SONOS, INC. You should read the following discussion of our financial condition and results of operations in conjunction with the 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- or 53-week fiscal year ending on the Saturday nearestSeptember 30 each year. Our fiscal year is divided into four quarters, each beginning on a Sunday and containing two 4-week periods followed by a 5-week period.References to fiscal 2019 are to our 52-week fiscal year endedSeptember 28, 2019 , references to fiscal 2018 are to our 52-week fiscal year endedSeptember 29, 2018 and references to fiscal 2017 are to our 52-week fiscal year endedSeptember 30, 2017 . Overview Sonos is one of the world's leading sound experience brands. As the inventor of multi-room wireless home audio, Sonos' innovation helps the world listen better by giving people access to the content they love and allowing them to control it however they choose. Known for delivering unparalleled sound experience, thoughtful design aesthetic, simplicity of use and an open platform, Sonos makes the breadth of audio content available to anyone. Our sound system provides an immersive listening experience created by our thoughtfully designed speakers and components, our proprietary software platform and the ability to wirelessly stream the content our customers love from the services they prefer. We manage the complexity of delivering a seamless customer experience in a multi-user and open-platform environment. The Sonos sound system is easy to set up, use and expand to bring audio to any room in the home. Through our software platform, we frequently enhance features and services on our products, improving functionality and customer experience. Our innovative products, seamless customer experience and expanding global footprint have driven 14 consecutive years of sustained revenue growth since our first product launch. We generate revenue from the sale of our wireless speakers, home theater speakers and component products, as new customers buy our products and existing customers continue to add products to their Sonos sound systems. 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. Our most recent steps in this direction occurred inOctober 2017 , with the introduction of our first voice-enabled wireless speaker, Sonos One, inJuly 2018 , with the introduction of our first voice-enabled home theater speaker, Sonos Beam. In fiscal 2019, we accelerated new product introductions including the introduction of Sonos Amp, Sonos Move, our first battery-powered, Bluetooth-enabled speaker for use both indoors and outdoors, Sonos One SL, and Sonos Port. 29
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Key metrics
In addition to the measures presented in our consolidated financial statements, we use the following additional 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 revenue, products sold, adjusted EBITDA and adjusted EBITDA margin. The most directly comparable financial measure calculated underU.S. GAAP for adjusted EBITDA is net income (loss). In the fiscal years endedSeptember 28, 2019 ,September 29, 2018 andSeptember 30, 2017 , we had a net loss of$4.8 million ,$15.6 million and$14.2 million , respectively. Fiscal Year Ended September 28, September 29, September 30, 2019 2018 2017 (In thousands, except percentages) Revenue$ 1,260,823 $ 1,137,008 $ 992,526 Products sold 6,132 5,078 3,935 Adjusted EBITDA$ 88,689 $ 69,128 $ 55,955 Adjusted EBITDA margin 7.0 % 6.1 % 5.6 % Revenue We generate substantially all of our revenue from the sale of wireless speakers, home theater speakers and components. We also generate revenue from other sources, such as module revenue, the sale of Sonos and third-party accessories like speaker stands and wall mounts, as well as licensing revenue. Module revenue is comprised of sales of hardware and embedded software that is integrated into final products that are manufactured and sold by our partners. 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. Products sold includes the sale of wireless speakers, home theater speakers, components and module units. Products sold excludes the sale of Sonos and third-party accessories. Historically, the sale of other items has not materially contributed to our revenue. 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 and the introduction of new products that may have higher or lower than average selling prices.
Adjusted EBITDA and adjusted EBITDA margin
We define adjusted EBITDA as net loss adjusted to exclude the impact of stock-based compensation expense, depreciation, interest income, interest expense, other income (expense), income taxes and items considered to be non-recurring. We define adjusted EBITDA margin as adjusted EBITDA divided by revenue. See the section titled "Selected Consolidated Financial and Other Data-Non-GAAP Financial Measures" for information regarding our use of adjusted EBITDA and adjusted EBITDA margin, and a reconciliation of net loss to adjusted EBITDA.
Factors affecting our performance
New product introductions. Since 2005, we have released a number of products in
multiple home audio categories. We intend to introduce new products that appeal
to a broad set of consumers, as well as bring our differentiated listening
platform and experience to all the places and spaces where our customers listen
to the breadth of audio content available on demand today, including outside of
the home. Accordingly, our future financial performance may be affected by our
ability to drive cost of revenue savings as we scale production over time.
