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

Good afternoon, everyone. Thank you for joining us today. My name is Erik Woodring. I'm an IT hardware analyst here at Morgan Stanley. Let me just quickly read disclosures here. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan sales -- Morgan Stanley sales representative. I'm pleased to welcome back Patrick Spence, Sonos' CEO; and Brittany Bagley, Sonos' CFO. Patrick has been at Sonos since 2012, been CEO since 2017. Brittany was part of the team at KKR, leading the investment in Sonos and he's been CFO since 2019. So thank you both for joining us today.

Thanks for having us.

Awesome. So maybe we'll start high level. Something we've talked about numerous times, is the Sonos flywheel. It's kind of key to the story. So maybe for the benefit of the audience, Patrick, can you just lay out what is the Sonos flywheel? And kind of why is it such an important differentiator for you guys?

Yes. Thanks, Erik. So I think the -- it's probably the thing that I think is either we aren't communicating as clearly as we need to or is the most misunderstood thing, which is we're not a one-and-done product, right? At Sonos, we have an amazing product portfolio, we bring 2 new products out -- at least 2 new products every year, and that helps us along with our marketing efforts to acquire new customers. Those new customers come into the Sonos family, and they add more over time. So now our average household has 3 products, and we've seen that behavior carry on for the 17 years we've been in business. And they also tell their friends and family about Sonos. So they come in to Sonos and the flywheel starts all over again. Of course, we're bringing out 2 new products a year, that's getting existing customers to add more to their system that's attracting new customers and around it spins. It's what we think about when we think about which products to introduce next, which services to add, those kind of things. It really is something that is unique to Sonos. And it sets us apart from really any other consumer electronics company I can think of.

So let's get into 2 key points that the kind of market debate here. One is there's this misperception, so to speak, that Sonos is kind of narrowly defined COVID beneficiary. So maybe give us a reason why that is not true? What are the high-level drivers of demand as we move out of the pandemic and into kind of the fiscal '24 that you guys have laid out for us?

Yes. So I think the -- we definitely saw an acceleration last year, for instance. You can see it in the fact that we delivered 30% year-over-year revenue growth. As we've looked out to this year, we've adjusted -- that was constrained as well. So we didn't have all the supply that was with the backlog. But we also ended up in a situation where a lot of that 46% of our registrations came from existing customers in there. We actually had a constrained amount of new homes that came in. And so we took all of that into account as we thought about where we're going over the next year and then over the next 3 years, and we've baked that in. And we think there are some big tailwinds. First of all, the flywheel. So the people that did join Sonos over the last year or 2 years, if they behave like the cohorts of the 17 years before, they will come back and purchase more over time, right? So we get that ongoing, come back, purchase more, tell their friends and families, they become new customers. And we also have some strong tailwinds, multiyear tailwinds. The first is the golden age of audio. So as all of you I'm sure are experiencing, you're listening to more podcasts, audio books, music streaming, social audio. There's a lot of things happening in audio. That is only going to grow. There's a lot of push. I'm sure you've heard it from others about the fact that audio has not been invested in and grown in the same way that video has. So there's a lot of runway there. The second is this Hollywood at Home trend where the video streaming services are investing billions of dollars in amazing content, that is theater quality that you want to enjoy at home. And there's no better way to enjoy the sound of all that great visual content than having the Sonos products in your home for your TV. And the last is the work-from-home trend, right? So certainly, it's great to be back in person. We'll spend a little more time in the office, but we're still going to have a lot of people working from home. And when you're at home, working from home, you want to have a decent experience there, a nice environment, and that's where Sonos comes in to create great music in the background and audio and all of those things. So we think those are strong tailwinds and that are going to help as we think about the future. The other thing I would say is we have grown 17 years straight where we've been, but we still, this year, we'll do $1.95 billion to $2 billion in revenue in a market, big audio market of $89 billion. So the other thing to think about is that we're only getting started in terms of taking more and more of that share. We've shown an ability to do it for 17 years straight, and we expect we can continue to do more given the tailwinds and our unique flywheel.

