Q3 2023 Sonos Inc Earnings Call
Good afternoon, My name is Anna and I will be your conference operator today.
At this time I would like to welcome everyone to the so knows third quarter fiscal 2023 earnings 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.
If you would like to ask a question. During this time simply press star followed by the number one on your telephone keypad.
If you would like to withdraw your question again press the star one thank you.
James James think wellness head of Investor Relations you May begin your conference.
Thanks, So much good afternoon, and welcome to <unk> third quarter fiscal 2023 earnings Conference call I'm, James Mcmanus and with me today, Arizona, CEO , Patrick Spence and CFO and Chief Legal Officer, Eddie Lazarus for those who joined the call early today's hold music is a sampling from our Sunset Fudge station before I hand, it over to Patrick I would like to remind everyone that today's discussion will <unk>.
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 full.
We detailed under the caption risk factors in our filings with the SEC. During this call. We will also refer to certain non-GAAP financial measures for information regarding our non-GAAP financials, and a reconciliation of GAAP to non-GAAP measures. Please refer to today's press release regarding our third quarter fiscal 2023 results posted to the Investor Relations portion of this website.
As a reminder, the press release supplemental earnings presentation and conference call transcript will be available on our Investor Relations website investors <unk> Dot Com I would also like to note that for convenience, we have separately posted an investor presentation to our Investor Relations website, which contains certain portions of our supplemental earnings presentation I will now turn the call over to Patrick.
Thanks, James and Hello, everyone.
Earlier. This afternoon, we reported strong fiscal Q3 results we.
The categories of consumer electronics that we participate in remain challenged as conditions have not yet returned to what we would consider normal and we continue to see unprecedented levels of discounting by our competitors.
Despite this our brand and product portfolio continued to perform well.
Consistent with past quarters, we have continued to gain significant market share in home theater in both the United States and Europe .
This is a testament to our continued investment in research and development, which remains focused on two things.
Raising the bar in the existing categories, where we play and entering new categories in innovative ways.
Speaking of raising the bar in existing categories or new era, a family of products is off to a great start.
We have seen media and consumers alike embrace <unk> hundred for its detailed stereo sound a deep base and <unk> 300 for its impressive outloud spatial audio listening with Dolby Atmos each.
Each product has arent stellar reviews from both media and consumers with consumers writing both the ear 100, and the year of 300 at four eight out of five stars on Santos Dot Com AR.
A recent Forbes review of Euro 300 noted it is nearly as perfect as any wireless speaker can be the spatial audio performance is fantastic.
Last quarter I outlined what changed between Q1, and Q2 earnings and how that affected our guidance for the second half of this year.
We are tracking to those revised expectations and thus today, we are maintaining the midpoint of the guidance we issued for the second half for revenue and adjusted EBITDA.
We saw a reduction in channel inventory in Q3, consistent with our expectation for registrations to outpace selling.
We expect this to continue through Q4, particularly in Europe , and Asia Pacific where retailers continue to tighten up.
As for underlying demand strength in the Americas helped offset the impact of the tough economic climate in Europe , and Asia Pacific Spa.
Specifically in the Americas, we saw steady registration trends through the quarter, followed by a strong response to our fathers day promo in mid June .
In both Europe , and Asia Pacific registration trends generally soften through the quarter, which we expect to continue through Q4.
As I've repeatedly said, we would reduce our spending if necessary to hit our EBITDA commitments, while staying on track to deliver our ambitious roadmap because harder times require a renewed commitment to rigour focus and efficiency.
This commitment led us to announce a 7% reduction in force in mid June .
This right sizing our expense base will enable us to increase future profitability, while making targeted investments in our exciting product roadmap.
Our journey to drive more efficiency in the organization is never over.
We will continue to closely scrutinize, our cost base and do whatever it takes to deliver on the kind of long term profitability we've targeted.
Our focus remains on driving sustainable profitable growth over the long term as we continue to release release products and are now five existing categories Sony.
Pro was added this year as well as three new categories, we expect to enter.
We are in the early innings of our growth as our more than 14 million households represent just 8% of the 172 million affluent households in our core markets.
