Sonos, Inc.

Q2 2023 Earnings Conference Call


spk01: All righty, so we're going to get started here, 205, 206, actually. For those of you that don't know me, my name is Eric Ledring. I lead the hardware research efforts here at Morgan Stanley. I'm very pleased to be joined here by Patrick Spence, Sonos' CEO, Eddie Lazarus, Sonos' CFO. Before I start, let me just read the research disclosure. For important disclosures, please see the Morgan Stanley Research Disclosure website at www. slash research disclosures. If you have any questions, please reach out to your Morgan Stanley sales rep.
spk00: I'd rather it work.
spk01: I got it. Thanks, Patrick. So today is an exciting day for you guys. Usher in, let's call it, a new era of sound. Very fun words there, of course. So maybe if you could just talk about the products you launched this morning and then some of the more, you know, the partnership that you announced as well. Let's start there and then we'll go on.
spk00: So what Eric's referring to is, and actually just to back up for one second, you know, we talk about the fact that we introduce at least two new products every single year. So this is one of those moments we're excited to be here and be able to share that. And so we've done something for the first time ever, which is introduced two products from the same family simultaneously, kind of shows our ability to continue to innovate in how we're doing research and development and share some of the engineering and innovation between platforms. So we brought out the Era 300, which is the world's best spatial speaker, spatial audio speaker. And spatial audio, if you haven't heard about it and you haven't experienced it yet, maybe you probably have through your AirPods or something like that, but you need to listen to it out loud because spatial was meant to be listened to out loud and be immersive in a room like this or any room because you have the height channels and you feel like you're in the middle of the music. And so we feel this is as revolutionary as the move from mono to stereo that happened in the 1950, kind of 40, 50, 60 period. So this is massive for the industry. Last year, 80% of Apple Music listeners listened to Spatial Audio. 85 of the top 100 Billboard artists released in Spatial Audio. And everybody's getting behind it, and it is a different experience. Phineas is a friend of the brand, and he... He has this amazing song. It's a concert six months from now that he's mixed in Spatial with the Aero 300, and it sounds absolutely incredible. And so the people that are on the leading edge of mixing music are going to be using Aero 300 to really figure out how they can bring new experiences to consumers, which we're really, really excited about. So that's huge news. And then we did something that I think, again, is a testament to the way we think about the world, which is we introduced today the Aero 100. a product called the Sonos One, which even this year, seven years after its introduction, was named Smart Speaker of the Year. So a seven-year-old product was named Smart Speaker of the Year by one of the publications out there. And it's our number one selling product. But we felt we could do better and we could create something that was even more innovative. And so it has full stereo sound. The old one had mono. It's amazing. I might be a little bit biased. in terms of that, but we've had, I mean, you'll get to see the media reviews in a couple of weeks and everything, but it is an absolutely outstanding speaker at the price point. And so we're super excited about that and the partnership with Apple Music as well. Apple Music is trying to push spatial audio in a big, big way. They are believers. We are very aligned in the fact that this is the next wave of audio, as is Amazon Music and Steve Boom over there. So One of the kind of superpowers of Sonos is the ability to give customers choice and not trap customers into one ecosystem. We don't have a dog in the hunt when it comes to those music services, so we support all the music services, and we're very excited to announce the Apple Music Spatial Audio Partnership today. Cool.
spk01: Perfect way to start. So maybe if we take a step back, it's been a So a very interesting journey for you guys, 17 years of consecutive revenue growth. The last two years, again, from a macro perspective, have been choppy, challenging. Maybe just help us understand how you guys got to where you are today. Where do you stand in terms of the business? And then we'll start going with the forward look.