Seasonality. Historically, we have experienced the highest levels of revenue in
the first fiscal quarter of the year, coinciding with the holiday shopping
season. For example, revenue in the first quarter of fiscal 2019 accounted for
39.4% of our revenue for fiscal 2019. Our promotional discounting activity is
higher in the first fiscal quarter as well, which negatively impacts gross
margin during this period. For example, gross margin in the first quarter of
fiscal 2019 was 39.3%, compared to gross margin
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of 41.8% for all of fiscal 2019. However, our higher sales volume in the holiday shopping season has historically resulted in a higher operating margin in the first fiscal quarter due to positive operating leverage. Ability to sell additional products to existing customers. As our customers add Sonos to their homes and listen to more audio content, they typically increase the number of our products in their homes. In fiscal 2019, follow-on purchases represented approximately 37% of new product registrations. As we execute on our product roadmap to address evolving consumer preferences, we believe we can expand the number of products in our customers' homes. Our ability to sell additional products to existing customers is a key part of our business model, as follow-on purchases indicate high customer engagement and satisfaction, decrease the likelihood of competitive substitution and result in higher customer lifetime value. We will continue to innovate and invest in product development in order to enhance customer experience and drive sales of additional products to existing customers. Expansion of partner ecosystem. Expanding and maintaining strong relationships with our partners will remain important to our success. We believe our partner ecosystem improves our customer experience, attracting more customers to Sonos, which in turn attracts more partners to the platform further enhancing our customer experience. We believe partners choose to be part of the Sonos platform because it provides access to a large, engaged customer base on a global scale. We look to partner with a wide variety of streaming music services, voice assistants, connected home integrators, content creators and podcast providers. To date, our agreements with these partners have all been on a royalty-free basis. As competition increases, we believe our ability to give users the freedom to choose across the broadest set of streaming services and voice control partners will be a key differentiating factor. Our product roadmap is largely focused on delivering products with voice control. Our ability to develop, manufacture and sell voice-enabled speakers that deliver differentiated consumer experiences will be a critical driver of our future performance, particularly as we compete in a larger market with an expanding number of competitors. We currently compete with, and will continue to compete with, companies that have greater resources than we do, many of which have already brought voice-enabled speakers to market. We are also partnering with certain of these companies in the development of our own voice-enabled products. Our competitiveness in the voice-enabled speaker market will depend on successful investment in research and development, market acceptance of our products and our ability to maintain and benefit from these technology partnerships. Channel strategy. We are focused on reaching and converting prospective customers through third-party retail stores, e-commerce retailers, custom installers of home audio systems and our website sonos.com. We are investing in our e-commerce capabilities and in-app experience to drive direct sales. Sales through sonos.com represented 12.2% of our revenue in fiscal 2019 and 11.5% of our revenue in fiscal 2018 and we believe the growth of our own e-commerce channel will be important to supporting our overall growth and profitability as consumers continue the shift from physical to online sales channels. Our physical retail distribution relies on third-party retailers, as our company-owned stores do not materially contribute to our revenue. While we seek to increase sales through our direct-to-consumer sales channel, we expect that our future sales will continue to be substantially dependent on our third-party retailers. We will continue to seek retail partners that can deliver differentiated in-store experiences to support customer demand for product demonstrations. International expansion. Our products are sold in over 50 countries and in fiscal 2019, 50.0% of our revenue was generated outsidethe United States . Our international growth will depend on our ability to generate sales from the global population of consumers, develop international distribution channels and diversify our partner ecosystem to appeal to a more global audience. We are committed to strengthening our brand in global markets and our future success will depend in part on our growth in international markets. Investing in product and software development. Our investments in product and software development consist primarily of expenses in personnel who support our research and development efforts and capital expenditures for new tooling and production line equipment to manufacture and test our products. We believe that our financial performance will significantly depend on the effectiveness of our investments to design and introduce innovative new products and services and enhance existing products and software. If we fail to innovate and expand our product and software offerings or fail to maintain high standards of quality in our products, our brand, market position and revenue will be adversely affected. Further, if our development efforts are not successful, we will not recover the investments made. Investing in sales and marketing. We intend to invest resources in our marketing and brand development efforts. Our marketing investments are focused on increasing brand awareness through advertising, public relations and brand promotion activities. While we maintain a base level of investment throughout the year, significant increases in spending are highly correlated with the holiday shopping season, new product launches and software introductions. We also invest in capital expenditures on 31
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product displays to support our retail channel partners. Sales and marketing investments are typically incurred in advance of any revenue benefits from these activities. Components of results of operations
Revenue
We generate substantially all of our revenue from the sale of wireless speakers,
home theater speakers and components. We also generate revenue from other
sources, such as module revenue, the sale of Sonos and third-party accessories
like speaker stands and wall mounts, as well as licensing revenue. Module
revenue is comprised of sales of hardware and embedded software that is
integrated into final products that are manufactured and sold by our partners.
