Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in the section titled "Risk Factors."
We operate on a 52-week or 53-week fiscal year ending on the Saturday nearest September 30 each year. Our fiscal year is divided into four quarters of 13 weeks, each beginning on a Sunday and containing two 4-week periods followed by a 5-week period. An additional week is included in the fourth fiscal quarter approximately every five years to realign fiscal quarters with calendar quarters. References to fiscal 2022 are to our 52-week fiscal year ended October 1, 2022, references to fiscal 2021 are to our 52-week fiscal year ended October 2, 2021, references to fiscal 2020 are to our 53-week fiscal year ended October 3, 2020.
Overview
Sonos is one of the world's leading sound experience brands.
We pioneered multi-room, wireless audio products, debuting the world's first multi-room wireless sound system in 2005. Today, our products include wireless, portable, and home theater speakers, components, and accessories to address consumers' evolving audio needs. We are known for delivering unparalleled sound, thoughtful design aesthetic, simplicity of use, and an open platform. Our platform has attracted a broad range of more than 130 streaming content providers, such as Apple Music, Spotify, Deezer, and Pandora. These partners find value in our independent platform and access to our millions of desirable and engaged customers. We frequently introduce new services and features across our platform, providing our customers with enhanced functionality, improved sound, and an enriched user experience. We are committed to continuous technological innovation as reflected in our growing global patent portfolio. We believe our patents comprise the foundational intellectual property for wireless multi-room and other audio technologies.
Our innovative products, seamless customer experience and expanding global footprint have driven 17 consecutive years of sustained revenue growth since our first product launch. We generate revenue from the sale of our Sonos speaker products, including wireless speakers and home theater speakers, from our Sonos system products, which largely comprises our component products, and from partner products and other revenue, including partnerships with IKEA and Sonance, Sonos and third-party accessories, licensing, and advertising revenue.
We have developed a robust product and software roadmap that we believe will help us capture the expanding addressable market for our products. We believe executing on our roadmap will position us to acquire new customers, offer a continuously improving experience to our existing customers, and grow follow-on purchases.
Recent developments
The impacts of, and uncertainty related to, the COVID-19 pandemic and its expected duration persist. Developments continue to occur, relating to the emergence of new variants of the virus, outbreaks, and resulting lockdowns globally. COVID-19 has affected our supply chain, consistent with its effect across many industries, including component supply-related challenges, inflationary pressures, port congestion and the continuing impacts of lockdowns in China. We began to see recovery in supply for some of our products, while supply chain constraints resulted in delayed product availability for certain products. As a result of these broader industry-wide supply chain challenges, in fiscal 2022, we experienced increased component costs, and increased shipping and logistics costs, as well as longer lead times.
More recently, macroeconomic trends have led to uncertainty in the economic environment. These include conditions such as the potential for a recession, foreign exchange rate fluctuations - particularly the strengthening of the U.S. dollar relative to the euro and the British pound, high inflation and the related negative impact on the global economy, and the continuing conflict between Russia and Ukraine. Foreign exchange rate fluctuations had an unfavorable impact on revenue for the second half of fiscal 2022, primarily due to the strength of the U.S. dollar relative to the euro and the British pound. These trends, as well as a shift in consumer spending from purchasing goods to purchasing services, led to softening demand in the second half of fiscal 2022. The falloff in demand resulted in an increase in our component supply and inventory as we had previously increased our investments and purchase commitments to secure inventory for long lead-time components during what had been a period of constrained availability and strong demand. We continue to work with our contract manufacturing partners to actively manage the impact of industry-wide supply chain challenges, including fluctuations in component availability and consumer demand. The extent to which our business, or the business of our suppliers or manufacturers, will be impacted in the future is unknown.
For additional information, refer to Part I, Item 1A. Risk factors.
Key Metrics
In addition to the measures presented in our consolidated financial statements, we use the following key metrics to evaluate our business, measure our performance, identify trends affecting our business and assist us in making strategic decisions. Our key metrics are total revenue, products sold, adjusted EBITDA and adjusted EBITDA margin. The most directly comparable financial measure calculated under U.S. GAAP for adjusted EBITDA is net income (loss). In the fiscal years ended October 1, 2022 and October 2, 2021, we had net income of $67.4 million and $158.6 million, respectively and in the fiscal year ended October 3, 2020, we had a net loss of $20.1 million.
Fiscal Year Ended
October 1,2022
October 2,2021
October 3,2020
(In thousands, except percentages)
Revenue
$
1,752,336
$
1,716,744
$
1,326,328
Products sold
6,281
6,503
5,806
Adjusted EBITDA(1)
$
226,549
$
278,585
$
108,543
Adjusted EBITDA margin(1)
12.9
%
16.2
%
8.2
%
(1)For additional information regarding adjusted EBITDA and adjusted EBITDA margin (which are non-GAAP financial measures), including reconciliations of net income (loss), to adjusted EBITDA, see the sections titled "Adjusted EBITDA and Adjusted EBITDA Margin" and "Non-GAAP Financial Measures" below.