spk00: Yeah, so I think the story of Sonos is a very unique one in this day and age. So we're unlike any other consumer electronics company I can think of. Because we build products to last for a long time, over 90% of the products we've ever shipped over that 17-year period are still in use today. And people, investors regularly are like, well, what are you doing to try and drive obsolescence and upgrades and some of those things? And the reality is... We're building these products playing the long game where we know customers will come back and add a product over time. So what happens is people may start with one or two Sonos products, but they'll expand their system over time. And so our average home is up to three at this particular point in time. But we have five million homes that have a single product. And then all the multi-homes have 4.3 products. And so it really becomes something where people add more products over time, which is different than any other model in consumer electronics. It's probably the hardest thing to help people understand about what it is that we do. But Sonos is so much better when you have two or three products and you have it in multiple rooms and everything around that. And we've just been relentlessly trying to innovate and bring new products out. And again, as I mentioned, at least two new products every year. But we use these story moments. And right now is one of those story moments with today's launch. where we get a ton of earned media. So we briefed 450 media over the last few weeks. You see a ton of coverage today, earned media coverage. That creates a halo for the entire brand. Existing customers come back and buy more. New customers come into the family as well. And the interesting thing about our story, even after 17 years, is the number one generator of new homes is existing homes. So existing customers tell their friends and family, you need to get Sonos. Sonos is awesome. Perhaps they see it at your house. I'm sure many of you have it. And then they get started with the brand that way, which is great, right, from a customer acquisition cost perspective. And so we've been able to get leverage out of sales and marketing over time, which everybody at the IPO told me there was no way we would do. And we've been able to keep our gross margins in a very attractive range for the kind of thing that we do. So I think we're very different in the way that we approach the world. the way our business model works, the way our brand does. And I think the best thing we can do in terms of serving consumers well, especially the next generation of consumers, is build products that last for a long time. I'm very proud of the fact that with the new products today, we have between 40% and 46% recycled materials in them, better repairability than ever, so you can do all the repair, and they're super energy efficient. So we've made great gains on all those fronts. But the number one thing that we do that I just don't see others in consumer electronics do is build products that last for 10 plus years. And I think that when consumers experience that and get that brand trust, they come back and they want to add more.
spk01: Cool. So let's take that and launch forward. December quarter, you reported 7% constant currency growth. Product registration is up 27% year over year. much stronger than the street expected. So what are you hearing from customers? What are the KPIs that you guys are looking at that gives you confidence as you look forward? And are there any more headwinds that you need to continue to work through as we look out over the next, call it, nine months or the end of this fiscal year?
spk02: I think the headwinds for us are the same as the headwinds for the economy as a whole. It's just a very subdued consumer environment. And like others, we've seen the shift in spend away from consumer goods to travel and services as people emerge from the pandemic. And I think that's especially true in our demographic. People who can afford to take that European vacation, they're taking it. That's fine. We plan for that. We always thought this year was going to be a subdued consumer environment. We did very well in the first quarter, although very much the way we expected it to come in. because we were in supply, and we could run our typical promotions. But the headwinds for us are going to be FX. As with many international companies, we're getting hit by the strong dollar. And that's probably number one, and then just the consumer environment. But we've We basically said to ourselves that we were going to lean forward while other people were leaning back. We've said from the outset that we were going to take a little bit less profit this year because we're going to enter these four new categories in the near future. We're going to announce one of those this year. We see tremendous opportunity, as we did today, by resetting the bar in our current categories. And we're also doing some geo-expansion. We're looking into India and Japan and LATAM, where we've made some inroads. So for us, the future is bright, and we want to seize it. But that does mean this year that we're looking at somewhat of a subdued result.
spk01: Okay. And then maybe if you just double-click, when you talk about either price points or geos or specific channels, where are you seeing relative strength versus relative weakness?
spk02: Well, to use a term of art, we're killing it in home theater. It's been a real strength for us. We have a wonderful set of products there. And in the holiday quarter, we gained tremendous share there, even though, of course, everybody was discounting, and we were actually discounting less than others. We've held our own in all-in-ones, but I fully expect now that we've launched these two incredible products that we'll even see improvement there. But the real strength right now has been in home theater. As far as the different channels, DTC, our installer channel, and retail, they've been performing basically according to expectations. We feel good about all of them. And then on the geos, as I said, we're really interested in what's going on in Japan and in India. We have some others in our sites that we haven't launched in yet. But we think over the course of, let's say, the next five years, we can do some real growth in those areas.
spk01: Okay. So I'm going to take some feedback that I've gotten since earnings. And one of the questions I've gotten is, you guys bundled multiple products together. You had success with that. You did discount or promote products. I think a bear thesis that emerged was because you didn't raise the guide for the full year, you pulled forward product. Now, I'm not saying Don't kill the messenger. Let's just say it that way, right? Help us understand why that wouldn't be true and why you're kind of taking a conservative view today, potentially.
spk02: Happy to. And I'm sure that there's whispers out there that the new CFO is laying a mattress for himself and doesn't want to fall into space and all the rest of that. But it's actually not true. Look, we performed as we expected to perform in the first quarter. We were in stock. We could do our promotions. We thought we were going to do well. We were delighted to set another revenue record. But that's in line with our expectations. We think where the external guide got it wrong was in the cadence of the quarters. We had an outstanding second quarter last year, but it was completely anomalous. It was driven by one-time events having to do with supply constraint, dropping back orders in, huge channel resupply. And so we're returning to the pre-COVID seasonality cadence that we expected, 55% to 60% revenue in the first half. And so now that you've seen what we did and what our guide is, you can calculate the second quarter. But we're on our track. And what we're actually watching for is, I mean, obviously if we see upside, that's wonderful. If we don't see upside, and we actually see weakness, we will make adjustments on the OPEC side because we are committed to keeping this business meaningfully profitable, even through an economic downturn.