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. 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.
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, component costs, shipping and handling costs,
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. In addition, we allocate
certain costs related to management and facilities, personnel-related expenses
and other expenses associated with supply chain logistics. Personnel-related
expenses primarily consist of salaries, bonuses, benefits and stock-based
compensation expense.
Gross profit and gross margin
Our gross margin may in the future fluctuate from period to period based on a
number of factors, including the mix of products we sell, the channel through
which we sell our products, the foreign currency in which our products are sold
and tariffs and duty costs implemented by governmental authorities. We have
historically seen that the gross margin for our newly released products are
lowest at launch and have tended to increase over time as we realize cost
efficiencies. In addition, our ability to reduce the cost of our products is
critical to increasing our gross margin over the long term.
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 and prototype materials and 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. We expect our research and development expenses to increase in
absolute dollars as we continue to make significant investments in developing
new products and enhancing existing products.
Sales and marketing. Sales and marketing expenses consist primarily of
advertising and marketing promotions of our products and personnel-related
expenses, as well as trade show and event costs, sponsorship costs, consulting
and contractor expenses, travel, product display expenses and related
depreciation, customer care costs 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, any
overhead, information technology, litigation expenses, patent costs and other
administrative expenses. We expect our general and administrative expenses to
increase in absolute dollars due to the growth of our business and related
infrastructure as well as legal, accounting, insurance, investor relations and
other costs associated with operating as a public company.
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.
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Other expense, net. Other 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 theU.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 income taxes We are subject to income taxes inthe United States and foreign jurisdictions in which we operate. Our provision for income taxes includes income tax in our foreign operations. Foreign jurisdictions have statutory tax rates different from those inthe United States . Accordingly, our effective tax rates will vary depending on the relative proportion of foreign toU.S. income, the utilization of foreign tax credits and changes in tax laws. 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 when it is more likely than not that the deferred tax assets will not be realized. We have established a full valuation allowance to offset ourU.S. and certain foreign net deferred tax assets due to the uncertainty of realizing future tax benefits from our net operating loss carryforwards and other deferred tax assets. It is possible that within the next 12 months there may be sufficient positive evidence to release a significant portion of the valuation allowance. Release of theU.S. valuation allowance would result in the establishment of certain deferred tax assets and a benefit to income tax expense for the period the release is recorded, which could have a material impact on net earnings. The exact timing and amount of the valuation allowance release are subject to change based on the level of profitability achieved. Results of operations The following table sets forth our consolidated results of operations and data as a percentage of revenue for the periods indicated (percentages in the table may not foot due to rounding). The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods. Fiscal Year Ended September 28, September 29, 2019 2018 (Dollars in thousands) $ % $ % Revenue$ 1,260,823 100.0 %$ 1,137,008 100.0 % Cost of revenue (1) 733,480 58.2 647,700 57.0 Gross profit 527,343 41.8 489,308 43.0 Operating expenses Research and development (1) 171,174 13.6 142,109 12.5 Sales and marketing (1) 247,599 19.6 270,869 23.8 General and administrative (1) 102,871 8.2 85,205 7.5 Total operating expenses 521,644 41.4 498,183 43.8 Operating income (loss) 5,699 0.5 (8,875 ) (0.8 ) Other income (expense),net Interest income 4,349 0.3 731 0.1 Interest expense (2,499 ) (0.2 ) (5,242 ) (0.5 ) Other expense, net (8,625 ) (0.7 ) (1,162 ) (0.1 ) Total other expense, net (6,775 ) (0.5 ) (5,673 ) (0.5 ) Loss before provision for income taxes (1,076 ) (0.1 ) (14,548 ) (1.3 ) Provision for income taxes 3,690 0.3 1,056 0.1 Net loss$ (4,766 ) (0.4 )%$ (15,604 ) (1.4 )%
(1) Amounts include stock-based compensation expense as follows:
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Fiscal Year Ended
September 28, September 29,
2019 2018
(Dollars in thousands) $ % $ %
Cost of revenue $ 985 0.1 % $ 198 - %
Research and development 17,643 1.4 13,960 1.2
Sales and marketing 12,965 1.0 15,885 1.4
General and administrative 14,982 1.2 8,602 0.8
Total stock-based compensation expense
Comparison of fiscal years 2019 and 2018
Revenue
Change from Prior Fiscal
Fiscal Year Ended Year
September 28, September 29,
2019 2018 $ %
(Dollars and products sold in thousands)
Revenue by geographical region:
Americas $ 678,224 $ 603,450 $ 74,774 12.4 %
Europe, Middle East and Africa ("EMEA") 484,785 478,518 6,267 1.3
Asia Pacific ("APAC") 97,814 55,040 42,774 77.7
Total revenue $ 1,260,823 $ 1,137,008 $ 123,815 10.9 %
Other data:
Total products sold 6,132 5,078 1,054 20.8 %
Revenue increased by $123.8 million , or 10.9%, from $1,137.0 million for fiscal
2018 to $1,260.8 million for fiscal 2019, primarily due to the continued success
of Sonos Beam and launches of Sonos Amp and our IKEA partnership.