Revenue
We generate substantially all of our revenue from the sale of Sonos speakers and Sonos system products. We also generate a portion of revenue from Partner products and other revenue sources, such as module revenue from our IKEA partnership, architectural speakers from our Sonance partnership, accessories such as speaker stands and wall mounts, professional services, licensing, and advertising revenue.
For a description of our revenue recognition policies, see the section titled "Critical accounting policies and estimates."
Products Sold
Products sold represents the number of products that are sold during a period, net of returns and includes the sale of products in the Sonos speakers and Sonos system products categories, as well as module units sold through our partnerships with IKEA and Sonance from our Partner products and other revenue category. Growth rates between products sold and revenue are not perfectly correlated because our revenue is affected by other variables, such as the mix of products sold during the period, promotional discount activity, the introduction of new products that may have higher or lower than average selling prices, as well as the impact of recognition of previously deferred revenue.
Adjusted EBITDA and Adjusted EBITDA Margin
We define adjusted EBITDA as net income (loss) adjusted to exclude the impact of stock-based compensation expense, depreciation, interest, other income (expense), taxes, and other items that we do not consider representative of our underlying operating performance.
We define adjusted EBITDA margin as adjusted EBITDA divided by revenue. See the section titled "Results of Operations -Non-GAAP Financial Measures" for information regarding our use of adjusted EBITDA and adjusted EBITDA margin, and a reconciliation of net income (loss) to adjusted EBITDA.
Components of Results of Operations
Revenue
We generate substantially all of our revenue from the sale of Sonos speakers and Sonos system products. We also generate a portion of revenue from Partner products and other revenue sources, such as module revenue from our IKEA partnership, architectural speakers from our Sonance partnership, and accessories such as speaker stands and wall mounts, as well as professional services,
licensing, advertising, and subscription revenue. We attribute revenue from our IKEA partnership to our Asia Pacific ("APAC") region, as our regional revenue is defined by the shipment location. Our revenue is recognized net of allowances for returns, discounts, sales incentives, and any taxes collected from customers. We also defer a portion of our revenue that is allocated to unspecified software upgrades and cloud-based services, as well as for newly launched products sold to resellers not recognized until the date of general availability is reached. Our revenue is subject to fluctuation based on the foreign currency in which our products are sold, principally for sales denominated in the euro and the British pound. The introduction of new products may result in an increase in revenue but may also impact revenue generated from existing products as consumers shift purchases to new products.
For a description of our revenue recognition policies, see the section titled "Critical accounting policies and estimates."
Cost of Revenue
Cost of revenue consists of product costs, including costs of our contract manufacturers for production, components, shipping and handling, tariffs, duty costs, warranty replacement costs, packaging, fulfillment costs, manufacturing and tooling equipment depreciation, warehousing costs, hosting costs, and excess and obsolete inventory write-downs. It also includes licensing costs, such as royalties to third parties, and attributable amortization of acquired developed technology. In addition, we allocate certain costs related to management and facilities, personnel-related expenses, and supply chain logistic costs. Personnel-related expenses consist of salaries, bonuses, benefits, and stock-based compensation expenses.
Gross Profit and Gross Margin
Our gross margin has fluctuated and may, in the future, fluctuate from period to period based on a number of factors, including the mix of products we sell, the channel mix through which we sell our products, fluctuations of the impacts of our product and material cost saving initiatives, the foreign currency in which our products are sold, and tariffs and duty costs implemented by governmental authorities.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, and general and administrative expenses.
Research and development. Research and development expenses consist primarily of personnel-related expenses, consulting and contractor expenses, tooling, test equipment, prototype materials, and related overhead costs. To date, software development costs have been expensed as incurred because the period between achieving technological feasibility and the release of the software has been short and development costs qualifying for capitalization have been insignificant.
Sales and marketing. Sales and marketing expenses consist primarily of advertising and marketing activity for our products and personnel-related expenses, as well as trade show and event costs, sponsorship costs, consulting and contractor expenses, travel costs, depreciation for product displays, as well as related maintenance and repair expenses, customer experience and technology support tool expenses, revenue related sales fees from our direct-to-consumer business, and overhead costs.
General and administrative. General and administrative expenses consist of personnel-related expenses for our finance, legal, human resources and administrative personnel, as well as the costs of professional services, information technology, litigation, patents, related overhead, and other administrative expenses.
Other Income (Expense), Net
Interest income. Interest income consists primarily of interest income earned on our cash and cash equivalents balances.
Interest expense. Interest expense consists primarily of interest expense associated with our debt financing arrangements and amortization of debt issuance costs.
Other income (expense), net. Other income (expense), net consists primarily of our foreign currency exchange gains and losses relating to transactions and remeasurement of asset and liability balances denominated in currencies other than the U.S. dollar. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates.
