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 2023 are to our 52-week fiscal year ended September 30, 2023, 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 and 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.
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, advertising, and subscription 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
In March 2023, we executed the successful launch of two new products simultaneously - Era 100 and Era 300, our next generation of smart speakers. We also entered our new category with the introduction of Sonos Pro, our new audio subscription service for businesses. In September 2023, we launched Move 2, our new and improved premium portable all-in-one speaker, which we are confident is the best on the market. Notwithstanding the success of these products, our fiscal 2023 results were impacted by the near term industry-wide macroeconomic pressures we have flagged throughout fiscal 2023, and our fiscal 2023 results were adversely affected by a tightening of inventory in our installer solutions channel and by our retail partners, as well as demand softening in the later part of the year.
During fiscal 2023, we saw improvements in our supply chain, including recovery of supply for our products, decreased spot market component costs, and decreased shipping and logistics costs compared to the prior year. This improvement was partially offset by inventory write-downs for component inventory for purchases we committed to in response to industry-wide supply constraints resulting from the impact of the COVID-19 pandemic. In fiscal 2023, we began the process of exiting certain partnerships with two of our contract manufacturers and we expect to complete these exits with minimal disruption by the first quarter of fiscal 2024. We also added to our diversified contract manufacturing partnerships and shifted more of our production into our new contract manufacturing locations in Malaysia and Vietnam, resulting in savings from tariff avoidance.
In June 2023, in response to the softening of underlying demand trends we observed in the prior quarter resulting from industry-wide macroeconomic pressures, we initiated a restructuring plan to reduce our cost base (the "2023 restructuring plan"). The 2023 restructuring plan included a reduction in force involving approximately 7% of our employees, a further reduction of our real estate footprint, and a re-evaluation of certain program spend. Restructuring and abandonment costs under the 2023 restructuring plan were $11.4 million, substantially all of which were incurred in the third quarter of fiscal 2023. Additionally, in March 2023, in support of
operational efficiencies, we abandoned portions of our office spaces for the remainder of their respective lease terms resulting in non-recurring abandonment charges of $4.8 million.
We have considered the impacts of these recent developments based on information currently available when developing our estimates and assumptions. Actual results and outcomes may differ from our estimates and assumptions. For additional information of risks related to our business, refer to Part II, 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 and adjusted EBITDA margin are net income (loss) and net income (loss) margin, respectively.
Fiscal Year Ended
September 30,2023
October 1,2022
October 2,2021
(In thousands, except percentages)
Revenue
$
1,655,255
$
1,752,336
$
1,716,744
Products sold
5,725
6,281
6,503
Net income (loss)
(10,274
)
67,383
158,595
Net income (loss) margin(1)
(0.6
)%
3.8
%
9.2
%
Adjusted EBITDA(2)
$
153,878
$
226,549
$
278,585
Adjusted EBITDA margin(2)
9.3
%
12.9
%
16.2
%
(1)Net income (loss) margin is calculated by dividing net income (loss) by revenue.
(2)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 and net income (loss) margin to adjusted EBITDA margin.
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.
31
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.
