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Strong Performance Amidst Challenging Market Conditions: Earnings Report Highlights

Q1 Revenue Exceeds Expectations

Saori Casey — Chief Financial Officer

Thank you, Tom. Hi, everyone. We reported Q1 revenue reaching $551 million, surpassing the high end of our guidance. Compared to last year, this marks a 10% decline, which is better than our projected decrease of 22% to 9%.

Market Challenges Impact Revenue

The drop in revenue stems from lower consumer demand and obstacles from our new app rollout for 2024. We have been acknowledging for some time that our categories are facing cyclic challenges and intense promotional pressures, particularly in portable devices. However, we saw unexpectedly strong demand for our sound bar, the Arc Ultra, which helped us secure our highest ever dollar market share in U.S. home theater.

Profit Margins Show Improvement

GAAP gross margin stood at 43.8%, exceeding our guidance by 80 basis points, thanks to an improved cost structure and product mix. It’s worth noting that the amortization of our new MY intangible assets reduced GAAP gross margins by 40 basis points year over year. Non-GAAP gross margins were reported at 44.7%. In Q1, GAAP operating expenses totaled $193 million with non-GAAP expenses at $169 million, both demonstrating a year-over-year decrease of 5% and 6%, respectively.

Cost Management Efforts Paying Off

Both expense figures included $6 million for app recovery investments made during the quarter. Non-GAAP operating expenses were about $13 million below our guidance figures due to efficient expense management and timing of expenditures. Our General and Administrative (G&A) costs saw a notable drop of 35% year over year, amounting to $25.8 million, thanks to several initiatives.

Factors Behind Decreased G&A Costs

The decline in G&A expenses resulted from four main factors: first, reduced personnel costs following the management restructuring in August 2023; second, lower litigation expenses; third, cutting operational costs through better vendor and facility management; and fourth, a timing shift in spending, providing an approximate $2 million benefit in the quarter. Year-on-year, sales and marketing expenses increased by 3%, influenced by app recovery investments. Research and development saw an increase of 2%, largely due to stock-based compensation for retaining key staff. Non-GAAP expenses reflected a 31% decline in G&A.

Cash Flow and Share Repurchases

Adjusted EBITDA for the quarter reached $91.2 million with a margin of 16.6%, which was above our guidance expectations due to improved gross margins and lower operating expenses. We concluded the quarter with $328 million in net cash, including $41 million in marketable securities, while also focusing on short-duration treasury bills.

Free cash flow recorded was $143 million, a decrease from $269 million last year. This reduction is attributed to lower revenue and two specific factors impacting last year’s cash flow: higher inventory levels of finished goods and favorable payment term changes with suppliers last year. Our ending inventory balance fell by 19% year over year to $141 million, primarily due to lower component inventory.

After pausing share repurchases in Q4 of the previous fiscal year, we returned $27 million to shareholders in Q1, reducing our share count by 1.9 million shares. This leaves $44 million remaining under our total $200 million share buyback authorization. Returning value to shareholders remains a core aspect of our capital allocation strategy.

Looking Ahead: Q2 Guidance

For Q2, we project revenue between $240 million and $265 million, suggesting a 5% decline or a 5% increase compared to last year. Our Q1 results and Q2 guidance indicate that revenue for the first half of the fiscal year will decrease between 9% and 6% compared to the same period last year.

While we aren’t providing guidance beyond Q2 now, it’s pertinent to remember that the Ace headphones launch last year will create a challenging year-over-year comparison in Q3. We expect Q2 GAAP gross margin to be between 42% and 44%, which would be a midpoint decrease from Q1, influenced by various factors including foreign exchange headwinds.

Non-GAAP gross margins are anticipated to range from 44% to 45.8%, showing an improvement over GAAP margins. Given our past efforts to diversify our supply chain, we expect minimal tariff impacts in Q2.