spk00: And the pull forward, I do want to address because I think if we pull forward a new customer, for instance, we're also pulling forward their repurchase. And so, you know, like if that's the way people want to think about it, I mean, we're building for the long term. So whether we get it in one quarter or the next doesn't really matter to us. But fundamentally, that just starts their journey towards repurchase even sooner, right? And so it's like, okay, Like, that's fine. If it got pulled in, then they're going to get to their second and third faster. Okay. Right. Perfect. Exactly.
spk01: So fiscal 22, you grew new households 11% year over year. That was a bit constrained just by supply and, again, the environment. How do we think about kind of the mix of new household additions versus existing purchases or purchases from the existing core base of households that you have? How does that look this year? Is there any nuances this year that we need to think about, or is this more normalized given some of the supply is now largely behind us?
spk00: Yeah, I think fundamentally, definitely we're in a better supply situation, so that'll be good. It hinges a little bit probably on product mix, so I wouldn't expect any big changes as we've gone through that. I don't think we've seen big changes as we go through it. So yeah, it's something that we're only at 9% of the addressable homes in the markets that we're in today. So we're pretty early days, but we also, we also believe in doing it in a sustainably profitable way. So we don't, you know, we don't spend a ton on customer acquisition side of it. You know, but we do have a constant kind of drumbeat around brand. We do a lot on earned media as you'll see, you know, from the new products that we're doing some advocacy and influencer work and then in performance as well. But yeah, I think the, We're always trying to make sure that our roadmap and our product portfolio is coming out in such a way that we're able to do both, acquire those new homes, right, and then at the same time be adding more to existing homes, which, as you know, has typically been in that 40% to 45% of our sales and, again, is a huge, unique strength versus any other consumer electronics company. Okay.
spk01: So let's touch on gross margins. About 42.5% in the December quarter in constant currency. That's a little bit over 45%. For the year, you've guided 45% to 46%. So a solid start to the year when you think about the directionality of the dollar, and we can all kind of do that math. But what other puts and takes should we be thinking about as we move through the year, specifically as it relates to gross margin?
spk02: Well, the FX headwind will abate in the second half. So the FX was really a front-loaded problem for us, and we bore the brunt of it in the first quarter. The dollar has also moved our way a little bit, although who knows what's going to happen with that. But that's a big piece of it. Look, again, first quarter we landed exactly where we thought we would because promotions naturally take down your gross margin. Supply chain has kind of normalized, and that's actually what we expected. And so we're right on track for the 45 to 46% that we projected in our guidance. And that's flat to last year. And that seems right to us, given the FX headwind that we're facing.
spk01: Okay. So let's talk about then what you're investing in. You guys haven't shied away from reinvestment in this business. This is a growth business. So over the last five years, you've grown off back to call it 8%. It's going to grow a little bit faster this year, despite that revenue is not growing that fast, which shows you are still investing in the future. What are you investing in?
spk00: Well, and I think this is a very interesting time because we've seen big tech pull back from our category. And so now it's become evident to everyone, we already knew this, that Google and Amazon have been losing billions in trying to do their hardware efforts and all of those things. And so you see them starting to pull back. You see what Apple introduced with HomePod 2 last month, which if you put our products in comparison today, I feel very comfortable. We are the innovation leader in audio, legacy audio brands, don't have software expertise. I always talk about Sonos being the story of software eating audio. And so we feel it's a time to really lean in and be investing. And so what Eric's referring to is we actually decided to consciously invest more and take our profit down a little more in 23 to go invest in four new categories. And so Today we plan about $22 billion of the $96 billion audio market. You can easily figure out categories we don't plan today that we will in the future as we go through that. But we just think we have a ton of opportunity there, and now is the time to strike. So R&D is largely where our dollars are going. Through my career, I've always seen that pay off in a sustainable way over a period of time. Remember, we're building these products for the long term. So when others are fearful, we're being more optimistic and investing. But as Eddie said, should anything change in that, we also remain on guard and ready to make changes and perhaps push out a category. For instance, if all of a sudden the world changes and we had weakness and we needed to do things to retain profitability. So we're always trying to balance those two things.