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 2023, 2022, and 2021, and the consolidated balance sheet data as of September 30, 2023, and October 1, 2022, 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 2020, and 2019, and the consolidated balance sheet data as of October 2, 2021, October 3, 2020, and September 28,
32
2019, 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
September 30,2023
October 1,2022
October 2,2021
October 3,2020
September 28,2019
(In thousands, except share and per share amounts and percentages)
Revenue
$
1,655,255
$
1,752,336
$
1,716,744
$
1,326,328
$
1,260,823
Cost of revenue (1)
938,765
955,969
906,750
754,372
733,480
Gross profit
716,490
796,367
809,994
571,956
527,343
Operating expenses
Research and development (1)
301,001
256,073
230,078
214,672
171,174
Sales and marketing (1)
267,518
280,333
272,124
263,539
247,599
General and administrative (1)
168,518
170,429
152,828
120,978
102,871
Total operating expenses
737,037
706,835
655,030
599,189
521,644
Operating income (loss)
(20,547
)
89,532
154,964
(27,233
)
5,699
Other income (expense), net
Interest income
10,201
1,655
146
1,998
4,349
Interest expense
(733
)
(552
)
(592
)
(1,487
)
(2,499
)
Other income (expense), net
15,473
(21,905
)
2,407
6,639
(8,625
)
Total other income (expense), net
24,941
(20,802
)
1,961
7,150
(6,775
)
Income (loss) before provision for (benefit from) income taxes
4,394
68,730
156,925
(20,083
)
(1,076
)
Provision for (benefit from) income taxes
14,668
1,347
(1,670
)
32
3,690
Net income (loss)
$
(10,274
)
$
67,383
$
158,595
$
(20,115
)
$
(4,766
)
Net income (loss) per share attributable to common stockholders:⁽²⁾
Basic
$
(0.08
)
$
0.53
$
1.30
$
(0.18
)
$
(0.05
)
Diluted
$
(0.08
)
$
0.49
$
1.13
$
(0.18
)
$
(0.05
)
Weighted-average shares used in computing net income (loss) per share attributable to common stockholders:⁽²⁾
Basic
127,702,885
127,691,030
122,245,212
109,807,154
103,783,006
Diluted
127,702,885
137,762,078
140,309,152
109,807,154
103,783,006
Other Data:
Products sold(4)
5,725
6,281
6,503
5,806
6,204
Adjusted EBITDA (3)
$
153,878
$
226,549
$
278,585
$
108,543
$
88,689
Net income (loss) margin
(0.6
)%
3.8
%
9.2
%
(1.5
)%
(0.4
)%
Adjusted EBITDA margin (3)
9.3
%
12.9
%
16.2
%
8.2
%
7.0
%
(1)Stock-based compensation was allocated as follows:
Fiscal Year Ended
September 30,2023
October 1,2022
October 2,2021
October 3,2020
September 28,2019
(In thousands)
Cost of revenue
$
2,038
$
1,620
$
988
$
1,106
$
985
Research and development
35,530
30,724
25,075
23,439
17,643
Sales and marketing
15,677
15,335
13,570
14,359
12,965
General and administrative
23,612
27,961
22,494
18,706
14,982
Total stock-based compensation expense
$
76,857
$
75,640
$
62,127
$
57,610
$
46,575
(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.
33
(4)Products sold for the fiscal 2019 has been recast to reflect the change in product revenue categorization.
As of
September 30,2023
October 1,2022
October 2,2021
October 3,2020
September 28,2019
(In thousands)
Consolidated balance sheet data:
Cash and cash equivalents
$
220,231
$
274,855
$
640,101
$
407,100
$
338,641
Working capital
305,413
331,752
481,384
267,362
276,635
Total assets
1,002,241
1,188,388
1,138,804
816,051
761,605
Total long-term debt
18,251
24,840
Total liabilities
483,584
627,875
569,762
518,212
480,677
Accumulated deficit
(12,788
)
(2,514
)
(69,897
)
(228,492
)
(208,377
)
Total stockholders' equity
518,657
560,513
569,042
297,839
280,928
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 and amortization, 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.
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 net income (loss) 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.
34
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
September 30,2023
October 1,2022
October 2,2021
October 3,2020
September 28,2019
(In thousands, except percentages)
Net income (loss)
$
(10,274
)
$
67,383
$
158,595
$
(20,115
)
$
(4,766
)
Add (deduct):
Depreciation and amortization
48,969
38,504
33,882
36,426
36,415
Stock-based compensation expense
76,857
75,640
62,127
57,610
46,575
Interest income
(10,201
)
(1,655
)
(146
)
(1,998
)
(4,349
)
Interest expense
733
552
592
1,487
2,499
Other (income) expense, net
(15,473
)
21,905
(2,407
)
(6,639
)
8,625
Provision for (benefit from) income taxes
14,668
1,347
(1,670
)
32
3,690
Legal and transaction related costs (1)
32,950
22,873
30,058
15,455
Restructuring, abandonment, and related expenses(2)
15,649
(2,446
)
26,285
Adjusted EBITDA
$
153,878
$
226,549
$
278,585
$
108,543
$
88,689
Revenue
1,655,255
1,752,336
1,716,744
1,326,328
1,260,823
Net income (loss) margin
(0.6
)%
3.8
%
9.2
%
(1.5
)%
(0.4
)%
Adjusted EBITDA margin
9.3
%
12.9
%
16.2
%
8.2
%
7.0
%
(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.
