Sonos, Inc. — Q1 FY2020 Form 10-Q
Business context and period: Sonos designs, develops, manufactures and sells audio products through retail, e-commerce and direct channels in more than 50 countries. The quarter was the three months ended December 28, 2019; comparisons are with the three months ended December 29, 2018. Figures below are in U.S. dollars; financial statement amounts are unaudited. Sonos notes that first-quarter results benefit from holiday-season demand and are not necessarily indicative of full-year results.
Financial performance
| Metric | Q1 FY2020 | Prior-year quarter | Change |
|---|---|---|---|
| Revenue | $562.1 million | $496.4 million | +13.2% |
| Gross profit / margin | $227.6 million / 40.5% | $195.3 million / 39.3% | Margin +1.2 percentage points |
| Operating income / margin | $67.5 million / 12.0% | $68.5 million / 13.8% | Income down $1.1 million |
| Net income / net margin | $70.8 million / 12.6% | $61.7 million / 12.4% | Net income +14.8% |
| Diluted earnings per share | $0.60 | $0.55 | Increased |
| Adjusted EBITDA / margin | $93.2 million / 16.6% | $87.4 million / 17.6% | EBITDA up; margin down |
| Net cash from operating activities | $118.8 million | $92.1 million | Increased |
Revenue growth reflected increases across product categories: Sonos speakers rose 7.0% to $466.7 million; Sonos system products rose 17.3% to $61.5 million; and partner products and other revenue rose to $33.9 million from $7.8 million, largely reflecting the IKEA relationship. Products sold increased 22.1% to 2.94 million units. Constant-currency revenue growth was 14.5%.
Gross margin improved despite $19.6 million of tariffs on products imported to the U.S. from China; the company said gross margin would have been 44.0% excluding tariff effects. Operating expenses increased 26.3% to $160.2 million, led by higher research and development, sales and marketing, and general and administrative spending. Operating income therefore declined despite higher revenue and gross profit. Foreign currency gains contributed $4.4 million of other income, versus a $4.0 million loss in the prior-year quarter.
Financial position and liquidity
- Cash and cash equivalents were $408.4 million at December 28, 2019, versus $338.6 million at September 28, 2019; restricted cash was $0.2 million.
- Total current assets were $688.6 million and current liabilities were $375.1 million. Stockholders’ equity was $367.3 million.
- Total indebtedness, net of debt issuance costs, was $32.6 million, including $9.4 million current and $23.2 million long-term. The $80 million revolving credit facility had no borrowings outstanding; $4.5 million of letters of credit reduced availability. The facility is subject to a borrowing base.
- Operating cash flow was $118.8 million. Investing used $51.5 million, including $35.6 million for the Snips acquisition and $15.9 million for property and equipment. Financing provided $1.2 million; cash, cash equivalents and restricted cash increased $69.8 million.
- Inventory declined to $113.1 million from $219.8 million, which management attributed primarily to seasonal working-capital patterns. The company had $34.8 million in non-cancelable inventory purchase commitments for the remainder of fiscal 2020.
Material changes, outlook and risks
- Snips acquisition: Sonos acquired voice-technology company Snips SAS on November 14, 2019 for $36.3 million in total consideration, including $35.6 million paid at closing. Snips’ results were not material to the quarter. Sonos recorded $1.4 million in one-time acquisition-related costs and recognized $14.3 million of estimated goodwill.
- Share repurchases: Under a $50 million authorization, Sonos repurchased 227,241 shares during the quarter for $2.9 million; $47.1 million remained authorized at quarter-end. Cash-flow payments for treasury stock were $5.1 million, including employee tax-withholding share purchases.
- Leases: Sonos adopted the new lease accounting standard in fiscal Q1, recognizing operating lease right-of-use assets and liabilities. At quarter-end, operating lease liabilities totaled $69.4 million.
- Guidance: The filing provides no specific revenue, earnings or margin guidance. Management said cash, operating cash flow and committed credit lines should be sufficient for working capital and capital expenditures over the next 12 months, while noting future needs depend on growth, investment, product launches and economic conditions.
- Key risks and contingencies: Tariffs on China-origin products affected costs; Sonos cited $19.6 million of tariff expense in the quarter and noted possible further trade measures. The company relies heavily on a key contract manufacturer and a limited supplier and logistics base, and faces competition, seasonal demand, foreign-exchange exposure and dependence on technology, content and retail partners. A 10% adverse currency movement on relevant exposures was estimated to reduce quarterly pretax income by approximately $6.4 million.
- Legal matters: Sonos’ patent case brought by Implicit, LLC remains unresolved; any loss range was not considered probable or reasonably estimable. On January 7, 2020, Sonos filed patent-infringement actions against Google and Alphabet. The company also identified $3.4 million of legal and transaction-related costs in its adjusted EBITDA reconciliation.
- Tax item: The quarter included an approximately $0.6 million discrete tax benefit from a favorable release of uncertain tax positions. Sonos maintained a full valuation allowance on U.S. deferred tax assets and said a significant release within 12 months was possible, depending on profitability; any release could materially affect earnings.
Most important facts for investors to verify
- Whether product and unit growth can continue beyond the seasonally strong holiday quarter, and how much growth reflects new products versus partner revenue.
- Whether operating expense growth and the decline in operating and adjusted EBITDA margins are consistent with management’s investment plans.
- The continuing cost and potential changes in tariffs, and the extent to which production diversification can reduce manufacturing concentration without disrupting supply.
- Cash generation after acquisition spending, capital expenditures, inventory commitments, debt service and the share-repurchase program.
- Developments in the Implicit and Google/Alphabet patent matters, including any material change in exposure or legal costs.
- The timing and potential earnings impact of any U.S. deferred-tax valuation-allowance release.