spk02: Just a couple of things on the numbers too. First of all, we're not going to grow OpEx ahead of our revenue growth for any long period of time. That full stop period at the end. But, you know, the revenue does lag the investment by a couple of years because of our product cycle. The other thing I would mention is that in some sense what we're seeing is the rollover of the investments we made last year. So if you annualize the headcount increases that we made last year, that's $30 million of OpEx this year. We also paid out a very low bonus last year because we didn't hit our financial metrics. We reset the bonus for the purposes of OPEX this year at 100%. That's another $30 million. So we're actually being quite, while we are definitely investing, it's deceptively, it's not as much as it might look on paper. And it's just enough to keep our roadmap on time, on track. And that's the most important thing from our perspective.
spk01: Okay, perfect. So I'm... This is going to be a bit of a nuanced question, but you've committed to two-plus new product launches every year. I know Submini was last year. Technically, you did launch an IKEA product this year. Does the era count as two? It does.
spk00: They do count as two, yes.
spk02: Okay.
spk00: But it's not a new category.
spk02: But it's not a new category, so that's still coming. And, you know, as Patrick has said many times, we have a history of beating our two. Right.
spk01: You do. So for those of you that don't know, Eddie is also Sonos' bulldog in court. He wears two hats. He's the chief CFO. He's the CLO. So, Eddie, maybe if you could just give us kind of an update on you're in a number of legal battles today defending Sonos' IP. Where do we stand with a number of those? Again, maybe some of the more headline-catching ones. Just help us give us an update on where we are.
spk02: I have no idea what you're referring to. So we're fighting all over the world with Google. We have been for quite some time. We have our first case going to trial, first damages case going to trial in Northern California on May 8th. That involves three patents. We already, as you know, had won at the ITC validity and infringement on five very important fundamental Sonos patents. That is, Google has appealed parts of that ruling. We've actually appealed parts of that ruling because we think some of the workarounds are not appropriate. And that will be decided this year as well. And then they have a couple of cases against us at the ITC that we'll go to hearing this summer. So it's very busy. 23 is going to be action-packed. And we need to keep winning. And if we do, we're going to have an outstanding result. And we think we should keep winning. But you never know until you get there.
spk01: Okay. So, Patrick, you touched on the competitive landscape earlier in terms of your leading interest and maybe others aren't. How is that competitive landscape changing? Again, I want to keep the focus on Sonos as opposed to others, but again, we talked about home theater being an area of share games. How do we think about that maybe longer term? Where are you having the most success versus your competitors?
spk00: Yeah. I mean, right now, so in these periods where the economy has some headwinds and those kind of things, the one thing we do look at is relative performance. And so We just killed it, as Eddie said, in terms of home theater in calendar Q4. But even before that, I mean, it's just incredible in terms of where we are. By, again, building quality premium products, you know, much the way Apple's been able to with the iPhone and just, you know, keeping at it and consistently over-delivering on customer expectations. I fully expect we'll see the same thing in wireless speakers, all-in-ones, as we call it, with the new product introductions that we have today. And that people in this category, especially if you're spending, you know, for a product that's going to last 10 years, They will step up right because they're putting in their home. It's something they want to show. And I think we went through an era where it was a little bit of disposable tech going in you know in these cheap pucks going into people's homes. But you know I think that era feels like it's over and instead people are looking at quality thinking more about the environment some of those things. And so we're very well positioned across the board. you know, our component products, one of our categories that the installers sell, you know, continue to lead the way and be the number one choice by far, far margin. I think it's 90 plus percent of installers choose Sonos over anything else. And so our portable products move and roam do incredibly well. So we have a well curated portfolio that's doing really well in all the categories we play. You know, despite the fact we're up against a lot of people discounting a lot of their products, quite frankly, we're trying to underprice infringing our intellectual property, etc., So, you know, my belief is these investments in innovation pay off over the long term. If you can be patient, you properly price your products, right, and then you do well by the consumers. And so I like where we are. I like the, you know, the irons we have in the fire on the new categories just set us up for continued growth and, again, growth with profitability.
spk01: So you made a point earlier that I think is really powerful that I just want to double-click on, and that is, 40% of households only have one product. If you can convert those single product households into multi-product households, that's a $5 billion revenue opportunity. The question is, what tools do you have to do that? And are there any examples of success, historical actions that you've taken that have actually driven that conversion from one to four or beyond?
