Table of contents
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read 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 2024 are to our 52-week fiscal year ended September 28, 2024, 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 and references to fiscal 2021 are to our 52-week fiscal year ended October 2, 2021.
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 operational and 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 28,2024September 30,2023October 1,2022
(In thousands, except percentages)
Revenue$1,518,056 $1,655,255 $1,752,336
Products sold5,000 5,725 6,281
Net income (loss)(38,146)(10,274)67,383
Net income (loss) margin(1)
(2.5)%(0.6)%3.8 %
Adjusted EBITDA(2)
$107,862 $153,878 $226,549
Adjusted EBITDA margin(2)
7.1 %9.3 %12.9 %
(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 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 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 and amortization, 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.
Non-GAAP Financial Measures
To supplement our consolidated financial statements presented in accordance with U.S. GAAP, we monitor and consider Adjusted EBITDA, Adjusted EBITDA margin, and constant currency 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, legal and transaction related costs, restructuring and abandonment costs, 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 also present percentage sales growth in constant currency to show performance unaffected by fluctuations in currency exchange rates. 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.
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.
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.
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The following table presents a reconciliation of net income (loss) to adjusted EBITDA:
Fiscal Year Ended
September 28,2024September 30,2023October 1,2022
(In thousands, except percentages)
Net income (loss)$(38,146)$(10,274)$67,383
Add (deduct):
Depreciation and amortization52,378 48,969 38,504
Stock-based compensation expense84,294 76,857 75,640
Interest income(11,965)(10,201)(1,655)
Interest expense441 733 552
Other (income) expense, net(9,371)(15,473)21,905
Provision for income taxes
10,995 14,668 1,347
Legal and transaction related costs (1)
7,383 32,950 22,873
Restructuring, abandonment, and related expenses(2)
11,853 15,649 -
Adjusted EBITDA$107,862 $153,878 $226,549
Revenue1,518,056 1,655,255 1,752,336
Net income (loss) margin(2.5)%(0.6)%3.8 %
Adjusted EBITDA margin7.1 %9.3 %12.9 %
(1)Legal and transaction-related costs consist of expenses related to our intellectual property ("IP") litigation against Alphabet and Google as well as legal and transaction costs associated with our acquisition activities, which we do not consider representative of our underlying operating performance.
(2)See Note 14. Restructuring Plan of the notes to our consolidated financial statement for further discussion related to our 2024 restructuring plan.
Comparison of Fiscal Years 2024 and 2023
Revenue
Fiscal Year EndedChange from Prior Fiscal Year
September 28, 2024September 30, 2023$
%
(Dollars in thousands)$%$%
Sonos speakers$1,169,604 77.0 %$1,293,440 78.1 %$(123,836)(9.6)%
Sonos system products267,744 17.6 285,064 17.2 (17,320)(6.1)
Partner products and other revenue80,708 5.3 76,751 4.6 3,957 5.2
Total revenue$1,518,056 100.0 %$1,655,255 100.0 %$(137,199)(8.3)%
Volume data (products sold in thousands)Units %
Total products sold5,0005,725(725)(12.7)%
Total revenue decreased $137.2 million, or 8.3% for fiscal 2024 compared to fiscal 2023, primarily due to softer demand across all regions due to market conditions and challenges resulting from our recent app rollout, partially offset by the introduction of Ace in June 2024, and the impact of favorable foreign exchange rates.
Sonos speakers represented 77.0% of total revenue for fiscal 2024 and decreased 9.6% compared to fiscal 2023, primarily driven by expected declines in Sonos One and softer demand across the category, particularly in our home theater products. These declines were partially offset by sales of Era 100 and Era 300 which were introduced in March 2023, and by the introduction of Ace in June 2024. Sonos system products represented 17.6% of total revenue for fiscal 2024 and decreased 6.1% compared fiscal 2023. Partner products and other revenue represented 5.3% of total revenue for fiscal 2024, and increased 5.2% compared to the twelve months ended September 30, 2023.
The volume of products sold decreased 12.7% for fiscal 2024, compared to fiscal 2023, primarily driven by expected declines in units of Sonos One, and softer demand, particularly in our home theater products. These declines were partially offset by sales of Era 100 and Era 300, as well as the introduction of Ace in June 2024. The decrease in volume of products sold outpaced that of revenue due to the impact of product mix.
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Revenue by Region
Fiscal Year EndedChange from Prior Fiscal Year
September 28, 2024September 30, 2023$
%Constant Currency
Change (1)
(Dollars in thousands)
Americas$1,004,770 $1,048,245 $(43,475)(4.1 %)(4.2)%
Europe, Middle East and Africa430,428 518,179 (87,751)(16.9)(19.2)
Asia Pacific82,858 88,831 (5,973)(6.7)(5.5)
Total revenue$1,518,056 $1,655,255 $(137,199)(8.3)%(9.0)%
(1) Constant currency is a financial measure that is not calculated in accordance with U.S. GAAP. For additional information, see the section titled "Non-GAAP Financial Measures" above.