33
Provision for (Benefit From) Income Taxes
We are subject to income taxes in the United States and foreign jurisdictions in which we operate. Foreign jurisdictions have statutory tax rates different from those in the United States. Accordingly, our effective tax rate will vary depending on jurisdictional mix of earnings, and changes in tax laws. In addition, certain U.S. tax regulations subject the earnings of our non-U.S. subsidiaries to current taxation in the United States. Our effective tax rate will be impacted by our ability to claim deductions and foreign tax credits to offset the taxation of foreign earnings in the United States.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided to reduce our deferred tax assets to amounts that are more-likely-than-not to be realized. We have assessed, on a jurisdictional basis, the available means of recovering deferred tax assets, including the ability to carry back net operating losses, the existence of taxable temporary differences, the availability of tax planning strategies and available sources of future taxable income. We have concluded that future taxable income can be considered a source of income to realize a benefit for deferred tax assets in certain foreign jurisdictions. In addition, we have concluded that a valuation allowance on deferred tax assets in the U.S. continues to be appropriate considering cumulative pre-tax losses in recent years and uncertainty with respect to future taxable income.
It is possible that in the foreseeable future there may be sufficient positive evidence to release a portion or all of the remaining valuation allowance. Release of the remaining valuation allowance would result in a benefit to income tax expense for the period the release is recorded, which could have a material impact on net earnings. The timing and amount of the potential valuation allowance release are subject to significant management judgment, as well as prospective earnings in the United States.
Results of Operations
The consolidated statements of operations data for fiscal years 2022, 2021, and 2020, and the consolidated balance sheet data as of October 1, 2022, and October 2, 2021, are derived from our audited consolidated financial statements appearing in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K. The consolidated statements of operations data for fiscal years 2019, and 2018, and the consolidated balance sheet data as of October 3, 2020, September 28, 2019, and September 29, 2018, are derived from audited consolidated financial statements not included in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of the results that may be expected in any future period.
Fiscal Year Ended
October 1,2022
October 2,2021
October 3,2020
September 28,2019
September 29,2018(4)
(In thousands, except share and per share amounts and percentages)
Revenue
$
1,752,336
$
1,716,744
$
1,326,328
$
1,260,823
$
1,137,008
Cost of revenue (1)
955,969
906,750
754,372
733,480
647,700
Gross profit
796,367
809,994
571,956
527,343
489,308
Operating expenses
Research and development (1)
256,073
230,078
214,672
171,174
142,109
Sales and marketing (1)
280,333
272,124
263,539
247,599
270,869
General and administrative (1)
170,429
152,828
120,978
102,871
85,205
Total operating expenses
706,835
655,030
599,189
521,644
498,183
Operating income (loss)
89,532
154,964
(27,233
)
5,699
(8,875
)
Other income (expense), net
Interest income
1,655
146
1,998
4,349
731
Interest expense
(552
)
(592
)
(1,487
)
(2,499
)
(5,242
)
Other income (expense), net
(21,905
)
2,407
6,639
(8,625
)
(1,162
)
Total other income (expense), net
(20,802
)
1,961
7,150
(6,775
)
(5,673
)
Income (loss) before provision for (benefit from) income taxes
68,730
156,925
(20,083
)
(1,076
)
(14,548
)
Provision for (benefit from) income taxes
1,347
(1,670
)
32
3,690
1,056
Net income (loss)
$
67,383
$
158,595
$
(20,115
)
$
(4,766
)
$
(15,604
)
Net income (loss) per share attributable to common stockholders:⁽²⁾
Basic
$
0.53
$
1.30
$
(0.18
)
$
(0.05
)
$
(0.24
)
Diluted
$
0.49
$
1.13
$
(0.18
)
$
(0.05
)
$
(0.24
)
Weighted-average shares used in computing net income (loss) per share attributable to common stockholders:⁽²⁾
Basic
127,691,030
122,245,212
109,807,154
103,783,006
65,706,215
34
Diluted
137,762,078
140,309,152
109,807,154
103,783,006
65,706,215
Other Data:
Products sold(5)
6,281
6,503
5,806
6,204
5,165
Adjusted EBITDA (3)
$
226,549
$
278,585
$
108,543
$
88,689
$
69,128
Adjusted EBITDA margin (3)
12.9
%
16.2
%
8.2
%
7.0
%
6.1
%
(1)Stock-based compensation was allocated as follows:
Fiscal Year Ended
October 1,2022
October 2,2021
October 3,2020
September 28,2019
September 29,2018
(In thousands)
Cost of revenue
$
1,620
$
988
$
1,106
$
985
$
198
Research and development
30,724
25,075
23,439
17,643
13,960
Sales and marketing
15,335
13,570
14,359
12,965
15,885
General and administrative
27,961
22,494
18,706
14,982
8,602
Total stock-based compensation expense
$
75,640
$
62,127
$
57,610
$
46,575
$
38,645
(2)See Note 11. Net Income (Loss) Per Share Attributable to Common Stockholders of the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for an explanation of the calculations of our net income (loss) per share attributable to common stockholders, basic and diluted.
(3)Adjusted EBITDA and adjusted EBITDA margin are financial measures that are not calculated in accordance with U.S. GAAP. See the section titled "-Non-GAAP Financial Measures" below for information regarding our use of these non-GAAP financial measures and a reconciliation of net income (loss) to adjusted EBITDA.
(4)Reflects the impact of the adoption of new accounting standard in fiscal year 2018 related to revenue recognition.
(5)Products sold for the fiscal years 2019 and 2018 have been recast to reflect the change in product revenue categorization.