Our projected non-GAAP operating expenses for Q2 will be between $140 million and $145 million, a decrease compared to $157 million from last year. Consequently, we estimate Q2 adjusted EBITDA to range from negative $27 million to negative $6 million, showing improvement from the negative $34 million last year. This outlook also includes an additional $4 million to $8 million investment for app recovery in Q2.

In Summary: Operational Improvements Ahead

To summarize our transformation journey, we expect the cost-saving measures we introduced during FY ’24 to yield run-rate savings of $60 million to $70 million by FY ’26. Although we aren’t currently providing an expense target for FY ’25, our baseline operating expenses for FY ’24, adjusted for variable compensation and restructuring costs, were approximately $770 million on a GAAP basis, and around $680 million on a non-GAAP basis. These steps are designed to simplify our operations and enhance efficiency while keeping our profitability in mind. We will continue to keep you updated on our progress.

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 the call. What prompted this approach?

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…

Sonos Leadership Update: Streamlining Operations for Success

In recent weeks, Sonos has undergone significant changes aimed at moving the company forward decisively. Interim Chief Financial Officer Tom Conrad discussed the restructuring efforts and their implications during the earnings call.

Strategic Changes Amid Cost Savings

Tom Conrad shared that organizational optimizations were among his primary focuses upon joining Sonos. Balancing the restructuring announcement with financial results was crucial, especially as around 200 employees were departing and nearly 1,000 product team members were adjusting roles. The decision was made to announce these changes after market hours, allowing for better communication and understanding with investors ahead of the earnings release.

A Path Toward Efficiency

Conrad emphasized a proactive approach, noting that in just over three weeks, the company has achieved a more efficient structure. “We’re clarifying our focus areas to ensure that everyone is aligned and moving in the same direction,” he said. This reorganization is expected to facilitate improved operations and a stronger sense of purpose within Sonos.

Progress on Product Development

When asked about the state of Sonos’ app, Conrad highlighted progress made in the fourth quarter, which contributed to successful product launches, such as the Arc Ultra and Sub 4. He acknowledged that while improvements to the app’s core functionality are important, there is still considerable work to be done. The team is focusing on enhancing performance, usability, and design.

Maintaining Product Launches

In response to inquiries about maintaining their product launch cadence, Conrad assured that Sonos remains committed to introducing innovative products annually, though he refrained from providing detailed timelines.

Capital Allocation Strategy

Chief Financial Officer Saori Casey addressed questions regarding capital allocation, stating that Sonos has resumed its stock buyback program after pausing it in the previous quarter. The pause had been a precaution while ensuring app performance stability. She reaffirmed the company’s commitment to prudent capital allocation to benefit shareholders.

Efforts to Simplify Structure

Analyst Erik Woodring questioned Conrad about the complexity within Sonos, specifically regarding decision-making layers that hinder collaboration. Conrad explained that the previous organizational layout led to redundancies across different product teams, resulting in inefficiencies. By transitioning to a functional organizational model, the company aims to streamline operations and embrace flexibility, which is essential for quick responses to market demands.

Through these ongoing changes, Sonos is striving to enhance its operational effectiveness and restore its brand reputation in a competitive market. As the company progresses, leadership remains focused on improving customer experiences and driving innovation.

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Changes at Sonos: Streamlining for Future Efficiency

Understanding the Shift in Sonos’ Strategy

It has been noted that Sonos has operated in a certain way for many years. With impressive growth, the company has faced challenges in the current market. What prompted the change in strategy during this crucial time?

Tom Conrad — Interim Chief Financial Officer

The new business unit structure was established around 18 months ago. Previously, Sonos operated under a model that was hardware-focused. The shift aims to enhance both efficiency and effectiveness in our projects and customer experiences. By returning to a structure that worked well for us, we believe we can better navigate today’s challenges.

Erik Woodring — Analyst

Thanks for the explanation; it really clarifies the situation. Looking back at the financials, the June quarter has seen fluctuating revenue patterns. Can you provide insights on how to best anticipate revenue for the upcoming June quarter? This data would help align expectations.