At the end of fiscal 2022, the average Thanos households at 298 products up from 295%. The prior year. This figure has steadily increased over the years underscoring how the lifetime value of our customers continues to grow.
As we have noted in the past 40% of our households are single product households, whereas our average multi product households is four three products.
In other words, we are starting to get into the range. We have previously discussed four to six products for every mature Sonus household we estimate that converting our single product households, the average multi product household install size represents a $5 billion revenue opportunity.
This highlights the long runway, we have to further monetize our install base.
I remain confident that <unk> is on the right track to continue to deliver value for customers and investors over the long term.
There is no doubt in my mind that we will emerge from this challenging period as a stronger company and resume making progress toward delivering on our long term targets of $2 5 billion in revenue and $375 million to $450 million and adjusted EBITDA.
Now I will turn the call over to Eddie to provide more details on our results and our outlook.
Thank you Patrick Hello, everyone.
Stepping back from the numbers for just a minute summary.
Summarize Q3, as having two areas of intense focus first making sure that we deliver on the second half revenue guidance, we gave on our Q2 earnings call.
Second making sure that we deliver on our expense reductions both to ensure that we meet the profitability guidance, we gave last quarter.
And to put us in a position to deliver our stated intention in fiscal year 'twenty four to grow revenue faster than expenses and expand our adjusted EBITDA margin. We are on track to do all these things.
Now for the Q3 results.
We reported revenues of $373 4 million up 23% sequentially and roughly flat year over year on both a reported and constant currency basis.
Americas grew 8% year over year to be 67% of total revenue driven by resilient consumer demand as well as a strong reception to our father's day promotion in June .
EMEA and APAC each declined year over year to be 28% and 4% of total revenue respectively.
This was due to soft consumer demand consistent with the challenging economic climate in each region.
We expect the softness in EMEA and APAC to continue through Q4.
So the shape of the second half is a bit different than we had anticipated.
Aggregate our expectations are unchanged from what we outlined last quarter I will discuss this further after I finish recapping this quarter's results.
Quarterly registrations declined 2% year over year, while products sold declined 11%.
This divergence with registrations outpacing selling is consistent with what we outlined last quarter about reducing channel inventory in the second half of the year.
Favorable product and channel mix as well as focused price increases caused revenue to be roughly flat year over year. Despite the 11% decline in products sold.
Q3, gross margin expanded 270 basis points sequentially from Q2 to 46% or 45, 9%, excluding the impact of FX consistent with last quarter's guidance.
This expansion was driven by a full quarter of some targeted price increases lower cost of components and favorable mix, partially offset by promotional activity and the reserves and expenses, we have taken related to a component inventory that we currently deem to be excess.
These reserves are included in our cost of revenue and thus hit our gross margin.
This is a temporary consequence of sourcing components during a period of Covid induced scarcity, followed by a period of slower demand.
We expect to work the rest of the way through this gradually diminishing COVID-19 overhang in mid fiscal year 'twenty four.
On a year over year basis gross margin declined by 130 basis points due to lack of typical promotional activity in Q3 of fiscal 'twenty two.
We offset by favorable product mix and fewer spot component purchases in Q3 of this year.
Adjusted EBITDA was $34 $3 million ahead of our expectations due to the combination of higher revenue and lower operating expenses.
Foreign exchange was an approximately <unk>.
$7 million tailwind to adjusted EBITDA.
Yeah.
Total non-GAAP adjusted operating expenses of $149 6 million declined by $4 4 million or 3% from Q2 due to delayed program in advertising spend and lowest lower bonus accrual.
Please note that mid June mid June risk had little impact on our Q3 expenses and that this expense figure excludes the $10 million restructuring charge, we recorded associated with the risk.
We ended the quarter with $268 million of cash and no debt free.
Free cash flow was negative $7 $8 million in the quarter, largely driven by a $31 million increase in accounts receivable and $18 million decrease in accounts payable and accrued expenses.
And $15 million of share repurchases.
Really offset by a $23 million decrease in inventory.
Within inventories finished goods were $240 million down 13% sequentially.
Looking ahead at typical seasonality has is building inventory in fiscal Q4 ahead of the holiday.
A component balance of $58 million was up 12% sequentially.