As of
October 1,2022
October 2,2021
October 3,2020
September 28,2019
September 29,2018
(In thousands)
Consolidated balance sheet data:
Cash and cash equivalents
$
274,855
$
640,101
$
407,100
$
338,641
$
220,930
Working capital
331,752
481,384
267,362
276,635
201,243
Total assets
1,188,388
1,138,804
816,051
761,605
587,498
Total long-term debt
18,251
24,840
33,097
Total liabilities
627,875
569,762
518,212
480,677
379,140
Accumulated deficit
(2,514
)
(69,897
)
(228,492
)
(208,377
)
(203,611
)
Total stockholders' equity
560,513
569,042
297,839
280,928
208,358
Non-GAAP Financial Measures
To supplement our consolidated financial statements presented in accordance with U.S. GAAP, we monitor and consider adjusted EBITDA and adjusted EBITDA margin, which are non-GAAP financial measures. These non-GAAP financial measures are not based on any standardized methodology prescribed by U.S. GAAP and are not necessarily comparable to similarly titled measures presented by other companies.
We define adjusted EBITDA as net income (loss) adjusted to exclude the impact of depreciation, stock-based compensation expense, interest income, interest expense, other income (expense), income taxes and other items that we do not consider representative of underlying operating performance. We define adjusted EBITDA margin as adjusted EBITDA divided by revenue.
We use these non-GAAP financial measures to evaluate our operating performance and trends and make planning decisions. We believe that these non-GAAP financial measures help identify underlying trends in our business that could otherwise be masked by the effect of the expenses and other items that we exclude in these non-GAAP financial measures. Accordingly, we believe that these non-GAAP financial measures provide useful information to investors and others in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects, and allowing for greater transparency with respect to a key financial metric used by our management in its financial and operational decision-making.
35
Adjusted EBITDA and adjusted EBITDA margin are non-GAAP financial measures, and should not be considered in isolation of, or as an alternative to, measures prepared in accordance with U.S. GAAP. There are a number of limitations related to the use of adjusted EBITDA rather than net income (loss), which is the nearest U.S. GAAP equivalent of adjusted EBITDA, and the use of adjusted EBITDA margin rather than operating margin, which is the nearest U.S. GAAP equivalent of adjusted EBITDA margin. These limitations include that the non-GAAP financial measures:
•exclude depreciation and amortization, and although these are non-cash expenses, the assets being depreciated may be replaced in the future;
•exclude stock-based compensation expense, which has been, and will continue to be, a significant recurring expense for our business and an important part of our compensation strategy;
•do not reflect interest income, primarily resulting from interest income earned on our cash and cash equivalent balances;
•do not reflect interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces cash available to us;
•do not reflect the effect of foreign currency exchange gains or losses, which is included in other income (expense), net;
•do not reflect the provision for or benefit from income tax that may result in payments that reduce cash available to us;
•do not reflect items that are not considered representative of our underlying operating performance which reduce cash available to us; and
•may not be comparable to similar non-GAAP financial measures used by other companies, because the expenses and other items that we exclude in our calculation of these non-GAAP financial measures may differ from the expenses and other items, if any, that other companies may exclude from these non-GAAP financial measures when they report their operating results.
Because of these limitations, these non-GAAP financial measures should be considered along with other operating and financial performance measures presented in accordance with U.S. GAAP.
The following table presents a reconciliation of net income (loss) to adjusted EBITDA:
Fiscal Year Ended
October 1,2022
October 2,2021
October 3,2020
September 28,2019
September 29,2018
(In thousands, except percentages)
Net income (loss)
$
67,383
$
158,595
$
(20,115
)
$
(4,766
)
$
(15,604
)
Depreciation and amortization
38,504
33,882
36,426
36,415
39,358
Stock-based compensation expense
75,640
62,127
57,610
46,575
38,645
Interest income
(1,655
)
(146
)
(1,998
)
(4,349
)
(731
)
Interest expense
552
592
1,487
2,499
5,242
Other (income) expense, net
21,905
(2,407
)
(6,639
)
8,625
1,162
Provision for (benefit from) income taxes
1,347
(1,670
)
32
3,690
1,056
Restructuring and related expenses
(2,446
)
26,285
Legal and transaction related costs (1)
22,873
30,058
15,455
Adjusted EBITDA
$
226,549
$
278,585
$
108,543
$
88,689
$
69,128
Revenue
1,752,336
1,716,744
1,326,328
1,260,823
1,137,008
Adjusted EBITDA margin
12.9
%
16.2
%
8.2
%
7.0
%
6.1
%
(1)Legal and transaction-related costs consist of expenses related to our intellectual property ("IP") litigation against Alphabet and Google as well as legal and transaction costs associated with our acquisition activities, which we do not consider representative of our underlying operating performance.
