10-Q 1 a10-qq3fy18.htm 10-Q Document

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from       to      
Commission File Number: 001-38603
 
SONOS, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
3577
03-0479476
(State or other jurisdiction
of incorporation or organization)
(Primary standard industrial code number)
(I.R.S. Employer Identification No.)
 
614 Chapala Street
Santa Barbara, CA 93101
(805) 965-3001
 
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ¨  No  x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x  No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
 
 
 
Accelerated filer ¨
 
 
 
Non-accelerated filer  x
 
 
 
Smaller reporting company ¨
 
 
(Do not check if a smaller reporting company)
 
 
 
Emerging growth company  x
 
 
If an emerging growth company indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨ No  x
As of August 31, 2018 the registrant had 100,032,880 shares of common stock outstanding.
 




TABLE OF CONTENTS

 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I. FINANCIAL INFORMATION
Item 1.    Financial Statements
SONOS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except par values)
 
As of
 
June 30,
2018
 
September 30,
2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
124,432

 
$
130,595

Restricted cash
191

 
193

Accounts receivable, net of allowances
53,095

 
47,363

Inventories
113,411

 
113,856

Other current assets
13,852

 
9,462

Total current assets
304,981

 
301,469

Property and equipment, net
89,600

 
95,130

Deferred tax assets
982

 
1,107

Other noncurrent assets
5,782

 
2,314

Total assets
$
401,345

 
$
400,020

 
 
 
 
Liabilities, redeemable convertible preferred stock and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
117,222

 
$
114,494

Accrued expenses
29,600

 
57,348

Accrued compensation
27,605

 
32,007

Deferred revenue
17,248

 
10,920

Other current liabilities
9,346

 
8,497

Total current liabilities
201,021

 
223,266

Long-term debt
39,686

 
39,600

Deferred revenue
38,546

 
34,647

Other noncurrent liabilities
10,851

 
12,139

Total liabilities
290,104

 
309,652

 
 
 
 
Commitments and contingencies (Note 11)

 

Redeemable convertible preferred stock, $0.001 par value
90,341

 
90,341

Stockholders’ equity:
 
 
 
Common stock, $0.001 par value
61

 
59

Treasury stock
(11,072
)
 
(10,161
)
Additional paid-in capital
235,444

 
200,301

Accumulated deficit
(201,891
)
 
(188,007
)
Accumulated other comprehensive loss
(1,642
)
 
(2,165
)
Total stockholders’ equity
20,900

 
27

Total liabilities, redeemable convertible preferred stock and stockholders’ equity
$
401,345

 
$
400,020

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

SONOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(unaudited, in thousands, except share and per share amounts)


 
Three Months Ended
 
Nine Months Ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Revenue
$
208,398

 
$
223,078

 
$
864,069

 
$
778,431

Cost of revenue
112,909

 
115,790

 
491,037

 
425,257

Gross profit
95,489

 
107,288

 
373,032

 
353,174

Operating expenses
 
 
 
 
 
 
 
Research and development
35,444

 
33,347

 
104,209

 
90,920

Sales and marketing
60,819

 
70,074

 
214,077

 
207,225

General and administrative
20,860

 
20,000

 
63,822

 
55,031

Total operating expenses
117,123

 
123,421

 
382,108

 
353,176

Operating loss
(21,634
)
 
(16,133
)
 
(9,076
)
 
(2
)
Other income (expense), net
 
 
 
 
 
 
 
Interest expense, net
(1,116
)
 
(1,185
)
 
(3,367
)
 
(3,187
)
Other income (expense), net
(3,744
)
 
2,975

 
(315
)
 
2,047

Total other income (expense), net
(4,860
)
 
1,790

 
(3,682
)
 
(1,140
)
Loss before provision for (benefit from) income taxes
(26,494
)
 
(14,343
)
 
(12,758
)
 
(1,142
)
Provision for (benefit from) income taxes
494

 
196

 
1,126

 
(1,830
)
Net income (loss)
$
(26,988
)
 
$
(14,539
)
 
$
(13,884
)
 
$
688

 
 
 
 
 
 
 
 
Net loss attributable to common stockholders
$
(26,988
)
 
$
(14,539
)
 
$
(13,884
)
 
$

 
 
 
 
 
 
 
 
Net loss per share attributable to common stockholders - basic and diluted
$
(0.45
)
 
$
(0.26
)
 
$
(0.23
)
 
$

 
 
 
 
 
 
 
 
Weighted-average shares used in computing net loss per share attributable to common stockholders - basic and diluted
60,074,763

 
56,334,641

 
59,484,761

 
55,776,325

 
 
 
 
 
 
 
 
Total comprehensive loss
 
 
 
 
 
 
 
Net income (loss)
$
(26,988
)
 
$
(14,539
)
 
$
(13,884
)
 
$
688

Change in foreign currency translation adjustment, net of tax
162

 
(406
)
 
523

 
(2,295
)
Comprehensive loss
$
(26,826
)
 
$
(14,945
)
 
$
(13,361
)
 
$
(1,607
)


The accompanying notes are an integral part of these condensed consolidated financial statements.

4

SONOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY
(unaudited, in thousands, except share amounts)


 
Redeemable
Convertible
Preferred Stock
 
 
Common Stock
 
Additional
Paid-In
Capital
 
Treasury Stock
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive
Loss
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
Shares
 
Amount
 
 
 
Balance at September 30, 2017
32,482,590

 
$
90,341

 
59,339,336

 
$
59

 
$
200,301

 
(746,462
)
 
$
(10,161
)
 
$
(188,007
)
 
$
(2,165
)
 
$
27

Exercise of stock options

 

 
1,735,750

 
2

 
5,746

 

 

 

 

 
5,748

Repurchase of common stock

 

 

 

 

 
(60,578
)
 
(911
)
 

 

 
(911
)
Stock-based compensation expense

 

 

 

 
29,397

 

 

 

 

 
29,397

Net loss

 

 

 

 

 

 

 
(13,884
)
 

 
(13,884
)
Change in foreign currency translation adjustment

 

 

 

 

 

 

 

 
523

 
523

Balance at June 30, 2018
32,482,590

 
$
90,341

 
61,075,086

 
$
61

 
$
235,444

 
(807,040
)
 
$
(11,072
)
 
$
(201,891
)
 
$
(1,642
)
 
$
20,900


The accompanying notes are an integral part of these condensed consolidated financial statements.