Over the last year, we moved swiftly to adjust our sourcing plan and our component purchase commitments.
While we have made good progress we still expect our component balance to continue to increase in the near term before reaching a peak sometime next fiscal year.
As I've said previously managing our owned inventory and improving cash conversion remains a top priority.
And finally before turning to guidance, we repurchased we purchased $15 million of stock in the quarter and in <unk>.
The average price of $16 10, a share representing 7% of common shares outstanding as of Q2.
As a reminder, we have approximately $55 million remaining of our previous $100 million share repurchase authorization.
Okay.
Turning to guidance.
As I previously mentioned our expectations for the second half of fiscal 2023 are largely unchanged from last quarter today.
Today, we are adjusting guidance ranges to reflect the three quarters of the way through fiscal 'twenty, three while maintaining the midpoint for revenue and adjusted EBITDA.
We now expect to report full year revenues between one.
Six four and $1 $66 billion down.
Down approximately 6% year over year.
At the midpoint, our guidance of $1 65 billion is unchanged from last quarter.
We expect Q4 revenue between 290 and $310 million down between 2% and 8% year over year.
Our Q4 guidance assumes that our Q3 promo over performance pulled in some demand from Q4.
While overall demand in the Americas is resilient we are.
EMEA and APAC to weigh on our results.
Taken together with our Q3 revenue of $373 million second half revenue at the midpoint of our revised guidance is $673 million unchanged from last quarter.
Okay.
We now expect gross margin will be in the range of 44% to 44, 2%.
The entirety of this revision is driven by higher excess component provisions.
As a result, we now expect Q4 gross margin between 45, 9% and 46, 9%.
At the midpoint this outlook implies a second half gross margin of approximately 46%.
Modestly below the midpoint of our prior guide of 47%.
Absent this excess component provision in Q4, how gross margin outlook would be in line with the prior guide.
To size this for you the.
Full year impacted the provision is expected to be at least 100 basis points headwind to gross margin.
And as a reminder, we've also faced significant FX headwinds this year adversely affecting gross margin by over 100 basis points as well.
Excluding FX and the provision gross margin would be well within our normal annual target of 47% to 40 $45 to 47%.
Okay.
We now expect adjusted EBITDA.
To be in the range of $148 million to $158 million.
Representing a margin of 9% to nine 5%.
At the midpoint of our guidance of $153 million is unchanged from last quarter.
We expect Q4, adjusted EBITDA to be between zero and $10 million, representing a margin of between zero to 3%.
Embedded in this Q4 adjusted EBIT guide as non-GAAP adjusted operating expense of approximately $147 million in Q4 down modestly from Q3 due to realized with savings and lower bonus partially offset by timing of program spend.
Full year non-GAAP adjusted operating expenses are expected to be approximately $623 million.
Taken together with our Q3 adjusted EBITDA of $34 million second half adjusted EBITDA at the midpoint of our revised guidance is $39 million again unchanged from last quarter.
As Patrick mentioned in Q3, we took the painful but necessary step of reducing our workforce by approximately 7%.
We have other expense reduction initiatives underway as well for example, continuing the process of reducing our leased office space.
We recently amended our long term lease in Boston, reducing our footprint by almost 50%.
And in Santa Barbara, we will be giving up our two current office locations and moving to a new consolidated office space early in the second quarter of 2024.
We will continue to review our expense base in search of further areas of savings managing expenses and improving efficiency is of critical importance.
We are in the throes of planning for fiscal 'twenty, four and while it is too early to provide guidance I do want to double down on our commitment to delivering operating leverage in fiscal 'twenty. Four we will provide further detail of this on our Q4 earnings call.
Last but not least let me touch briefly on a Google litigation.
In our northern California case against Google The jury awarded US $32 $5 million based on Googles infringement of one of our <unk> Pak <unk>.
Post trial motions are currently pending.
In Google's, two pending cases against Sony at the at the ITC.
Hearing was held in one case with an initial decision expected in September .
In the second case, the judge delayed the expected July here and indicated that you would be issuing an order finding the Google patents at issue there to be invalid, we expect a written ruling shortly.
With that I'd like to turn the call over for questions.
Okay.