Products sold increased by 1.1 million, or 20.8%, from 5.1 million for fiscal
2018 to 6.1 million for fiscal 2019. The volume growth was primarily driven by
sales of our newest home theater speaker product, Sonos Beam, which launched in
July 2018 , as well as by sales of our newest component product, Sonos Amp, which
launched in November 2018 . Wireless speakers continue to be the largest category
and revenue in the category declined largely due to a volume shift from Play:1
to Sonos One speakers and the discontinuation of Play:3. Revenue growth from the
sale of our home theater speakers was primarily driven by continued success of
our Sonos Beam. Volume growth from the sale of our components was driven by
sales of our new Sonos Amp, which was partially offset by a decrease in sales of
our Connect:Amp, which was discontinued in fiscal 2019.
Revenue from the Americas increased $74.8 million , or 12.4%, from $603.5 million
for fiscal 2018 to $678.2 million for fiscal 2019. The increase in the Americas
revenue was driven primarily by growth in sales of home theater speakers and
components and partially offset by a decline in wireless speaker sales. Revenue
from EMEA increased $6.3 million , or 1.3%, from $478.5 million for fiscal 2018
to $484.8 million for fiscal 2019. EMEA revenue increased due to growth in sales
of home theater speakers and components and offset by a decline in wireless
speaker sales. Revenue from APAC increased $42.8 million , or 77.7%, from $55.0
million for fiscal 2018 to $97.8 million for fiscal 2019. APAC growth was driven
primarily by module sales associated with the launch of the IKEA relationship.
In constant
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Cost of revenue and gross profit
Change from Prior Fiscal
Fiscal Year Ended Year
September 28, September 29,
2019 2018 $ %
(Dollars in thousands)
Cost of revenue $ 733,480 $ 647,700 $ 85,780 13.2 %
Gross profit $ 527,343 $ 489,308 $ 38,035 7.8 %
Gross margin 41.8 % 43.0 %
Cost of revenue increased
Gross margin decreased to 41.8% for fiscal 2019 from 43.0% for fiscal 2018. The
decrease was primarily due to product mix, unfavorable foreign currency impact
and the launching of a new distribution channel, partially offset by product and
material cost reductions.
Research and development
Change from Prior Fiscal
Fiscal Year Ended Year
September 28, September 29,
2019 2018 $ %
(Dollars in thousands)
Research and development $ 171,174 $ 142,109 $ 29,065 20.5 %
Percentage of revenue 13.6 % 12.5 %
Research and development expenses increased $29.1 million , or 20.5%, from $142.1
million for fiscal 2018 to $171.2 million for fiscal 2019. The increase was
primarily due to higher personnel-related expenses of $22.7 million as our
headcount, particularly in software personnel, increased during the period as we
focused on increasing the pace of new product introductions.
Sales and marketing
Change from Prior Fiscal
Fiscal Year Ended Year
September 28, September 29,
2019 2018 $ %
(Dollars in thousands)
Sales and marketing $ 247,599 $ 270,869 $ (23,270 ) (8.6 )%
Percentage of revenue 19.6 % 23.8 %
Sales and marketing expenses decreased by $23.3 million , or 8.6%, from $270.9
million for fiscal 2018 to $247.6 million in fiscal 2019 as we demonstrated
improved operating leverage. The decrease was primarily due to decreases in
personnel-related costs of $17.9 million driven by a decrease in headcount, and
decreases in marketing and advertising costs of $7.7 million as we transitioned
away from traditional paid media and we adopted more efficient
direct-to-consumer and digital marketing tools. These decreases were partially
offset by an increase in professional services fees associated with production
costs of $4.1 million related to a new product launch campaign.
