Sonos, Inc. (SONO) Earnings Call Transcript & Summary

Welcome, everyone. I'm Katy Huberty, U.S. IT hardware analyst at Morgan Stanley, and I'm really excited to host this discussion with Patrick Spence, CEO of Sonos. Patrick joined Sonos in 2012 and as CEO since 2017. He led the IPO. He's accelerated the rate of product development. He's elevated the brand with a shift in the marketing strategy. He's built a team to defend Sonos' really impressive and leading IP portfolio. And more recently, he committed to layering services on everything that Sonos does in extending the portfolio outside of the home. So Patrick, lots to talk about, and thank you so much for joining us today.

You bet. I'm glad to be here.

Before we begin the discussion, let me just point out to everybody listening in that you can view Morgan Stanley research disclosures at morganstanley.com/research disclosures. If you have any questions, please don't hesitate to reach out to Morgan Stanley sales rep. With that, I will jump into Q&A, but for those listening in, you can submit questions on the web portal, and I'll try to work those into the discussion.

So Patrick, to start out, really the spirit of this conference is to help investors understand the impact to business models and fundamentals as the world normalizes post the pandemic. As we think about the last year or so, there were areas of your business that were helped, like direct-to-consumer and the success of the new products. And there were other areas of the business that were hurt with, for instance, all the retail stores shut down, and that impacted some of your channels last year. And so when we net that out, in 2020, your growth undershot your long-term target. But this year, you are seeing growth accelerate faster than you originally expected. And so just to start the conversation, what is happening in the business? What are the drivers of that growth acceleration that you were seeing coming out of the pandemic?

Yes. Thanks, Katy. I think there's a -- so there's kind of a couple of things. One is, I actually think in the September quarter of last year, we kind of hit the scale where our model started to really show what it's capable of. So you started to see that in terms of the kind of numbers that were coming through, and we've really just built on that. And we've kind of shown what that looks like as well, accelerating in the targets that we set for 2024 as well that we recently shared, right? And so I think part of it is that we're kind of in an industry and a space where that scale matters and the system-ness that we've built over time put us in a strong position to really start to yield the benefits of that, and you're really starting to see it work in the way it's come together. But I would say, there's also 3 big macro trends that are powering really why we're so confident about the future and the growth today. The first is, we are in this golden age of audio, where everything is streaming, people are listening more than ever. And you see this, whether they're in the home or on the go. And so podcasts, audio books, now social audio, right? People are engaging with audio in a different way. The second is really around what we've seen with the video streaming side. So we've seen a lot more going direct-to-consumer for video and a lot more new movie releases, but just a lot more content in general. And you need a way at home to really enjoy that in its full fidelity. And that's really powered part of -- a big part of our business, which is sound bars and home theater, making that audio experience in -- for video really great. And the last is what Rich Barton coined the great reshuffling, and I'm a big believer in, I'm seeing it happen, where a lot of people, particularly in the -- our target audience are moving because they have the flexibility to do so right now, as the world kind of changes and people rethink where they work and where they live. And so we're seeing that. And I think that's a multiyear trend based on the things that I'm seeing right now. Scott Galloway has talked about it a lot as well in terms of what we're seeing. So it's going to be interesting because I think all of these are big trends that are happening over the next few years, and that's really the kind of the tailwinds that we have that have helped us in accelerating the growth beyond where we were in the past.

That's great. And those trends speak to a very large market opportunity. And when I think about this, just to take a step back for a moment because I've spent time at your headquarters and a heavy user of the product, I think there are a lot of similarities between Sonos and another company I follow, Apple. Both companies have this intense focus on product design. The technology is really about tightly integrated hardware and software that creates this magic of really easy to use products. And your employees are incredibly passionate about the market, the audio market that you serve. And the list goes on. But the reason I bring this up is investors always underestimate the market opportunity for Apple's products, right? The iPod, which is as big as the Sony Walkman, or the Watch was supposed to be as big as the Swiss watch market. And those products did multiples of what everybody expected. And so I appreciate that you're in 11 million households. So no matter how you cut the addressable market, your penetration is quite low. But when I think about it, there are 1 billion-plus iOS users. And I know iOS is, by far, the operating system that your users access the Sonos system on, there are maybe 400 million, 500 million households that subscribe to streaming music or video. And so I just -- I wonder if the market opportunity here is maybe even bigger than what you've laid out at your Analyst Day in March.