(2)Restructuring, abandonment, and related expenses for fiscal 2023 include $4.8 million of non-recurring lease abandonment charges that were incurred in March 2023, when we abandoned portions of our office spaces for the remainder of their respective lease terms in support of operational efficiencies. See Note 14. Restructuring Plan of the notes to our consolidated financial statement for further discussion related to our 2023 restructuring plan.
35
Comparison of Fiscal Years 2023 and 2022
Revenue
Fiscal Year Ended
Change from Prior Fiscal Year
September 30,2023
October 1,2022
$
%
(Dollars in thousands)
Sonos speakers
$
1,293,440
$
1,368,916
$
(75,476
)
(5.5
)%
Sonos system products
285,064
297,110
(12,046
)
(4.1
)
Partner products and other revenue
76,751
86,310
(9,559
)
(11.1
)
Total revenue
$
1,655,255
$
1,752,336
$
(97,081
)
(5.5
)%
Volume data (products sold in thousands)
Units
%
Total products sold
5,725
6,281
(556
)
(8.9
)%
Total revenue decreased $97.1 million, or 5.5%, for fiscal 2023, compared to fiscal 2022. The decrease was mainly driven by reduced orders from retail and installer solutions partners as they tightened channel inventory positions, as well as demand softening in the later part of the year and the unfavorable impact of foreign exchange rates. These impacts were further exacerbated by an unfavorable comparison to fiscal 2022, during which we experienced significant fulfillment of backorders as supply began to improve following a long period of supply constraints. The overall decrease was partially offset by the strong performance of our new product introductions.
Sonos speakers revenue represented 78.1% of total revenue for fiscal 2023. The category decreased 5.5% compared to fiscal 2022, driven by expected declines in sales of Sonos One as we introduced the next generation of this product (Era 100), as well as Roam demand softness, partially offset by the strong performance of Sub Mini which was introduced in October 2022, and Era 300 and Era 100 which were introduced in March 2023. Sonos system products represented 17.2% of total revenue for fiscal 2023, and decreased 4.1% compared to the fiscal 2022, primarily due to our installer solutions channel partners tightening inventory of products in this category during the first half of the year, partially offset by the favorability due to the impact of the severely supply-constrained prior year. Partner products and other revenue represented 4.6% of total revenue for fiscal 2023, and decreased 11.1% compared to fiscal 2022. The decline was driven by a decrease in orders of our partner products.
The volume of products sold decreased 8.9% for fiscal 2023, compared to fiscal 2022, driven by unit decreases across all categories. The rate of decrease of volume of products sold was larger than the rate of decrease of revenue for fiscal 2023, compared to fiscal 2022, primarily due to large decreases in products with lower selling prices which contributed a smaller corresponding decrease in revenue.
Revenue by Region
Fiscal Year Ended
Change from Prior Fiscal Year
September 30,2023
October 1,2022
$
%
Constant Currency Change
(Dollars in thousands)
Americas
$
1,048,245
$
1,044,113
$
4,132
0.4
%
1.5
%
EMEA
518,179
578,034
(59,855
)
(10.4
)
(6.8
)
APAC
88,831
130,189
(41,358
)
(31.8
)
(25.8
)
Total revenue
$
1,655,255
$
1,752,336
$
(97,081
)
(5.5
)%
(3.3
)%
In constant currency U.S. dollars, total revenue decreased 3.3% for the twelve months ended September 30, 2023, compared to the twelve months ended October 1, 2022. We calculate constant currency growth percentages by translating our current period financial results using the prior period average currency exchange rates and comparing these amounts to our prior period reported results.