5

SONOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

 
 
Nine Months Ended
 
 
June 30,
2018
 
July 1,
2017
Cash flows from operating activities
 
 
 
 
Net income (loss)
 
$
(13,884
)
 
$
688

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
 
Depreciation
 
28,647

 
24,447

Stock-based compensation expense
 
29,397

 
26,961

Other
 
639

 
493

Deferred income taxes
 
117

 
1,593

Foreign currency transaction (gain) loss
 
301

 
(2,499
)
Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable, net
 
(5,659
)
 
(6,973
)
Inventories, net
 
(79
)
 
14,202

Other assets
 
(4,901
)
 
335

Accounts payable and accrued expenses
 
(24,357
)
 
(20,702
)
Accrued compensation
 
(4,237
)
 
554

Deferred revenue
 
10,342

 
6,636

Other liabilities
 
(534
)
 
181

Net cash provided by operating activities
 
15,792

 
45,916

Cash flows from investing activities
 
 
 
 
Purchases of property and equipment
 
(25,927
)
 
(21,073
)
Net cash used in investing activities
 
(25,927
)
 
(21,073
)
Cash flows from financing activities
 
 
 
 
Proceeds from credit facilities and issuance of debt, net of issuance costs
 
30,000

 
14,987

Payments of principal on credit facilities
 
(30,000
)
 

Proceeds from issuance of common stock, net of issuance costs
 

 
10,078

Repurchase of common stock
 
(911
)
 
(10,016
)
Proceeds from exercise of common stock options
 
5,748

 
5,421

Payments of offering costs
 
(2,154
)
 

Net cash provided by financing activities
 
2,683

 
20,470

Effect of exchange rate changes on cash and cash equivalents
 
1,289

 
955

Net increase (decrease) in cash and cash equivalents
 
(6,163
)
 
46,268

Cash and cash equivalents
 
 
 
 
Beginning of period
 
130,595

 
74,913

End of period
 
$
124,432

 
$
121,181

Supplemental disclosure
 
 
 
 
Cash paid for interest
 
$
3,596

 
$
3,006

Cash paid for taxes, net of refunds
 
$
1,251

 
$
268

Supplemental disclosure of non-cash investing and financing activities
 
 
 
 
Purchases of property and equipment in accounts payable and accrued expenses
 
$
7,187

 
$
10,732

Deferred offering costs in accounts payable and accrued expenses
 
$
972

 
$


The accompanying notes are an integral part of these condensed consolidated financial statements.

6


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



1. Business overview and basis of presentation

Description of business

Sonos, Inc. (collectively with its wholly owned subsidiaries, “Sonos,” the “Company,” “we,” “us,” or “our”) designs, develops, manufactures and sells multi-room audio products primarily for use in private residences. The Sonos home sound system provides customers with an immersive listening experience created by the design of its speakers and components, a proprietary software platform and the ability to stream content from a variety of sources throughout the home over the customer’s wireless network.

The Company’s products are sold through third-party retail stores, including custom installers of home audio systems. The Company also sells through select e-commerce retailers and its website sonos.com. The Company’s products are distributed in over 50 countries through its wholly owned subsidiaries: Sonos Europe B.V., Beijing Sonos Technology Co., Ltd. and Sonos Australia Pty Ltd., located in the Netherlands, China and Australia, respectively.

Initial public offering

On August 6, 2018, the Company completed its initial public offering (the "IPO") of its common stock, in which it sold 6,388,888 shares of its common stock, including 833,333 shares of its common stock pursuant to the underwriters’ over-allotment option, and selling stockholders sold 9,583,333 shares of the Company's common stock, including 1,250,000 shares pursuant to the underwriters' over-allotment option. The shares were sold at the IPO price of $15.00 per share for net proceeds of $90.6 million, after deducting underwriting discounts and commissions of $5.3 million. Additionally, offering costs incurred by the Company are expected to total approximately $4.6 million. Upon the closing of the IPO, all outstanding shares of the Company's redeemable convertible preferred stock automatically converted into 32,482,590 shares of common stock on a one-for-one basis.

Basis of presentation and preparation

The accompanying condensed consolidated financial statements are unaudited. The condensed consolidated balance sheet as of September 30, 2017 has been derived from the audited financial statements of the Company. The accompanying condensed financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information, and in management’s opinion, includes all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the Company’s financial position, its results of operations and cash flows for the interim periods presented. The results of operations for the three and nine months ended June 30, 2018 are not necessarily indicative of the results to be expected for the full fiscal year or any other period.

The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended (the "Securities Act"), with the Securities and Exchange Commission (“SEC”) on August 2, 2018 (the "Final Prospectus").

The Company has a 4-4-5 fiscal year ending on the Saturday nearest September 30 each year. The Company’s fiscal year is divided into four quarters of 13 weeks, each beginning on a Sunday and containing two 4-week months followed by a 5-week “month.” An additional week is included in the fourth fiscal quarter approximately every five years to realign fiscal quarters with calendar quarters. This last occurred in the fourth quarter of the Company’s fiscal year ended October 3, 2015. The nine months ended June 30, 2018 and July 1, 2017 spanned 39 weeks each.

Stock split

On July 19, 2018, the Company effected a two-for-one stock split of all outstanding shares of the Company’s capital stock, including its common stock and its redeemable convertible preferred stock. All share and per share information presented in the condensed consolidated financial statements has been retroactively adjusted for all periods presented for the effects of the stock split.


7


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


Use of estimates and judgments

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the amounts reported and disclosed in the condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, the Company evaluates its estimates and judgments compared to historical experience and expected trends.

2. Summary of significant accounting policies

There have been no changes in the Company's significant accounting policies, recently adopted accounting pronouncements, or recent accounting pronouncements pending adoption from those disclosed in the Final Prospectus, except as noted below.

Recently adopted accounting pronouncements

Revenue from Contracts with Customers

In May 2014, the Financial Accounting Standards Board (the "FASB") issued a new standard related to revenue recognition, Accounting Standards Codification (“ASC”) No. 606, Revenue from Contracts with Customers (“ASC 606”). Under ASC 606, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

ASC 606 is required to be adopted for annual reporting periods beginning after December 15, 2017, including interim periods therein, and may be earlier adopted, though no earlier than for annual reporting periods beginning after December 15, 2016. The Company elected to early adopt ASC 606 effective October 1, 2017, using the full retrospective transition method, which required the Company to adjust each prior reporting period presented.

The most significant impact of the adoption of this standard related to the Company’s accounting for arrangements with certain distributors and retail partners with implicit or explicit return rights that were recognized based on a sell-through method under ASC 605, Revenue Recognition. Under ASC 606, revenue with these parties is recognized upon transfer of control to the customer which occurs when the product is either shipped to or delivered to the customer depending on the contractual terms of the arrangement. This change resulted in an acceleration of revenue and related costs of revenue and most significantly, a reduction in deferred costs of revenue and deferred revenue at each balance sheet date. This acceleration of revenue can have a net increase or decrease in the adjusted revenue for the respective fiscal year depending on the year over year impact of the amounts accelerated across reporting periods. The Company has not previously reported its financial statements for fiscal 2017 under ASC 605 and therefore the October 1, 2017 adoption of ASC 606 had no impact on the fiscal 2017 information included in the accompanying condensed consolidated financial statements.

Recent accounting pronouncements pending adoption

Leases

In February 2016, the FASB issued Accounting Standards Update 2016-02, Leases (Topic 842) (“ASU 2016-02”), which amends a number of aspects of lease accounting, including requiring lessees to recognize operating leases with a term greater than one year on their balance sheet as a right-of-use asset and corresponding liability, measured at the present value of the lease payments. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842) Targeted Improvements, which amends ASU 2016-02 to provide an additional transition method option. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. The Company is currently evaluating the timing of adoption and the impact of adopting ASU 2016-02 on its consolidated financial statements.


8


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


Disclosure Update and Simplification

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. This final rule is effective 30 days after publication in the Federal Register. The final rule was not yet published in the Federal Register as of the date this Quarterly Report on Form 10-Q. The Company is evaluating the impact of this guidance on its consolidated financial statements.