As a reminder, if you would like to ask a question press star followed by the number one on your telephone keypad.
Your first question comes from the line of Eric Woodring with Morgan Stanley .
Your line is open.
Awesome.
You guys and nice work in the quarter.
Maybe Patrick already I'm, not sure which one.
Either one of you but.
Just to confirm I guess, the fiscal <unk> and fiscal <unk> guide down that's largely it seems like a product or a result of strong promotional activity. So you pulled forward. Some demand. There was also some incremental weakness in international markets. So one just making sure those are the kind of the two key factors to think about for <unk>.
And the follow up to that is just like how should we think about product registration.
Growth or declines I guess as we then think about the September quarter should we think about the trajectory worsening just just given the guide down or maybe if you could just share some color on how to think about that for for the September quarter that would be helpful. And then I have a follow up thank you.
Yes.
Alright. Thanks for that question. So we've been intensely focused on our hitting our revised second half top and Bottomline targets and obviously, we're very happy that we're going to be meeting those goals.
As to the balanced between Q3 and Q4.
I think you hit it well we had a very successful Q3 promo, which no doubt pulled forward. Some revenue from Q4. We're also expecting some further channel tightening in EMEA and APAC and you touched on that.
Overall, we see the Americas holding steady with continued weakness in those other regions consistent with the economic conditions in those other areas.
For the whole year I just want to emphasize this because you asked about registration for the whole year registrations have been outpacing selling so the underlying demand is actually a bit stronger than the headline revenue numbers and our goal is to continue to compete effectively which we've been doing as we wait for our categories to recover which they definitely will in time.
And so so but I think you summarized things pretty well there.
Awesome perfect. Thank you for that and then maybe Patrick.
You you continuously kind of talked about this for new categories. Obviously now with three new categories. After the launch of <unk> Pro.
Can you help us maybe think about the timeline to entering those new product categories and I know you don't want to give away any trade.
Secret So maybe if I phrase that question as you've set a long term target for $2 5 billion of revenue $375 million to $450 million of EBITDA do you need to enter those three new categories to reach that goal or do you think you can reach that goal with the.
The exposure that you have and any subsequent product launches in existing categories already and that's it for me. Thank you.
Thanks, Eric.
Entering the new categories you know.
Yet that our strategy is both raising the bar in the existing categories, which is important to driving growth and then the second element of that is entering new categories and so both of those both parts of our strategy, just like acquiring new homes and as well getting our existing homes to purchase additional are part of the strategy. It's all part of getting to.
Our $2 5 billion in revenue so.
And as you are.
Alluded to stay tuned because we definitely don't foreshadow.
Product roadmap for competitive reasons. So thank you.
Thank you Patrick.
Your next question comes from the line of Brent Thill with Jefferies. Your line is open.
Thanks, Hey, guys. This is David on for Brian Andy I wanted to start on the litigation I. Appreciate the color you just gave I am curious just on kind of the go forward path from here. How you guys are thinking about this.
Maybe one I guess what are the next mile markers that we shouldnt as investors should be watching for and two how are you guys thinking about I know you guys have in the past said that you think Google is infringing on more than just the five in patents you guys have gone with.
Kind of reloading that and coming with more patents down the road just curious to get an update on that.
Well the next milestone is going to be the post trial motions in the case that that we so far have prevailed in northern California, the judges holding hearing actually tomorrow.
And we should get it I would think a decision on that.
In relatively soon after the hearing.
So that's step one step two is going to be.
The oral argument in the federal circuit of the appeal from the case that we won at the ITC.
Finding five Google patents to be both valid.
Google is infringing five are valid patents.
And once that appeal first of all that appeal could.
Could could benefit significantly if we prevail in any respect there on our cross appeal.
And the second point there is that once that appeal has decided the damages case for those five patents.
We will begin in the Central district of California, and those are foundational patents that Google has been infringe.
Infringing for a very very long time and that we've already done.
We have already withstand stood the test of litigation.
So that's probably the next.
Big event.
And then we will be getting a decision and then.
They're remaining case against us at the ITC.
Initial decision in September final decision in January .
We're cautiously optimistic that that will come out well for us.
