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

Afternoon to day 2 of the Flagship TMT Conference. My name is Erik Woodring. I lead the hardware coverage here at Morgan Stanley. I'm delighted to be joined by Sonos today, Permanent CEO, Tom Conrad, a shift from a year ago.

I mean the Board likes to remind me. Nothing is permanent, but more permanent than the interim.

And then obviously, CFO, Saori Casey. So both of you, thank you very much for joining us today.

Thanks for having us.

Before we start, very quickly, let me point you to the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

So Tom and Saori, welcome back to the conference. Congrats again, Tom, on being named permanent or -- you know what I mean? A lot has changed in the last 12 months strategically for Sonos. And kind of 2 quarters ago, you kind of first laid out your vision or at least your updated vision for Sonos. Can you maybe elaborate on what you're trying to change, maybe what you're trying to keep the same and what this means for the future of Sonos?

Yes. I mean, a year ago, just about, I was -- I've been the interim CEO for a month or 2. Board was in the middle of their search process for the permanent CEO. And I was really focused then on 2 things of the company. The first was restoring the performance and reliability of the underlying software platform for Sonos to return us to customer advocacy and just materially improve the delivering on all of our core promises in our customers' homes. And then Saori and I were deeply engaged in kind of transforming the efficiency of the company. And over the course of the 6 months before I arrived and the 6 months or so after I arrived, Saori was really instrumental in helping us optimize $100 million of run rate out of the operation. And I'm delighted to say, too, on top of all of that, I think that we're operating with greater urgency with greater impact and delivering on a more sophisticated ambition and road map than we were in the previous chapter. So like it was a kind of win-win. But I was named CEO just about August 1, so 7 months ago. And the nature of an interim assignment, I think particularly in the case of Sonos is that it's fairly tactical. You're focused on the sort of a relatively short-term horizon. And so when I was named in August, it was really my first opportunity to begin to bend the arc of the company towards the strategy for our next decade. And I think if you look at the 20-year history of the company, a decade under the stewardship of our founder, John MacFarlane, and then almost another decade under Patrick Spence. You might describe the chapters as the first chapter was relentlessly focused on delivering the whole home music vision that John and his co-founding team started from. And so the product was really Sonos. They had a couple of amplifiers and a speaker, but it was really -- what they sold was the experience of Sonos whole home music. And they really anticipated this shift from physical media to media that was streamed from the cloud in a really prescient way. The second decade of the company's life under Patrick, I think the emphasis was around excellence in operations and delivery as a hardware company. So the company went from shipping a product every couple of years to shipping really, really reliably 2 great new expressions of Sonos' hardware every single year under Patrick's stewardship. And I think if I were to critique the last 5 or 6 years of the company before I arrived, it would simply be that, that laser focus on turning the company into a hardware execution team had the unintended consequence of letting the company take its eye off of the system-level promise of Sonos. And by the time I arrived, not only were we in crisis on the performance and reliability of the software stack, we had also sort of forgotten what it meant to sell Sonos as the product as opposed to a pair of headphones or a mid-tier soundbar or an entry-level portable speaker. And so, my strategy is really to combine the best of both of those capabilities in one, a return to Sonos as a system for seamless entertainment in the home, powered by best-in-the-world hardware execution engine. And so the -- that has a lot of implications for the company in terms of how we operate every day. And maybe in some ways, the single biggest thing is it puts equal strategic weight on ensuring that the whole is greater than the sum of its parts than rather all of the emphasis being on these individual launch points for individual SKUs.

And I think that -- it might be a nuance, but I think it's important because if we do go back to kind of the original promise of Sonos, it was create this system, you can have this amazing zoning, amazing sound quality. You're refocusing on the system. So can you maybe elaborate a bit on the distinction that you're trying to make there between a collection of endpoints and reinvigorating the kind of system that the story started with?

