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Sonos Inc (NASDAQ:SONO)
Q1 2019 Earnings Conference Call
Feb. 6, 2019 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sonos fiscal first-quarter 2019 earnings conference call. [Operator instructions] I will now turn the call over to VP of Corporate Finance Mike Groeninger.

You may begin your conference.

Mike Groeninger -- Vice President of Corporate Finance

Thank you. Good afternoon, and welcome to Sonos' first-quarter 2019 earnings conference call. I'm Mike Groeninger, VP of corporate finance. And with me today are Sonos CEO Patrick Spence, and CFO Mike Giannetto.

For those joining the call early, today's hold music comes from the Q1 playlist included in our shareholder letter. The 64-track playlist was created by our Black @ Sonos employee resource group to celebrate Black History Month. Before I hand it over to Patrick, I'd 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 non-GAAP financial measures, including adjusted EBITDA and adjusted EBITDA margin. For complete information regarding our non-GAAP financial information and a quantitative reconciliation of those measures, please refer to today's shareholder letter regarding our first-quarter fiscal 2019 results posted to the Investor Relations portion of our website.

I'll now turn the call over to Patrick Spence.

Patrick Spence -- Chief Executive Officer

Thanks, Mike, and good afternoon, everyone. Thanks for joining. We made good progress this quarter toward our long-term goal of sustainable profitable growth. Q1 was the most profitable quarter in Sonos history, thanks to our record sales and increasing efficiency in our investments.

Our adjusted EBITDA in Q1 grew 34% year over year, reaching a 17.6% adjusted EBITDA margin, and we achieved record revenue for the quarter at $496 million and generated $87 million in free cash flow. And we're also proud to share that we're now helping over 8 million homes around the world listen better, which is a gratifying milestone for everyone that works here. If I were to highlight one thing for Q1, it would be the success of our home theater portfolio being led away, and we achieved 42% year-over-year growth across the home theater portfolio. Our home theater products earned two of the top three market share positions by dollar value in the U.S.

according to NPD, three of the top 4 value share positions in the U.K. and four of the top 8 value share positions in Germany according to GfK. These market share positions demonstrate the powerful longevity of our existing products like Playbar and the market receptivity of innovative new products like Beam. 2019 is off to a good start, thanks to our strong portfolio of products, and we have some exciting things coming.

We've got Google Assistant coming to Sonos. We'll bring our first products to market with IKEA, which means new form factors, new countries and new price points. We'll make our first moves outside the home, and last but certainly not least is what we announced yesterday around Sonos Amp and Sonos Architectural with Sonance. We've been reinvigorating our Installed Solutions channel with new products and a renewed commitment to the professional installer community.

Sonos customers served through the Installed Solutions channel traditionally deliver our highest revenue per household and our highest Net Promoter Scores. That's why we're excited to have all -- the all-new Sonos Amp available around the world this month. We're also excited to deliver Sonos Architectural speakers as a collection of In-Wall, In-Ceiling and Outdoor speakers designed specifically for use with the Sonos Amp. We've had component products to power other non-Sonos speakers for a decade, but until now, we've been missing a clear revenue attach opportunity.

This helps us create the best expense for customers and capture more of the revenue. Sonos In-Wall and Sonos In-Ceiling are available for preorder now and will be globally available end of February. Sonos Outdoor will be available in April.As I'm sure you saw in my shareholder letter, our CFO, Mike Giannetto, is planning to retire. Mike has graciously agreed to stay on until we identify and onboard his replacement to ensure a seamless transition.

Mike joined Sonos over seven years ago when the finance department was only a handful of people. He has done a tremendous job building a strong team and has set up processes and controls that have enabled us to scale the company to over $1 billion of revenue and to go public last year. Even more importantly, Mike has been a leader who has embodied the Sonos behaviors and values and is a person of incredible character and integrity. Everyone at Sonos is incredibly thankful for all Mike has done for the company.

It's been an honor to work with Mike. And while we're sad to see him leave us, we're excited for what the future holds for him in this next phase. I'll now pass over to Mike.

