Sonos (SONO) Q1 2025 Earnings Call Transcript

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Sonos (NASDAQ: SONO)
Q1 2025 Earnings Call
Feb 06, 2025, 4:15 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Thank you for standing by. My name is Jay, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos first quarter fiscal 2025 conference call. [Operator instructions] I would now like to turn the conference over to James Baglanis, head of investor relations.

You may begin.

James Baglanis -- Head of Investor Relations and Treasury

Good afternoon, and welcome to Sonos first quarter fiscal 2025 earnings conference call. I am James Baglanis and with me today are Sonos' interim CEO, Tom Conrad; CFO, Saori Casey; and chief legal and strategy officer, Eddie Lazarus. For those who joined the call early, today's hold music is a sampling from the Sonos Radio Station, Say It Loud, which is curated in collaboration with Black at Sonos and recognition of Black History Month. Before I hand it over to Tom, I would like to remind everyone that today's discussion will include forward-looking statements regarding future events and our future financial performance.

These statements reflect our views as of today only and should not be considered as representing our views of any subsequent date. These statements are also subject to material risks and uncertainties that could cause actual results to differ materially from expectations reflected in the forward-looking statements. A discussion of these risk factors is fully detailed under the caption Risk Factors in our filings with the SEC. During this call, we will also refer to certain non-GAAP financial measures.

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For information regarding our non-GAAP financials and a reconciliation of GAAP to non-GAAP measures, please refer to today's press release regarding our first quarter results posted to the investor relations portion of our website. As a reminder, the press release, supplemental earnings presentation, including our guidance and a conference call transcript will be available on our investor relations website, investors.sonos.com. I will now turn the call over to Tom.

Tom Conrad -- Interim Chief Financial Officer

Thank you, James, and thank you all for joining us today. I'm now in my fourth week as interim CEO. It's still early days, but not too soon to make a few observations. First, we have a lot of work to do.

Despite recent progress, our core experience still needs significant improvement. Second, we must continue our effort to bring our expenses in line with our revenue. And third, I'm more convinced than ever that Sonos has a large market opportunity ahead of us, both in its current categories and in close adjacencies, and I know that we have the best team in the world to seize this opportunity. We're moving quickly and with purpose across all these interrelated fronts.

As a board member, I started working closely with our software team this past fall, and I can tell you that they have an absolute dedication to improving the Sonos experience to a place that exceeds the expectations of all of our customers. I'm all in on reinvigorating and accelerating this essential work, helping with focus and priorities as we tackle what are, frankly, some very complex and long-standing software problems. As a longtime passionate customer and myself, I know the magic of Sonos, but I also know the extreme disappointment of the company's recent tech challenges. With respect to our expense base, I'm closely partnering with our CFO, Saori Casey, to drive operational efficiency and improve our financial performance.

To accomplish this, I'm returning Sonos to a scrappier and more focused enterprise, drawing on the lessons I've learned from the successes and challenges I've navigated at companies of all stripes for over 30 years from Apple to Pandora to Snapchat to Quibi. To this end, yesterday, we executed on a set of significant changes to the way we operate. I've reorganized our product and engineering staff into functional teams for hardware, software, design, quality and operations and away from dedicated business units devoted to individual product categories. This allows us to bring together rightsized cross functional projects that maximize our efficiency as we continuously evaluate, prioritize and focus on the highest value market opportunities.

These changes revealed organizational layers and redundancies that we're not serving us. This means the difficult task of saying goodbye to about 200 employees, including nearly 50 managers and executives. This is one more step in the structural transformation process that Saori has been describing on our last two earnings calls. This process began in our G&A function and other parts of Sonos have followed suit.

As I just mentioned, our focus is now on the total overhaul of the product organization, which houses more than half of our employees. While these actions represent a major milestone in our transformation journey, we are not finished. We will continue to carefully scrutinize the allocation of all dollars to ensure that they're being applied to the highest return opportunities. The leaner and more effective we are as a company, the better we can capitalize on the opportunities in front of us.

It's a wonderful honor to be stepping into lead Sonos at this pivotal juncture. The board will be conducting a robust national search for the next permanent CEO with the assistance of a leading executive search firm, and I will be a candidate. While that process plays out, there's no time to lose in pushing forward the vital work of fixing, restructuring and innovating. Sonos today has the deepest, most innovative product lineup in its history.