Yes. I mean, there's so many different dimensions to this. One dimension is just the core experience of the platform needs to be seamless and effortless and work every time and anticipate your needs using the power of AI. And we're doing all kinds of work to get to a place where you just have that sense of like you sort of imagine what you want on Sonos and it just happens. But to talk a little bit about the difference between launching something like a pair of headphones in a SKU-centric model versus a system-centric model. When we launched Sonos Ace, without question, the best headphone you can buy in terms of noise cancellation, comfort, battery life, Bluetooth compatibility, it's an exceptional product relative to any other pair of headphones out there. Ironically, though, it's missed opportunity is that at launch, it was not deeply integrated into the Sonos environment. So I think what any Sonos customer would reasonably expect from a pair of headphones we sell them is that they would be able to move through their home and have music effortlessly flow from the speakers and sound bars that they have to the headphones and Ace didn't deliver on any of that at launch. Today, it delivers an exceptional experience with respect to integration with our soundbar experience, but still underdelivers with respect to the rest of the Sonos ecosystem. Another example might be our Era 300 Atmos speaker, best speaker in the world for listening to surround music and home theater. However, when you place it in a room with the rest of the Sonos home theater experience, it does not have the sophistication today to understand its orientation. And as a result, it kind of -- it diminishes to a lowest common denominator about what its role is going to be in the home theater setup. This is a failure of system. We have all of the mechanisms and expertise to place the speaker in the room. But in the NPI and this new product introduction sort of model, the SKU-centric model, all of the emphasis went into that object as a single item, not as how it expressed itself in the home there. So we're -- I could go on and on and on. But there are countless examples, both high level and low level of how an investment in system up levels the entire product offering.

And while you're not explicitly saying this, what I hear or what I hear when you say that is there's investments in software that we're making also to enable this system. Can you maybe talk about, again, going beyond the improvement to the app, but the improvement that you're focusing on with software to make that system what you want the system to be?

Yes. I mean, I think the interesting thing about software investment is that so much of what we do accrues to the totality of the experience and not to the individual SKU. And so during this sort of SKU-centric chapter of the company, it was it was culturally hard for the organization to prioritize the software investments that differentiated the whole versus the software investments that enabled the individual object, if that makes sense. So we are very focused today on a world-class software organization that is delivering the Sonos platform, which sits atop all of the particular hardware instances and delivers all of these delightful completely differentiated one-of-a-kind experiences.

Okay. And in the past, we've kind of talked about this model of like there's a number of households, there's product per household. I forget if it was last quarter or the quarter before, but you kind of outlined 5 different growth levers that you have for the company. At a high level, can you maybe just refocus on exactly what you're trying to do with each of those 5 growth levers?

Yes. So it was on the last call, we talked about the answer to the question of how do you return Sonos to growth. I think there's 5 dimensions of opportunity. We will continue to launch incredible new hardware projects. And so this year, in the back half of the year, we have a whole bunch of things ready to go. Very, very excited to start telling the world about our hardware portfolio after almost a year of pause while we were working on restoring performance reliability, delight to the core software experience. And new hardware launches for us will always be a vector for growth, differentiation, repurchase from existing customers, expansion within the home. Second dimension is return to customer advocacy. I think if you look back at the history of Sonos and try to ask the question of like where did growth and familiarity come from, it was truly from word of mouth, like people actually advocating for a product like true NPS activating in the world. People love Sonos, it's a social experience. You go to someone's home, Sonos is playing, you'll talk about the experience, and we were a huge benefit of -- beneficiary of customer advocacy throughout our history. And because of the underinvestment in the software platform and because of the acute performance issues that were introduced in the sort of infamous software release from early 2024, we saw all of that, frankly, reverse. And we've made so much progress that all of the metrics, whether it's NPS or customer sentiment on social, customer satisfaction through our CX channels, all those trends are reversed and are in a place I'm really proud of, and we're seeing that begin to become a tailwind again. I think in part because we were such a beneficiary of efficient word-of-mouth, the product sold itself, I don't know that the company has ever had an exceptionally developed full stack marketing muscle. And so the third growth lever for us is a renewed investment in best-in-world marketing capability. Colleen DeCourcy just joined us as our Chief Marketing Officer. She was Co-President and Chief Creative Officer at Wieden+Kennedy for a decade, truly one of the greatest marketers in the whole world. And she's been with us here for about 6 weeks now, and her thinking is already starting to take hold in the organization. We're really, really excited about what it means to become a brand that can tell the whole story of the company and our ethos and then the product and really up-level our presence and culture and familiarity. As a result, the fourth lever is a geographic expansion. We talked about this on calls for my whole tenure at the company. We have -- we've identified a handful of key markets that are showing early promising signs of potential for us and are leaning into the investments that are required to facilitate that early growth. We're seeing results. They're early, but exactly what we would hope to see the investments yielding at this point. And then the fifth dimension is there are really interesting consumer behavior adjacencies that are happening around audio, I mean, particularly around conversational AI. We're in 17 million homes. We have tens of millions of microphones that we can connect to services that are integrated with the conversational AI personalities that customers are increasingly making a part of their daily life. That unlocks not just behavior in our traditional scenarios around entertainment and mood, but really just around the whole broad sphere of modern computing, where you can do almost anything with your voice that you just used to be reliant on your phone or a personal computer for. So I'm really, really confident that we can return the company to growth. We will in the second half of the year. We've talked openly about that. And I think the combination of these 5 levers working together are a really powerful tool for us to get back to impressive growth.