Mike Giannetto -- Chief Financial Officer

Thank you, Patrick, for the kind words. Good afternoon, everyone. After 34 years in the corporate finance world, I've decided to retire as the CFO. It's a big decision and something I've been thinking about for a while.

The last seven years at Sonos have been truly remarkable. It's a special place filled with incredibly talented people who all share a love for music and a passion for building great sound experiences. I'll retire proud of what we've accomplished, confident in the future of the business and eternally grateful for the many great friends and colleagues I've met along the way. I'm in no rush.

I will be here to help bring on a new CFO and help out with the transition. So now back to business at hand. I want to comment on our financial outlook for fiscal 2019, as described in our shareholder letter we issued earlier today. We are reaffirming the outlook we initially provided in our Q4 FY '18 shareholder letter back in November.

Our outlook highlights revenue and adjusted EBITDA growth ranges as these are the metrics we focus on to deliver sustainable profitable growth. As a reminder, our long-term financial targets are to grow revenue by greater than 10% year after year while growing adjusted EBITDA by at least 20%. For the full fiscal year 2019 ending September 28, 2019, we expect annual revenue in the range of $1.25 billion to $1.275 billion or 10% to 12% growth year over year. We expect annual adjusted EBITDA in the range of $83 million to $88 million or 28% to 27% growth year over year.

In the very short term, reduced sell-through velocity toward the end of our Q1 2019 created higher channel inventory levels than we would have liked heading into Q2. We have also firmed up our manufacturing and product launch schedule with IKEA. We initially expected manufacturing and revenue to begin in late Q2. We now have visibility into revenue shifting into Q3 and Q4 while the expected product volumes are unchanged.

This combination of channel inventory and our IKEA production schedule will impact Q2 revenue but does not alter our full-year revenue or adjusted EBITDA outlook. With that, we'll open it up for questions. 

Questions and Answers:

Operator

[Operator instructions] Your first question comes from Rod Hall from Goldman Sachs.

Rod Hall -- Goldman Sachs -- Analyst

Thanks, guys. I wanted to start off just by asking about the EBITDA guidance. It sounds like you did have this inventory problem in Q1, and it kind of sounds like you were surprised by demand right at the end of the quarter. So I wonder if you could just comment on why you're holding that EBITDA guidance.

What gives you the confidence? And then I have a follow-up.

Mike Giannetto -- Chief Financial Officer

Sure, Rod. This is Mike. Yes, we -- as I said, we did see some sell-through velocity turned down a little bit in December but finished strong. You'll see that we finished at the top end for Q1 in terms of revenue and had a real strong performance from a bottom line standpoint.

So as we look to the rest of the year, we feel quite confident with the revenue range as well as the EBITDA range. We're seeing -- from a profit standpoint, we're seeing the strategies work. Gross margin actually came up very strong. We feel good about that going forward.

And the efficiencies we're driving within operating expense, you can certainly see it in our Q1 with the sales and market leverage, and we expect to see that kind of performance throughout the year. So we feel very confident with the range we have.

Rod Hall -- Goldman Sachs -- Analyst

OK. And congratulations, by the way, on your retirement. Or moving on to something else, I'm not sure which. The second question I had was Europe.

You guys called out weakness there. Is there any way you could size that for us? And give us some idea as to how big a contributor to this late quarter demand deterioration Europe was.

Patrick Spence -- Chief Executive Officer

Rod, it's Patrick here. Really what I would point to is there's been a trend in North America over the last two holiday periods where we've seen a huge uptick in voice-enabled smartspeakers and a ton of money poured into the category. It was interesting because we've seen that for the first time kind of happening in Europe, if you will. And so like any of the -- so I think as a precursor to kind of getting Europe going around the voice category, which bodes well for us given what we saw in this holiday period in North America, we saw weakness across both North America and Europe as we came to the end of the first quarter.

But I think the good news is we've seen it bounce back in the January time frame, too, in both. So we're feeling pretty good about what we've seen in the -- lately.