There's tremendous opportunity in front of us, and my job is to help zones take full advantage of it while running the company with a heightened focus on fiscal responsibility. We have a terrific team, and I look forward to the progress we're going to make together. Now let me turn things over to Saori to discuss our Q1 results.

Saori Casey -- Chief Financial Officer

Thank you, Tom. Hi, everyone. We delivered Q1 revenue toward the high end of our guidance at $551 million. On a year-over-year basis, revenue was down 10% versus our guidance of down 22% to down 9%.

The decline was driven by softer demand due to market conditions and challenges resulting from our 2024 app rollout. As we've been talking about for some time now, our categories remain cyclically challenged and highly promotional, which was particularly notable in our portables category. Despite these headwinds, we saw stronger-than-expected demand for our new industry-leading sound bar, the Arc Ultra, which helped us achieve our highest ever quarterly market share in U.S. home theater on a dollar basis.

GAAP gross margin was 43.8%, plus 80 basis points above the high end of our guidance range, driven by better cost and product mix. As a reminder, we began amortizing the MY intangible assets now that we're using its sound motion technology in Arc Ultra, which was minus 40 basis point headwind year over year to GAAP gross margins. Non-GAAP gross margins were 44.7%. Q1 GAAP operating expenses were $193 million and non-GAAP operating expenses were $169 million, down 5% and down 6% year over year, respectively.

Both figures include $6 million of app recovery investments in the quarter. Non-GAAP operating expenses came in about $13 million below our guidance due to both expense management efforts and timing of spend. Speaking of expense management, last quarter, I spoke about how we had begun our transformation efforts last year with our G&A functions. As a result, this quarter, we saw GAAP G&A expenses decrease significantly to $25.8 million, down 35% year over year.

This decline is attributable to four factors: one, lower personnel costs from the August 2024 reduction in force, which was focused on reducing management layers and optimizing cost structure; second, lower litigation expenses; third, lower operational costs through facilities and vendor spend rationalization; fourth, timing shift of spending, which had approximately $2 million of benefit to G&A in the quarter. On a GAAP year-over-year basis, sales and marketing increased by 3%, in part due to app recovery investments. Research and development increased 2% and primarily due to a stock-based compensation expense related to retention of key personnel. On a non-GAAP year-over-year basis, G&A expenses decreased by 31%.

Research and development expenses decreased by 3% and sales and marketing expenses increased by 1%. Adjusted EBITDA was $91.2 million, representing a margin of 16.6%. This was above the high end of our guidance range due to higher gross margin and lower operating expenses. We ended the quarter with $328 million of net cash, which includes $41 million of marketable securities as we hold excess cash in short-duration treasury bills.

Q1 free cash flow was $143 million, down from $269 million last year due to lower revenue, as well as two unique factors that impacted last year's free cash flow. First, we were actively working down our excess owned inventory as we entered Q1 of fiscal 2024, with $82 million more finished goods inventory than this year's Q1. Second, Q1 of last year benefited from the implementation of new payment terms with our suppliers, which resulted in a large onetime benefit to free cash flow. Our period-end inventory balance decreased by 19% year over year to $141 million, primarily due to lower component balances.

Sequentially, this was a decline of 39%. Our inventory consists of $117 million of finished goods and $24 million of components. After pausing share repurchases in fiscal Q4, we returned $27 million to shareholders in Q1, reducing our share count by 1.9 million shares, leaving us with $44 million under our current $200 million share repurchase authorization. Returning capital to our shareholders mean a key pillar of our capital allocation framework.

Turning to our guidance. The Q2 outlook we are providing reflects our best estimates as of today. We expect Q2 revenue in the range of $240 million to $265 million, a year-over-year change of negative 5% to positive 5%. Our Q1 results and Q2 guidance implies our revenue in the first half of the year will be down between minus 9% to minus 6%, versus the first half of fiscal 2024.