It's a really important question, and I think it's one of timescale. So our ambition, let me be clear, our ambition knows no bounds. And we want to be the world's leading sound experience company. So when we think about it, we do think in terms of, hey, we're inventing a category, we believe, that ultimately, we'll be able to play a role in everyone's lives. And those numbers that you put up there, exactly right. And Katy, look, I've seen this before, too, in my time at Blackberry, right, where people were like, oh, it's going to be in this segment or whatever, and it's much bigger, right, because you're actually doing something and bringing things together and experiences people have never seen before. And so I do think, over that long term, that it's a much, much bigger opportunity. And it's why we work so hard at developing that culture you talked about in terms of building things that matter and why the system is so important, right, which is so different than many other. Just like kind of typical hardware companies, it's much more about how are you building that system that grows over time. But I do think it's also important, at least what I've learned since we've gone public, is to help people understand kind of where we are today, and in the next 3 to 5 years, what is that addressable market look like. And that's kind of what we tried to strike the balance of with Investor Day. And to your point, we're single-digit penetrated, even in kind of like the smaller market that we think is addressable in the near term. As you think about the long term, I am very confident that we will find new opportunities, new categories and areas to grow, and we certainly don't constrain our thinking in any way and believe this will be -- we believe, more than anyone, that this is going to be just a massive, massive market. There's $90 billion spent in audio today. With the kind of innovation we're seeing in audio today, that could be a much bigger opportunity long term. And so this is going to continue to grow, and it's why we put our blood, sweat and tears into what we do.

Makes sense. Now the trends of streaming audio, streaming video, I think those are a little bit better understood by your traditional TMT investor. But the real estate dynamic is particularly interesting because you sell into largely affluent households. Again, sort of the Apple iOS household is really your target market. And that consumer base is buying second homes, they're moving out of cities, they're upgrading the home they live in, they're moving to a larger home. And we've looked at the correlation of your business to residential real estate investment, and there's a very clear correlation sort of on a six month lag. So if this lasts for 2 years, you'll see the benefit for 3 years. So just talk a little bit about what you're seeing in that installer market. Your component lead times, for instance, right now, are really extended. And I know there's some component constraints. But I think a lot of that is demand driven, isn't it?

Absolutely. It is -- I have never seen demand like we're seeing right now. And the good thing about it is that it's been very nonperishable in terms of what we've seen so far, right? And there's really nothing else that lives up to the reputation that we have and the customer experience we deliver. And I think there's something important in the fact -- so first of all, what we call our installed solutions channel, the dealer channel has been so resilient in the face of this, even last year, in terms of really doing well even through the pandemic, which is pretty surprising, quite frankly. And it continues to be something that I think many people that are new to the story wouldn't have realized would still be useful, but is a huge driver for our business. And we think there's a lot more opportunity there, right? We think that there -- we have other product ideas, concept services as we think about what we do in that space. And I just think there's so much more opportunity. And even though we're seeing like that, what I think will be multiyear kind of great reshuffling and everything that's happening in the housing sector and then just the cycles we go through in housing, what I think is important, Katy, is that just because, as well, that will slow at some point, the main thing is, we're in these homes, and then they're adding more products to the system over time, right? And so even as perhaps housing slows down, I think the key thing is that doesn't stop our expansion into more places in the home, right, and really what we're trying to do there. And that's the flywheel for getting more new homes, right? Because our #1 new home driver is existing customers telling their friends and family about Sonos. So you can see how it all feeds. And certainly, something like red hot real estate is a nice kind of tailwind. But our model works, and this is what I mean about the scale, and kind of the inflection point we hit last year, the model works even when that isn't a tailwind, just because of the nature of the system that we built.