Rod Hall -- Goldman Sachs -- Analyst

Great. OK. Thank you, Patrick. Thanks, guys.

Operator

Your next question comes from Yuuji Anderson from Morgan Stanley.

Yuuji Anderson -- Morgan Stanley -- Analyst

Great. Thanks for taking my question. Just a couple on that channel inventories here. Can you just give us a little bit more clarity on where you're seeing the higher channel inventory? Is this just across the board? Is it related to Europe? Any color on the product level there?

Mike Giannetto -- Chief Financial Officer

Sure. It's Mike again. It's not across the board. I mean, some channels adjust fine.

Some have some excess. It is not just the European issue. We see it in some channels in the U.S. as well.

To think about in terms of the excess channel inventory levels, it's about 10 to 12 days as we enter the quarter higher than we would target to give you kind of a sense of the magnitude. So it's not a large overstart, but it's enough that we want to call it out. And as Patrick mentioned, January is off to a pretty solid start, so we're starting to see the sell-through registrations come through and some of that excess -- or higher inventory come down.

Yuuji Anderson -- Morgan Stanley -- Analyst

Got it. Perhaps maybe what would be helpful, could you help -- could you describe how much you'll have to draw down this year versus what you had to last year?

Mike Giannetto -- Chief Financial Officer

Yes. I think the drawdown in terms of -- when you think in terms of days of channel inventory is similar year over year as we ended December. But again, what we're seeing now, and that's that 10 to 12 days, is we're seeing now January was solid and we're seeing the inventory come down as the sell-through continues.

Yuuji Anderson -- Morgan Stanley -- Analyst

OK. Got it. Thank you so much.

Operator

Your next question comes from Adam Tindle from Raymond James.

Adam Tindle -- Raymond James -- Analyst

OK. Thanks and good afternoon. I just want to start, Patrick, in the shareholder letter, you talked about believing to be the most compelling long-term hardware and software road map you've seen since you've been at Sonos. Obviously, you've talked about outside the home.

There's been a number of rumors from headphones, portable speakers, Bluetooth enablement. I just want to know if you maybe want to clear the air on the road map and then also maybe how you prioritize the many opportunities to leverage the brand and platform outside the home.

Patrick Spence -- Chief Executive Officer

Adam, thanks. I think there's not going to be any clearing the air because we're pretty thoughtful about when we share details of when products are ready as we go through this. But we're excited. I'm excited for what we have planned.

I think there's a lot of opportunity in a lot of categories that we don't plan today. And the way we think about that is, can we bring -- how big is that category in terms of category size? And how does it help the Sonos system? So how does it build on what we are already strong in, in terms of our expertise around experience, sounds, design, the wireless expertise we have, the cloud connectivity and services we do? And so as we're looking at all of these new categories, we're considering the innovation we can bring and really make sure that if we -- you can count on if we enter a category, we're going to do it with an innovative perspective and bring something new to the table. And so that, combined with the category size, is something that we think about and will guide the products that you see from us over the next two to three years.

Adam Tindle -- Raymond James -- Analyst

OK. That's helpful. Maybe just as a follow-up on capital allocation. The balance sheet, quite clean.

You've had strong cash generation. You've got over $200 million in net cash. Maybe just help me think about the sustainability of positive cash flow, what's the right cash level to run the business, I think you've got a lot of excess, and then how you think about potential uses of cash.

Mike Giannetto -- Chief Financial Officer

Sure. And it's Mike. Yes, in terms of the free cash flow, you can see we're in very, very positive free cash flow for the quarter and expect to be for the year and ongoing. So for 2019, if you look at our EBITDA guidance and how we talked about CAPEX, we'll be free cash flow for '19 and we plan to be so going forward.

In terms of cash on the balance sheet, we raised it for a few reasons. One is just we're in a solid position from a working capital standpoint. But another is potential, as we look around, M&A to give us some capital to do so. That's not pointing to anything specific.

But as we look at the road map and what we're trying to do, as Patrick was just talking about, it is something that we will consider in terms of speed to market. If there's already some technology out there that we could make good use of and come up with some great Sonos products, that's something we'd look at doing so. That's the way we are thinking about it at this point to help drive the growth in the business.

