what led to my promise to deliver at least 2 new products every year, a promise we have successfully delivered on. With the app, however, my push for speed backfired. It's important to note that this was really a redesign of the entire system, not only the app, but also the player side of our system as well as our cloud infrastructure. And this was an enormously complex undertaking. As we rolled out the new software to more and more users, it became evident that there were stubborn bugs we had not discovered in our testing.

Speaker 3

As a result, far too many of our customers, especially those with some of our older products in their systems, are having an experience that is worse than what they previously had. For some, this meant existing speakers missing from their Sonos systems, while others saw latency issues or errors while setting up new products. Regardless of the issues experienced, our customers deserve better from us. The app situation has become a headwind to existing product sales and we believe our focus needs to be addressing the app ahead of everything else. This means delaying the 2 major new product releases we had planned for Q4 until our app experience meets the level of quality that we, our customers and our partners expect from Sonos.

Speaker 3

While this has the painful effect of reducing our Q4 sales expectations, we believe it will set our future products up for greater success over the medium to long term. We have been working tirelessly on fixing the bugs in the new app, adding back certain features and exploring every option for improving the customer experience. Since launch, we've introduced 9 new software updates that address these issues. We expect the app will get better every 2 weeks with each subsequent release and we're committed to continuing to improve the experience on that same cadence and even faster where we can. We are able to rapidly deliver these major software updates because of the modular developer platform of our new app.

Speaker 3

I want to highlight 3 important areas where we're taking action. First, fixing the app. I've asked Nick Millington, the original software architect of the Sonos experience to do whatever it takes to address the issues with our new app. We have identified the key bugs, have a plan to fix them and are improving our processes and staffing to ensure we successfully execute our action plan. One of our Board members, Tom Conrad, has over 30 years of experience in software engineering and Tom is helping us ensure our software efforts are on the right track as well as providing another expert perspective.

Speaker 3

Because we expect that our app will continue to get better every 2 weeks, we're making more and more customers happy with each release. We're doing everything we can to put all of these issues behind us in time for the important holiday season. The second is supporting our customers. We are increasing our investment in customer support to be able to engage with more of our customers and partners and do it faster. Our customer support has always been something that has set us apart, and we need to ramp this faster to help our customers navigate in the near term.

Speaker 3

And finally, winning back our customers and partners. We are enacting programs this quarter to both support and thank our customers and partners for sticking with us through this period and turn their dissatisfaction to delight. These programs will run across Q4 and Q1. We expect these investments will come at a cost in the range of $20,000,000 to $30,000,000 in the short term but are necessary to right the ship for the long term. And given we've been at this for 20 years, we know what's needed to win in the long term.

Speaker 3

Now turning to the other important launch from the quarter, I'm pleased to share that even with the challenges of the app, our first headphones, Ace, are off to a good start. As you may have heard me say before, this is our most requested product ever. Headphones is a very exciting category for us to play in as the premium over the ear headphone category is a €5,000,000,000 addressable market growing by double digits annually, which stands in contrast to the cyclical downswing we continue to navigate in our existing categories. Our goal of participating in more and more categories is to continue to diversify our revenue streams, and headphones are a great opportunity to do just that. The customer reviews have been outstanding, as Sonos Ace is rated 4.6 of 5 stars on sonos.com and 4.5 of 5 stars on Best Buy.

Speaker 3

In its 1st month, Ace gained a meaningful share in the premium over the year category in our key countries despite competitors dropping their prices and offering unprecedented promotions in tandem with our launch. We take those competitor actions as a complement to the quality of our offering. To support the launch of ACE, we signed a number of new distribution partnerships. Last quarter, I mentioned we went live as a first party seller on Amazon in the United States. We have since expanded this partnership to Europe.

Speaker 3

Additionally, you can now find Sonos Ace on the shelves of In motion stores in many major airports around the world. In motion is a premier airport electronics retailer, and we are delighted to build upon this partnership over time. ACE represents an evolution of the role that Sonos can play in your life. With our categories, we are very well established in the home and we will continue to innovate there. For the first time, ACE enables us to be with you all day long, to be a part of the major moments in your day, whether at home, in the office, on a plane or out for a walk.

Speaker 3

This is integral to our mission of being everywhere our customers experience sound. To recap, it is deeply disappointing for me personally and for all of us at Sonos to be on track for the 1st 3 quarters of the year and to have a successful new product launch in an exciting new category only to revise our expectations for the Q4 due to the challenges with our new app. Of all the reasons that could have taken us off track, knowing that it is because we failed our customers and partners is perhaps the most painful. I want to reiterate again that the entire team and I are committed to making this right with our customers and partners. It's my number one focus, and I will not rest until we're in a position where we've addressed these issues and have customers raving about Sonos again.