Cost of Revenue and Gross Profit
Fiscal Year Ended
Change from Prior Fiscal Year
September 28, 2024September 30, 2023$
%
(Dollars in thousands)
Cost of revenue
$828,683 $938,765 $(110,082)(11.7)%
Gross profit$689,373 $716,490 $(27,117)(3.8)%
Gross margin45.4 %43.3 %
Cost of revenue consists of product costs, including costs of our contract manufacturers for production, components, shipping and handling, tariffs, duty costs, warranty replacement costs, packaging, fulfillment costs, manufacturing and tooling equipment depreciation, warehousing costs, hosting costs, and excess and obsolete inventory write-downs. It also includes licensing costs, such as royalties to third parties, and attributable amortization of acquired developed technology. In addition, we allocate certain costs related to management and facilities, personnel-related expenses, and supply chain logistic costs. Personnel-related expenses consist of salaries, bonuses, benefits, and stock-based compensation expenses.
Our gross margin has fluctuated and may, in the future, fluctuate from period to period based on a number of factors, including the mix of products we sell, the mix of channels through which we sell our products, fluctuations of our product and material cost saving initiatives, fluctuations in our product and material markets, promotional activity, the foreign currency in which our products are sold, and tariffs and duty costs implemented by governmental authorities.
Cost of revenue and gross profit decreased for fiscal 2024 compared to fiscal 2023, primarily due to a decrease in products sold. Gross margin increased 210 basis points for fiscal 2024 compared to fiscal 2023. The increase was primarily due to a decrease in product and material costs, decreased inventory-related write-downs, and favorability from product mix, partially offset by higher promotional activity.
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Operating Expenses
Fiscal Year Ended
Change from Prior Fiscal Year
September 28, 2024September 30, 2023$%
(Dollars in thousands)
Research and development$298,815 $294,445 $4,370 1.5 %
Restructuring and abandonment costs(1)
5,743 6,556 (813)(12.4)
Total research and development$304,558 $301,001 $3,557 1.2 %
Percentage of revenue20.1 %18.2 %
Sales and marketing$287,839 $261,883 $25,956 9.9 %
Restructuring and abandonment costs(1)
2,770 5,635 (2,865)(50.8)
Total sales and marketing$290,609 $267,518 $23,091 8.6 %
Percentage of revenue19.1 %16.2 %
General and administrative$138,912 $165,060 $(26,148)(15.8)%
Restructuring and abandonment costs(1)
3,340 3,458 (118)(3.4)
Total general and administrative$142,252 $168,518 $(26,266)(15.6)%
Percentage of revenue9.4 %10.2 %
Operating expenses$725,566 $721,388 $4,178 0.6 %
Restructuring and abandonment costs(1)
11,853 15,649 (3,796)(24.3)
Total operating expenses$737,419 $737,037 $382 0.1 %
Percent of revenue48.6 %44.5 %
(1) On August 14, 2024, we initiated a restructuring plan to reduce our cost base (the "2024 restructuring plan"), including a reduction in force involving approximately 6% of our employees. Restructuring and abandonment costs also include nominal remaining costs incurred related to the restructuring plan incurred on June 14, 2023. See Note 14. Restructuring Plan of the notes to our consolidated financial statements for further discussion related to our 2024 restructuring plan.
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.
Research and development expenses increased $3.6 million, or 1.2%, for fiscal 2024 compared to fiscal 2023. This increase was primarily driven by product development program spend.
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.
Sales and marketing expenses increased $23.1 million, or 8.6%, for fiscal 2024 compared to fiscal 2023. This was primarily driven by an increase in our advertising and marketing activity, and an increase in depreciation mainly for our product displays.
General and Administrative
General and administrative expenses consist of administrative personnel-related expenses for our finance, legal, human resources and similar personnel, as well as the costs of professional services, information technology, litigation, patents, related overhead, and other administrative expenses.
General and administrative expenses decreased $26.3 million, or 15.6%, for fiscal 2024 compared to the fiscal 2023. This was primarily driven by a decrease in legal fees related to our IP litigation.
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Interest Income, Interest Expense, and Other Income, Net
Fiscal Year Ended
Change from Prior Fiscal Year
September 28, 2024September 30, 2023$
%
(Dollars in thousands)
Interest income$11,965 $10,201 $1,764 17.3 %
Interest expense(441)(733)292 (39.8)
Other income, net
9,371 15,473 (6,102)(39.4)
Total other income, net
$20,895 $24,941 $(4,046)(16.2)%
Interest income consists primarily of interest income earned on our cash, cash equivalents, and marketable securities balances. Interest expense consists primarily of interest expense associated with our debt financing arrangements and amortization of debt issuance costs. Other income, net consists primarily of our foreign currency exchange gains and losses relating to transactions and remeasurement of asset and liability balances denominated in currencies other than the U.S. dollar. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates.