Adam Tindle -- Raymond James -- Analyst

OK. Just one last clarification. I know you talked about the 10 to 12 days of excess inventory. I just wanted to know.

I mean, you had really nice gross margin in Q1, beat by quite a bit, had a lot of wiggle room in there. Why not promote more heavily to have a better inventory situation entering Q2? Because I think you could have put in quite a bit on that based on the back-of-the-envelope math.

Mike Giannetto -- Chief Financial Officer

Yes. The holiday quarter which we just ended, it is a promotional period. We did participate in that, which I'm sure you saw around Black Friday and beyond. We feel good about the level of promotion we did.

We're a premium brand, and we use promotion as we think is appropriate. And certainly, it's appropriate in the period we just ended. We just did a pre-Super Bowl promotion in the United States because it's a time of increased TV buying. So we have the attach with the home theater products.

So we feel comfortable with our level of promotion and what that -- and what those results gave us for the quarter going into Q2.

Adam Tindle -- Raymond James -- Analyst

OK. Thank you.

Operator

Your next question comes from Brent Thill from Jefferies.

Brent Thill -- Jefferies -- Analyst

Good afternoon. Patrick, just from your 40,000-foot view, when you think about the tailwinds that you see this year that maybe haven't existed since you've been running the company, if you could talk about anything new you're seeing. I guess one thing this morning was Spotify buying some podcasting companies. There's obviously a tailwind to the overall category there.

Are there other things that you're seeing that maybe are new on your radar that you haven't seen? And I had a quick follow-up.

Patrick Spence -- Chief Executive Officer

Yes, sure, Brent. I think the first thing I would call out from the holiday period is I was very encouraged by our business in North America and what I -- I talked about this a little bit last year, this notion of the Google and Amazon sub-$100 products being stepping stones to Sonos. And I think what we saw in the holiday quarter is people starting to step up to premium products like Sonos and Beam and adding that into the mix. And so I think that's a great tailwind.

As people get more comfortable with voice assistant, Sonos is a natural step-up point for them. And that's our job, is to get them to do that. You called out the other one, which is something ironically we called out about a year ago, which is really what we call the Sonic Internet and the move for everything on the Internet moving to audio, moving sonic. And so what you saw from Spotify today in buying two podcast companies, I think, is another testament to that.

We've seen a huge explosion in listening hours. They're up 39% year over year. And I think some of that has to do with the explosion of podcasts. We had Audible join the platform last year.

And what we always watch is engagement. And every time we introduce something new, whether it's AirPlay or Audible or when we added Alexa, engagement goes up. And that to me is a great thing because it gets customers thinking more about adding Sonos to other rooms and other areas. So I think this whole explosion of podcasts, of audiobooks and everything going sonic is a huge tailwind for us ultimately.

And so what's good for the music industry, what's good for audio in general, I think, is good for Sonos.

Brent Thill -- Jefferies -- Analyst

And just to follow up, not to go into specifics of products, but is your cadence still on track to deliver a couple of new meaningful products a year? Is that the cadence you're shooting for? Has that changed?

Patrick Spence -- Chief Executive Officer

No. Absolutely right. I think -- yes, so that's absolutely right. That's absolutely right.

Brent Thill -- Jefferies -- Analyst

OK. Thanks, and congrats Mike to a nice seven year to the company.

Mike Giannetto -- Chief Financial Officer

Thank you very much, Brent.

Operator

[Operator instructions] The next question comes from Matt Sheerin from Stifel.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

Yes, thank you. Just regarding the inventory issue you talked about. It sounds like it's different than the inventory issues you saw in December a year ago when there seemed like a mismatch of products relative to demand. It sounds like this time it's -- it was more sort of a broad-based issue at the end of the quarter.

Or was there another product issue in terms of mismatch of parts or products?

Mike Giannetto -- Chief Financial Officer

Yes. Matt, I wouldn't call it a mismatch. It is broader-based. When we planned the business and as we went through the quarter, October and November were strong.