Speaker 3

I'll now turn it over to Sayori to take you through our financials.

Speaker 4

Thank you, Patrick. Hi, everyone. Q3 revenues came in slightly ahead of our expectations at $397,000,000 up 6% year over year. Our positive year over year growth was driven by the introduction of our first over the year headphone, ACE. This brings our year to date revenue to $1,262,700,000 down 6.5% year over year.

Speaker 4

Though our financial results over the past 3 quarters had put us on track to meet our annual expectations, the challenges from the launch of our app requires us to adjust our Q4 expectations, as Patrick mentioned earlier. I'll come back to this after I finish recapping our Q3 performance. GAAP gross margin was 48.3%, up 2 30 bps year over year, considerably better than our guidance we gave last quarter. This over performance was primarily due to a one time benefit from improved inventory management. Gross margin increased sequentially from our 2nd quarter due to fixed cost leverage from higher revenue in Q3 and inventory management.

Speaker 4

Our Q3 performance brings our year to date gross margin to 46.4%, up from 43.6% in the comparable period last year. Non GAAP adjusted operating expenses were $155,000,000 in the quarter, down $2,000,000 sequentially. Adjusted EBITDA was $48,900,000 representing a margin of 12.3%, ahead of our guidance driven by higher gross margins and to a lesser extent higher revenue. This brings our year to date adjusted EBITDA to $130,500,000 representing a margin of 10.3%. We ended the quarter with $277,000,000 of net cash, which includes $50,000,000 of marketable securities as we hold some excess cash and short duration treasury bills.

Speaker 4

Free cash flow in Q3 was $40,300,000 bringing our year to date free cash flow to $188,000,000 compared to $38,000,000 in the comparable period last year. This increase was primarily driven by working capital improvements resulting from 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 $155,000,000 down 48% year over year and down 14% from last quarter. This consists of $102,000,000 of finished goods $53,000,000 of components. We are working hard to keep inventory balances in check.

Speaker 4

And finally, we returned $52,500,000 to our shareholders through stock repurchases in the quarter, representing 2 point 6% of common shares outstanding as of Q2. We have $71,000,000 remaining under our current $200,000,000 of share repurchase authorization. Expect to continue to be active in the market purchasing our stock. Turning to our guidance. The Q4 outlook we're providing reflects our best as a as a result of challenges stemming from the rollout of our new app.

Speaker 4

We expect Q4 revenue in the range of $240,000,000 to $260,000,000 The challenges with our app have had a twofold impact to our Q4 revenue expectations: 1, lower sales across our portfolio due to app launch issues 2, decision to delay the launch of 2 major new products until our app experience meets the level of quality that we, our customers and our partners expect from Sonos. As a result of the reduction to Q4, we expect the revenue in the range of $1,503,000,000 to $1,520,000,000 for the full year. We expect Q4 GAAP gross margins in the range of 40% to 42%, down sequentially from Q3 driven by deleverage resulting from lower revenue. For the full year, we expect GAAP gross profit dollars in the range of $682,000,000 to $696,000,000 representing a gross margin of 45.4 percent to 45.7 percent. We expect non GAAP gross margins to be approximately 40 bps higher due to approximately $6,000,000 of stock based compensation and amortization of intangibles included in GAAP cost of revenue.

Speaker 4

We expect Q4 adjusted EBITDA to be in the range of minus $37,000,000 to minus $14,000,000 resulting in full year adjusted EBITDA in the range of $93,000,000 to $117,000,000 representing a margin of 6.2% to 7.7%. The reduction in our expectation for adjusted EBITDA is primarily due to lower revenue. As Patrick mentioned, from now through the holidays, we're investing approximately $20,000,000 to $30,000,000 in fixing the app, supporting our customers and regaining their trust. We expect that this will come in the form of revenue and gross profit reductions as well as operating expense increases. A portion of this investment that will be incurred in Q4 has not been factored into our guidance range.

Speaker 4

Despite the reduction in our expectations from Q4, we still expect to show significantly improved free cash flow conversions versus last year due to our efforts to improve working capital. We have spoken in the past about our focus of expense management driving efficiencies across the organization. In the spring, it became clear that we needed to do more structurally and evolve how we operate. As a result, we began working on a transformational cost initiative that we will provide an update in November. With that, I'd like to turn the call over for questions.

Operator

Thank you. The floor is now open for questions. Your first question comes from the line of Adam Tindle of Raymond James. Your line is open.