spk00: What we know is that those that are highly engaged, so they're listening and engaged in their Sonos, they're using Sonos voice control, they could be using Sonos Radio are more likely to repurchase more quickly and go through it. And so we've done some learning to understand what does it take to get people that are single player to move to the next level. And so those that are single player will see that we also have all the customer data. People open the app. We have 500 million app sessions a month right now. So people open the app all the time. And so we have ways now to talk to those customers and be able to actually approach them with you know offers of assistance or setup or services but as well an offer if we want to make in terms of saying hey like you could pair that product with one or the other Our CRM efforts have worked. They haven't been so targeted on the single player, but now we're starting to do that with the investments we've made in CRM. We've gotten a little bit more mature, put a couple systems in place that allow us to do that. So we're really starting that journey at this point, but I'm optimistic we'll be able to find the path.
spk01: Okay. And so we add all of this together and we say, if you look back, you know, kind of pre-pandemic, this was a business that was growing top line 10%. EBITDA 20% annually. Again, we're in a bit of an odd period today, right? As we look forward, should we still be thinking about kind of 10% top line, 20% EBITDA? Is that the goal? If not better, for sure.
spk02: I mean, look, we have at least three strong levers to drive growth. Resetting the quality bar in the categories we're already playing, and obviously the era speakers do just that. enter two categories, and we've spoken to the fact that we're going to work on four, and then geo-expansion. And when you put that together with the consistent repurchase patterns that we see, our ability to attract new households over time, we absolutely should be able to drive double-digit top-line growth and expand our bottom-line margin.
spk01: Okay, perfect. Let's just quickly touch on capital allocation. I want to save kind of a bigger-picture question for the end. You have over $400 million of growth in net cash. Your focus today is on kind of reinvesting buybacks and some tuck in M&A. As we look at over the next two or three years, any reason for those priorities to change whatsoever? And then specifically on M&A, you know, what are you looking for? Is it filling technology gaps, product gaps, talent gaps? Maybe, again, help us understand that.
spk00: Yeah, I mean, it's really to accelerate our roadmap. So we've got this great roadmap we're very excited to bring to the world. you know, anywhere we can pick up talent and technology to help accelerate that is a good thing for us and will obviously be opportunistic in terms of stock buybacks as well and going through that. But for us, it's really about growth and investment in technology for the future. Okay.
spk01: So I probably could have saved 30 minutes for this last question that I'm going to ask you. I'll give you three minutes though. And so that is, and someone actually asked me this question. I thought it was very insightful, so I want to ask it to you. And that is, You've always talked about kind of your past experiences at Research in Motion, kind of dictating how you think about the world and making sure that you're staying competitive as you look three and five and ten years out into the future. What do you think of the future of sound? How is Sonos preparing itself to make sure that you are still at the top of your game, again, in three and five and ten years down the line? Again, with the question in mind of What is the future?
spk00: Yeah, look, I think the probably like a good proof point in that right now is just even looking at what Apple did with HomePod 2 and what we've done today with the Aera 300. So I'd say, you know, we're resetting the bar in terms of what we're doing with sound. But I think the most important thing is we've also done things like have a partnership with IKEA where we've collaborated on products. and technology and one of the things that I learned at RIM that's very important is understanding that what you do today may not be what you do tomorrow and so we have technology that we've invented which allows us to put great sound in things like a picture frame that we've launched with IKEA or a lamp and some of these things and so as we think about the future, a decade or two from now, perhaps you won't be hearing us from these big, ugly speakers that are on either two sides of this, but rather from the table itself, perhaps, or just from the lights that are above. And so I think you have to be very mindful of the fact that things change. And so we're always pushing on what are the physics and what are the physical products that may actually become sound in the future. But I also think that it's important to be on the leading edge of the technologies and emerging standards, like a spatial audio, for instance, right? And so spatial audio, as I talked about, is so key because I think that's as major as the move from mono to stereo. And so as we go from stereo to spatial, there's opportunities to create sound in different ways. And these artists are looking at it and saying, hey, how can I change the way people experience sound in their living room, their kitchen, and all of these areas, which I think is very exciting. And we want to experiment with them as they go through it. And then the last thing I would say, is really something like it's tens of thousands of tracks that are uploaded to Spotify every single day. I'm sure everybody's overwhelmed by the number of podcasts they get and see and are told to listen to these days. There is so much audio content out there these days that curation is a massive issue. And I think as we think about the future of audio and sound and all of these things, I actually think helping, and this is where AI and machine learning come into it as well, is that curation is also going to be something that's very important so that people have a better experience and kind of get to something that they enjoy a little bit faster and don't have to kind of work through, you know, all of the content that's out there because it is just an overwhelming amount at this time.
spk01: So that's just about time. So Patrick, are you the bulldog? Thank you guys for spending your time with us today.

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