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General and administrative
Change from Prior Fiscal
Fiscal Year Ended Year
September 28, September 29,
2019 2018 $ %
(Dollars in thousands)
General and administrative $ 102,871 $ 85,205 $ 17,666 20.7 %
Percentage of revenue 8.2 % 7.5 %
General and administrative expenses increased $17.7 million , or 20.7% from $85.2
million for fiscal 2018 to $102.9 million for fiscal 2019. The increase was
primarily due to increases in personnel-related costs of $10.6 million , and
professional fees of $4.8 million , as we continue to invest in personnel and
programs to create the infrastructure necessary to support our operations as a
public company.
Other income (expense), net
Change from Prior Fiscal
Fiscal Year Ended Year
September 28, September 29,
2019 2018 $ %
(Dollars in thousands)
Interest income $ 4,349 $ 731 $ 3,618 *
Interest expense $ 2,499 $ 5,242 $ (2,743 ) (52.3)%
Other expense, net $ (8,625 ) $ (1,162 ) $ (7,463 ) *
* not meaningful
Interest income increased by $3.6 million , from $0.7 million for fiscal 2018 to
$4.3 million for fiscal 2019, primarily related to interest income generated
from both higher balances and increased investment yields. Interest expense
decreased by $2.7 million , from $5.2 million in fiscal 2018 to $2.5 million in
fiscal 2019, primarily due to the effect of reduced effective interest rate as a
result of refinancing our J.P. Morgan Chase Bank, N.A. Secured Term Loan (the
"Term Loan").
Other expense, net increased
Provision for income taxes
Fiscal Year Ended Change from Prior Fiscal Year
September 28, September 29,
2019 2018 $ %
(Dollars in thousands)
Provision for income taxes $ 3,690 $ 1,056 $ 2,634 249.4 %
Provision for income taxes increased $2.6 million , from a $1.1 million provision
for fiscal 2018 to a provision of $3.7 million for fiscal 2019. For the year
ended September 28, 2019 , we recorded a provision for income taxes of $1.2
million for certain profitable foreign entities and $2.5 million for U.S.
federal and state income tax for a total provision of $3.7 million . We recorded
a provision for income taxes of $1.1 million for certain profitable foreign
entities for the year ended September 29, 2018 .
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Comparison of fiscal years 2018 and 2017 For the comparison of fiscal years 2018 and 2017, 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 endedSeptember 29, 2018 , filed with theSEC onNovember 28, 2018 under the subheading "Comparison of fiscal years 2018, 2017 and 2016."
Liquidity and capital resources
Our operations are financed primarily through cash flow from operating activities, net proceeds from the sale of our equity securities, including net proceeds of$90.6 million from the closing of our IPO onAugust 6, 2018 , borrowings under our Secured Credit Facility withJ.P. Morgan Chase Bank, N.A. (the "Credit Facility") and the Term Loan. As ofSeptember 28, 2019 , our principal sources of liquidity consisted of cash flow from operating activities, cash and cash equivalents of$338.6 million , including$26.5 million held by our foreign subsidiaries, and borrowing capacity under our credit facility. In accordance with our policy, the undistributed earnings of our non-U.S. subsidiaries remain indefinitely reinvested outside ofthe United States as ofSeptember 28, 2019 , as they are required to fund needs outsidethe United States . In the event funds from foreign operations are needed to fund operations inthe United States and ifU.S. tax has not already been previously provided, we may be required to accrue and pay additionalU.S. taxes in order to repatriate these funds. We believe our existing cash and cash equivalent balances, cash flow from operations and committed credit lines will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. 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, the expansion of sales and marketing activities, the timing of new product introductions, market acceptance of our products and overall economic conditions. To the extent that current and anticipated future 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 additional dilution to our stockholders. The incurrence of debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations.