That's helpful. And then maybe just on the promotional activity I know you guys have in the past talked about competitors being a little bit more aggressive on promotion activity. Obviously, you guys weren't promoting as much as you.
Last year as much as you are this year. Just curious have you guys found yourself, maybe promoting a little bit more than you would like.
Just curious around that trend.
I think we.
What I'd say is that our promotional strategy overall really hasnt changed we are promoting in very particular moments in time. When we think the consumers are really focused on an hour.
Product context, and that's proven very very successful so while we have in some sense promoted more this year because we've been so successful with our promotions. It hasnt been because we've been on sale all the time and I think that strategy has proven successful and I expect that we're going to continue much the same way because we are gains.
And market share as Patrick described very significantly in home theater on both here and abroad and then.
So it just I think we've.
We've hit the right notes with a brand it's really really strong right now in place with these occasional moments as opposed to being on sale all the time.
That's helpful. Thanks, guys appreciate it.
Your next question comes from the line of Jason Haas with Bank of America. Your line is open.
Hey, good afternoon, and thanks for taking my questions I thought the commentary on what's going on with the second half shipped has been really helpful. I'm curious if that changes your thinking at all.
A holiday period I know it falls into next fiscal period, but just curious as were again, a little bit closer to the holidays. There is there any change in your hedging there.
No change in that thinking.
We have a great product lineup and a good strategy yet we're setting in place.
And right.
We can't tell exactly when theyre kind of cyclical issues.
Aerospace will turn.
But.
We're going to be ready to to excel at the moment that happens and <unk>.
Q1 is always a strong quarter for us and we're looking forward to going through that again.
That's great to hear and in terms of just curious to get a little bit more commentary on inventory levels. Both your own and I. Appreciate all the commentary you gave on on <unk>.
What's going on with components.
But just more broadly speaking how you feel about your inventory levels and then also to extent that you could see into your retail channel inventory levels that were closer to getting to the end of the destocking that need to happen and.
Again, just given how important the holidays for you if there is any risk of that.
Yes, let me challenge, we're having a warning to reorder, yes, yes.
Yeah sure. So look we brought inventory levels down by more than $100 million since the beginning of the year.
Feel good about that but.
With a bit of a slowdown or demand theres somewhat elevated and we will be building a little bit more into Q1 is typical for the holiday season.
With respect to finished goods, we expect to return to a normal level exiting Q1 on.
On the component side of things will be taking a bit more onto our balance sheet as we exit from certain <unk> relationships and also due to the aging of some inventory purchased during Covid and now held by some third parties, it's going to take us a little longer to work through that temporary spike in our our own inventory, but we expect to do so in fiscal year 2004. So.
Little bit elevated right now a little bit of seasonality at work.
But but we will we expect to be in very good shape next year.
On that note in terms of.
Our retail partners.
Little bit of.
Tale of two cities.
In EMEA.
Yes.
Our distribution pattern is much more diffuse, but we're definitely seeing some tightening there.
We've already experienced a lot of tightening here in the U S. Best buy has got many fewer weeks of coverage than they used to hold that's fine we have great relationship there, but but we've already seen a lot of the squeeze in that system and as I said, that's why registrations have been outpacing.
Outpacing selling all year long.
Okay, great very helpful. Thank you.
Your next question comes from the line of Mark cash with Raymond James Your line is open.
Hi, Thanks. This is mark on for Adam and Patrick If I can start with you.
Since you brought up <unk> pro it'd be great. If you can give an update on that I understand it's early days, but how is the interest and have you learned anything since introduction that could help catalyze demand for soda SaaS offerings.
Yes. It is early days.
Like you mentioned Mark I think we're pleased with the customers that have adopted it and b.
The interest that we've received we haven't even really started to promote it yet because we want to make sure that.
Through marketing efforts, because we want to make sure that it's <unk>.
Meeting the mark with the customers.
Feels pretty good in terms of doing so we think we have opportunity. There. We think we have some work to do as well.
Easy for customers to really adopt it.
Even faster, but I think we're on the right path for addressing the needs of the customers. We have targeted with that with that offering and we are going to continue to look for opportunities to add recurring revenue flows to our business wherever we can in a in a way that benefits customers and so.