Awesome. And underlying that return to growth, talk to us just about the broader kind of market landscape. And I'm not -- we'll get into one specific memory question. But just when we return to growth, is that Sonos taking share and kind of Sonos-specific actions that are bearing fruit? Is that the market maybe getting a little bit better and you seeing a tailwind from your own actions? Just where does demand stand today? Where do you see it going at a broad level?

Yes. I mean I think there's a couple of ways to interrogate this. On top of the 5 sort of dimensions of growth that I talked about, we're spending a lot of time talking about what we call the lifetime value model inside the company, which is like how do we acquire new households? How do we get those households started with a collection of products that demonstrate the system value of Sonos? How do we get them to extend the portfolio of products throughout their home over time. And then ultimately, how do we get them to repurchase products and refresh them at what would have been otherwise the normal end of their life cycle. And like none of what I just described is going to be anything new to anybody who's ever led Sonos. But like so many things in business, it really is about execution. And I think if there's a change here, it's really fundamentally that we're driving the business on these dimensions every day in every department. And so the sales organization is with our retail partners, armed with data that speaks to how many households are your stores helping us acquire, what's the initial receipt size in terms of the number of objects that they're taking home with them, those particular customers, what's their repurchase behavior? How does it relate to what your competitors are doing and how can we get you to the place that you're best-in-class? One example of how you take the LTV model and drive it to action from individual contributors in the company. So there's just a lot of execution, execution, execution across all the lanes I described through that lens. I think one of the unintended consequences of being so focused on individual SKUs is that we let the conversation about the company be about the sum of those categories. And so growth even became measured by well, what's happening in the categories, what's happening to headphones, what's happening to portables, what's happening to soundbars. And while in the details, of course, there's a tailwind or a headwind associated with those things. I think it's much more interesting to examine what is the opportunity for the whole Sonos system? Who are the true competitors in that landscape? And how do you stack up against those competitors? So like it's not that interesting to me that we compete with Samsung for soundbars or JBL for portable speakers or Sony and Bose for headphones. It's much more interesting about like who is trying to control the sound operating system in the home. And I think, candidly, those competitors look much more like Amazon and Apple and Google. And I'll tell you, I think the -- the first point of differentiation for Sonos in that market is that we're the only company in the mix that understands that to do this well, you have to deliver every dimension of sound. So -- and Alexa has like 4 SKUs. Apple has 2 SKUs. I think Google has 2 or 3. But the customer they want -- they want a large sound bar for the 100-inch television in the living room, and they want a subwoofer to go with it, and they want some spatial rears as well. They want a small sound bar for the television in the bedroom so they can understand the dialogue when their kids are asleep. They want a pair of headphones that pairs with the TV that's in the basement so when their kids are playing video games, the whole house doesn't have to hear the audio. They want a small speaker for the bathroom and in the dining room and kitchen, they want in ceiling speakers powered by commercial class amplifier that's hidden in the closet somewhere. And no one has that ambition but us, and it literally is what the customer require. And like don't even get me started on like the services and transports they want. They want Bluetooth. They want Spotify Connect. They want Airplay. They want all of the music service providers. They want increasingly all of the AI agents. And again, just -- I don't think anyone that Sonos has signed up for that task.

Cool. That's awesome. Let's -- maybe Saori, I want to bring you into this conversation. Something that you guys have done that's been incredibly impressive has been use pricing as a lever to offset tariffs. Two-part question. One is, post Supreme Court ruling, just how does the landscape on tariffs change? I realize it could change again, but just as we're sitting here at this moment in time...

I mean we've been up here for 15 minutes.

We're going to stand with 15 minutes left of the conversation. But then second to that is, obviously, there's kind of this new emerging price concern or cost concern, which is memory. And I would love if you could just kind of address the memory concern in terms of access to supply, sensitivity, what you're doing to offset that as well.