Sell-in in December was strong in support of what we were seeing, what our retailers were seeing. And we saw the surge as we normally do. It just didn't hit kind of some of the peaks that we had planned for. So it was broader-based.

It's across a few different products. So I wouldn't call it a mismatch, but it's just it was a little slower in December than what we planned for.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

OK. And I appreciate you're not giving specific guidance for the March quarter. But last year, you were down something like 65% or so sequentially because there was an inventory work-down in your channels last year. Are we talking about that kind of magnitude at this time? Or just a little bit worse than seasonal?

Mike Giannetto -- Chief Financial Officer

Yes. So there's obviously the seasonality in the business, which was obvious. What I would say, Matt, is I would kind of go back to my comments on the channel inventory in terms of excess days of inventory, the 10 to 12 or something. That's how I would think about it in terms of looking at the Q2 revenue potential.

I wouldn't compare it to last year. I would just focus on the 10 to 12 days that we'll be working through in January and February.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

OK. Fair enough. And just lastly on the IKEA program ramps, another reason why you sort of pushed out some of the revenue expectations further out in the year. But it also sounds like it could be fairly significant.

Can you give us an idea of the potential size of that kind of program and that relationship?

Patrick Spence -- Chief Executive Officer

Yes. Really -- Matt, it's Patrick here. I'm really excited about the relationship. We just spent more time together recently.

I think both parties are very committed to it, and it opens some new opportunities. There's going to be new form factors, opens up a ton of new countries, obviously, price points as well. It's a great way to get a lot of new listeners into the Sonos family. So really excited about that.

But in keeping with our tradition, we're also being very prudent about what we're putting into the plan around that. We want to see. We want to get out. We want to launch it.

We want to see the market reception before we start to build too big an expectation around some of these things. So I'm excited to see it launch and see it arrive in customers' homes, and we'll provide more color and keep building on it from there. But the relationship is in a great spot. I'm super excited about the products that we have coming.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

OK. Great. And just last quick housekeeping question. I didn't see the geographic revenue breakdown in the letter, or I may have missed it.

Do you have that? Or did you give that number? Your reference is North America...

Mike Giannetto -- Chief Financial Officer

Yes, yes. From a growth standpoint, the Americas grew constant currency about 12.5%, and EMEA is about 2.5% constant currency.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

2.5%. OK, great. OK, thanks so much. Appreciate it.

Mike Giannetto -- Chief Financial Officer

You're welcome.

Operator

There are no further questions at this time. I will turn the call back over to the presenters.

Patrick Spence -- Chief Executive Officer

Thanks, Mike. In closing, I'll just reiterate that 2019 is off to a good start. We're excited about what we have planned for the year ahead. We're looking further into the future than ever before.

And there's no shortage of opportunity, thanks to the amazing people that we have here, our capabilities in software, cloud, wireless and hardware and thanks to our strong and loyal customer base of now over 8 million homes. Of course, it wouldn't be a Sonos call without some music. Mike mentioned it at the beginning. But I want to draw your attention to the playlist noted at the end of the shareholder letter.

It's been crafted in honor of Black History Month by our Black @ Sonos employee resource group. Employee resource groups at Sonos are open forums for employees with shared backgrounds or interests and an important part of our culture. I'm proud of the work these groups do every day to support each other and educate and support the broader Sonos community and the communities in which we live and work. Thanks again for joining us today, and we look forward to speaking with you again soon.

That's it, Mike.

Operator

[Operator signoff]

Duration: 26 minutes

Call Participants:

Mike Groeninger -- Vice President of Corporate Finance

Patrick Spence -- Chief Executive Officer

Mike Giannetto -- Chief Financial Officer

Rod Hall -- Goldman Sachs -- Analyst

Yuuji Anderson -- Morgan Stanley -- Analyst

Adam Tindle -- Raymond James -- Analyst

Brent Thill -- Jefferies -- Analyst

Matt Sheerin -- Stifel Financial Corp. -- Analyst

More SONO analysis

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