That's a really important point because there's really strong user engagement, meaning listening hours go up every month, every year. And then there's loyalty because of the stickiness of the platform and the benefit of the system. And so, well, yes, the majority of your revenue and profit comes from transactional business selling more hardware, it's actually more of a repeat business, recurring revenue model. So talk a little bit about what the land and expand model looks like for a typical customer.

Yes. So there's really no typical as we go through it. But as we've thought about the -- we've really been focused on customer acquisition costs and making sure that we've got a really thoughtful approach there. And we feel really good about where we are in that. We made a lot of good progress. I think that surprised a lot of people as we work through it, but very digital, very targeted. And then, of course, we've got the great strength of our existing customers telling their friends and family. But I think on the LTV side of the equation, today, we're at about 3 products per home, right? And many of those will have started with one. Some will start with 10 and like they'll do their home at once, but it's more typically starting with 1, maybe 2. And we think, over time, there's no reason we can't be getting to 6 in terms of what's there in a home. And based -- and we think about that when we think about our road map, right, as well. And so we're thinking about the other places, how do we make that work, how the products work together, a little bit like LEGO, right, so that you can use them as surrounds or you can put them as speakers in other rooms. Maybe you move one to a kid's room when you buy the new one to go in another room. And then the other thing that we've started to see, again, now that we've been at this 16 years, is that something like Arc last year, our new sound bar, that elevates the experience with Dolby Atmos, drove those loyal customers that were original Playbar owners to now buy an Arc and move the Playbar somewhere else in the house, right, as well and go through it. And that's a bit of a new phenomenon in our model, but it proves out the fact that people will stick with the brand because they built trust and we build these long-term relationships, if you will, with customers and go through it. So we absolutely are thinking about -- and this was important for us to land with investors on Investor Day, the CAC, LTV side of the equation, how do you expand that over time. That's the way we think about this, which, again, I think is very different than a typical hardware company, if you will.

Right. And one of the big opportunities is that a little under 40% of your households do own just one product today. And the magic of the software really presents itself when a household buys the second and third product, right? Because that's really when you can run the multiroom system and controls. So talk about what you're doing to convert those 40% of households that only have one product today into a full system home.

Yes. And really, we threw the playbook out last year when the pandemic struck and said, okay, world's changed, what are we going to do a little differently? And we launched a program called At Home with Sonos. And we really targeted particular use cases. So it was like how do you use Sonos in a home office environment? How do you use it if you're going to do streaming and like make your Netflix experience better? And we went really targeted, and that worked extremely well. You saw the benefits of that in our growth, but in our DTC numbers as well. And so we're getting more and more focused on our customer base, how they're using the products, which products they have today and then which ones we should add. And there's generally been -- it's interesting, I think we see a lot of opportunity for people that have been kind of speaker-minded, if you will, and music-focused and those that have been video and home theater-focused, there's not actually been a ton of crossover there, and that's a huge opportunity, right? So if your 1 product could be a sound bar for television and if we can get you to put a speaker in another room and then you see the full benefit, that's going to open the door to some big growth. And then if you're listening in a bedroom or the kitchen on a speaker and you want to elevate the video experience and get a sound bar, that's the kind of thing that we're working on and trying to think about really addressing the customer needs and making sure they're understanding the benefit of the whole system. Because like you said, it gets better the more that you have. And we see that. Our NPS goes up depending on the number, the more products you have in a home, which is pretty interesting.

Right. Now at the March Analyst Day, you talked about your experience at Blackberry to convey this idea that companies like Sonos need to adjust their strategy over time as the market dynamics shift. How do you see Sonos' business model evolving over time?