Saori Casey — Chief Financial Officer

Thank you, Erik. It is indeed a complex situation with a wide range of possible outcomes. While we cannot predict specific figures, we anticipate that upcoming sales will differ from previous years, particularly following the ACE launch last quarter. We are evaluating patterns but cannot draw clear comparisons for this June.

Erik Woodring — Analyst

I understand; thank you for your insights.

Operator

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

Alex Fuhrman — Analyst

Thanks for taking my question. Regarding the recent workforce reductions, how is Sonos balancing hardware and software development going forward? What organizational changes have occurred over the past year?

Tom Conrad — Interim Chief Financial Officer

Our product organization has shifted significantly. Today, software development has grown in importance and size, with over 300 staff compared to about 150 in hardware. This change highlights the integral role software plays in our products.

Saori Casey — Chief Financial Officer

Looking at our operational expenses, a sizable portion is allocated to R&D, followed by general and administrative needs, and lastly, sales and marketing. The seasonal marketing expenditures are more variable, but overall, R&D dominates the workforce structure.

Alex Fuhrman — Analyst

That’s informative, thank you. Are we expecting operational expenses to significantly reduce going forward, or will the focus remain on growing sales faster than costs?

Saori Casey — Chief Financial Officer

We are analyzing various cost optimization strategies. Although we have announced layoffs, we are also reevaluating all expenditure categories to ensure efficient resource allocation. There are no immediate changes to operational expense guidance, but we are committed to finding more efficient practices.

Tom Conrad — Interim Chief Financial Officer

My experience aligns with a focus on scrutinizing expenses. It’s crucial that we invest in areas that promise the highest returns as we adapt our operations.

Alex Fuhrman — Analyst

Thank you for the clarity.

Tom Conrad — Interim Chief Financial Officer

Thank you.

Operator

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Sonos Cuts Workforce to Strengthen Core Teams and Improve Product Development

Workforce Reduction Focuses on Efficiency

Brent Thill — Analyst

Thanks. Tom, could you elaborate on the 12% reduction in force? Was it spread across all departments, or was it targeted at specific areas? Additionally, what changes have been made within the software development team, especially in leadership?

Tom Conrad — Interim Chief Financial Officer

Sure. Significant work was accomplished by Saori in managing our operating expenses in recent quarters. The latest changes primarily target the remaining areas of the company, particularly focusing on the product organization. This reorganization uncovered redundancies that paved the way for a more compact and efficient team.

During my time in startups, I’ve seen that team size does not always correlate with output. We have taken strides to make our product and engineering teams smaller yet more effective. I am optimistic that the current team is positioned to enhance the core experiences we are committed to improving.

Leadership Changes in Product Organization

Brent Thill — Analyst

Have there been leadership changes in the software side to ensure progress is being made?

Tom Conrad — Interim Chief Financial Officer

Yes. We have exited approximately six vice presidents within the product organization and restructured teams around the most capable leadership for our plans moving forward. I am confident that this group will deliver significant progress.

Ace’s Performance During the Holiday Season

Brent Thill — Analyst

Thank you.

Operator

Next, we have a follow-up from Steve Frankel of Rosenblatt. Your line is open.

Steven Frankel — Analyst

Could you provide insights on how Ace performed during the crucial holiday season?

Saori Casey — Chief Financial Officer

Hello, Steve. From a revenue standpoint, Ace contributed positively to our year-over-year and quarter performance, receiving excellent reviews from customers. As previously noted on our earnings call, its launch was slow. Unfortunately, the timing of Ace’s release coincided with a challenging period for our brand, but we are making noticeable progress.

While we can’t share specific figures beyond what we disclose externally, we are pleased with Ace’s customer reception and its contribution to revenue growth.

Steven Frankel — Analyst

Thanks.

Operator

[Operator signoff]

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

This article is a transcript of this conference call produced for The Motley Fool. While we strive for accuracy, there may be errors or omissions. We encourage you to do your own research, including listening to the call and reviewing the company’s SEC filings. Please see our Terms and Conditions for further information.

The Motley Fool has positions in and recommends Sonos. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.