Speaker 5

Okay, thanks. Good afternoon. I wanted to start, Patrick on the 2 products that are being pushed and appreciate you taking responsibility and I think have garnered a lot of trust from customers over time. On those two products that are pushed, how can you give us a sense of how far along those products were? And as we think forward to a time where these near term headwinds are through us and into fiscal 2025, Would that be a potential year where you might envision that stuff gets behind us, we'd have something like 4 product increases, sorry, introductions or are those kind of indefinitely pushed?

Speaker 3

Thanks for the question, Adam. These products were ready to be shipped in Q4. But as we've mentioned, we felt like it would be that we had to address the app issues first because we hold a high bar on the experience we want customers to have. So that is the number one focus at this particular point in time. And so I don't want to get too far into fiscal 2025, but I will say these products were ready to ship in Q4.

Speaker 5

Got it. Okay. And understand obviously all the near term pain that we're enduring on the app, But as you kind of think about the longer term vision once we get through this, you talked about being with customers all day long. I wonder if you might just expand on that vision over time what that could bring from a Sonos perspective. Could there be a time where this app given the modular development that you're talking about could introduce new monetization streams?

Speaker 5

Just anything that you could give us from an investor standpoint as help as to what the long term vision would be as we endure some of the short term pain?

Speaker 3

Yes. Thanks, Adam. I think that's a good one. You know, we remain, confident that over the long term, we can take more and more of that $100,000,000,000 audio market. We're only 2% less than 2% of it today.

Speaker 3

And definitely, the work that we've done on the app was the right work as we position ourselves for the future and build, you know, kind of build what we need from a, a future proofing and allowing us to be outside the home, in all of those areas. And so we feel we have a lot of opportunity ahead in new categories. But also right now, the number one thing for our customers is to make sure that we address the app and earn back that trust so we can extend into all of those new categories we have plans for.

Operator

Your next question comes from the line of Steve Frankel of Rosenblatt. Your line is open.

Speaker 1

Good afternoon, Patrick. Obviously, a lot to work through here. When we look at the magnitude of the revenue reduction in Q4, maybe give us some help parsing through how much of that is to new products that aren't going into the channel and how much is the app issues causing a significant slowdown in sell through? And if to the extent that's the case, where are channel inventories relative to where you want them to be for Q4?

Speaker 4

Steve, this is Sayori. I can take that. And so the way we characterize the impact, the Q4 reduction to our expectation in two folds. 1, first, in the larger of the 2 is the lower sales across our portfolio due to the app issues. And second, material enough to mention and certainly is the delay in the launch of our 2 major new products that were ready to go, as Patrick just mentioned.

Speaker 4

And so those were sort of in order that of magnitude to the impact of the guidance reduction. As far as channel inventory for Q at the end of Q3, knowing our Q4 revenue now that we're continuing to monitor very carefully, that would put us a little bit higher than we would have liked now knowing our trend currently. But certainly, that impact is comprehended in our Q4 guidance that we gave today, best we know as of today.

Speaker 1

Okay. And then on the $20,000,000 to $30,000,000 number, If a portion of that is price protection in the channel, is that already reflected in gross margins? Or might gross margins end up lower if you end up putting more price protection into or discounts into effect to Goose sale?

Speaker 4

Yes. The Q4 guidance that we gave out does not fully comprehend the $20,000,000 to $30,000,000 that we mentioned today. That has impact, as I mentioned, to multiple line items of the P and L revenue, gross profit and operating expenses and also the timing in which it would hit between Q4 and Q1. And so some actions are already underway, but there are others that are a little bit more in progress in determining exactly how to position that. To your point about whether that's a price protection type of activity that we hit in Q4 versus Q1.

Speaker 4

We believe more will hit in Q1 than Q4 at this point, best we know.

Operator

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

Speaker 6

Hi. This is Brianna Mitraji on for Brent Thill. Thanks for the question. Could you speak a bit more to the issues from the app rollout and the impact it could have on purchase intent for hardware going forward?

Speaker 3

Yeah. Thanks, Rhianna. So, we a few years ago, we embarked on a complete roundup rewrite of the app. We wanted to address the performance and reliability issues, and we also wanted to create something that would allow us to expand into new categories and bring a lot of new features to the system. So redesigning the app was definitely the right move for Sonos, But we, you know, we fell short on our execution of this one.

Speaker 3

And, you know, I think we're seeing the short term pain that we're having right now in that rollout, but it's our number one priority right now to address this. And so, I believe we will be able to address this, determined that we will address it in the short term and be able to make sure that we keep our flywheel intact for the future.

Speaker 6

Okay, cool. And then what are you seeing in the demand environment in general? Has a weaker macro further impacted consumer spend or is that hard to tell with the app problems as well?