We recognize the value of those types of offerings and we will continue to work on that.
Okay, Okay, and then father's day strength has called out with promotional activity. So I was wondering if you could give.
Sense of linearity in the quarter are things better now versus if you look back back in April .
Understand the father's day may be skewed by middle of June somewhat but if you kind of give a sense of how things progressed throughout the quarter that'd be great.
I don't really have any more color for you on that other than to say, what I said earlier, which is that we do think that that did pull forward.
Some some revenue from Q4. So you can you can read into that but but that that effect over time will dissipate.
Okay, and then I just wanted to circle back to the inventory topic.
In the installer channel and retailer retail partners tightening.
Can you give a sense of what kind of inventory levels, they're holding now versus what you consider historical norms by these different go to market avenues.
We don't we don't actually give out those numbers, but what I would say is that by historical standards.
Hi.
Retail partners here in the States for example have definitely tightened.
So.
Alright.
To the point, where we're very comfortable with where those inventory levels are now.
And.
That overtime registrations in sell in will now balance out as opposed to registration outstripping San Juan as it has all year long.
Okay. If I can just ask one more for Eddie.
The gross margin headwinds you mentioned from the increased reserve.
I think you mentioned youre getting through this in fiscal year 'twenty four if that was right and then so if that's right. When do you see this headwinds subsiding and would it still be a 100 basis impact for for some of the year.
Hi.
I think the phrase I used as it is gradually diminishing and.
And we should be all the way through it.
In 'twenty four.
Okay. Okay wonderful thank you for taking the questions.
Your next question comes from the line of Tom Forte with D. A Davidson your line is open.
Alright.
Guarantee for Tom. Thank you so much for taking my question.
One question and one follow up so for my first question, how should investors think about the refresh rate for consumer electronics in general and your product focused to care its our understanding that your product.
Refresh rate given the relative build quality and the integrated powertrain components.
Yes.
Yes. Thanks, Darren I think this is where we differ from pretty much every other company that participates in consumer electronics, our model stands alone because the premise is ultimately that the products will last a long time, which I think from an investor standpoint should be viewed as a higher return on investment from the investment we make in bringing a new product to market.
And from a.
Everybody.
Would recognize its also better for the the world since we're not creating stuff that ends up in a landfill or recycled as well and then the.
The part of our model. That's important is that people will add more over time, and we know from a cohort model that this continues to be the case and has been for 20 years.
This is why were always focused more on the long term value as opposed to that onetime purchase or some of the cyclical it refreshes that so many other companies are because.
As I mentioned, we believe we have a 5 billion opportunity 5 billion dollar revenue opportunity alone simply from.
Being able to take our single product households to multi product and so the way to think about it I would say is we're playing the long game and playing the adder.
Adding more and more products over time and getting higher ROI from our products.
Awesome. Thank you and for my follow up how if at all have you been impacted by consumer consumers focusing their discretionary income on travel. So some recent examples including a focus on international travel Analyzer, then what's your best exemplified by the Tesla Aerostar.
Yeah, So I think.
We I think we've all seen and heard.
Some of the.
B the services and travel versus good spending on a macro level and that shift definitely isn't just new in Q3, I think we have been encountering that throughout the throughout the year, we talked about that a little bit, but what I think is most important on that is that it is impacting.
The audio market overall as opposed to Sony specifically and so when we look at the category share we think about market share in times like these it's really important to understand how you are competing and how you are winning and we're pleased to say that we are holding or gaining share in the categories that we play despite not discounting to the levels there.
Our competitors are and so we feel very good about our position our product portfolio and our brand positioning.
In a difficult market right now and I think.
We look forward to the day that would be the <unk>.
Spend on goods normalizes, a bit from where it is today and it swings back from services. So.
We are that's why we are investing for the long term, we will be in the best position of any company and audio to take advantage of that.
When things normalize.
Thank you.
As a reminder, if you'd like to ask a question press star followed by the number one on your telephone keypad.
We will pause for any last minute questions.
There are no further questions at this time, Patrick I'll turn the call back over to you.
Alright, Thanks, Emma and thanks to all of you for joining we look forward to updating you again in November .
This concludes today's conference call you may now disconnect.
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