3. Fair value measurements

The carrying values of the Company’s financial instruments, including accounts receivable and accounts payable, approximate their fair values due to the short period of time to maturity or repayment. The carrying values of the Company’s long-term debt approximate their fair values as of June 30, 2018 and September 30, 2017 as the debt carries a variable rate or market rates that approximate those currently available to the Company.

The following table summarizes fair value measurements by level for the assets measured at fair value on a recurring basis as of June 30, 2018 and September 30, 2017:
 
June 30, 2018
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds (cash equivalents)
$
50,362

 
$

 
$

 
$
50,362


 
September 30, 2017
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds (cash equivalents)
$
40,072

 
$

 
$

 
$
40,072


4. Revenue and geographic information

Disaggregation of revenue

Revenue by geographical region includes the applicable service revenue attributable to each region and is based on ship-to address, as follows:

 
 
Three Months Ended
 
Nine Months Ended
 
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
 
 
 
 
 
 
 
 
 
(In thousands)
 
 
Americas
 
$
122,982

 
$
114,707

 
$
447,705

 
$
388,620

Europe, Middle East and Africa
 
75,585

 
95,802

 
374,790

 
349,327

Asia Pacific
 
9,831

 
12,569

 
41,574

 
40,484

Total revenue
 
$
208,398

 
$
223,078

 
$
864,069

 
$
778,431



9


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


Revenue from external customers is attributed to individual countries based on ship-to address and includes the applicable service revenue attributable to each country. Revenue by significant countries is as follows:

 
 
Three Months Ended
 
Nine Months Ended
 
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
 
 
 
 
 
 
 
 
 
(In thousands)
 
 
United States
 
$
113,558

 
$
106,364

 
$
409,701

 
$
352,194

United Kingdom
 
17,930

 
20,500

 
$
88,421

 
88,505

Germany
 
18,512

 
25,973

 
$
95,720

 
86,308

Other countries
 
58,398

 
70,241

 
270,227

 
251,424

Total revenue
 
$
208,398

 
$
223,078

 
$
864,069

 
$
778,431


Revenue by product categories includes the applicable service revenue attributable to each product category. Revenue by major product category is as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
 
 
 
 
 
 
 
 
 
(In thousands)
 
 
Wireless speakers
 
$
93,867

 
$
92,797

 
$
453,185

 
$
389,300

Home theater speakers
 
66,732

 
83,928

 
283,952

 
266,972

Components
 
42,283

 
44,160

 
113,530

 
114,007

Other
 
5,516

 
2,193

 
13,402

 
8,152

Total revenue
 
$
208,398

 
$
223,078

 
$
864,069

 
$
778,431



10


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


5. Balance sheet components

Inventories

Inventories, net, consist of the following:
 
June 30, 2018
 
September 30, 2017
(In thousands)
 
Finished goods
$
98,565

 
$
104,014

Components
14,846

 
9,842

Inventories
$
113,411

 
$
113,856


The Company writes down inventory as a result of excess and obsolete inventories, or when it believes that the net realizable value of inventories is less than the carrying value.

Deferred revenue

Amounts invoiced in advance of revenue recognition are recorded as deferred revenue on the condensed consolidated balance sheets. Changes in deferred revenue balances as of June 30, 2018 and July 1, 2017 were as follows:

 
June 30, 2018
 
July 1, 2017
 
 
 
 
(In thousands)
 
 
 
Deferred revenue, beginning of period
$
45,567

 
$
36,160

Recognition of revenue included in beginning of period deferred revenue
(8,367
)
 
(5,171
)
Revenue deferred, net of revenue recognized on contracts in the respective period
18,594

 
11,817

Deferred revenue, end of period
$
55,794

 
$
42,806


As of June 30, 2018, deferred revenue was $55.8 million. The Company expects to recognize approximately $8.9 million in the remainder of fiscal 2018, $11.0 million in fiscal 2019, $10.3 million in fiscal 2020, $9.0 million in fiscal 2021, $7.2 million in fiscal 2022 and $9.4 million thereafter.


6. Long-term debt

JP Morgan credit facility

In October 2015, the Company entered into a credit agreement with J.P. Morgan Chase Bank, N.A. (the “Credit Facility”). The Credit Facility allows the Company to borrow up to $80.0 million, including up to a $10.0 million for the issuance of letters of credit and up to $8.0 million for swing line loans. The Credit Facility matures on October 28, 2020. The Company has the option to repay the borrowings under the Credit Facility without penalty prior to maturity. As of June 30, 2018 and September 30, 2017 the Company was in compliance with all covenants. Obligations under the Credit Facility are collateralized by eligible inventory, accounts receivable and intellectual property of the Company. As of June 30, 2018 and September 30, 2017 the Company did not have any outstanding borrowings under the Credit Facility and had $4.5 million and $4.4 million, respectively, in undrawn letters of credit that reduced the availability under the Credit Facility. The average interest rates were LIBOR +1.25% as of June 30, 2018 and September 30, 2017.

Subsequent to the nine months ended June 30, 2018, in July 2018, the Company amended its existing 2015 Credit Facility with J.P. Morgan Chase Bank, N.A. to, among other things, extend its term from October 2020 to October 2021 and provide for a $40.0 million term loan, which increased the Company’s borrowing capacity thereunder from $80.0 million to $120.0 million. In connection with the amendment, the Company borrowed $40.0

11


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


million under a term loan (the "New Term Loan”), which the Company used to pay off all outstanding borrowings, accrued interest and fees under its then-outstanding term loan, as described below. The New Term Loan has a maturity date of October 2021 and bears interest at a variable rate equal to an adjusted LIBOR plus 2.25%. The Company will make its first principal payment under the New Term Loan in July 2019 and will make quarterly principal payments thereafter. The Company elected to make interest payments on a semi-annual basis.

Term loan

In March 2016, the Company entered into a $25.0 million, five-year term loan agreement with Gordon Brothers Finance Company (the “Term Loan”). The Term Loan initially bore interest at a variable rate equal to an adjusted LIBOR plus 10.0%, with a minimum rate of 10.5% per annum. In December 2016, the Company amended the Term Loan (the “Amended Term Loan”) and borrowed an additional $15.0 million net of issuance costs, increasing the aggregate principal amount of the loan to $40.0 million, reducing the interest rate to a variable rate equal to an adjusted LIBOR plus 9.5% and changing prepayment penalty terms. The Amended Term Loan bore interest at a variable rate equal to an adjusted LIBOR plus 9.5%, with a minimum rate of 10.0% per annum. The effective interest rate on the Term Loan was 11.48% and 10.74% as of June 30, 2018 and September 30, 2017, respectively. As of June 30, 2018 and September 30, 2017, the Company was in compliance with all covenants and the carrying value of the Amended Term Loan was $39.7 million and $39.6 million, respectively, net of unamortized debt discount of $0.3 million and $0.4 million, respectively. Obligations under the Amended Term Loan were collateralized by eligible inventory, accounts receivable and intellectual property of the Company.

As described above, in July 2018, the Company terminated its $40.0 million Amended Term Loan with Gordon Brothers Finance Company. In connection with the termination and new borrowings under the New Term Loan, the Company paid off all outstanding borrowings, accrued interest, and fees under the Amended Term Loan.