And then maybe, Brittany, I'll follow up with you. And so from a numbers perspective, guiding to 14% to 16% revenue growth this year, a little more back-end loaded than normal years. Maybe just explain why that is and kind of convince the audience why that 14% to 16% is achievable?

Yes. I'll do my best on convincing. So I would say in Q1, which is typically our largest quarter, we continued to be very demand -- very supply constrained. So it wasn't really a demand question. It was really about supply. And so what that gives us for the rest of the year is as we work through and do get some additional supply available for people, we can actually start meeting some of that demand. And what that looks like for the year is you see us filling the backlog that we had, you see us filling up the channel again. So there's actually inventory at our channel partners. And then you have 2 additional factors beyond backlog and channel fill. One is just price increases. We took price in September. Across our portfolio, the average price increase was about 10%, different on different products. But on average, it was about 10%. Once we work through some of that backlog that was at the original pricing, you'll see those price increases flow through our year. And then we have new products and we have new products every year, but to Patrick's Flywheel point, those new products really drive our existing customers coming back in and repurchasing, and they drive new customers into the Sonos system. Mechanically, we also have channel fill and things like that when we launch new products, and so it all supports that 14% to 16% growth outlook that we're seeing.

And then how about as we move from fiscal '22 to fiscal '24, you've laid out the target of $2.5 billion of revenue. What do we kind of need to assume to get to that $2.5 billion of revenue?

So that $2.5 billion is sort of a 13% CAGR off the midpoint of our guidance for this year. So you don't need to assume that everything that happened in COVID continues. We're really going back to a much more normalized business level relative to what we saw pre-COVID. And what supports that is the fact that we do have existing customers who come back in and repurchase very consistently every year. So if you put aside '21 where that existing repurchase was much higher than normal, on average, 37% to 40% of our product registrations come from our existing customers. So you've got a nice base there to support that. And then you can do some math on what that means in terms of pulling in new customers to the Sonos household. We're supporting those new customers coming in through our product road map and the products that we have coming out over the next couple of years. First and foremost, we also support it through brand marketing, building the top of the funnel, expanding in the market opportunity we have, expanding in the household opportunity we have. We're very underpenetrated relative to the 116 million affluent global households that we are going after in markets that we're already in. So there's a lot of support where we can go out and get more share to underpin that.

Great. So Patrick, back to you maybe thinking longer term, kind of a longer-term debate is this topic of competition, right? There's Sonos and you're competing with the likes of an Amazon or a Google or an Apple, who have, obviously, large customer bases, huge balance sheet. So from my perspective, there's a different purchasing decision when you're buying a Sonos versus a product from 1 of them. But maybe from your perspective, can you explain to us how you think about your competitive advantages? And why there -- and why they might not be as core competitors as some might?

Yes. I think it's a good point. And we have been competing with Amazon and Google for 6 years, I want to say this point, and Apple as they brought product set, so we have some history now, and we've continued to innovate and grow through that period. The focus, I think, in a situation like ours, the focus on audio is the key, and we are doing it for the customer, right? So we think about creating an experience that is easy, if you talk to anybody that's -- I'm sure many of you have Sonos, is the easiest one. It is premium, right? So we don't play in the $25 kind of speaker market. We're playing for people who want to purchase something premium for their home. It is something that is open to all the services. We're not trying to lock you into 1 ecosystem, which is obviously really the thing that's driving a lot of the big tech products out there. It's not to help you with a wonderful product in your home for a long time, it's to get you using their service and ultimately, like kind of cross subsidizing that. So being open is absolutely critical. And of course, sounds great, looks great. And so this has worked like for us to be able to differentiate and really kind of dominate in this segment. And what the kind of special sauce is really the software right behind it. So 2/3 of our engineering team is on the software side. It's how we've disrupted what is traditionally a hardware space from the audio companies, the legacy audio companies and why they can't compete with what it is that we do. So that's why we feel so confident that we can methodically take more and more of that $89 billion audio market over time because we're doing it with software, and we're really the story of software meets audio.