Yes. Thanks for the -- you always get -- I always get the hard question. Yes. So as far as tariffs, we had set out to -- since last April as the tariff rates were going all over the place, we were doing the work even previous to that on our pricing strategy, which was specifically -- and the changes that we had made beginning of April. Coincidentally, the timing when the tariffs started to take hold was around the understanding what Tom talked about, the lifetime value of customer, how do we gain -- monetize that over time. And we -- based on the data that we've looked at from the past on what are the customer behaviors and what products are the entry into Sonos system and how they grow over time with Sonos system that Era 100 was a key product in our portfolio that plays that role exactly. And the pricing level that we had previously made was not doing that job that it was intended to do. So we took that opportunity to reduce the price. As tariff happened, we used that same playbook in looking at what each one of our products, what do they do in our portfolio, and we did a very surgical approach to this pricing for mitigating tariffs to maximize our gross profit dollars, if you will, and minimize the elasticity of reduced revenue coming from that price increase in order to mitigate tariffs. And so fast forward the clock, we had implemented those pricing mitigation actions tail end of September. And so we had the full impact of that, that we could see resulting in Q1 and mostly in aggregate, it came as expected. So we're extremely not happy about tariffs, but happy that our pricing strategy worked according to our data suggests and how we executed. And so, that's something we'll continue to look at, along with our pricing strategy and specifically about where are we today? Most of our products are produced in Vietnam and Malaysia. So our rates are somewhere in the 19%, 20% tariff rates. Most recent, it went to 10%, possibly 15%. But if it lands at 10%, it will be half of what we incurred in Q1. So that certainly is a benefit to us. And at some point, maybe like the last round of tariffs that we may be in a position to be able to file for refunds, but we're not counting on that at the moment since the landscape believing what the rate is, is still up in the air. As far as -- yes.

Before we move to memory, just I want to just pop up for a minute to one level higher and say that inside the company, we have a phenomenal global operations team, who owns supply chain, logistics, manufacture and cost down, optimizing the cost structure of the portfolio after it leaves, initial engineering and production and lives in the market over its lifetime. And this is the team that we primarily tasked with tackling the tariff mitigations. This is the same team that would have managed rare earth metal cost fluctuations that goes -- went into our transducers 6, 7 years ago. The same team that helped figure out how to get products in and out of overloaded ports during the COVID period. It's just to say that one of the complicated aspects of the life we've chosen is things like an emergent memory crisis. And so I'll let you take over from here, but the same team that did such exceptional work mitigating the tariff exposure began the work in anticipation of what now the whole world is talking about on the memory front way back last summer.

So you can tell a little bit about where we are and all that.

No, definitely. Yes. So the same team -- just to add to that point on the operations team, they also had done a really nice job moving the supply chain over from China to Vietnam, Malaysia because had the tariff hit. While we were still in China, we were much more bigger world of -- on that. So really a shout out on that one. Even though Vietnam and Malaysia ended up taking these tariff rates, it could have been much worse. So we were extremely -- I don't want to say lucky because it was planned to move it off from the risk of that supply chain, but it worked out really well for us. On the memory front, we're certainly not immune to this, and we're keeping an eye open on a daily, hourly basis on this front. Certainly, it's dynamic. So again, we're not immune to it. But unlike other consumer electronics that may be more memory-heavy like the smartphones and the PCs, our configuration is such that the most memory consumption is at 2 gig level down to 512 megs -- on the average about 1 gig of memory on our configuration. So the percentage of the BOM for our products is less so than others. Again, the price increases is so massive that certainly will affect us and it is affecting us. And what we're seeing so far is in our Q2 guidance that we have guided our gross margin from 44% to 46%, but we're certainly not going to predict where the market is going. And so the same operations team is working very actively on securing more suppliers to make sure that we reduce the need to buy the memory at the spot price, which is the worst of the price we can get. So that is an active ongoing, very urgently done activity. The operations team has been working on. And so not to say we're done and check on that given the market dynamics, but we're working on that as well as looking at the configuration of our products. Do they need the amount of memory configuration in the products, both existing and new. In particular, on the new one, we have control over them. And Tom has also talked in the past about how we control the stack of our products, including how the software is inducing the need for the memory. And given we write our own OS for this, that we have some control over what kind of configuration of the memory is necessary in our products, both existing and new. So lots of mitigation actions that we're taking at this point as we observe where the market is going, and we're doing everything we can.

And maybe just last question attached to that. Just pricing as a mitigation tool. I imagine it's kind of last -- like the last tool that you probably want to use, but I guess it's still a tool that you'd be willing to use if you have to.

That's right.

Okay. All right. Cool. Something I want to dig into, and it's funny. I get excited by this, even though some might not, is the cost side because you guys have done an incredible job of becoming much more efficient in your business. Saori, this was kind of a huge initiative that you drove. Can you just -- you've been able to cut OpEx on an annual basis by about $70 million. That's like 10% of OpEx. That's a big cut. Just help us understand what's left to do beyond what you've already done? And given a lot of the initiatives that Tom has talked about, where you might have to lean in, like where do we think OpEx goes from here?

