Sonos, Inc. (SONO) Q4 2019 Earnings Report, Transcript and Summary

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

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. 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 also refer to non-GAAP financial measures, including adjusted EBITDA, adjusted EBITDA margin, and free cash flow. For complete information regarding our non-GAAP financial information and a reconciliation of those measures, please refer to our today's shareholder letter regarding our fourth quarter and fiscal 2019 results, posted to the Investor Relations portion of our website. With that, I'll turn the call over to Patrick.

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. Additionally, and this is one of the things that sets us apart from any company we can think of, our existing households accounted for 37% of our new product registrations. This means 37% of the products registered in the year were from customers who were adding an additional Sonos product to their home. This strength, and customers buying more over time, is also reflected in the increase we've seen in average number of registered products per household, going from 2.8 to 2.9 in fiscal 2019. Together, these results illustrate our continued ability to acquire new Sonos customers, and to convince our existing customers to continue to add to their system. Since inventing multi-room home audio over 17 years ago, Sonos has consistently grown our revenues and profits, innovated and enhanced our product offering and platform, and further advanced our leadership position. The quality of our products across design, ease of use, sound quality, the openness of our platform and the premium positioning our brand drives growth in purchases by both new and existing customers. We continue to invest in innovation and differentiation, our core areas of strength. We made tremendous progress in fiscal 2019 toward our stated goal of increasing product velocity, and moving outside the home, unveiling several new products, including Sonos Move, Sonos One SL, Sonos Port and Sonos Amp. These introductions demonstrate our ability to extend our leadership within the home, while introducing our first product that takes Sonos outside the home. Move takes freedom of choice to the next level, marking the first time, you can take Sonos anywhere, and adds a product category, our existing customers have been asking for. Expanding our product offering outside the home, we'll also introduce Sonos to a much broader market than the current $18 billion in-home audio market. We see significant opportunity in the years ahead, leveraging our software and hardware expertise in new categories. In addition to new products, we also expanded our partner ecosystem with the launch of new products with partners like Sonance and IKEA. These partnerships give us access to both new categories, and a vast number of new customers. IKEA has unparalleled global reach with over 1 billion consumers visiting their 422 stores in over 50 countries, all shopping exclusively for their homes. Partnering with IKEA creates new ways for us to monetize our existing technology by enabling the Sonos experience and software in products manufactured and sold by IKEA. The collaboration also brings the Sonos sound experience to unique form factors at new price points. We've been very pleased with the IKEA performance. On the first day of launch, IKEA sold more than 30,000 SYMFONISK table lamps and bookshelf speakers, illustrating significant early demand. In addition, our data suggests that IKEA households are purchasing their next Sonos product in a similar way to traditional Sonos new households. Consistent with our expectation, that once introduced to the simplicity of the Sonos experience, customers will add more products to augment their home sound system. And today, we are delighted to share with you the acquisition of Snips. Snips is a private-by-design voice platform, and the amazing team will bring expertise and strategic intellectual property that will make the voice experience on Sonos even better. We are not looking to replicate what general purpose voice assistants offer, instead we'll be enhancing customer choice, ease of use and control, and privacy as we continue to differentiate the end-to-end Sonos experience. Snips, and our ongoing software investments, add to our considerable intellectual property value, ranked second in the electronics category and 19th overall in the latest IEEE Patent Power Report. We are working towards realizing the value of our IP assets over time. Since our settlement with Denon, we've engaged many companies in constructive conversations, and are prepared to take action, as necessary, in order to protect our rights. As we look ahead to fiscal 2020, I could not be more excited about what we have planned. We have a robust and innovative product roadmap that will fuel our continued growth and expand our market opportunity. We will deliver against our promised new product velocity through fiscal 2020, and continue to test new unique offerings like Trade Up, Sonos for Business and Sonos Flex. Lastly, we remain committed to our long-term growth targets, and have a clear line of sight to continue delivering sustainable profitable growth to enhance shareholder value over the long term. I will now turn it over to Brittany to say a few words.