36
Comparison of Fiscal Years 2022 and 2021
Revenue
Fiscal Year Ended
Change from Prior Fiscal Year
October 1,2022
October 2,2021
$
%
(Dollars in thousands)
Sonos speakers
$
1,368,916
$
1,378,808
$
(9,892
)
(0.7
)%
Sonos system products
297,110
265,180
31,930
12.0
Partner products and other revenue
86,310
72,756
13,554
18.6
Total revenue
$
1,752,336
$
1,716,744
$
35,592
2.1
%
Volume data (products sold in thousands)
Units
%
Total products sold
6,281
6,503
(222
)
(3.4
)%
Total revenue increased 2.1% for fiscal 2022, compared to fiscal 2021. The growth was driven by strong demand for our products in the first half of the fiscal year despite lower promotional activity, somewhat offset by the continuing impact of constrained product availability, as well as the softening demand in the third and fourth fiscal quarters.
Sonos speakers revenue represented 78.1% of total revenue for fiscal 2022. The category decreased 0.7% compared to fiscal 2021, mainly related to decreased sales in Move and One, which resulted primarily from lower promotional activity in the first fiscal quarter due to limited supply. Sonos system products represented 17.0% of total revenue for fiscal 2022, and increased 12.0% compared to the fiscal 2021, supported by demand and availability of supply. Partner products and other revenue represented 4.9% of total revenue for fiscal 2022, and increased 18.6% compared to fiscal 2021. The increase was driven by sales from our partnerships with Sonance and IKEA.
The volume of products sold decreased for fiscal 2022, compared to fiscal 2021, as we sold fewer units in the Sonos speakers category. Revenue increased despite a decrease in volume for fiscal 2022, compared to fiscal 2021, primarily due to the impact of higher selling prices.
Revenue for fiscal 2022, compared to fiscal 2021, increased 6.4% in the Americas, decreased 6.5% in EMEA, and increased 11.0% in APAC.
In constant currency U.S. dollars, total revenue increased 4.9% for the twelve months ended October 1, 2022, compared to the twelve months ended October 2, 2021. We calculate constant currency growth percentages by translating our prior period financial results using the current period average currency exchange rates and comparing these amounts to our current period reported results.
Cost of Revenue and Gross Profit
Fiscal Year Ended
Change from Prior Fiscal Year
October 1,2022
October 2,2021
$
%
(Dollars in thousands)
Cost of revenue
$
955,969
$
906,750
$
49,219
5.4
%
Percentage of revenue
54.6
%
52.8
%
Gross profit
$
796,367
$
809,994
$
(13,627
)
(1.7
)%
Gross margin
45.4
%
47.2
%
The increase in cost of revenue for fiscal 2022, compared to fiscal 2021, was primarily driven by an increase in air freight shipping in the first quarter of fiscal 2022, higher component costs, and an overall increase in shipping and logistics costs related to industry-wide supply chain dynamics.
Gross margin decreased 180 basis points for fiscal 2022, compared to fiscal 2021. The decrease was primarily due to increased shipping and logistics costs as well as increased component costs, both of which stemmed from broader industry-wide supply chain dynamics. The decrease in gross margin was also related to increased tariff expenses of $6.0 million, net of refunds recognized, compared to fiscal 2021, resulting from the impact of having an exemption from tariffs on core speaker products in the first half of fiscal 2021,
37
which we did not have in the first half of fiscal 2022. The overall decrease was partially offset by the impact of reduced promotional activity and higher selling prices.
Research and Development
Fiscal Year Ended
Change from Prior Fiscal Year
October 1,2022
October 2,2021
$
%
(Dollars in thousands)
Research and development
$
256,073
$
230,078
$
25,995
11.3
%
Percentage of revenue
14.6
%
13.4
%
Research and development expenses increased $26.0 million, or 11.3%, for fiscal 2022 compared to fiscal 2021. The increase was primarily driven by $17.0 million in personnel-related expenses due to increased headcount and stock-based compensation partially offset by lower variable compensation. The increase was also driven by an increase of $12.4 million in product development costs and professional fees, and $2.0 million in information technology, partially offset by a decrease of $10.0 million from a one-time product development investment in the prior year.
Sales and Marketing
Fiscal Year Ended
Change from Prior Fiscal Year
October 1,2022
October 2,2021
$
%
(Dollars in thousands)
Sales and marketing
$
280,333
$
272,124
$
8,209
3.0
%
Percentage of revenue
16.0
%
15.9
%
Sales and marketing expenses increased $8.2 million, or 3.0%, in fiscal 2022 compared to fiscal 2021. The increase was primarily due to higher brand and marketing expenses of $5.3 million, additional professional fees of $3.9 million, and an increase of $2.8 million resulting from a gain that was recognized in the prior year related to the restructuring plan initiated in June 2020. The increase was partially offset by $5.7 million in lower personnel-related expenses due to lower variable compensation, partially offset by increased headcount and stock-based compensation.
General and Administrative
Fiscal Year Ended
Change from Prior Fiscal Year
October 1,2022
October 2,2021
$
%
(Dollars in thousands)
General and administrative
$
170,429
$
152,828
$
17,601
11.5
%
Percentage of revenue
9.7
%
8.9
%
General and administrative expenses increased $17.6 million, or 11.5%, in fiscal 2022 compared to fiscal 2021. The increase was primarily driven by $11.6 million in personnel-related expenses due to increased headcount and stock-based compensation, offset by lower variable compensation. The increase was also driven by $8.4 million primarily related to our investments in information technology, including replacing our legacy enterprise resource planning system, offset by a $3.6 million decrease in legal fees, including legal fees incurred in connection with our IP litigation.