7. Redeemable convertible preferred stock

As of June 30, 2018 and September 30, 2017 redeemable convertible preferred stock consisted of the following:

(In thousands, except shares)
 
 
 
 
 
 
 
As of June 30, 2018 and September 30, 2017
 
Authorized Shares
 
Issued and Outstanding Shares
 
Carrying Value
 
Liquidation Preference
Series A Preferred Stock
10,035,000

 
10,005,000

 
$
15,060

 
$
15,008

Series B Preferred Stock
3,881,250

 
3,730,000

 
5,926

 
5,968

Series C Preferred Stock
11,700,000

 
11,688,766

 
26,556

 
25,000

Series D Preferred Stock
7,058,824

 
7,058,824

 
42,799

 
45,000

Total
32,675,074

 
32,482,590

 
$
90,341

 
$
90,976


Upon the closing of the IPO, all shares of the Company's outstanding redeemable convertible preferred stock automatically converted on a one-for-one basis into an aggregate of 32,482,590 shares of common stock.

8. Stock option plan and stock-based compensation

During 2003, the Company’s Board of Directors (the "Board") established the 2003 Stock Plan, as amended (the “2003 Plan”). As of June 30, 2018, there were 89,000,000 shares authorized under the 2003 Plan and 1,799,258 shares were reserved for future issuance. As of September 30, 2017, there were 85,000,000 shares authorized under the 2003 Plan, and 2,088,004 shares were reserved for future issuance. The 2003 Plan includes incentive stock options that are subject to the rules and regulations of the Internal Revenue Code of 1986, as amended (the "Code"), and nonqualified stock options. The option price, number of shares and grant date are determined at the discretion of the Board. As long as the optionholder performs services for the Company, the options generally vest over 48 months, with cliff vesting after one year and monthly vesting thereafter. All options are exercisable for a period not to exceed ten years from the date of grant.


12


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


In July 2018, the Board adopted the 2018 Equity Incentive Plan (the "2018 Plan") and ceased granting awards under the 2003 Plan. The 2018 Plan became effective in connection with the IPO. The Company reserved 21,200,000 shares of its common stock for issuance under the 2018 Plan. Any remaining shares available for issuance under the 2003 Stock Plan on the effective date of the 2018 Plan were added to the shares of common stock reserved for issuance under the 2018 Plan.

Stock option activity was as follows:
 



Number of
Options
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Term
 
Weighted Average Intrinsic Value
 
 
 
 
 
(in years)
 
(in thousands)
Outstanding at September 30, 2017
45,817,252

 
$
9.20

 
6.9
 
$
199,663

Granted
7,676,414

 
$
15.09

 
 
 
 
Exercised
(1,735,750
)
 
$
3.31

 
 
 
 
Forfeited
(3,387,668
)
 
$
13.05

 
 
 
 
Outstanding at June 30, 2018
48,370,248

 
$
10.08

 
6.7
 
$
243,060

 
 
 
 
 
 
 
 
At June 30, 2018
 
 
 
 
 
 
 
Options exercisable
30,582,952

 
$
7.70

 
5.4
 
$
226,453

Options vested and expected to vest
45,413,361

 
$
9.80

 
6.6
 
$
240,964

 
 
 
 
 
 
 
 

As of June 30, 2018 and September 30, 2017, the Company had $73.5 million and $74.9 million, respectively, of unrecognized stock-based compensation expense which is expected to be recognized over a weighted-average period of 2.7 and 2.8 years, respectively.

The Company’s policy for issuing stock upon stock option exercise is to issue new common stock.

Total stock-based compensation expense by function category was as follows:
 
Three Months Ended
 
Nine Months Ended
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
(In thousands)
 
 
 
 
 
 
 
Cost of revenue
$
49

 
$
65

 
$
156

 
$
179

Research and development
3,651

 
3,529

 
10,417

 
10,136

Sales and marketing
4,391

 
3,899

 
12,414

 
11,172

General and administrative
2,242

 
2,045

 
6,410

 
5,474

Total stock-based compensation expense
$
10,333

 
$
9,538

 
$
29,397

 
$
26,961


9. Income taxes

The Company's tax provision and the resulting effective tax rate for interim periods is determined based upon its estimated annual effective tax rate, adjusted for the effect of discrete items arising in that quarter. The impact of such inclusions could result in a higher or lower effective tax rate during a particular quarter, based upon the mix and timing of actual earnings or losses versus annual projections. In each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual tax rate changes, a cumulative adjustment is made in that quarter. The Company had an income tax expense of $0.5 million and $0.2 million for the three months ended June 30, 2018 and July 1, 2017, respectively, and an income tax expense of $1.1 million and an income tax benefit of $1.8 million for the nine months ended June 30, 2018 and July 1, 2017, respectively. In fiscal 2017, the Company amended a tax audit settlement agreement with the Dutch Tax Administration, which, among other things, resulted in a release

13


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


of previously accrued tax liabilities for Sonos Europe B.V. that was partially offset by the establishment of a valuation allowance based on cumulative losses, resulting in a net tax benefit in the first nine months of fiscal 2017.

Tax Act

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (the "Tax Act") into law, implementing a wide variety of changes to the U.S. tax system. Among other changes at the corporate level, the Tax Act includes (i) a reduction in the U.S. federal corporate income tax rate from 35% to 21%, (ii) further limitations on the deductibility of interest expense and certain executive compensation, (iii) the repeal of the corporate alternative minimum tax, (iv) the imposition of a territorial tax system with a one-time repatriation tax on deemed repatriated earnings of foreign subsidiaries and (v) subjecting certain foreign earnings to U.S. taxation through a base erosion anti-abuse tax (“BEAT”) and a new tax related to global intangible low taxed income (“GILTI”). Additionally, certain foreign derived intangible income (“FDII”) may prospectively be subject to a reduced rate of income tax from the statutorily enacted rate of 21%. Some of these changes, including the BEAT, FDII and GILTI provisions, will not come into effect until the Company’s 2019 fiscal year, but because the decrease in the corporate income tax rate was effective January 1, 2018, the Company has reduced the future tax benefits of the Company’s existing U.S. deferred tax assets. However, since the Company maintains a full valuation allowance against these assets, it did not have a material impact on the Company’s results of operations or financial condition. The Company has not recorded a provision related to the one-time transition tax under Section 965 of the Code as the Company has estimated that its foreign subsidiaries have a consolidated deficit in accumulated and current earnings and profits.

The Company’s accounting for the elements of the Tax Act is incomplete. The Company has made reasonable estimates of the effects to the condensed consolidated statements of operations and comprehensive loss and condensed consolidated balance sheets and have preliminarily determined that a provision is not required. The ultimate impact of the Tax Act may differ from the above estimates due to potential future legislative action to address questions that have arisen because of the Tax Act, issuance of additional guidance by the Internal Revenue Service (the "IRS") to provide clarity on certain provisions of the Tax Act and any changes in accounting standards for income taxes or related interpretations in response to the Tax Act. The SEC has issued rules that allow for a measurement period of up to one year after the enactment date of the Tax Act to finalize the recording of the related tax impacts. The Company currently anticipates finalizing and recording any resulting adjustments by the end of its fiscal quarter ending December 29, 2018.