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. Our wireless speaker category was down 5.1% year-over-year, but it gained momentum in the back-half and performed particularly well in Q4, partly due to the addition of Move. Home theater grew 17% year-over-year, but it was down in Q4, as we lapped the introduction of Beam last year. Components had a strong Q4 and full year, due to the refresh of our Sonos Amp introduced in November of 2018, and other was driven by strong IKEA module sales. Fiscal 2019 gross margin decreased 120 basis points to 41.8%, due to a variety of factors including product mix, unfavorable foreign currency impact, and the launching of a new distribution channel, partially offset by product and material cost reduction. Sales and marketing as a percentage of revenue decreased 420 basis points on top of a 340 basis point year-over-year decrease in fiscal 2018. We benefited from differentiated, high-impact creative and the adoption of more efficient direct-to-consumer and digital marketing tool. The reduction in sales and marketing, coupled with the strong continued growth of 1.7 million new households means the cost to acquire our customers is coming down. Sonos customers continue to add more to their system over time, meaning our customers true lifetime value has yet to be fully realized. We are continuing to invest in R&D. R&D as a percentage of revenue, increased 110 basis points in fiscal 2019, as we supported the increased product philosophy Patrick mentioned, while also continuing to invest in software and the consumer experience, which truly differentiates Sonos. Snips will be a great addition to this effort and we are excited to add this team and its capabilities to Sonos in fiscal year '20. We achieved a 28% increase in adjusted EBITDA to $89 million in 2019. This represents a 7% margin, up from 6.1% in 2018. We have talked about our ability to scale Sonos and drive outsized adjusted EBITDA growth, which we have demonstrated again in 2019. We also drove a significant improvement in free cash flow, and have a healthy balance sheet. As a reminder, since our last earnings call, our Board authorized a $50 million share repurchase program. We see tremendous value in our stock and our strong balance sheet enables us to implement this repurchase program, even as we invest in our long-term roadmap and maintain our flexibility to pursue new strategic opportunities like Snips. Looking ahead, we are excited for a strong fiscal 2020, supported by the great products and partnerships we launched in 2019, including Move, IKEA, One SL, Port and Amp. Our fiscal 2020 outlook is for revenue of $1.365 billion to $1.4 billion. This represents growth of 8% to 11% for the year, and at the midpoint it's consistent with our average annual target of 10% revenue growth. As a reminder, effective September 1, 2019, our products are subject to a 15% tariff under List 4A. While there is frequent speculation on the trade negotiations, we are assuming for the purposes of this call that this remains in effect for the full year at 15%. We have discussed in prior quarters, our goal of diversifying our supply chain outside of China, and have accelerated our efforts specifically by prioritizing the production of US-bound products to Malaysia. Our manufacturing capacity in Malaysia is ramping up quickly and we believe we will have largely eliminated, the go forward impact of tariffs by the end of the fiscal year. In the year, we do expect tariffs to have a net negative impact to our profitability of $30 million, with about half of that coming in the first quarter, which is our largest sales quarter. We anticipate that efforts to diversify our supply chain into Malaysia will offset the impact to a greater extent in the back half of the year. Fiscal 2020 GAAP gross margin is expected to be in the range of 41.2% to 42.2%. Excluding tariff-related costs, GAAP gross margin would be in the range of 43.2% to 44.2% in fiscal 2020, representing a 140 basis point to 240 basis point improvement from fiscal '19. The strong improvement in gross margins over 2019 is driven by the introduction of higher margin new products, and improvements in material and product costs. Thanks to the great work of our teams, gross margins inclusive of tariffs, are still in line with 2019, and excluding tariffs would be coming in towards the high-end of our long-term guidance. The result is an adjusted EBITDA range of $72 million to $82 million, including tariffs. Excluding tariff-related costs, which we view as one-time, adjusted EBITDA would be in the range of $102 million and $112 million, representing growth at the midpoint, in line with our average annual 20% growth target. Ultimately, we are investing in the business. As noted in our shareholder letter today, we plan to align our revenue reporting with how we look at our business internally, the evolving nature of our products into new categories, and how our customers are purchasing from us across multiple categories. For example, the Beam may be your living room speaker, and two One SL's are great for creating rear surround sound in your home theater set up. Our products are used in increasingly flexible ways inside and now outside of the home. As a result, beginning with next quarter's earnings, we will report our product revenue in the following categories. Sonos speakers, which is essentially consolidating, wireless and home theater into a single category, more reflective of what our consumers are buying from us. Sonos system products, reflecting our component products and other-related non-audio producing Sonos products, and partner products and other revenue, which will be inclusive of our partner revenue, licensing, accessories and other. Accordingly, we will no longer report wireless home theater components and other revenue. We are very pleased with the strong consistent results we delivered in 2019. We look forward to 2020, and believe we are on track to deliver another year of strong revenue and adjusted profitability growth. And with that, we look forward to answering any question.

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

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.

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.

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.

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.

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.

Understood. Thank you.

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

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?

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 [ph] 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.

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.

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.

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.

Okay. Thanks for taking the questions.

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

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?

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.

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

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.

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

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

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.

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.

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.

Got it. Thank you.

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

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?

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.

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.

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.

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.

Got it. Thank you very much.

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

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.

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.

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.

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.

Understood.

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

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.

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.

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?

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.

Okay. Thank you very much.

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

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.

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