Speaker 3

Our categories have really been under pressure for the last 2 years. So we continue to believe that they will recover at some point. But what we are focused on is best positioning for what we see today right now. Part of this is also why we are undergoing the cost transformation initiative that Sayori had mentioned, and also why it's so important that we entered the premium over the ear headphone category as that is a $5,000,000,000 market and growing double digits.

Operator

Thank you. Your next question comes from the line of Eric Woodring of Morgan Stanley. Your line is open.

Speaker 7

Hey guys, thanks so much for taking my questions. Patrick, I know you guys are alluding to the $20,000,000 to $30,000,000 of costs in the near term. I'm just wondering if you take a step back and think about the potential reputational damage that you could have from this app update. Could that be longer lasting and more kind of cost intensity than just $20,000,000 to $30,000,000 I mean, if you go through, I'm sure you have a number of message boards, is a lot of backlash. And so I'm just wondering if there is a longer term plan here in place outside of fixing the app and promoting, what else you have in store to try to get those customers that have either been loyal customers or new customers that were potentially considering Sonos products to actually come back after this?

Speaker 7

And then I will follow-up. Thanks.

Speaker 3

Yeah. Thanks, Eric. So I think the key is to address the pain points that we have right now and those customers that are having issues with the new app for sure. But remember, we're not standing still on the innovation front. So we have 2 major new products that we're pushing out again to get make sure that we're in a position where the app issues are behind us.

Speaker 3

As we do that and as we launch those, we launch other products we have planned. We do our day to day execution in the channels and in marketing and all our other areas. People will be able to see the products, they'll experience our products. And I'm confident that with the roadmap we have, with the innovation we have coming that this will be just one chapter in our long history. And so we do feel like the $20,000,000 to $30,000,000 is what it takes to address the short term pain and that with everything we have coming, we'll be able to ultimately address that pain and then get back to a place of customers raving about Sonos.

Speaker 7

Okay, understood. And then just maybe as my follow-up, I wanted to make sure I was fully understanding, say, already some of your comments. So the 4Q guide does not incorporate those $20,000,000 to 30,000,000 dollars of costs. Is that I'm just trying to understand if you flagged them for us, but then you're not including it in the guide. Does that mean we need to include $20,000,000 to $30,000,000 of costs in 4Q?

Speaker 7

Or are you saying that those are likely to come in fiscal year 2025? Thanks.

Speaker 4

You're correct that the $20,000,000 to $30,000,000 does not is not comprehended in our Q4 guidance. Part of it is because the $20,000,000 to $30,000,000 will be incurred over Q4 and Q1. And majority of it, we expect it to be incurred in Q1. There are some activities that are already in progress, but there are others that we're still vetting through the details. And so we did not want to detail that out in our guidance until we have a better clarity for Q4 specifically.

Operator

Thank you. There are no further questions at this time thus concluding our Q and A session. I will now turn the conference back over to CEO, Patrick Spence for closing remarks.

Speaker 3

Thanks, JL, and thanks to all of you for your time today. Just three things I want to hit in closing. 1st, building a new software foundation was the right investment for the future of Sonos, but our rollout in May has fallen short of the mark. We will not rest until we've addressed the issues with our app and have delivered new versions that materially improve our customers' experiences. 2nd, while our app setback is regrettable, it is one chapter in our over 20 years of delighting customers.

Speaker 3

I speak for everyone at Sonos when I say that our number one priority is to make this right and ensure that the next chapter is even better than the previous ones. And finally, our entry into headphones, ACE, is off to a good start and presents a great opportunity for us in a new, large and growing category. Thank you and we'll talk to you again next quarter.

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Key Takeaways

  • Sonos has delayed two major Q4 product launches and cut its Q4 revenue outlook to $240 million–$260 million (full‐year $1.503 billion–$1.520 billion) as it prioritizes fixing performance and reliability issues stemming from its ground‐up app rewrite.
  • Since the May rollout, Sonos has issued nine updates and committed to biweekly software releases to root out “stubborn bugs,” overhaul testing processes, and restore customer trust.
  • The company plans to invest $20 million–$30 million in the near term on app remediation, enhanced customer support, and partner programs, with most of the cost impact shifting into Q1.
  • Despite the app headwinds, the Sonos Ace over-ear headphones launched to strong reviews (4.6/5 on Sonos.com), secured meaningful share in the €5 billion premium headphone market, and expanded distribution on Amazon Europe and InMotion airport stores.
A.I. generated. May contain errors.
Earnings Conference Call
Sonos Q3 2024
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