Great. Maybe let's shift gears a little bit and talk about products. You launched a new product last week the Roam SL, your second product so far within -- in this fiscal year. So why is this an attractive product to bring to market after you launched the Roam last year? How do we think about kind of the future launch cadence?

So we learned something very interesting when we had the Sonos One, our entry product that there were a lot of customers that were saying, I want a product without a microphone as well. So it has a microphone in at the one. So we did a SL without a microphone, and that's been a huge success for us. And so the same kind of ask from customers has come for Roam, which is our -- now our entry-level ultra portable product. And so we wanted to be able to address that concern for customers and it's a good time to the year to be bringing out that product as we hit the spring and people are going outside, right? So we just, over the last 2-plus years started to go outside of the home. This is one of the other growth vectors for us is that for the first 15 years, we were just focused on sound in the home. Now we're starting to go outside the home with both the Move and the Roam products. We want to make sure we have the right product. So adding Roam SL to the mix is important. And we think about our products, and we think about that 2 new products to your cadence in terms of both raising the bar for existing categories that we're playing in and making sure we continue to lead in those categories and set the pace for the industry. And then the other is new categories as well, like ultra portable, which we did last year. And so making sure that we can tap into new customers we're not approaching today and get existing customers to add something new to their system as well. Hence the flywheel spin.

And so let's talk about maybe as you started to move outside the home, right? You've announced a partnership with Audi, you've announced past partnerships with IKEA, which is a bit different approach to the traditional premium approach you've had. And so maybe just explain how some of these partnerships or relationships are kind of accretive to the overall Sonos story?

Yes. So we think about -- with each partnership, we're kind of thinking about how does it help us or can it help us reach into more of those 116 million homes that Brittany mentioned, that $89 billion total market. And auto, for instance, is a big chunk of that $89 billion every year. In Audi, we found a partner that as they go into electric vehicles, are thinking they want to create something more premium. The whole sound dynamics obviously have an electric car change versus traditional. And so it's a really interesting way to bring our brand to the next generation of auto customers on our way to, I think, autonomous vehicles and vehicles becoming more like the home, quite frankly, and being an entertainment area. And so whenever we do something like this, we want it to, first and foremost, be something that wins over customers, and we are very pleased because What Hi-Fi?, which is kind of a definitive publication for audio products has given that a very strong positive rating. So I think we've kind of hit the mark with Audi. We've dipped our toe in the water in auto and think that there's opportunity there over the long term. With IKEA, it was an opportunity to work -- it was 1 that we went into a little bit wondering if there would be a fit or any overlapping in customer. And we found that there was and that it gave us an ability to leverage everything we've done on the software side. We sell them basically a module they put in some of these products. And these products helped us test this idea that it doesn't -- that sound doesn't have to come from traditional speaker form factors, right? That doesn't have to be little black boxes. With the software we've created, you can have furniture actually emit sound in a great way, and we can tune that given the software that we have. And so we've really been playing with kind of new form factors, there's new price points and then as well, it's helped us get into some countries and see the demand for Sonos in some countries that we weren't in as well. And so there's multi-dimensions to kind of partnership that we strike. But they're all strategic in terms of how we're using them to kind of test our hypothesis in certain areas.

Cool. So you mentioned countries. I just have to ask, obviously, because of what's going on in the world. One, can you just talk about your efforts to expand geographically? And then two, any changes in recent behavior, purchasing behavior from some of your markets in Europe, just given the conflict that's taking place right now?

I mean I think that we're lucky to be able to say we really don't have any material revenue from Russia or the Ukraine right now. So that alone is not a big impact. It's too early to see what the long-term impact will be on EMEA. EMEA is a big region for us. We did about 36% of our revenue in 2021 in EMEA. So we're watching it really closely. It's just -- it's a bit too early to call. From a country diversification standpoint, we think we have a lot of opportunity in all the markets we're in, including the U.S. and Europe. But as I said, the U.S. and Western Europe are really our largest markets. And then we've seen some really nice growth in our APAC region, where we've been investing methodically for a long time to really make sure we have the right strategy, the right partners, the right brand awareness in those markets.