Interest income for fiscal 2024, compared to fiscal 2023, increased primarily due to the allocation of some excess cash into marketable securities and higher yields on our cash and cash equivalents. Interest expense for fiscal 2024, compared to fiscal 2023, decreased primarily due to reduced expenses associated with our Revolving Credit Agreement. The decrease in other income, net for fiscal 2024, compared to fiscal 2023, was primarily due to foreign currency exchange fluctuations.
Provision for Income Taxes
Fiscal Year EndedChange from Prior Fiscal Year
September 28, 2024September 30, 2023$%
(Dollars in thousands)
Provision for income taxes$10,995 $14,668 $(3,673)(25.0)%
Provision for income taxes for fiscal 2024, compared to fiscal 2023, decreased due to a favorable tax ruling on a Dutch Innovation Box application resulting in a revaluation of certain Dutch deferred tax liabilities, a reduction in the amount of net expense subject to capitalization under Section 174 of the U.S. Internal Revenue Code, and a reduction in operating income, partially offset by income tax expense in the Netherlands related to an intercompany sale of intellectual property to the U.S.
Comparison of Fiscal Years 2023 and 2022
For the comparison of fiscal years 2023 and 2022, 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 September 30, 2023, filed with the SEC on November 20, 2023, under the subheading "Comparison of fiscal years 2023 and 2022."
Liquidity and Capital Resources
Our operations are financed primarily through cash flows from operating activities. As of September 28, 2024, our principal sources of liquidity consisted of cash flows from operating activities, cash and cash equivalents of $169.7 million, including $36.4 million held by our foreign subsidiaries, marketable securities of $51.4 million, 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 28, 2024, 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 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
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additional debt financing it would result in increased debt service obligations and the instruments governing such debt could require additional 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 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 28, 2024, 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 28, 2024, we were in compliance with all financial covenants under the Revolving Credit Agreement.
Cash Flows
Fiscal 2024 Changes in Cash Flows
The following table summarizes our cash flows for the periods indicated:
Fiscal Year Ended
(In thousands)September 28, 2024September 30, 2023
Net cash provided by (used in):
Operating activities$189,906 $100,406
Investing activities(105,242)(50,286)
Financing activities(137,309)(108,592)
Effect of exchange rate changes2,146 3,848
Net decrease in cash, cash equivalents and restricted cash$(50,499)$(54,624)
Cash Flows from Operating Activities
Net cash provided by operating activities of $189.9 million for fiscal 2024 consisted of a net loss of $38.1 million, a favorable impact of non-cash adjustments of $125.3 million, and a favorable impact of net changes in operating assets and liabilities of $102.8 million. Non-cash adjustments primarily consisted of stock-based compensation expense and depreciation and amortization, partially offset by deferred income taxes as a result of a benefit from income taxes from the reversal of a deferred tax liability related to an intercompany sale of intellectual property. The net increase in cash from the change in operating assets and liabilities was primarily due to a decrease in inventories of $106.1 million as the result of measures taken to more efficiently manage inventory and the implementation of new payment terms with suppliers, and a decrease in accounts receivable of $23.0 million. The net increase in cash from the change in operating assets and liabilities was partially offset by an increase in other assets of $28.8 million due to timing of prepaid contracts.
Cash Flows from Investing Activities
Cash used in investing activities of $105.2 million for fiscal 2024, primarily consisted of the purchases of marketable securities of $90.5 million, and purchases of property and equipment of $55.2 million mainly related to point-of-sale product displays, manufacturing-related tooling and test equipment to support the launch of new products, and leasehold improvements, partially offset by cash provided by maturities of marketable securities of $40.5 million.
Cash Flows from Financing Activities
Cash used in financing activities of $137.3 million for fiscal 2024, primarily consisted of payments for repurchase of common stock of $129.0 million and payments for repurchase of common stock related to shares withheld for tax in connection with vesting of stock awards of $25.3 million, partially offset by proceeds from the exercise of options of $17.1 million.
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Fiscal 2023 Changes in Cash Flows
For the comparison of fiscal 2023 to fiscal 2022, 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 September 30, 2023, filed with the SEC on November 20, 2023, under the subheading "Liquidity and capital resources."
Contractual obligations
See Note 7. 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
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 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).
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
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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.
For fiscal 2024, 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 2024 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 2024 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 as of September 28, 2024. We intend to continue maintaining a full valuation allowance on our U.S. 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
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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.