Debt obligations
Our debt obligations consist of the Credit Facility and the Term Loan. Our short- and long-term debt obligations are as follows:
As of
September 28, September 29,
2019 2018
Rate Balance Rate Balance
(In thousands)
Term Loan (1) 4.6 % $ 33,333 4.8 % $ 40,000
Unamortized debt issuance costs (2) (160 ) (236 )
Total indebtedness 33,173 39,764
Less short term portion (8,333 ) (6,667 )
Long term debt $ 24,840 $ 33,097
(1) Bears interest at a variable rate equal to an adjusted LIBOR plus 2.25%
and is payable quarterly. Due in
payments beginning in July 2019 .
(2) Debt issuance costs are recorded as a debt discount and charged to
interest expense over the term of the agreement.
The Credit Facility allows us to borrow up to $80.0 million restricted to the
value of the borrowing base which is based on the value of our inventory and
accounts receivable and is subject to quarterly redetermination. The Credit
Facility matures in October 2021 and may be drawn as Commercial Bank Floating
Rate Loans (at the higher of the prime rate or adjusted LIBOR plus 2.50%) or
Eurocurrency Loans (at LIBOR plus an applicable margin). As of September 28,
2019 and September 29, 2018 , we did not have any outstanding borrowings and $4.5
million and $4.5 million , respectively, in undrawn letters of credit that reduce
the availability under the Credit Facility.
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Debt obligations under the Credit Facility and the Term Loan require that we maintain a consolidated fixed charge ratio of at least 1.0, restrict distribution of dividends unless certain conditions are met, such as having a fixed charge ratio of at least 1.15, and require financial statement reporting and delivery of borrowing base certificates. As ofSeptember 28, 2019 andSeptember 29, 2018 , we were in compliance with all financial covenants. The Credit Facility and the Term Loan are collateralized by our eligible inventory and accounts receivable as well as our intellectual property including patents and trademarks. Cash flows
Fiscal 2019 changes in cash flows
The following table summarizes our cash flows for the periods indicated:
Fiscal Year Ended
September 28, September 29,
2019 2018
(In thousands)
Net cash provided by (used in):
Operating activities $ 120,636 $ 30,570
Investing activities (23,222 ) (35,747 )
Financing activities 21,896 94,374
Effect of exchange rate changes (1,610 ) 1,135
Net change in cash, cash equivalents and restricted cash
Cash flows from operating activities
Net cash provided by operating activities of$120.6 million for fiscal 2019 was primarily due to non-cash adjustments of$89.5 million , and by a net increase in net operating assets and liabilities of$35.9 million , slightly offset by a net loss of$4.8 million . Non-cash adjustments primarily consisted of stock-based compensation expense of$46.6 million and depreciation of$36.4 million . The net increase in net operating assets and liabilities was primarily due to an$85.9 million increase in accounts payable and accrued expenses, primarily related to inventory purchases, an$8.2 million increase in accrued compensation primarily due to an increase in bonuses, a$7.1 million increase in other liabilities, and a$6.2 million increase in deferred revenue. The increase in net operating assets and liabilities was offset by a$32.1 million increase in accounts receivable primarily related to timing of receipts, as well as due to new customers, a$31.8 million increase in inventory related to our new products such as Sonos Move and Sonos One SL, and$7.6 million increase in other assets primarily related to an increase in prepaid expenses.
Cash flows from investing activities
Cash used in investing activities for fiscal 2019 of$23.2 million was due to payments for property and equipment, which primarily comprised of manufacturing-related tooling and test equipment to support the launch of new products, leasehold improvements and marketing-related product displays.
Cash flows from financing activities
Cash provided by financing activities for fiscal 2019 of$21.9 million primarily consisted of$31.6 million in proceeds from the exercise of stock options. This increase was partially offset by payment of outstanding borrowings under the Term Loan of$6.7 million ,$2.4 million to repurchase treasury stock related to our election to withhold shares to cover taxes in conjunction with restricted stock vesting beginning in our second quarter of fiscal 2019, and$0.6 million in payments for offering costs.