Other Income (Expense), Net
Fiscal Year Ended
Change from Prior Fiscal Year
October 1,2022
October 2,2021
$
%
(Dollars in thousands)
Interest income
$
1,655
$
146
$
1,509
Interest expense
$
552
$
592
$
(40
)
(6.8
)%
Other income (expense), net
$
(21,905
)
$
2,407
$
(24,312
)
38
Interest income increased by $1.5 million, in fiscal 2022 compared to fiscal 2021, due to higher yields earned on our cash and cash equivalents during fiscal 2022. Other income (expense), net decreased from other income of $2.4 million for fiscal 2021 to other expense of $21.9 million for fiscal 2022, due to foreign currency exchange losses.
Provision for (Benefit From) Income Taxes
Fiscal Year Ended
Change from Prior Fiscal Year
October 1,2022
October 2,2021
$
%
(Dollars in thousands)
Provision for (benefit from) income taxes
$
1,347
$
(1,670
)
$
3,017
-180.7
%
The provision for income taxes increased from a benefit from income taxes of $1.7 million for fiscal 2021 to a provision for income taxes of $1.3 million for fiscal 2022. For fiscal 2022, we recorded a $2.3 million provision for non-U.S. entities and a benefit of $1.0 million for the U.S. entity, resulting in a total provision for income tax of $1.3 million. The most significant factors impacting the fiscal 2022 provision include a benefit of $7.3 million for the release of valuation allowances in certain foreign jurisdictions and a provision of $5.2 million for the revaluation of certain foreign deferred tax assets. For fiscal 2021, we recorded a benefit of $2.1 million for non-U.S. entities and a provision of $0.4 million for the U.S. entity, resulting in a total tax benefit of $1.7 million. The benefit from income taxes for the year ended October 2, 2021, includes a benefit of $7.8 million from the release of the valuation allowance in the Netherlands offset by the provision for income taxes recognized on current year earnings.
Comparison of Fiscal Years 2021 and 2020
For the comparison of fiscal years 2021 and 2020, refer to Part II, Item 7 "Management's discussion and analysis of financial condition and results of operations" on Form 10-K for our fiscal year ended October 2, 2021, filed with the SEC on November 22, 2021, under the subheading "Comparison of fiscal years 2021 and 2020."
Liquidity and Capital Resources
Our operations are financed primarily through cash flows from operating activities and net proceeds from the sale of our equity securities. As of October 1, 2022, our principal sources of liquidity consisted of cash flows from operating activities, cash and cash equivalents of $274.9 million, including $65.6 million held by our foreign subsidiaries, proceeds from the exercise of stock options and borrowing capacity under the Credit Facility. In accordance with our policy, the undistributed earnings of our non-U.S. subsidiaries remain indefinitely reinvested outside of the United States as of October 1, 2022, as they are required to fund needs outside of the United States. In the event funds from foreign operations are needed to fund operations in the United States and if U.S. tax has not already been previously provided, we may be required to accrue and pay additional U.S. taxes to repatriate these funds.
We believe our existing cash and cash equivalent balances, cash flows from operations and committed credit lines will be sufficient to meet our long-term working capital and capital expenditure needs for at least the next 12 months. In October 2021, we entered into a credit agreement with JPMorgan Chase Bank, N.A., Bank of America N.A., Morgan Stanley Senior Funding, Inc., and Goldman Sachs Bank USA (the "Revolving Credit Agreement"), which allows us to borrow up to $100 million, with a maturity date of October 2026. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenue growth, the timing and extent of spending on research and development efforts and other business initiatives, our planned sales and marketing activities, the timing of new product introductions, our potential merger and acquisition activity, market acceptance of our products, and overall economic conditions. To the extent that current and anticipated sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in increased dilution to our stockholders. If we were to incur additional debt financing it would result in increased debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations.
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Debt Obligations
On October 13, 2021, we entered into the Revolving Credit Agreement, which replaced our prior $80.0 million credit facility with JPMorgan Chase Bank, N.A., which matured in October 2021, in its entirety.
The Revolving Credit Agreement provides for (i) a five-year senior secured revolving credit facility in the amount of up to $100.0 million and (ii) an uncommitted incremental facility subject to certain conditions. Proceeds are to be used for working capital and general corporate purposes. The facility may be drawn as an Alternative Base Rate Loan (at 1.00% plus an applicable margin) or Eurocurrency Loans (at the London interbank offered rate ("LIBOR") plus an applicable margin). We must also pay (i) an unused commitment fee ranging from 0.200% to 0.275% per annum of the average daily unused portion of the aggregate revolving credit commitment under the agreement and (ii) a per annum fee equal to the applicable margin over LIBOR multiplied by the aggregate face amount of outstanding letters of credit. As of October 1, 2022, we did not have any outstanding borrowings and $3.0 million in undrawn letters of credit that reduce the availability under the Revolving Credit Agreement.