Please note that while we are not providing guidance beyond Q2 at this point, I'd like to remind everyone that we benefited from the launch and the associated channel fill of Ace headphones toward the end of Q3 last year. And as a result, we expect to have a very difficult year-over-year comparison in Q3. We expect Q2 GAAP gross margin in the range of 42% to 44%, down at midpoint from Q1, driven by deleverage, partly offset by product mix and seasonally lower discount. The decrease from last year's Q2 GAAP gross margin of 44.3% is driven by FX headwinds and the amortization of MY intangible assets for the Sound Motion technology in Arc Ultra partly offset by improved cost structure.

Non-GAAP gross margins are expected to be 44% to 45.8%, 180 bps to 200 bps higher than GAAP gross margins. You may recall we underwent a significant effort to diversify our supply chain a few years ago, which resulted in a manufacturing of nearly all of our U.S.-bound products shifting to Malaysia and Vietnam. As a result, we expect tariffs to have a minimal impact to our gross margin in Q2 based on what we know today. We expect non-GAAP operating expenses to be between $140 million to $145 million, compared to $157 million last year.

As a result, we expect Q2 adjusted EBITDA to be in the range of negative $27 million to negative $6 million, compared to negative $34 million last year. Our guidance contemplates that we will make another $4 million to $8 million of app recovery investments in Q2. Lastly, I want to summarize the actions from our transformation journey that Tom and I mentioned on this earnings call. We expect the run rate savings of the announced actions from yesterday and those taken in FY '24 to be in the range of $60 million to $70 million into FY '26.

While we are not providing fiscal 2025 expense target, please note that our FY '24 baseline opex normalized for variable compensation and restructuring expenses was around $770 million on a GAAP basis, and around $680 million on a non-GAAP basis. We expect that the actions we have taken so far will fundamentally change and simplify the way we operate. We're flattening and evolving our organization structure, as well as identifying areas to reduce our operational costs. These actions are intended to reduce our run rate expense base while improving our efficiency and effectiveness.

Though we have made significant progress, our transformation journey will continue as we work to identify other areas of operational improvements and spend rationalization. We believe that successfully executing on our efforts will allow us to invest in the most impactful growth-oriented opportunities while structurally improving our profitability. We will continue to update you on our progress as we work through the year. With that, I'd like to turn the call over for questions.

Questions & Answers:

Operator

Thank you. The floor is now open for questions. [Operator instructions] Your first question comes from the line of Steve Frankel of Rosenblatt. Your line is open.

Steven Frankel -- Analyst

Good afternoon. Tom, the release today was a bit unconventional with the numbers out before they open, and then the call happened this afternoon. What drove that behavior?

Tom Conrad -- Interim Chief Financial Officer

Let me start by apologizing for the unconventional nature of this timing and we'll take you through a little bit about how we ended up there. I've been here for three-and-a-half weeks now, and I'm working to move the company forward quickly and with purpose. We've made a set of organizational optimizations and the related cost savings were among my top priorities coming in the door, which meant that the timing of the reorganization announcement and the earnings was sort of a delicate matter. I had to balance effectively communicating these complicated changes involving around 200 departing colleagues and nearly 1,000 product team members being reorganized with my responsibilities around the call.

I decided that the best course was to announce the reorganization-related rift after the market closed yesterday and a day ahead of earnings, which gave me the time late yesterday to land these changes with the team to minimize uncertainty with our investors today, we moved the release timing to before the market open. We left the timing of the earnings call itself intact because it had been announced and before I arrived, and we thought it would be too disruptive to move it then. Thank you for your understanding about the late breaking shifts to all of this.

Steven Frankel -- Analyst

Thank you for that insight. Maybe give us the Top 2 or 3 most important changes you think the company has to make going forward?

Tom Conrad -- Interim Chief Financial Officer

You know, as I said, I have a strong bias to action. And in my first three-and-a-half weeks, we've reorganized the company into a far more efficient structure. We've made concrete progress on rightsizing our expense base. We've clarified our areas of focus to get the entire company rolling together in the same direction, which really sets us all up to begin operating the company much more efficiently and with a much more shared stronger sense of purpose.

So my focus now is getting Sonos back on track, which means improving the core experience for our customers, optimizing our business to drive innovation and delivering operational and financial performance.

Steven Frankel -- Analyst

OK. And the last quarter, I think the message was the app was almost there. Where do we think we are today? And how much longer is it going to take to get both the iOS and the Android experience where they need to be to kind of restore the brand?