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Cost of Revenue and Gross Profit
Fiscal Year Ended
Change from Prior Fiscal Year
September 30,2023
October 1,2022
$
%
(Dollars in thousands)
Cost of revenue
$
938,765
$
955,969
$
(17,204
)
(1.8
)%
Percentage of revenue
56.7
%
54.6
%
Gross profit
$
716,490
$
796,367
$
(79,877
)
(10.0
)%
Gross margin
43.3
%
45.4
%
Cost of revenue decreased $17.2 million, or 1.8%, for fiscal 2023, compared to fiscal 2022, primarily due to decreased volume of products sold, lower shipping and logistics costs related to the improvement in industry-wide supply chain dynamics compared to the prior year, and decreased spot market component costs due to the normalization of the supply chain. The decrease was partially offset by the impact of product mix related to selling more products with higher costs per unit, higher general component costs, and higher inventory-related write-downs.
Gross margin decreased 216 basis points for fiscal 2023, compared to fiscal 2022. The decrease was primarily due to higher promotional activity, higher general component costs, the unfavorable impact of foreign exchange rates, and higher inventory-related write-downs. The overall decrease was partially offset by lower shipping and logistics costs, the impact of planned selling price increases and decreased spot market component costs due to the normalization of the supply chain.
Research and Development
Fiscal Year Ended
Change from Prior Fiscal Year
September 30,2023
October 1,2022
$
%
(Dollars in thousands)
Research and development
$
294,445
$
256,073
$
38,372
15.0
%
Restructuring and abandonment costs
6,556
6,556
Total research and development
$
301,001
$
256,073
$
44,928
17.5
%
Percentage of revenue
18.2
%
14.6
%
Research and development expenses increased $44.9 million, or 17.5%, for fiscal 2023, compared to fiscal 2022. This increase was primarily driven by $40.4 million of higher personnel-related expenses, stock-based compensation and overhead driven by increased headcount related to our continued execution on our product roadmap and category expansion, and the impact of $6.6 million of restructuring and abandonment costs resulting from the 2023 restructuring plan.
Sales and Marketing
Fiscal Year Ended
Change from Prior Fiscal Year
September 30,2023
October 1,2022
$
%
(Dollars in thousands)
Sales and marketing
$
261,883
$
280,333
$
(18,450
)
(6.6
)%
Restructuring and abandonment costs
5,635
5,635
Total sales and marketing
$
267,518
$
280,333
$
(12,815
)
(4.6
)%
Percentage of revenue
16.2
%
16.0
%
Sales and marketing expenses decreased $12.8 million, or 4.6%, for fiscal 2023, compared to fiscal 2022. This decrease was primarily driven by lower marketing expenses of $28.0 million partially offset by an increase of $6.3 million in personnel-related expenses, stock-based compensation and overhead due to increased headcount, as well as $5.6 million of restructuring and abandonment costs resulting from the 2023 restructuring plan.
37
General and Administrative
Fiscal Year Ended
Change from Prior Fiscal Year
September 30,2023
October 1,2022
$
%
(Dollars in thousands)
General and administrative
$
165,060
$
170,429
$
(5,369
)
(3.2
)%
Restructuring and abandonment costs
3,458
3,458
Total general and administrative
$
168,518
$
170,429
$
(1,911
)
(1.1
)%
Percentage of revenue
10.2
%
9.7
%
General and administrative expenses decreased $1.9 million, or 1.1%, for fiscal 2023, compared to fiscal 2022. The decrease was mainly due to $14.9 million of decreased stock-based compensation expense and lower overhead costs, partially offset by $11.6 million legal fees incurred in connection with our IP litigation, and the impact of $3.5 million of restructuring and abandonment costs resulting from the 2023 restructuring plan.
Other Income (Expense), Net
Fiscal Year Ended
Change from Prior Fiscal Year
September 30,2023
October 1,2022
$
%
(Dollars in thousands)
Interest income
$
10,201
$
1,655
$
8,546
Interest expense
(733
)
(552
)
(181
)
32.80
%
Other income (expense), net
15,473
(21,905
)
37,378
Total other income (expense), net
$
24,941
$
(20,802
)
$
45,743
Interest income for fiscal 2023, compared to fiscal 2022, increased due to higher yields on our cash and cash equivalents. Interest expense for fiscal 2023, compared to fiscal 2022, increased primarily due to expenses associated with amending our Revolving Credit Agreement. The increase in other income (expense), net for fiscal 2023, compared to fiscal 2022, was primarily due to foreign currency exchange gains. These gains stem from the remeasurement of monetary assets and liabilities denominated in non-functional currencies, and were driven notably by the strengthening of the euro.