Fiscal 2018 changes in cash flows
For the comparison of fiscal 2018 to fiscal 2017, refer to Part II, Item 7 "Management's discussion and analysis of financial condition and results of operations" of our Form 10-K for our fiscal year endedSeptember 29, 2018 , filed with theSEC onNovember 28, 2018 under the subheading "Liquidity and capital resources." 38
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Commitments and contingencies
The following table summarizes our contractual commitments as ofSeptember 28, 2019 : Payments due by fiscal year Total 2020 2021 2022 2023 2024 Beyond (In thousands) Debt principal and interest (1)$ 36,246 $ 8,229 $ 7,922 $ 20,095 $ - $ - $ - Operating leases (2) 83,483 15,627 14,759 14,136 14,395 13,615 10,951 Inventory (3) 58,918 58,918 - - - - - Other noncancelable agreements 16,321 7,985 4,207 1,525 1,510 1,094 - Total contractual
commitments
(1) Interest payments were calculated using the applicable interest rate as of
(2) Operating lease amounts in the table above represent fixed rental payments
and fixed maintenance costs. We lease our facilities under long-term
operating leases, which expire at various dates through 2027. The lease
agreements frequently include provisions that require us to pay taxes,
insurance or maintenance costs.
(3) We enter into various inventory-related purchase agreements withsuppliers. Under these agreements, 100% of orders are cancelable by giving
sufficient notice prior to the expected shipment date.
Off-balance sheet arrangements
We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.
Critical accounting policies and estimates
Our financial statements are prepared in accordance withU.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates. Our critical accounting policies requiring estimates, assumptions and judgments that we believe have the most significant impact on our consolidated financial statements are described below.
Revenue recognition
Revenue is recognized upon transfer of control of promised products or services
to customers in an amount that reflects the consideration we expect to receive
in exchange for those products or services. We generally enter into contracts
that include a combination of products and services. Revenue is allocated to
distinct performance obligations and is recognized net of allowances for
returns, discounts, sales incentives and any taxes collected from customers,
which are subsequently remitted to governmental authorities. Shipping and
handling costs associated with outbound freight after control over a product has
transferred to a customer are accounted for as a fulfillment cost and are
included in cost of revenue. We do not have material assets related to
incremental costs to obtain or fulfill customer contracts.
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Nature of products and services
Our product revenue includes sales of wireless speakers, home theater speakers and components, which include software that enables our products to operate over a customer's wireless network, as well as connect to various third-party services, including music and voice. We also generate a small portion of revenue from other revenue sources such as sales of module units and Sonos and third-party accessories, which include speaker stands and wall mounts. Module revenue is comprised of hardware and embedded software that is integrated into final products that are manufactured and sold by our partners. Our software primarily consists of firmware embedded in the products and the Sonos app, which is software that can be downloaded to consumer devices at no charge, with or without the purchase of one of our products. Products and related software are accounted for as a single performance obligation and all intended functionality is available to the customer upon purchase. The revenue allocated to the products and related software is the substantial portion of the total sale price. Revenue is recognized at the point in time when control is transferred, which is either upon shipment or upon delivery to the customer, depending on delivery terms. Our service revenue includes revenue allocated to (i) unspecified software upgrades and (ii) cloud services that enable products to access third-party music and voice assistant platforms, which are each distinct performance obligations and are provided to customers at no additional charge. Unspecified software upgrades are provided on a when-and-if-available basis and have historically included updates and enhancements such as bug fixes, feature enhancements and updates to the ability to connect to third-party music or voice assistant platforms. Service revenue is recognized ratably over the estimated service period. Significant judgments
Our contracts with customers generally contain promises to transfer products and services as described above. Determining whether products and services are considered distinct performance obligations that should be accounted for separately may require significant judgment.
Judgment is required to determine the standalone selling price ("SSP") for each
distinct performance obligation. 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 analyses of the
cost of providing the products or services plus a reasonable margin. In
developing SSP estimates, we also consider the nature of the products and
services and the expected level of future services.
Determining the revenue recognition period for unspecified software upgrades and
cloud services also requires judgment. We recognize revenue attributable to
these performance obligations ratably over the best estimate of the period that
the customer is expected to receive the services. In developing the estimated
period of providing future services, we consider our past history, our plans to
continue to provide services, including plans to continue to support updates and
enhancements to prior versions of our products, expected technological
developments, obsolescence, competition and other factors. The estimated service
period may change in the future in response to competition, technology
developments and our business strategy.
We offer sales incentives through various programs, consisting primarily of
discounts, cooperative advertising and market development fund programs. We
record cooperative advertising and market development fund programs with
customers as a reduction to revenue unless it receives a distinct benefit in
exchange for credits claimed by the customer and can reasonably estimate the
fair value of the benefit received, in which case we record it as an expense. We
recognize a liability, or a reduction to accounts receivable, and reduce revenue
for sales incentives based on the estimated amount of sales incentives that will
be claimed by customers. Estimates for sales incentives are developed using the
most likely amount and are included in the transaction price to the extent that
a significant reversal of revenue would not result once the uncertainty is
resolved. In developing its estimate, we also consider the susceptibility of the
incentive to outside influences, the length of time until the uncertainty is
resolved, our experience with similar contracts and the range of possible
outcomes. Reductions in revenue related to discounts are allocated to products
and services on a relative basis based on their respective SSP. Judgment is
required to determine the timing and amount of recognition of marketing funds,
which we estimate based on past practice of providing similar funds.