Tom Conrad -- Interim Chief Financial Officer

So the team certainly made a lot of progress in Q4, and that allowed us to successfully launch Arc Ultra and Sub 4, both of which are a hit with both customers and reviewers. And now, I would say that the team and I are just really focused on what I would call a return to excellence in the core experience kind of having moved beyond getting the app back to the place that we needed that's core functionality to be. But honestly, there remains a lot of work to do to meet my bar. And so, we're focusing on three areas: performance and reliability, usability and design, and new experiences.

Steven Frankel -- Analyst

OK. And any timetable for when you think you'll be satisfied?

Tom Conrad -- Interim Chief Financial Officer

I mean, at some level, as a product and engineering leader of 30 years, I'm not sure I'm ever going to be fully satisfied. Part of what makes great companies is to continuing to invest in improving the experience day in and day out. And I put most of the work that we have in front of us in exactly that category.

Steven Frankel -- Analyst

OK. And then, one last quick one. where are channel inventory today? And how does that square with the desired levels?

Saori Casey -- Chief Financial Officer

Hi, Steve, Saori here. I can take that question. We ended the channel inventory at a comfortable place at the end of Q1. As you recall, last year, we were in a different place.

So we're pleased with where we ended the quarter going into Q2.

Steven Frankel -- Analyst

OK. Thank you. I'll go back into the queue.

Operator

Your next question comes from the line of Logan Katzman of Raymond James. Your line is open.

Logan Katzman -- Raymond James -- Analyst

Hi, guys, this is Logan on for Adam. Just two quick ones for me. Tom, maybe first for you. With all the changes you're implementing are you -- can we still expect two product launches a year? Or is that then put on pause?

Tom Conrad -- Interim Chief Financial Officer

We're certainly committed to continuing to ship many great products each year. I think, I'm probably going to hold off on making specific commitments about the product road map.

Logan Katzman -- Raymond James -- Analyst

Yeah, makes sense. Thank you. And then, just one last question from me. Any changes to capital allocation or anything that you guys want to talk about around that?

Saori Casey -- Chief Financial Officer

I can take that question. We continue to be focused on our capital allocation strategy. As you recall, we did pause the buyback in Q4, while we were focused on the app recovery progress to make sure that it was stable enough, but we have resumed the buyback. As we mentioned, and we continue to be judicious about our capital allocation and returning capital to our shareholders remains our pillar of our strategy.

Logan Katzman -- Raymond James -- Analyst

Great. Thanks, guys.

Operator

Your next question comes from the line of Erik Woodring of Morgan Stanley. Your line is open.

Erik Woodring -- Analyst

Great. Thank you so much for taking my question, and nice to meet you, Tom. In the letter you sent to employees yesterday, you referenced Sonos becoming mired in too many layers that have made collaboration and decision-making harder than it needs to be. Can you maybe just expand upon exactly what you mean by that? And help us understand how the actions you're taking are going to kind of help on the product front or if it's more beyond the product front? Just help us understand what exactly you mean by that? And then, I have a quick follow-up.

Thank you.

Tom Conrad -- Interim Chief Financial Officer

Sure. So the product organization in particular, had, had a sort of business unit organization strategy where there were separate organizations for different elements of our product line, a professional category, a portables category, home category and so on. And what that meant is we had a bunch of kind of redundancies across those teams. You have a head of mechanical engineering, for example, on each one and team members underneath that.

As we seek to have flexibility in the way that we apply our resources to our road map. Having that particular set of products, hard coded into the organizational structure, just creates a lot of overhead and a lack of flexibility around being able to react nimbly to market conditions. And so, by moving to a functional organization with a hardware team and a software team, and an operations team and a design team and a QA team, that allows us to sort of put together what I would call rightsized projects that have the sort of minimal powerful set of people that need to come together to address some particular market opportunity. And just lets us move more quickly and it gets us collaborating much more efficiently, and that's just one of the things I was alluding to in the email yesterday.

Erik Woodring -- Analyst

OK. No, no, that's helpful. And maybe now I have a different follow-up, which is just if I could maybe double click on that is it seems like that's been the kind of the -- and please correct me if I'm wrong, kind of the Sonos MO for years, if not decades now. So I guess, what has really changed now? I mean, you've been on the board, I guess.