One of the ways -- I think what's really important is exploring new areas. And we are a story of software eats audio is kind of the way that I talked about it. And so what does that mean to the future? And what matters to us is that we're thinking about the ways that we can bring great sound experiences to people. So that manifests itself in things like the IKEA partnership, right, and exploring new form factors, new price points, new countries with a partner that knows the home really well. That manifests itself in our Audi partnership and what does it mean to be in auto, right? And what role do we play in that using what we have with our system and our cloud connectivity and how do we think about the way that shows up as we go through it. And then as well, we offer ongoing benefits to customers. We're upgrading the software all the time. We're bringing new features, like AirPlay that we did, for free essentially to our customers and go through it. And so we run a service in the background today. And so understanding how to match up what it is we're doing and the way we're delivering customer value with what the business model is, is the other part of that thinking as we go through this. And so we've seen -- we've started to experiment with services, like you saw last year, we launched Sonos Radio, an advertising-based service, and then Radio HD, subscription-based. We see the business segment as another area that's a really interesting new one. And we're thinking, as we get into it, differently about business model as well and what makes sense there, given the way our model works, right, because it really is ongoing relationship, daily engagement with these things. And so how do we best serve customers in that model as we think about both the way we deliver value and then the way we charge for value is definitely on our mind. And then I just keep trying to think about and be on the forefront of anything that's happening in the space, innovation-wise, so that we don't get caught flat-footed on any of the things that are happening in the industry. We got caught a little flat-footed on voice back when it first came out, but then we used our strength around kind of being the open player, the Switzerland, if you will, to really bring both Amazon and Google into the fold and offer that to customers. And I think it worked in a really strong way. But I always want to make sure that we're contemplating those areas in which we could potentially change the game or keep driving innovation. So there's a whole bunch of factors that go into it. But suffice to say, I'm probably the most paranoid person you'll meet when it comes to that, just given my experience at Blackberry.

Right, right. And I mentioned earlier that when you became CEO, one of the things you did was accelerate product development, and you've committed to launching at least 2 new products per year. Recently, you launched Sonos Roam, which sort of takes audio out of the home. And you disclosed the Audi partnership, which you just mentioned. Talk a little bit more about what some of the most attractive markets are outside of the home in the future. And then sometimes I get asked whether you would ever move beyond audio because, look, what you've created in terms of a wireless mesh network where you could have multiple devices and you have multiroom control could be applied to other markets as well.

Certainly, it could. And I think -- and then again, it depends on the timescale that you're talking about as you think about these things are, we're going to continue to innovate and look for opportunities to do something that others aren't and bring new experiences to people, and that can go in a variety of different directions. It's just, right now, there is so much room in the rest of audio as we look at it. So dipping our toe in the water in auto, like you mentioned, with Audi, just stepping outside the home with what we're doing with Roam. And I think the best way to think about it, so we're playing today in the 18 -- let's say the -- before stepping into Roam, we're playing in $18 billion kind of home audio space, and then you talk about $90 billion total audio market dollar spent annually. So like that's a big space for us to go. And this year, we're -- and so as we think about that, there's just -- this is all about choices and making sure we're taking the right steps at the right time to build something that's sustainable, right, and not just jumping in. I think this has been part of the downfall of more typical hardware companies in the past has been like just almost like a too rapid jump into a bunch of different areas without understanding how it connects back to the whole system, right? And so you see with something like Roam, Sound Swap, where it's got a great feature that makes it easier for you to take that experience with you because you can bring the Roam up to an existing speaker, transfer the music and walk out of the house with it, right? And so we're trying to take away all the points of friction in something like that. And when you think about the entire day that you go through and all the audio that you're consuming and all the different ways you are, as you go into a coffee shop, as you put headphones on, as you get into your car, as you go to a restaurant and you see something in your office, right? All of these areas are opportunities from our perspective. But the important thing is how do we reduce the friction that exists there today in somebody's experience so that it is just like a magical experience throughout the day, and you're connected to all the services that you want to be, and we're making that very easy. And so we think about it as we think about a customer's day and kind of their journey, and that's where we see like opportunity really in all the different areas of audio.

Speaking of services, what is Sonos' services strategy? And should investors think about it as contributing meaningfully to the financial model? Or is it more of a foundational layer that improves the experience, increases engagement, increases loyalty?