14


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



10. Net loss per share attributable to common stockholders

Basic and diluted net loss per share attributable to common stockholders is presented in conformity with the two-class method required for participating securities. The Company considers its redeemable convertible preferred stock to be participating securities as the holders of redeemable convertible preferred stock are entitled to receive noncumulative dividends in the event that a dividend is paid on common stock. The holders of redeemable convertible preferred stock and the holders of non-vested restricted stock do not have a contractual obligation to share in the losses of the Company. Basic net loss attributable to common stockholders per share is calculated by dividing net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding less shares subject to repurchase. Diluted net loss per share attributable to common stockholders adjusts the basic net loss per share attributable to common stockholders and the weighted-average number of shares of common stock outstanding for the potentially dilutive impact of stock options and restricted stock, using the treasury stock method, and convertible preferred stock using the as-if-converted method.

The following table sets forth the computation of the Company’s basic and diluted net loss per share attributable to common stockholders:
 
Three Months Ended
 
Nine Months Ended
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
(In thousands, except per share data)
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income (loss)
$
(26,988
)
 
$
(14,539
)
 
$
(13,884
)
 
$
688

Less: earnings attributable to preferred stockholders

 

 

 
(688
)
Net loss attributable to common stockholders—basic and diluted
(26,988
)
 
(14,539
)
 
(13,884
)
 

Denominator:
 
 
 
 
 
 
 
Weighted-average shares of common stock—basic and diluted
60,074,763

 
56,334,641

 
59,484,761

 
55,776,325

Net loss per share attributable to common stockholders:
 
 
 
 
 
 
 
Net loss per share attributable to common stockholders—basic and diluted
$
(0.45
)
 
$
(0.26
)
 
$
(0.23
)
 
$


The following potentially dilutive shares were excluded from the computation of diluted net loss per share for the periods presented because including them would have been antidilutive:
 
Three Months Ended
 
Nine Months Ended
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
Stock options to purchase common stock
48,370,248

 
48,554,772

 
48,370,248

 
48,554,772

Convertible preferred stock
32,482,590

 
32,482,590

 
32,482,590

 
32,482,590

Shares subject to repurchase
53,892

 
53,892

 
53,892

 
53,892

Total
80,906,730

 
81,091,254

 
80,906,730

 
81,091,254


15


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


11. Commitments and contingencies

Inventory

The Company enters into various inventory-related purchase agreements with suppliers. Generally, under these agreements, 100% of orders are cancelable by giving notice 29 days prior to the expected shipment date. Orders are non-cancelable within 28 days prior to the expected shipment date. At June 30, 2018, the Company had $40.9 million in non-cancelable purchase commitments with inventory suppliers. The remaining minimum total purchase commitments under the agreements with these suppliers at June 30, 2018 was $38.9 million for the remainder of fiscal 2018 and $2.0 million in fiscal 2019.

Legal proceedings

From time to time, the Company is involved in legal proceedings in the ordinary course of business, including claims relating to employee relations, business practices and patent infringement. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict and the Company’s view of these matters may change in the future as the litigation and events related thereto unfold. The Company expenses legal fees as incurred. The Company records a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. An unfavorable outcome to any legal matter, if material, could have an adverse effect on the Company’s operations or its financial position, liquidity or results of operations.

On October 21, 2014, the Company commenced a patent infringement action in the United States District Court, District of Delaware against D&M Holdings Inc. d/b/a The D+M Group, D&M Holdings U.S. Inc. and Denon Electronics (USA), LLC (collectively, “Denon”). On May 18, 2018, the Company entered into a patent covenant agreement with Denon, effective May 17, 2018, with a term lasting through May 22, 2022. Under the agreement, Denon will make royalty payments over the nine months following the effective date, covering both historical sales and sales throughout the term, at an effective royalty rate materially consistent with the December 14, 2017 jury verdict. Pursuant to the agreement, all claims asserted in the Company’s patent infringement claim against Denon and in Denon’s countersuit against the Company were dismissed with prejudice and the parties released claims of any past infringement of the patents asserted in the litigation between the Company and Denon and any patents related thereto.

On March 10, 2017, Implicit, LLC (“Implicit”) filed a patent infringement action in the United States District Court, District of Delaware against the Company. Implicit is asserting that the Company infringed on two patents in this case. The Company denies the allegations. There is no assurance of a favorable outcome and the Company’s business could be adversely affected as a result of a finding that the Company patents-in-suit are invalid and/or unenforceable. A range of loss, if any, associated with this matter is not probable or reasonably estimable as of June 30, 2018 and September 30, 2017.

The Company is involved in certain other litigation matters not listed above but does not consider the matters to be material either individually or in the aggregate at this time. The Company’s view of the matters not listed may change in the future as the litigation and events related thereto unfold.

12. Subsequent events

On August 6, 2018, the Company completed the IPO of its common stock (see Note 1).

Upon the closing of the IPO, all outstanding shares of the Company's redeemable convertible preferred stock automatically converted into 32,482,590 shares of common stock on a one-for-one basis.

In July 2018 the Board adopted the 2018 Plan and ceased granting awards under the 2003 Plan (see Note 8).

In July 2018, the Company amended its existing Credit Facility with J.P. Morgan Chase Bank, N.A. to, among other things, extend its term from October 2020 to October 2021 and provide for a $40.0 million term loan. At the same time, in July 2018, the Company terminated the Amended Term Loan with Gordon Brothers Finance Company and paid off all outstanding borrowings, accrued interest and fees thereunder (see Note 6).

16


SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



On July 19, 2018, the Company effected a two-for-one stock split of all outstanding shares of the Company’s capital stock, including its common stock and its redeemable convertible preferred stock (see Note 1).

17


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in the Final Prospectus.

We have a 4-4-5 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 months followed by a 5-week "month."

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding future operations are forward-looking statements. In some cases, forward-looking statements may be identified by words such as "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "could," "would," "expect," "objective," "plan," "potential," "seek," "grow," "target," "if," and similar expressions intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the section titled "Risk Factors" set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings, including the Final Prospectus. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results may differ materially and adversely from those anticipated or implied in the forward-looking statements. You should read this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.

Overview

Sonos was founded with a clear mission—to fill every home with music. This mission led us to invent wireless multi-room home audio. Sonos transforms the way people live and interact by restoring the shared experience of music throughout the home. Our home 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 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 home sound systems. We sell our products primarily through over 10,000 third-party physical retail stores, including custom installers of home audio systems. We also sell through select e-commerce retailers and our website sonos.com. Our products are distributed in over 50 countries. We operate offices and development labs worldwide, with a significant presence in the United States, the Netherlands and China.

We are focused on driving sustainable, profitable long-term growth with our five key growth strategies, which include: (1) consistently introducing innovative products; (2) investing in geographic expansion into new countries by employing country-specific marketing campaigns and distribution channels; (3) continuing to build direct relationships with current and prospective customers through sonos.com and the Sonos app to drive direct sales; (4) expanding our partner ecosystem to provide our customers access to streaming music services, voice assistants, internet radio, podcasts and audiobook content; (5) increasing our household penetration rates in our existing geographic markets by investing in brand awareness, expanding our product offerings and growing our partner ecosystem.



18


Key Metrics

In addition to the measures presented in our condensed 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 products sold, adjusted EBITDA and adjusted EBITDA margin.

Net income (loss) is the most directly comparable financial measure calculated under U.S. GAAP for adjusted EBITDA. In the three months ended June 30, 2018 and July 1, 2017, we had net loss of $27.0 million and $14.5 million, respectively. In the nine months ended June 30, 2018 and July 1, 2017, we had net loss of $13.9 million and net income of $0.7 million, respectively.
 