I'm just wondering why make the change now with, if we look back beyond maybe the last three years, you guys were going through multiple years of 10% growth. Obviously, it's been a very challenging market, but you've had that structure while you were successful. So why is that not the success successful structure going forward? Or is this really just about making sure you're being more efficient going forward?

Tom Conrad -- Interim Chief Financial Officer

Yeah. Actually, the business unit structure was put into place about 18 months ago at replacing sort of what I would call a sort of semi functional model that was, I guess, I would describe it as hardware top heavy in its previous incarnation, where the encoded in the hardware organization were some of the same more product line dimensions, but the hardware group is complemented by a functional group for software and a functional group for design, for example. And so, what we are doing here is, in a way, a return to form that works so well for us, but also I think we're further refining the model pulling out the idea that everything we do has to start with a hardware new product, which would allow us, I think, to navigate much more not just efficiently but effectively with respect to the kinds of core experience initiatives that our customers care about.

Erik Woodring -- Analyst

OK. That makes a ton of sense, and thank you for the clarification. Super helpful. And then, last question for me, Saori.

I know you don't guide beyond the quarter out. If you look -- and I appreciate the comments you made on the product launch last June quarter. If you look back in history and just exclude the June '24 quarter, your seasonality in fiscal 3Q revenue seasonality has been anywhere between down 7% sequentially and up 42% sequentially. It just leaves a very wide range for consensus to fall in.

I'm just wondering if you have -- can share any comments to help us on the call, kind of make sure that we're kind of thinking about just where maybe -- what years we could look to in history to maybe set the proper bar for the June quarter. I realize there's a lot of moving pieces. But just wondering if we could have any more detail to just kind of maybe help us narrow the scope of how we should be thinking about the June quarter. And that's it for me.

Thank you.

Saori Casey -- Chief Financial Officer

Hi, Erik, thanks for that question. It certainly is challenging. Even I was looking back if there was a pattern there. And to your point, there's a wide range at this point.

we were only able to provide color relative to last year's view that the pattern will look different than last year as a result of the ACE launch and the channel field we had at the end of the quarter. So we are living at that at this point. Exactly to your point, there is not a great pattern on a sequential basis going into Q3. So thank you.

Erik Woodring -- Analyst

OK. OK. I understand. No, I understand.

Thank you so much.

Operator

Your next question comes from the line of Alex Fuhrman of Craig Hallum. Your line is open.

Alex Fuhrman -- Analyst

Hey, guys, thanks very much for taking my question. You know, I wanted to ask about the workforce reduction. And just more broadly, as you think about kind of the company going forward being a leaner more streamlined operation. How much of the organization today is focused on hardware development versus software development versus things like sales and marketing.

Can you give us a sense of just the biggest shifts in how the company is different today than how it was just a year ago?

Tom Conrad -- Interim Chief Financial Officer

I'll start by talking about the product organization. So I think -- so much of what we do that people perceive as hardware is actually software. And so, our software organization is today, in fact, quite a bit larger than our hardware organization. I think the rough numbers are hardware is around 150 people and software is more than double that.

Of course, we have a talented team around design, QA, operations and so forth that complement all of that in our product organization. Saori, do you want to talk to how that relates to our --

Saori Casey -- Chief Financial Officer

Yeah. Just from a -- if you look at our opex, you'll see the ratio among -- just on a dollar basis among R&D, sales and marketing and G&A. Now there are cyclicality to the marketing spend for holiday seasons and so forth. So just generally in aggregate.

But from a headcount perspective, Vast -- probably biggest part of the company by far is the R&D headcount. And then, there's G&A headcount and then sales and marketing headcount. Marketing as I would have a big part of the expenses related to the non-headcount dollars with G&A more leaning toward the headcount dollars as is for R&D. So probably best to look at this on a dollar basis because of the way we spend the operating expenses and the investments, but that's sort of the general lineup relative terms in terms of headcount resources.

Alex Fuhrman -- Analyst

OK. That's really helpful. And then, Saori, I think you'd mentioned some kind of baseline opex numbers from this year. Should we be thinking about the opportunity for a step function lower in the future in opex? Or is it maybe more about an opportunity to just be growing sales faster than expenses in future years.