Our obligations under the Revolving Credit Agreement are secured by substantially all of our assets. The Revolving Credit Agreement contains customary representations and warranties, customary affirmative and negative covenants, a financial covenant that is tested quarterly and requires us to maintain a certain consolidated leverage ratio, and customary events of default. As of October 1, 2022, we were in compliance with all financial covenants under the Revolving Credit Agreement.
Cash Flows
Fiscal 2022 Changes in Cash Flows
The following table summarizes our cash flows for the periods indicated:
Fiscal Year Ended
October 1,2022
October 2,2021
(In thousands)
Net cash provided by (used in):
Operating activities
$
(28,260
)
$
253,226
Investing activities
(172,632
)
(45,531
)
Financing activities
(150,260
)
24,967
Effect of exchange rate changes
(14,094
)
148
Net increase in cash, cash equivalents and restricted cash
$
(365,246
)
$
232,810
Cash Flows from Operating Activities
Net cash used in operating activities of $28.3 million for fiscal 2022 consisted of net income of $67.4 million, non-cash adjustments of $134.4 million and a net decrease in cash related to changes in operating assets and liabilities of $230.0 million. Non-cash adjustments primarily consisted of stock-based compensation expense of $75.6 million and depreciation and amortization of $38.5 million. The net decrease in net operating assets and liabilities was primarily due to an increase in inventories of $277.5 million due to the recovery of supply for certain products, as well as higher inventory balances in preparation for the holiday season, a decrease in accrued compensation of $52.9 million due to a decrease in accrued variable compensation, an increase in other assets of $16.6 million related to capitalized costs related to the replacement of our legacy enterprise resource management system, a decrease in other liabilities of $5.5 million, and an increase in accounts receivable of $5.5 million. The decrease in net operating assets and liabilities was partially offset by an increase in accounts payable and accrued expenses of $129.7 million primarily related to an increase in accrued inventory payments.
Cash Flows from Investing Activities
Cash used in investing activities for fiscal 2022 of $172.6 million consisted primarily of payments for acquisitions, net of acquired cash of $126.4 million, as well as purchases of property and equipment and intangible assets of $46.2 million, which were primarily related to manufacturing-related tooling and test equipment to support the launch of new products, as well as purchased intangible assets.
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Cash Flows from Financing Activities
Cash used in financing activities for fiscal 2022 of $150.3 million consisted primarily of payments for repurchases of common stock of $150.1 million, payments for repurchases of common stock related to shares withheld for tax in connection with vesting of RSUs of $39.7 million, as well as payments for debt issuance costs of $0.9 million, offset by proceeds from the exercise of stock options of $40.4 million.
Fiscal 2021 Changes in Cash Flows
For the comparison of fiscal 2021 to fiscal 2020, refer to Part II, Item 7 "Management's discussion and analysis of financial condition and results of operations" of our Form 10-K for our fiscal year ended October 2, 2021, filed with the SEC on November 22, 2021, under the subheading "Liquidity and capital resources."
Contractual obligations
See Note 6. Leases and Note 13. Commitments and Contingencies of the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for further details.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates.
Our critical accounting policies requiring estimates, assumptions and judgments that we believe have the most significant impact on our consolidated financial statements are described below.
Revenue Recognition
Revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. We generally enter into contracts that include a combination of products and services. Revenue is allocated to distinct performance obligations and is recognized net of allowances for returns, discounts, sales incentives and any taxes collected from customers, which are subsequently remitted to governmental authorities. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of revenue. We do not have material assets related to incremental costs to obtain or fulfill customer contracts.
Nature of Products and Services
Our product revenue primarily includes sales of Sonos speakers and Sonos system products, which include software that enables our products to operate over a customer's wireless network as well as connect to various third-party services, including music and voice. We also generate a small portion of revenue from partner products and other revenue sources, such as module revenue from our IKEA partnership, architectural speakers from our Sonance partnership, and accessories such as speaker stands and wall mounts, as well as professional services, licensing and advertising revenue. Module revenue comprises hardware and embedded software that is integrated into final products that are manufactured and sold by our partners. Our software primarily consists of firmware embedded in the products and the Sonos app, which is software that can be downloaded to consumer devices at no charge, with or without the purchase of one of our products. Products and related software are accounted for as a single performance obligation and all intended functionality is available to the customer upon purchase. The revenue allocated to the products and related software is the substantial portion of the total sale price. Revenue is recognized at the point in time when control is transferred, which is either upon shipment or upon delivery to the customer, depending on delivery terms.
Our service revenue includes revenue allocated to (i) unspecified software upgrades and (ii) cloud-based services that enable products to access third-party music and voice assistant platforms, which are each distinct performance obligations and are provided to customers at no additional charge. Unspecified software upgrades are provided on a when-and-if-available basis and have historically included updates and enhancements such as bug fixes, feature enhancements and updates to the ability to connect to third-party music or voice assistant platforms. Service revenue is recognized ratably over the estimated service period.
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Significant Judgments
Our contracts with customers generally contain promises to transfer products and services as described above. Determining whether products and services are considered distinct performance obligations that should be accounted for separately may require significant judgment.