In the short term, it's the latter. In the long term, I think it's the former would obviously be part of the goal as we go through this. But right now, it's also like early in our learning journey, let me put it that way. We've been shipping hardware for 16 years. We know what we're doing on that front. We know what a good cadence of new products look like, how they should work together. When it comes to services, we're exploring, we're testing. We're trying some things, and we have ideas that we want to go out there. But it's just -- it's super interesting because it's a different model than the hardware model where we need to determine every 18 to 24 months in advance exactly what we're building, and then we go and we work through it and have to bring it out and almost has to be perfect when it actually comes out, whereas we're learning this world of iterating quickly and testing new things in services and see what works and see what doesn't and then moving from there. So right now, it's like how do we elevate the experience is kind of the way I've talked about it with services. And then over time, the goal, obviously, would be to be building a great complementary business there as well.

What -- how do you think about Sonos for business? Is there a services opportunity? Or is that more of a product opportunity? And what are some of the commercial markets that are most interesting? I mean you mentioned retailer, coffee shops, you can imagine checking into a hotel room. Some of your customers probably spend 1/3 of the time away from home. And so that could be an interesting market. What does Sonos for business look like? And what are the most attractive end markets?

Yes. It's right now difficult for small business owners, hotel owners to really deliver a good audio experience and do it in a simple way. And so it takes -- there's this heavy burden for all of these kind of companies to do something. And the reality is it was that same way in consumer before we got into it, right? If you wanted to do streaming audio in your home, you had to put a bunch of pieces together, if you will. And so we see the opportunity to really help bring all of these pieces together, make sure that it's licensed music, make sure that it's easy, make sure that it's supported well. One of our secret weapons is our customer support, world-class, very focused and rewarded on solving the customer's problem, not how quickly you get somebody off the phone. I always joke, we solve more networking problems than the router and networking companies that are out there. But I think for small businesses, that's a huge opportunity because right now, the idea that they could plug something in, and we could monitor it, for instance, and be able to service it 24/7, all of these things remotely is a pretty interesting concept and take away from some of the complexity that isn't their business today. And so we see an opportunity for that space to be something that is different and we're thinking, as we think about new spaces like that, we think about what's the right business model to accompany it as well because that needs to go into the picture. And how do we keep it simple for those companies and make sure that if something breaks, it can be fixed and replaced pretty quickly. And so there's a lot of thinking that's gone into how do we approach this in a different way and just keep it super simple for the businesses, we do see, like every different type of business in there, but I think you'll see us focus a little more to start on the smaller businesses that are really struggling with how to deal with audio in their office or shop and those kind of things. But it will be interesting over time to watch this space because I think there's a lot of opportunity.

What could be more impactful from a financial perspective over the next couple of years is potential licensing revenue that you generate as you defend and then license your IP to others. Talk a little bit about the strength of Sonos' IP portfolio and then just the time line of the current cases that might have financial impact in the future.

Yes. So we've invested in intellectual property from the beginning and building up that portfolio, making sure -- because we -- and that's a testament to understanding that we knew this was going to be a big space. We're the inventors of this space, and we had to do that to make sure that when the giants would come in, we'd be able to properly protect ourselves. And so the IEEE has ranked our patent portfolio the second most powerful in consumer electronics, behind only Apple. So I think that says a lot just in terms of its relevance not just sheer numbers. There's lot of people that play the vanity game of number of patents, but it's what actually matters with those patents and kind of where are things in the broader economy right now, what's important to customer experiences and those kind of things. And so we obviously have conversations. We have relationships with all of the big tech players, the streaming music companies. But last year, we launched a lawsuit against Google for infringing our intellectual property with the ITC, and that's done to -- the remedy there is an injunction against their products that infringe our intellectual property. And so that case, we'll see the preliminary ruling August 13, so not too long away, and we're very confident in our case there. We recently won an injunction in Germany for a different patent. So we believe Google violates about 150 different patents that we have. There's 5 at the ITC. We had a different one in Germany that we launched a case against. And so an injunction there to stop the shipment of their products into Germany as well that we won about 1 week, 1.5 weeks ago, 2 weeks maybe now. So we feel like we've got strong intellectual property. We've already had 2 licensees, one that we had to go through a court case to actually drive to a license. And we think that everybody that plays in this space infringes on our intellectual property. And so we think that ultimately, we're happy for people to build on top of what we've done, but you can't copy what we put out there. And so licensing is definitely something that we're focused on. And right now, I'd say the big one to watch is certainly the ITC case with Google.