Can you help us understand that?

Saori Casey -- Chief Financial Officer

Yeah. Thanks for that question. While we've announced these reduction in force, specifically around the head counts, we're continuing to look at a lot of the cost optimization opportunities. I know we've been a little less concrete about what it means by changing cost structures, but it really is looking at every dollar and how we are able to spend that dollar in a more efficient way, effective way, and that could be anywhere from real estate footprint that may or not be effective in producing and helping our best return for the investments all the way to negotiating better fees and so forth.

So it is beyond headcount that we're looking at as we continue to go through our transformation process. And so, it's sort of a journey than what we've already announced so far. We're not announcing any guidance on opex beyond what we are providing today, but we are continuing to look at this to make sure that -- it's -- there's still opportunities, as we said on the earnings -- on the prepared remarks that there are still opportunities that we can continue to drive for.

Tom Conrad -- Interim Chief Financial Officer

I'll just add -- I was just going to add that if you look at my background, you're going to see a lot of instances where I've helped take young sort of start-up companies through their growth phase and into being newly public and one of the muscles that you really develop in that process learning to scrutinize all expenses as they come through. And I'm really particularly focused on making sure that we're making investments where we'll see the highest possible returns.

Alex Fuhrman -- Analyst

OK. That's really helpful. Thank you, both.

Tom Conrad -- Interim Chief Financial Officer

Thank you.

Operator

[Operator instructions] Your next question comes from the line of Brent Thill of Jefferies. Your line is open.

Brent Thill -- Analyst

Thanks. Tom, just on the 12% reduction in force, can you discuss was that kind of across all functional areas? Was it focused on a couple of bigger areas. And perhaps you could discuss some of the changes that you made in the software development team. Have you made changes in leadership? What are you doing there to get those experiences back.

So we, as all consumers have a cleaner, simpler experience.

Tom Conrad -- Interim Chief Financial Officer

Yeah. So a lot of great work had been done by Saori to bring our operating expenses in line in the G&A lane in previous quarters. This set of changes was really focused on the remaining dimensions of the company with a particular emphasis on changes in the product organization. As I've described, the reorganization itself revealed significant redundancies across the product organization and opportunities for us to step into a smaller but more effective team.

So another thing that kind of comes from having spent a chunk of my career in start-up land, you often discover that the size of the team is not highly correlated with the output of the team, and we've done a really great job, I think, over the course of this recent period of sorting a path to making the product and engineering organization smaller but more efficient and more powerful. I'm really confident that we have the right team in place to deliver on the enhancements to the core experience that I'm so committed to.

Brent Thill -- Analyst

OK. And just on the software side, have you made changes in that leadership team to ensure they're on the right track?

Tom Conrad -- Interim Chief Financial Officer

That's right. So about -- across the product organization, we exited about half a dozen vice presidents and reorganized teams around our most effective leadership route for the go-forward plan. it's a great group. I know we are going to make lots of progress.

Brent Thill -- Analyst

OK. Great. Thanks.

Operator

We have a follow-up question from the line of Steve Frankel of Rosenblatt. Your line is open.

Steven Frankel -- Analyst

I just wondered if you might give us any color on how Ace did in the important holiday season.

Saori Casey -- Chief Financial Officer

Hi, Steve. We -- from a revenue results perspective, certainly, Ace was incremental to our year over year and to our quarter, and it continues to get great reviews from our customers. And as we mentioned on our earnings call, it was off to a slow start. And so, we were -- as we continue to go through the recovery of our brand, certainly, Ace is launched at the worst time possible from an app launch timing perspective, and so we're certainly making progress.

And we're not able to disclose the exact results as we disclose the categories that we do externally, but we're pleased to have Ace being a great review from our customers and incremental to our revenue.

Steven Frankel -- Analyst

All right. Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

James Baglanis -- Head of Investor Relations and Treasury

Tom Conrad -- Interim Chief Financial Officer

Saori Casey -- Chief Financial Officer

Steven Frankel -- Analyst

Steve Frankel -- Analyst

Logan Katzman -- Raymond James -- Analyst

Erik Woodring -- Analyst

Alex Fuhrman -- Analyst

Brent Thill -- Analyst

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