Okay. Great. Maybe 1 more question here as we talk about kind of products and growth. It's obviously still very early days for your services build-out. How should we think as investors think about the services business in terms of -- is that 1 day more of a contributing factor to the financial model? Or is it more of kind of like this foundational layer that improves the experience, helps increase engagement, increases loyalty and so forth?

I really think it's both, and it depends on the service that you look at. If you look at something like Sonos Radio, we've talked about how that's the third most listen-to service on our platform. That's really about improving the experience and increasing engagement with our customers. When you look beyond that, we ended '21 with 12.6 million highly affluent homes. We recognized that there's a big opportunity to potentially sell more to those homes. But we want to do that in the right way. We want to do that in a way that works from a business model standpoint and from a customer standpoint. So really always putting the customer front and center when we think about that. So that's a much longer-term effort and initiative for us. I think the other place you've really heard us talk about services is in our Sonos for Business initiative, where we think that there's an opportunity to serve any type of customer from a bar or a restaurant, a gym, a hotel with a more business-focused offering from Sonos, but again, we're playing for the long term there. So when I give '24 guidance, we're really not assuming that you need to have Sonos for business really, contributing to that in a meaningful way. We've talked about how radio isn't meaningful at this point. We'll break it out when it is. So I think there's a lot as we look at '24, that's really just us continuing to execute on our existing business and our existing categories. And then services is really the long-term game for us as we continue to grow beyond '24.

Okay. Perfect. So maybe let's pivot a little bit to litigation. One of the -- what I would say, most underappreciated aspects of the story is the fact that you have this extremely strong IP portfolio you've demonstrated the ability to protect those patents. Obviously, the ITC decision earlier this year was extremely important. So maybe just help us understand what should we be looking for going forward? Maybe starting with this week in terms of -- what are the next mileposts when it comes to your litigation efforts and your efforts to kind of protect the IP that you guys have developed over time?

Yes. So as Erik you mentioned, we went 5 for 5 at the ITC in terms of Google infringing 5 of the -- you can only do max 5 patents at once of the 150-plus that they violate. They've chosen -- so yesterday was actually the injunction date. And so they've chosen to degrade their products. And you can see the customer reaction to that on their website, not very pretty. Now it's up to customs to decide if the product coming into the country is actually lived to that degradation, it actually works around the patents or not. So that's in process. And the next big milestone is the May kick off of the federal case that we have where damages start to be contemplated, and we go through that process. So it's something that we're very confident in. We're investing in because we believe we need to stand up for the intellectual property we have. At the same time, 99% of my time and the team's time goes into continuing to drive innovation and growth as you've seen that, so we've been at this for a couple of years now. We continue to grow, innovate, and we'll continue to launch those new products. And at the same time, we have a team that can enforce our intellectual property. And we think anybody playing in this space in force -- actually infringes our intellectual property. We've had to take 2 to court at this point, and we're talking to others.

With the goal ultimately being, I'd imagine hopefully signing a license...

That's been the -- that's exactly right. That's been the conclusion in 2 other cases.

Great. And so you alluded to investments. Obviously, we know you're investing in innovation and new product launches, services or expanding services. And so maybe, Brittany, if you could just talk about some of the other investments that you're making in the business to perhaps in the infrastructure internally, in branding, in sales and marketing? And then just how we should think about that perhaps impacting the model from a margin perspective?

Yes. We're investing in all of those things. I mean, I would say we've put out long-term guidance for '24 at 15% to 18% EBITDA margins. we are guiding at 15% to 16% for '22. So we're already in our adjusted EBITDA guidance range. And what that really means is we are investing back in the business to continue to drive growth through '24 and really beyond, because some of the things I've talked about are investments we're making in seeds we're planning for the long term. So first and foremost really is about innovation, R&D, engineering, we continue to invest in sales and marketing in our brand, in our top of the funnel to go drive some of the new customers in that will continue to support our business. And then we scaled a lot more quickly than we thought we would from a top line standpoint. And so we're paying a little bit of catch up from our systems, IT infrastructure standpoint, what you're seeing come through in our G&A line item.