Yes. No, thanks for that. In fact, I think we could probably count to more $100 million plus on a run rate basis. And so your number is accurate about how we ended the year. And so we're -- the work is definitely not done. I mean, in fact, as an enterprise, you want to look at how you operate on an ongoing basis and drive efficiency, especially in the world of AI, and we have a large software team. And so Tom definitely is championing the opportunity on how we seize those opportunities for the company to become not only more efficient, but to be able to even do more with the software capabilities of the company, and I'll have Tom add to any point on this. But -- so I think any of those operational efficiency we gain, we get to do more and/or we get to reinvest back into other initiatives in the company. There's certainly no shortage of those. We're in the mode of what Tom -- as Tom came in, and we really honed in on doing fewer things better, but that means we may be leaving some opportunities on the table that we couldn't invest with the envelope that we're looking at, but that allows us the opportunity to invest more into the future growth. So we're very excited about that.

Cool. Capital allocation, capital structure, very clean capital structure, obviously. Any changes to capital allocation as you think about it, as you look forward, again, thinking new Sonos strategy, anything that changes as it relates to maybe your strategy?

Yes. Yes. No, part of our capital allocation framework is to leave enough behind for opportunities where in the past, we've done more tuck-in type of M&A. So -- and also any operational risks that might emerge. For example, last year, when there was a period in which it would have behooved us to pull in our production for the finished goods earlier before the new tariff rate was kicking in. So times like that, we're having enough capital to have flexibility operationally to do that was tremendously helpful. And so we tend to -- we'll continue to have some level of buffer to be able to take opportunities, both operational or strategic and then pour the rest into the buyback opportunities. Our capital expenditures are fairly minimal. It is down on a year-over-year basis, partly due to the biggest capital expenses were coming from the investments in the point-of-sale displays in our retail sites, but we're also taking approach in rationalizing that and also understanding the useful life of those CapEx. So now we're expensing those. So you'll see our capital expenses going down on a year basis. It is still flowing through the P&L, but to make sure that we're looking at that more diligently. So -- yes, so we'll continue to keep that capital allocation framework going and buyback as much as we can.

Last 2 questions for me. Tom and Saori, please feel free to jump in on this. When we're kind of hypothetically sitting here in 3 years and having this kind of same discussion, you've executed through this transition and this new strategy that you're looking to perfect. What is structurally different about the business, whether that is revenue mix, revenue growth, software as a driver, margin profile, competitive position? I'm just trying to think big picture, like what is your intention if we can look 3 years for Sonos to look different than it does today, macro and market notwithstanding?

I mean I'll start by saying I just -- I think that the product offering will be perceived as a segment of one. I think we're the only people in the world that do what we do and the product will better articulate that. Our marketing will better articulate that. The awareness of our brand will be dramatically expanded in the world. We'll have a dramatically expanded presence in countries that where today we are just getting started. I'm confident that we're on a path as a company and as a world to conversational AI in every environment, and Sonos will be at the center of that. And we'll be back in a place where we're just one of the defining beloved brands in consumer electronics.

Cool.

Yes. No, nothing more to add there.

Perfect. Before we end, maybe just very quickly touching -- I'm going to go back -- just touching on the installer channel. It's something I feel like is maybe underappreciated, 25% of revenue, though, so it should not be underappreciated. Just how is it a differentiator, you're leaning into it? Just maybe expand on that a little bit.

Yes. So it's about 22% of our business today. We have -- they sell everything from the sound bars and subwoofers that our consumer customers buy, but also we've made a portfolio of unique products available to them. Era 100 Pro is custom designed for that channel. And Sonos Amp Multi, which we just announced at ISE in February, will come to market this fall. It's a multi-channel amplifier, first of its kind in the market, really redefines the way that an installer puts a high-end audio system into a custom home. And I see just so much upside in that channel. And it's -- again, it's an example of how where every dimension is sound and we cover these use cases from $139 entry-level portable speaker all the way up to, I think, the number of speakers that of installation of Sonos Amp Multi fully configured can support 768 speakers in [indiscernible]. So we really run the gamut from people starting off in the dorm room to somebody in their -- their mansion in Malibu.

Cool. Maybe just last word before we let you go.

I'm just excited about what the future holds. I mean, like the -- to begin to bend the arc of the company to the new strategy that we're pursuing is a tremendous honor for me and feel really lucky to be partnered with people like Saori on the journey.

Awesome. Saori, Tom, thank you very much.

Thank you.