Provision for Income Taxes
Fiscal Year Ended
Change from Prior Fiscal Year
September 30,2023
October 1,2022
$
%
(Dollars in thousands)
Provision for income taxes
$
14,668
$
1,347
$
13,321
For the fiscal year ended September 30, 2023, our U.S. tax expense was adversely impacted by the requirement to capitalize and amortize research and development expenses under Section 174 of the U.S. Internal Revenue Code ("Section 174") as we recorded a U.S. current tax expense with no corresponding deferred tax benefit due to the valuation allowance maintained against our U.S. deferred tax assets.
Comparison of Fiscal Years 2022 and 2021
For the comparison of fiscal years 2022 and 2021, 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 1, 2022, filed with the SEC on November 23, 2022, under the subheading "Comparison of fiscal years 2022 and 2021."
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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 September 30, 2023, our principal sources of liquidity consisted of cash flows from operating activities, cash and cash equivalents of $220.2 million, including $44.5 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 September 30, 2023, 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. We hold our cash with a diverse group of major financial institutions and have processes and safeguards in place to manage our cash balances and mitigate the risk of loss. 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.
Debt Obligations
On October 13, 2021, we entered into the Revolving Credit Agreement. 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. In June 2023, we amended our Revolving Credit Agreement to change the reference rate from LIBOR to the Secured Overnight Financing Rate ("SOFR"), effective July 1, 2023. The facility may be drawn as an Alternative Base Rate Loan (at 1.00% plus an applicable margin) or Term Benchmark Loan (SOFR 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 SOFR multiplied by the aggregate face amount of outstanding letters of credit. As of September 30, 2023, we did not have any outstanding borrowings and $1.8 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 September 30, 2023, we were in compliance with all financial covenants under the Revolving Credit Agreement.
Cash Flows
Fiscal 2023 Changes in Cash Flows
The following table summarizes our cash flows for the periods indicated:
Fiscal Year Ended
September 30,2023
October 1,2022
(In thousands)
Net cash provided by (used in):
Operating activities
$
100,406
$
(28,260
)
Investing activities
(50,286
)
(172,632
)
Financing activities
(108,592
)
(150,260
)
Effect of exchange rate changes
3,848
(14,094
)
Net decrease in cash, cash equivalents and restricted cash
$
(54,624
)
$
(365,246
)
39
Cash Flows from Operating Activities
Net cash provided by operating activities of $100.4 million for fiscal 2023 consisted of net loss of $10.3 million, non-cash adjustments of $149.6 million and a net decrease in cash related to changes in operating assets and liabilities of $38.9 million. Non-cash adjustments primarily consisted of stock-based compensation expense of $76.9 million, depreciation and amortization of $49.0 million, provision for inventory obsolescence of $20.6 million, restructuring and abandonment charges of $5.5 million, and other adjustments of $5.5 million, partially offset by foreign currency transaction gains of $7.3 million. The net decrease in net operating assets and liabilities was primarily due to a decreases in accounts payable and accrued expenses of $162.3 million due to lower inventory purchases, a decrease in deferred revenue of $4.6 million, and a decrease in accrued compensation of $2.2 million due to lower accrued variable compensation. The net decrease in cash from the change in operating assets and liabilities was partially offset by lower inventory balances of $87.0 million as a result of improved inventory management, a decrease in accounts receivable of $32.1 million, and a decrease in other assets of $10.5 million driven by a decrease in prepaid expenses.
Cash Flows from Investing Activities
Cash used in investing activities for fiscal 2023 of $50.3 million consisted primarily of purchases of property and equipment mainly related to point-of-sale product displays and manufacturing-related tooling and test equipment to support the launch of new products.
Cash Flows from Financing Activities
Cash used in financing activities for fiscal 2023 of $108.6 million consisted primarily of payments for repurchase of common stock of $100.1 million, payments for repurchase of common stock related to shares withheld for tax in connection with vesting of RSUs of $29.9 million, partially offset by proceeds from exercise of common stock options of $21.3 million.