And then maybe just to pair that, how do we think about gross margins, obviously very strong, close to 50 in your December quarter. Full year guidance is a little bit lower than that. Just what are the puts and takes that kind of get us not only this year, but as we think longer term again?

Yes, there's so many puts and takes going into gross margin right now with everything going on from a supply chain standpoint. So I think some of what you saw in our holiday quarter was that we didn't run promotions. And typically, we run the promotions that we do run in that holiday quarter. So you saw a nice benefit to that. I think what you continue to see as we go through the year is that we are continuing to work through the supply chain. We're continuing to do spot [ eyes ] on component prices. Continue -- costs continue to be elevated from a shipping and logistics standpoint. We continue to have air freight needs. So you put all of that in. And then as we go forward, both for this year and longer term, we also factor in things like product mix, channel mix, where we think that will land and that's how you get to both our '22 guidance and then our long-term guidance. There's a litigation point in '24, there is nothing major baked in from a litigation win standpoint, right? So you don't have to believe that to hit any of our long-term guide either.

Okay. Great. Maybe let's shift to capital allocation. Obviously, you become more cash generative. You have a larger cash balance, $750 million of net and gross cash nearly 25% of your market cap. And so you're buying back more stock, but what are the other uses of cash? How are you prioritizing as we think forward?

First and foremost, we're really investing back into the business, and that's both organic investments, but also inorganic investments. So we spent just under $30 million on M&A in Q1. That M&A investment is really about accelerating our road map, our pace of innovation could be aqua hire. It could be anything that's really going to help us take advantage of that large long-term opportunity we see. So that's really important for us. And then after that, we will do share repurchases, and you've seen us increase the size of our share repurchase authorization. So it was $50 million in '20, $50 million in '21, and then we came out with $150 million authorization at the beginning of this year. So we are increasing that as we are increasingly cash generative.

And then from an M&A perspective, what do you guys look for? Is it filling technology gaps? Is it distribution? Is it engineering talent? How -- what's kind of -- as you look out at the world, what's the most interesting to you from an M&A perspective?

I think it's really technology, talent and filling product and road map gaps where we have -- we've got nice distribution. We've got nice geographic presence. It's about how do we go after that $89 billion market opportunity that Patrick talked about and how do we do that faster, but also in a way that's very consistent with the Sonos brand, our premium offering and our customer promise.

And then you touched on the $89 billion TAM. Patrick maybe, what takes us from $18 billion kind of premium global home audio TAM to $89 billion global audio TAM? What is in that?

Yes. So you've got some commercial in there and Brittany talked about the fact that we're doing some work in that space. You've got auto. We've dipped our toe in the water with Audi, obviously, and then you also have headphones and personal audio that's in that category as well. And so really, those are the ones, I think, that help take us in that area. I don't think I'm forgetting any.

No, I think the other call out going out of the home is just portable and we've dipped home in with Roam and Move.

Sure. So we have just about a minute left, and I want to give you guys the opportunity maybe here to kind of make the case for investment in Sonos. What is most underappreciated? What is most misunderstood why Sonos screaming buyers, screaming over...

I think the -- what you need to believe is that the last 17 years, will continue to happen in terms of our flywheel, right? So you need to believe that we will introduce at least 2 new products every year that are going to attract new customers and get existing customers to come back and buy more and that, that flywheel will continue to happen and that we're early in the whole size of the market or fundamentally it. So obviously, it's for you to decide. But that is what we're going after, that's what we're confident we'll be able to do. That's what we've proven our ability to do over the last 17 years, and we're excited about the reaching those '24 goals.

Cool. So we're out of time. Thank you guys for showing up, really fun to host you, and thank you, everybody, for attending. I appreciate it.

Thanks, Erik. Thank you.

Thank you.