Three Months Ended
 
Nine Months Ended
 
June 30, 2018
 
July 1, 2017
 
June 30, 2018
 
July 1, 2017
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Products sold
887

 
796

 
3,957

 
3,173

Adjusted EBITDA
$
(1,541
)
 
$
2,306

 
$
48,968

 
$
51,406

Adjusted EBITDA margin
(0.7
)%
 
1.0
%
 
5.7
%
 
6.6
%

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 and components. Products sold excludes the sale of other products, such as Sonos and third-party accessories. Historically, the sale of these accessories has not materially contributed to our revenue and we expect this trend to continue. 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 income (loss) adjusted to exclude the impact of stock-based compensation expense, depreciation, interest expense, net, other income (expense), net and provision for (benefit from) income taxes. We define adjusted EBITDA margin as adjusted EBITDA divided by revenue. See "Non-GAAP Financial Measures" below for information regarding our use of adjusted EBITDA and adjusted EBITDA margin and a reconciliation of net income (loss) to adjusted EBITDA.

Non-GAAP Financial Measures

To supplement our condensed 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.


19


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 operating margin, which is the nearest U.S. GAAP equivalent of adjusted EBITDA margin. Some of these limitations are:

these non-GAAP financial measures exclude depreciation and, although these are non-cash expenses, the assets being depreciated may be replaced in the future;
these non-GAAP financial measures 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;
these non-GAAP financial measures 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;
these non-GAAP financial measures do not reflect the effect of foreign currency exchange gains or losses, which is included in other income (expense), net;
these non-GAAP financial measures do not reflect income tax payments that reduce cash available to us; and
the expenses and other items that we exclude in our calculation of these non-GAAP financial measures may differ from the expenses and other items, if any, that other companies may exclude from these non-GAAP financial measures when they report their operating results.

Because of these limitations, these non-GAAP financial measures should be considered along with other operating and financial performance measures presented in accordance with U.S. GAAP.

The following table presents a reconciliation of net income (loss) to adjusted EBITDA:
 
Three Months Ended
 
Nine Months Ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
 
(in thousands, except percentages)
Net income (loss)
$
(26,988
)
 
$
(14,539
)
 
$
(13,884
)
 
$
688

Depreciation
9,760

 
8,901

 
28,647

 
24,447

Stock-based compensation expense
10,333

 
9,538

 
29,397

 
26,961

Interest expense, net
1,116

 
1,185

 
3,367

 
3,187

Other (income) expense, net
3,744

 
(2,975
)
 
315

 
(2,047
)
Provision for (benefit from) income taxes
494

 
196

 
1,126

 
(1,830
)
Adjusted EBITDA
$
(1,541
)
 
$
2,306

 
$
48,968

 
$
51,406

Revenue
$
208,398

 
$
223,078

 
$
864,069

 
$
778,431

Adjusted EBITDA margin
(0.7
)%
 
1.0
%
 
5.7
%
 
6.6
%



20


Factors Affecting Performance

New Product Introductions. To date, new product introductions have had a positive impact on our revenue. We intend to introduce new products that appeal to a broad set of consumers and to increase the cadence of new product launches. As we increase the pace of our product introductions, we expect our gross margin to decline in the near to intermediate term as new products gain a larger share of our overall product mix. Accordingly, our future financial performance will be affected by our ability to drive cost of revenue savings as we scale production over time.

Voice Control. We believe voice control technology is disrupting the home audio market and changing what consumers expect from a home speaker. Therefore, our product roadmap is focused on delivering products with native voice control. For example, we released Sonos One in the first quarter of fiscal 2018, our entry into the voice-enabled speaker category, and we introduced the voice-enabled Sonos Beam in July 2018. 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, some 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.

Seasonality. Historically, we have experienced the highest levels of revenue in the first fiscal quarter of the year, coinciding with the holiday shopping season. Our promotional discounting activity is higher in the first fiscal quarter as well, which negatively impacts gross margin during this period. 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. Given this significant seasonality, accurate forecasting for the first fiscal quarter is critical to our inventory management, as well as to our full-year financial planning and performance.

Ability to Sell Additional Products to Existing Customers. 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. As our customers add Sonos to their homes and listen to more music, they typically increase the number of our products in their homes. 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 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.


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 a small portion of our revenue from other revenue sources, such as the sale of Sonos and third-party accessories like speaker stands and wall mounts. 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.

Cost of Revenue

Cost of revenue consists of product costs, including costs of our contract manufacturer for production, component costs, shipping and handling 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

21


expenses associated with supply chain logistics. Personnel-related expenses consist of salaries, bonuses, benefits and stock-based compensation expenses.

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 and the foreign currency in which our products are sold. As we increase the pace of our product introductions, we expect our gross margin to decline in the near to intermediate term as new products gain a larger share of our overall product mix. 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. In this regard, we believe our ability to achieve these results will be negatively impacted through calendar year 2019 due to an industry-wide supply shortage of multilayer ceramic capacitors, arising from an imbalance of global demand and supply capacity and related increases in the costs of these components.

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 allocated 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. We also anticipate that these expenses will decline as a percentage of our revenue over the long term, but that they may fluctuate based on our product development efforts.

Sales and Marketing. Sales and marketing expenses represent the largest component of our operating expenses and 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 allocated overhead costs. We expect our sales and marketing expenses to increase in absolute dollars as we continue to actively promote our products. We also anticipate that these expenses will decrease as a percentage of our revenue, but that they may fluctuate as we introduce new products.

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 allocated 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 recently becoming a public company. However, we expect our general and administrative expenses to decrease as a percentage of our revenue as we scale our business.

Other Income (Expense), Net

Interest Expense, Net. Interest expense consists primarily of interest expense associated with our debt financing arrangements and amortization of debt issuance costs. Interest income consists primarily of interest income earned on our cash and cash equivalents balances.

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.


22


Provision for (Benefit from) Income Taxes

We are subject to income taxes in the United States and foreign jurisdictions in which we operate. Our provision for (benefit from) income taxes results principally from our foreign operations. Foreign jurisdictions have statutory tax rates different from those in the United States. Accordingly, our effective tax rates will vary depending on the relative proportion of foreign to U.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 our U.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.



23


Results of Operations

The following table sets forth our condensed consolidated results of operations for the periods indicated. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.