Fiscal 2022 Changes in Cash Flows
For the comparison of fiscal 2022 to fiscal 2021, 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 1, 2022, filed with the SEC on November 23, 2022, under the subheading "Liquidity and capital resources."
Contractual obligations
See Note 6. Leases and Note 12. 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
Nature of Products and Services
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, advertising revenue, licensing and subscription revenue such as Sonos Radio HD and Sonos Pro (software-as-a-service).
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Our contracts generally include a combination of products and related software, and services. Products and related software primarily constitute Sonos speakers and Sonos system products and 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. Additionally, module revenue includes hardware and embedded software that is integrated into final products that are manufactured and sold by our partners. 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. Unspecified software upgrades 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.
Performance Obligations
Determining whether products and services are considered distinct performance obligations that should be accounted for separately requires significant judgment. We have determined that products and related software represent a single performance obligation. The basis of our determination is these products are highly dependent on, and interrelated with, the embedded software and cannot function as they are intended without the software.
We determined that unspecified software upgrades represent a separate performance obligation as they occur subsequent to the time of purchase, fulfillment of these promises can be made separately, there are no resulting significant modification or customization to our products, and these services are provided to customers at no additional charge. We have also determined cloud-based services to be a separate performance obligation based as they are additive to our products rather than transformative.
Transaction price
Revenue is recognized at transaction price which is the amount that we expect to receive in exchange for our products and services. Transaction price is calculated as the stated consideration net of variable consideration such as allowances for returns, discounts, sales incentives, and any tax collected from customers. The transaction price is allocated to the separate performance obligations in the contract based on relative standalone selling prices ("SSPs").
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.
We offer sales incentives through various programs, consisting primarily of discounts, cooperative advertising and market development fund programs. Reductions in revenue related to discounts are allocated to products and services on a relative basis based on their respective SSP. Estimates for sales incentives are developed using the most likely amount based on our past experience with similar contracts and are included in the transaction price to the extent that a significant reversal of revenue would not result once the uncertainty is resolved.
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.
A change in contract, future business initiatives, or customer behavior due to macroeconomic conditions could require us to change the above estimates, or if actual results differ significantly from the estimates, we would be required to increase or reduce revenue to reflect the impact.
Revenue Recognition
Revenue is allocated to products and related software, and to unspecified software upgrades and cloud-based services. Revenue allocated to the products and related software is the substantial portion of the total sale price. Revenue for products and related software is recognized at the point in time when control is transferred to the customer, which is either upon shipment or upon delivery to the customer, depending on delivery terms.
Revenue allocated to unspecified software upgrades and cloud-based services is deferred and recognized ratably over our best estimate of the period that the customer is expected to receive the services. Determining the revenue recognition period for unspecified software upgrades and cloud services requires judgment. 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.
41
For fiscal 2023, there has not been any event that would require us to materially change the underlying assumptions of revenue estimates. A hypothetical 10% change to our SSP estimates and/or the estimated recognition period for unspecified software upgrades and cloud-based services, would not result in a material change to our fiscal 2023 revenue.
Inventories
Inventory consists of finished goods and component parts, which we purchase from contract manufacturers and component suppliers. We record and value our inventory at the lower-of-cost and net realizable value. We determine cost using a standard costing method, which approximates first-in first-out. On a quarterly basis, we assess the value of our inventory on hand and non-cancelable purchase commitments for potential excess and/or obsolete inventory and will periodically write down the value to account for estimated excess and/or obsolete inventory. We determine excess or obsolete inventory based on market conditions, age/condition of inventory, an estimate of the future demand for our products within a specified time horizon, generally the shorter of 24 months or remaining life of the product, and product life cycle status. Inventory write-downs and losses on purchase commitments are recorded as a component of cost of revenue in our consolidated statement of operations and comprehensive income (loss). If actual demand is lower than our forecasted demand, we could be required to write down the value of additional inventory, which would have a negative effect on our gross profit. A hypothetical 10% change to our inventory reserves percentages would not result in a material change to our fiscal 2023 cost of revenue.
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 September 30, 2023. 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. Changes in the recognition or measurement of uncertain tax positions could result in material increases or decreases in our income tax expense in the period in which we make the change, which could have a material impact on our effective tax rate and operating results.
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.