Determining the standalone selling price ("SSP") for each distinct performance obligation requires judgment. We estimate SSP for items that are not sold separately, which include the products and related software, unspecified software upgrades and cloud services, using information that may include competitive pricing information, where available, as well as analysis of the cost of providing the products or services plus a reasonable margin. In developing SSP estimates, we also consider the nature of the products and services and the expected level of future services.
Determining the revenue recognition period for unspecified software upgrades and cloud services requires judgment. We recognize revenue attributable to these performance obligations ratably over the best estimate of the period that the customer is expected to receive the services. In developing the estimated period of providing future services, we consider our past history, our plans to continue to provide services, including plans to continue to support updates and enhancements to prior versions of our products, expected technological developments, obsolescence, competition and other factors. The estimated service period may change in the future in response to competition, technology developments and our business strategy.
Estimating variable consideration such as sales incentives and product returns requires judgment. We offer sales incentives through various programs, consisting primarily of discounts, cooperative advertising and market development fund programs. We record transactions related to cooperative advertising and market development fund programs with customers as a reduction to revenue unless we receive a distinct benefit in exchange for credits claimed by the customer and can reasonably estimate the fair value of the benefit received, in which case we record them as operating expenses. We recognize a liability, or a reduction to accounts receivable, and reduce revenue for sales incentives based on the estimated amount of sales incentives that will be claimed by customers. Estimates for sales incentives are developed using the most likely amount and are included in the transaction price to the extent that a significant reversal of revenue would not result once the uncertainty is resolved. In developing our estimates, we also consider the susceptibility of the incentive to outside influences, the length of time until the uncertainty is resolved, our experience with similar contracts, and the range of possible outcomes. Reductions in revenue related to discounts are allocated to products and services on a relative basis based on their respective SSP. Judgment is required to determine the timing and amount of recognition of marketing funds, which we estimate based on past practice of providing similar funds.
We accept returns from direct customers and from certain resellers. To establish an estimate for returns, we use the expected value method by considering a portfolio of contracts with similar characteristics to calculate the historical returns rate. When determining the expected value of returns, we consider future business initiatives and relevant anticipated future events.
Inventories
Inventories consist of finished goods and component parts, which are purchased from contract manufacturers and component suppliers. Inventories are stated at the lower of cost and net realizable value. Cost is determined using a standard costing method, which approximates first-in first-out. We assess the valuation of inventory balances including an assessment to determine potential excess and/or obsolete inventory. We may be required to write down the value of inventory if estimates of future demand and market conditions indicate estimated excess and/or obsolete inventory. We may be required to write down the value of inventory if estimates of future demand and market conditions indicate excess and/or obsolete inventory. Inventory write-downs and losses on purchase commitments are recorded as a component of cost of revenue in the consolidated statement of operations and comprehensive income (loss).
Business Combinations
We use the acquisition method of accounting for business combinations and recognize assets acquired and liabilities assumed measured at their fair values on the date acquired. Goodwill is measured as of the acquisition date as the excess of consideration transferred over the net acquisition date fair value of the assets acquired and the liabilities assumed. These estimates are inherently uncertain and subject to refinement. During the measurement period, which may be up to one year from the acquisition date, adjustments to the fair value of these tangible and intangible assets acquired and liabilities assumed may be recorded, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired and liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations and comprehensive income (loss).
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Product Warranties
Our products are covered by a warranty to be free from defects in material and workmanship for a period of one year, except for products sold in the EU and select other countries where we provide a minimum two-year warranty, depending on the region, on all our products. At the time of sale, an estimate of future warranty costs is recorded as a component of the cost of revenue. Our estimate of costs to fulfill our warranty obligations is based on historical experience and expectations of future costs to repair or replace.
Income Taxes
Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect our best estimate of current and future taxes to be paid. Significant judgments and estimates are required in the determination of the consolidated income tax expense.
We prepare and file income tax returns based on our interpretation of each jurisdiction's tax laws and regulations. In preparing our consolidated financial statements, we estimate our income tax liability in each of the jurisdictions in which we operate by estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. Significant management judgment is required in assessing the realizability of our deferred tax assets. In performing this assessment, we consider whether it is "more-likely-than-not" that some portion or all the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making this determination, we consider the scheduled reversal of deferred tax liabilities, projected future taxable income and the effects of tax planning strategies. We recorded a valuation allowance against all our U.S. deferred tax assets and certain of our foreign deferred tax assets as of October 1, 2022. We intend to continue maintaining a full valuation allowance on our U.S. and certain foreign deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances.
We account for uncertain tax positions using a "more-likely-than-not" threshold for recognizing and resolving uncertain tax positions. We evaluate uncertain tax positions on a quarterly basis and consider various factors, that include, but are not limited to, changes in tax law, the measurement of tax positions taken or expected to be taken in tax returns, the effective settlement of matters subject to audit, information obtained during in process audit activities and changes in facts or circumstances related to a tax position. We accrue for potential interest and penalties related to unrecognized tax benefits in income tax expense.
Our policy with respect to the undistributed earnings of our non-U.S. subsidiaries is to maintain an indefinite reinvestment assertion as they are required to fund needs outside of the United States. This assertion is made on a jurisdiction by jurisdiction basis and takes into account the liquidity requirements in both the United States and of our foreign subsidiaries.