Right. And if you win that case, is it a watershed moment, where then it's easier to negotiate licensing agreements with other companies or not necessarily?

I do think so. It just -- it tests the patents and the intellectual property at a whole different level. It is only 5, right? So I would also say there's -- in that case -- in that situation alone, there's another 145 that are there. There are some other actions that are underway, but it's a pretty important one just to help illustrate the power of the patent portfolio that we have. And you're taking on one of the most powerful companies in the world. And so I do think that coming through that one successful is an important signal an important validation of the power of our patent portfolio.

I want to wrap up with a couple more near-term questions. One of the big topics in the market is semiconductor and other component shortages. And we talked earlier that there are long lead times for some of your products. Just talk about where you're seeing the most extreme shortages, how that's impacting your ability to meet demand? And is there a line of sight into addressing some of those challenges?

Yes. So we've been heavily investing in our supply chain team, and it's something we've prided ourselves on since the beginning. And we've -- I would say, you're always dealing with maybe 3 to 5 different things that are potentially like problems in terms of shipping and all of these that the world never sees. So like there's always these many crises that are happening all along the way. And that -- and over time, it taught us, and I've learned through my 23 years in this space, you do have to be clicking down a certain level. And you'll see that some companies use more aggregated level distributors, although rely on their manufacturers and those kind of things. And we don't. We've clicked down different levels into all of the supply chain. And I think it's really helped us navigate the last 3 quarters where this has been an issue, but we've come through pretty strongly. That's important. So how you approach this space, how you build relationships, how you think about long-term contracts as well and making sure you're making those commitments are important. We've been working with all of the partners through this. They've been fantastic. As you can see from our most recent quarter, we delivered much more than we thought that we would, and that's a testament to our supply chain team, really. And demand continues to even outstrip what we can ship. But I do think that while we face this, we are still navigating it, and our team is navigating it by working with partners on those longer-term contracts, trying to grab anything we can through the rest of the industry. That part is something that kind of everybody is going. But I do feel like we'll be navigating it for a while, but I also feel like our team does a great job in kind of working through this as the best anybody can. And we'll just try to keep everybody apprised of what we're seeing as we go through it. And then I'd go back to a comment I made earlier about the demand not being perishable. So the nice thing is that we've seen that the cancellation rates on orders have actually trended at or below historical rates which is pretty interesting, and people have been willing to wait. So we don't take that for granted. But at the same time, we're pretty proud of the fact that people will wait for their Sonos products.

Last quarter, as you said, you meaningfully beat expectations and you raised the fiscal '21 revenue guidance to $1.65 billion, which is 24% year-over-year growth, significantly above the sort of historical rate and long-term model. But the guidance implies that revenue over the fiscal third and fourth quarter will be weaker than seasonal. It sounds like demand is incredibly strong in the business. So is that a function of conservatism? Is that a function of the component constraints? Or is there another driver of that slower than seasonal growth in the second half of the year?

The function -- right now, everything is about supply. So it is -- the demand continues to be extremely strong. And so this is all about supply that we can get. And so that's really the key for where we are right now. And we're going to be really thoughtful. You know how thoughtful we are in terms of trying to make sure that we're providing reasonable insight into what the year looks like since we don't chunk it out specifically into quarters because I think, in our world especially with timing of launches and a variety of things that move, I think that's important to help people understand and have that longer-term perspective. But it really is a supply story at this point because our demand is just -- continues to be so strong. And I think one of the important points, I mentioned this on the call, but I do think it's important for anyone to understand is we're watching so closely those areas that open up versus those that are still locked down. And from what we can see right now, the demand remains strong in those areas that have opened up as much as it has, where people are still in more of a lockdown setup. And so we'll be watching that extremely carefully. But right now, it's all about trying to build as many products as we can to get them in the hands of consumers.

Right. That's great to hear. And a perfect place to wrap up. Thank you, everyone, for joining us. Thank you, Patrick, for the insights. And if anybody has any questions, please don't hesitate to reach out to me. Happy to double-click and go a little bit deeper on the story. Thanks again. Have a good day, everyone.

Thank you. Thanks, Katy.