 
Three Months Ended
 
Nine Months Ended
 
June 30, 2018
 
July 1,
2017
 
June 30, 2018
 
July 1,
2017
 
(in thousands)
Revenue
$
208,398

 
$
223,078

 
$
864,069

 
$
778,431

Cost of revenue(1)
112,909

 
115,790

 
491,037

 
425,257

Gross profit
95,489

 
107,288

 
373,032

 
353,174

Operating expenses
 
 
 
 
 
 
 
Research and development(1)
35,444

 
33,347

 
104,209

 
90,920

Sales and marketing(1)
60,819

 
70,074

 
214,077

 
207,225

General and administrative(1)
20,860

 
20,000

 
63,822

 
55,031

Total operating expenses
117,123

 
123,421

 
382,108

 
353,176

Operating loss
(21,634
)
 
(16,133
)
 
(9,076
)
 
(2
)
Other income (expense), net
 
 
 
 
 
 
 
Interest expense, net
(1,116
)
 
(1,185
)
 
(3,367
)
 
(3,187
)
Other income (expense), net
(3,744
)
 
2,975

 
(315
)
 
2,047

Total other income (expense), net
(4,860
)
 
1,790

 
(3,682
)
 
(1,140
)
 
 
 
 
 
 
 
 
Loss before provision for (benefit from) income taxes
(26,494
)
 
(14,343
)
 
(12,758
)
 
(1,142
)
Provision for (benefit from) income taxes
494

 
196

 
1,126

 
(1,830
)
Net income (loss)
$
(26,988
)
 
$
(14,539
)
 
$
(13,884
)
 
$
688

Adjusted EBITDA(2)
$
(1,541
)
 
$
2,306

 
$
48,968

 
$
51,406

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) Amounts include stock-based compensation expense as follows:
 
Three Months Ended
 
Nine Months Ended
 
June 30, 2018
 
July 1,
2017
 
June 30, 2018
 
July 1,
2017
Cost of revenue
$
49

 
$
65

 
$
156

 
$
179

Research and development
3,651

 
3,529

 
10,417

 
10,136

Sales and marketing
4,391

 
3,899

 
12,414

 
11,172

General and administrative
2,242

 
2,045

 
6,410

 
5,474

Total stock-based compensation expense
$
10,333

 
$
9,538

 
$
29,397

 
$
26,961

 
 
 
 
 
 
 
 
(2) Adjusted EBITDA is a financial measure that is not calculated in accordance with U.S. GAAP. See the section titled "Non-GAAP Financial Measures."


24


The following table sets forth selected condensed consolidated financial data for the periods indicated, expressed as a percentage of revenue (the table may not foot due to rounding):
 
Three Months Ended
 
Nine Months Ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Revenue
100.0
 %
 
100.0
%
 
100.0
%
 
100.0
%
Cost of revenue(1)
54.2

 
51.9

 
56.8

 
54.6

Gross profit
45.8

 
48.1

 
43.2

 
45.4

Operating expenses
 
 
 
 
 
 
 
Research and development(1)
17.0

 
14.9

 
12.1

 
11.7

Sales and marketing(1)
29.2

 
31.4

 
24.8

 
26.6

General and administrative(1)
10.0

 
9.0

 
7.4

 
7.1

Total operating expenses
56.2

 
55.3

 
44.2

 
45.4

Operating loss
(10.4
)
 
(7.2
)
 
(1.1
)
 

Other income (expense), net
 
 
 
 
 
 
 
Interest expense, net
(0.5
)
 
(0.5
)
 
(0.4
)
 
(0.4
)
Other income (expense), net
(1.8
)
 
1.3

 

 
0.3

Total other income (expense), net
(2.3
)
 
0.8

 
(0.4
)
 
(0.1
)
Loss before provision for (benefit from) income taxes
(12.7
)
 
(6.4
)
 
(1.5
)
 
(0.1
)
Provision for (benefit from) income taxes
0.2

 
0.1

 
0.1

 
(0.2
)
Net income (loss)
(13.0
)
 
(6.5
)
 
(1.6
)
 
0.1

Adjusted EBITDA margin(2)
(0.7
)%
 
1.0
%
 
5.7
%
 
6.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) Amounts include stock-based compensation expense as follows:
 
Three Months Ended
 
Nine Months Ended
 
June 30,
2018
 
July 1,
2017
 
June 30,
2018
 
July 1,
2017
Cost of revenue
 %
 
%
 
%
 
%
Research and development
1.8

 
1.6

 
1.2

 
1.3

Sales and marketing
2.1

 
1.7

 
1.4

 
1.4

General and administrative
1.1

 
0.9

 
0.7

 
0.7

Total Stock-based compensation expense
5.0
 %
 
4.3
%
 
3.4
%
 
3.5
%
 
 
 
 
 
 
 
 
(2) Adjusted EBITDA is a financial measure that is not calculated in accordance with U.S. GAAP. See the section titled "Non-GAAP Financial Measures."


25


Comparison of the Three and Nine Months Ended June 30, 2018 and July 1, 2017

Revenue
 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
(dollars and products sold in thousands)
Americas
$
122,982

 
$
114,707

 
$
8,275

 
7.2
 %
 
$
447,705

 
$
388,620

 
$
59,085

 
15.2
%
Europe, Middle East and Africa
75,585

 
95,802

 
(20,217
)
 
(21.1
)%
 
374,790

 
349,327

 
25,463

 
7.3
%
Asia Pacific
9,831

 
12,569

 
(2,738
)
 
(21.8
)%
 
41,574

 
40,484

 
1,090

 
2.7
%
Total revenue
$
208,398

 
$
223,078

 
$
(14,680
)
 
(6.6
)%
 
$
864,069

 
$
778,431

 
$
85,638

 
11.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total products sold
887

 
796

 
91

 
11.4
 %
 
3,957

 
3,173

 
784

 
24.7
%

Comparison of the Three Months Ended June 30, 2018 and July 1, 2017

Revenue decreased by $14.7 million, or 6.6%, from $223.1 million for the three months ended July 1, 2017 to $208.4 million for the three months ended June 30, 2018, primarily due to an expected decrease in PLAYBASE revenue. PLAYBASE launched as a new product in the three months ended July 1, 2017, resulting in a large revenue increase as our retail partners purchased their initial PLAYBASE inventory.

Products sold increased by 0.1 million, or 11.4%, from 0.8 million for the three months ended July 1, 2017 to 0.9 million for the three months ended June 30, 2018. The volume growth was primarily driven by sales of our newest wireless speaker product, Sonos One, which launched in October 2017, partially offset by a decrease from sales of our home theater speakers driven by decrease in sales of our PLAYBASE product, which launched in the April 2017.

In constant U.S. dollars, total revenue decreased by 9.8% for the three months ended June 30, 2018 compared to the three months ended July 1, 2018, which excludes the impact of foreign currencies weakening against the U.S. dollar. We calculate constant currency growth percentages by translating our prior-period financial results using the current period average currency exchange rates and comparing these amounts to our current period reported results.

Comparison of the Nine Months Ended June 30, 2018 and July 1, 2017

Revenue increased $85.6 million, or 11.0%, from $778.4 million for the nine months ended July 1, 2017 to $864.1 million for the nine months ended June 30, 2018, primarily due to an increase in the number of products sold. In the nine months ended June 30, 2018 products sold increased 24.7% and revenue increased 11.0% compared to the nine months ended July 1, 2017. Wireless speakers are our largest product category and revenue grew 16.4% compared to the same period in the prior fiscal year, driven by the introduction of Sonos One in October 2017. Home theater speakers revenue increased 6.4% compared to the same period in the prior fiscal year, despite last year’s PLAYBASE launch.

In constant U.S. dollars, revenue increased by 6.2% for the nine months ended June 30, 2018 compared to the nine months ended July 1, 2017, which excludes the impact of foreign currencies weakening against the U.S. dollar.