We accept returns from direct customers and from certain resellers. To establish
an estimate for returns, we use the expected value method by considering a
portfolio of contracts with similar characteristics to calculate the historical
returns rate. When determining the expected value of returns, we consider future
business initiatives and relevant anticipated future events.
Inventories
Inventories consist of finished goods and component parts, which are purchased
from contract manufacturers and component suppliers. Inventories are stated at
the lower of cost or market and net realizable value on a first-in, first-out
basis. We assess
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the valuation of inventory balances including an assessment to determine potential excess and/or obsolete inventory. We may be required to write down the value of inventory if estimates of future demand and market conditions indicate estimated excess and/or obsolete inventory.
Product warranties
Our products are covered by warranty to be free from defects in material and workmanship for a period of one year, except for products sold in the EU and select other countries where we provide a two-year warranty. At the time of sale, an estimate of future warranty costs is recorded as a component of the cost of revenue. Our estimate of costs to fulfill our warranty obligations is based on historical experience and expectations of future costs to repair or replace. Income taxes Our income tax expense, deferred tax assets and liabilities and liabilities for unrecognized tax benefits reflect our best estimate of current and future taxes to be paid. Significant judgments and estimates are required in the determination of the consolidated income tax expense. We prepare and file income tax returns based on our interpretation of each jurisdiction's tax laws and regulations. In preparing our consolidated financial statements, we estimate our income tax liability in each of the jurisdictions in which we operate by estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets. Significant management judgment is required in assessing the realizability of our deferred tax assets. In performing this assessment, we consider whether it is more likely than not that some portion or all the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making this determination, we consider the scheduled reversal of deferred tax liabilities, projected future taxable income and the effects of tax planning strategies. We recorded a valuation allowance against all ourU.S. deferred tax assets and certain of our foreign deferred tax assets as ofSeptember 28, 2019 . We intend to continue maintaining a full valuation allowance on ourU.S. and certain foreign deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of these allowances. We account for uncertain tax positions using a "more-likely-than-not" threshold for recognizing and resolving uncertain tax positions. We evaluate uncertain tax positions on a quarterly basis and consider various factors, that include, but are not limited to, changes in tax law, the measurement of tax positions taken or expected to be taken in tax returns, the effective settlement of matters subject to audit, information obtained during in process audit activities and changes in facts or circumstances related to a tax position. We accrue for potential interest and penalties related to unrecognized tax benefits in income tax expense. Our policy with respect to the undistributed earnings of our non-U.S. subsidiaries is to maintain an indefinite reinvestment assertion as they are required to fund needs outside ofthe United States and cannot be repatriated in a manner that is substantially tax-free. This assertion is made on a jurisdiction by jurisdiction basis and takes into account the liquidity requirements in boththe United States and of our foreign subsidiaries.
Stock-based compensation
We measure stock-based compensation cost at fair value on the date of grant.
Compensation cost for share-based awards is recognized, on a straight-line
basis, as expense over the period of vesting as the employee performs the
related services, net of estimated forfeitures, over the remaining requisite
service period. The fair value of restricted stock units ("RSUs") is based on
the Company's closing stock price on the trading day immediately preceding the
date of grant. We estimate the fair value of stock option awards using the
Black-Scholes option-pricing model to determine the fair value of stock options.
Determining the fair value of stock-based awards at the grant date requires
judgment. Our use of the Black-Scholes model requires the input of assumptions
regarding a number of variables.
The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of judgment. As a result, if factors change or we use different assumptions, stock-based compensation expense could be materially different in the future.
In addition, we estimate at the time of grant the expected forfeiture rate and
only recognize expense for those stock-based awards expected to vest. We
estimate the forfeiture rate of our stock-based awards based on an analysis of
our actual and historical forfeitures and other factors such as employee
turnover. The impact from a forfeiture rate adjustment would be recognized in
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the period in which the forfeiture rate changes and, if the actual number of future forfeitures differs from our prior estimates, we may be required to record adjustments to stock-based compensation.
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