26


Cost of Revenue and Gross Profit

 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
(dollars in thousands)
Cost of revenue
$
112,909

 
$
115,790

 
$
(2,881
)
 
(2.5
)%
 
$
491,037

 
$
425,257

 
$
65,780

 
15.5
%
Gross profit
$
95,489

 
$
107,288

 
$
(11,799
)
 
(11.0
)%
 
$
373,032

 
$
353,174

 
$
19,858

 
5.6
%
Gross margin
45.8
%
 
48.1
%
 

 
 
 
43.2
%
 
45.4
%
 

 
 

Comparison of the Three Months Ended June 30, 2018 and July 1, 2017

Cost of revenue decreased $2.9 million, or 2.5%, from $115.8 million for the three months ended July 1, 2017 to $112.9 million for the three months ended June 30, 2018, primarily due to the decrease in revenue. Gross margin decreased by 2.3 percentage points for the three months ended June 30, 2018 compared to the three months ended July 1, 2017, primarily due to the impact of lower margins on wireless speakers in connection with the launch of our new Sonos One product in October 2017, as well as lower retail prices on our older wireless speakers.

Comparison of the Nine Months Ended June 30, 2018 and July 1, 2017

Cost of revenue increased $65.8 million, or 15.5%, from $425.3 million for the nine months ended July 1, 2017 to $491.0 million for the nine months ended June 30, 2018, primarily due to the increase in revenue. Gross margin decreased by 2.2 percentage points for the nine months ended June 30, 2018 compared to the nine months ended July 1, 2017, primarily due to the impact of lower margins on wireless speakers in connection with the launch of our new Sonos One product in October 2017, as well as lower retail prices on our older wireless speakers.

Research and Development

 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
(dollars in thousands)
Research and development
$
35,444

 
$
33,347

 
$
2,097

 
6.3
%
 
$
104,209

 
$
90,920

 
$
13,289

 
14.6
%
Percentage of revenue
17.0
%
 
14.9
%
 
 
 
 
 
12.1
%
 
11.7
%
 
 
 
 

Comparison of the Three Months Ended June 30, 2018 and July 1, 2017

Research and development expenses increased $2.1 million, or 6.3%, from $33.3 million for the three months ended July 1, 2017 to $35.4 million for the three months ended June 30, 2018. The increase was primarily due to higher personnel-related expenses of $3.7 million as we increased our headcount, particularly in software personnel, during the period. The increase was offset by decreases in product development and professional fees associated with Sonos One and lower allocated overhead costs.

Comparison of the Nine Months Ended June 30, 2018 and July 1, 2017

Research and development expenses increased $13.3 million, or 14.6%, from $90.9 million for the nine months ended July 1, 2017 to $104.2 million for the nine months ended June 30, 2018. The increase was primarily due to higher personnel-related expenses of $13.7 million as our headcount, particularly in software personnel, increased during the period.


27


Sales and Marketing
 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
(dollars in thousands)
Sales and marketing
$
60,819

 
$
70,074

 
$
(9,255
)
 
(13.2
)%
 
$
214,077

 
$
207,225

 
$
6,852

 
3.3
%
Percentage of revenue
29.2
%
 
31.4
%
 
 
 
 
 
24.8
%
 
26.6
%
 
 
 
 

Comparison of the Three Months Ended June 30, 2018 and July 1, 2017

Sales and marketing expenses decreased $9.3 million, or 13.2%, from $70.1 million for the three months ended July 1, 2017 to $60.8 million for the three months ended June 30, 2018. The decrease was primarily due to a decrease of $13.9 million in marketing and advertising costs primarily related to the support of our launch of PLAYBASE in April 2017, as well as reduced marketing expenses as we transitioned away from traditional paid media and we adopted more efficient direct-to-consumer and digital marketing tools. The decrease was offset by $3.5 million in one-time charges during the three months ended June 30, 2018 associated with our reorganization that combined our marketing and commercial teams, as well as an increase of $1.2 million related to third-party customer care services.

Comparison of the Nine Months Ended June 30, 2018 and July 1, 2017

Sales and marketing expenses increased $6.9 million, or 3.3%, from $207.2 million for the nine months ended July 1, 2017 to $214.1 million for the nine months ended June 30, 2018. The increase was primarily due to an increase of $12.5 million in personnel-related costs due to increased headcount and one-time charges associated with our reorganization that combined our marketing and commercial teams, an increase of $5.7 million related to increased third-party customer care activity and retail store investments, and an increase of $3.4 million in depreciation related to a refresh of our product displays. These increases were partially offset by a decrease of $15.5 million in marketing program expenses as compared to the same period last year due in part to the product launch of PLAYBASE in April 2017, as well as reduced marketing expenses in the current period as we transitioned away from traditional paid media and adopted more efficient direct-to-consumer and digital marketing tools.

General and Administrative
 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
(dollars in thousands)
General and administrative
$
20,860

 
$
20,000

 
$
860

 
4.3
%
 
$
63,822

 
$
55,031

 
$
8,791

 
16.0
%
Percentage of revenue
10.0
%
 
9.0
%
 
 
 
 
 
7.4
%
 
7.1
%
 
 
 
 

Comparison of the Three Months Ended June 30, 2018 and July 1, 2017

General and administrative expenses increased $0.9 million, or 4.3%, from $20.0 million for the three months ended July 1, 2017 to $20.9 million for the three months ended June 30, 2018. The increase was primarily due to an increase in personnel-related costs of $0.6 million, predominantly driven by growth in headcount as we invested in personnel and programs to create the infrastructure necessary to support a public company.

Comparison of the Nine Months Ended June 30, 2018 and July 1, 2017

General and administrative expenses increased $8.8 million, or 16.0%, from $55.0 million for the nine months ended July 1, 2017 to $63.8 million for the nine months ended June 30, 2018. The increase was primarily due to an increase in personnel-related costs of $5.5 million, predominantly driven by growth in headcount as we invested in personnel and programs to create the infrastructure necessary to support a public company. In addition, professional

28


services increased $3.1 million primarily for audit, compliance and other fees related to the preparation for our IPO, as well as external legal fees related to our patent infringement case against Denon.

Interest Expense, Net and Other Income (Expense), Net

 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
(dollars in thousands)
Interest expense, net
$
(1,116
)
 
$
(1,185
)
 
$
69

 
5.8
 %
 
$
(3,367
)
 
$
(3,187
)
 
$
(180
)
 
5.6
 %
Other income (expense), net
$
(3,744
)
 
$
2,975

 
$
(6,719
)
 
(225.8
)%
 
$
(315
)
 
$
2,047

 
$
(2,362
)
 
(115.4
)%

Comparison of the Three Months Ended June 30, 2018 and July 1, 2017

For the three months ended June 30, 2018, we had other expense of $3.7 million compared to other income of $3.0 million for the three months ended July 1, 2017. The change in other income (expense) is primarily due to foreign currency exchange losses, net, caused by the strengthening of the U.S. dollar against foreign currencies.

Comparison of the Nine Months Ended June 30, 2018 and July 1, 2017

For the nine months ended June 30, 2018, we had nominal other expense compared to other income of $2.0 million for the three months ended July 1, 2017. The change in other income (expense) is primarily due to foreign currency exchange losses, net, caused by the strengthening of the U.S. dollar against foreign currencies.

Provision for (Benefit from) Income Taxes

 
Three Months Ended
 
Change
 
Nine Months Ended
 
Change
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
June 30, 2018
 
July 1, 2017
 
$
 
%
 
(dollars in thousands)
Provision for (benefit from) income taxes
$
494

 
$
196

 
$
298

 
152.0
%
 
$
1,126

 
$
(1,830
)
 
$
2,956

 
(161.5
)%


Provision for income taxes changed from a tax benefit of $1.8 million for the nine months ended July 1, 2017 to a provision for income taxes of $1.1 million for the nine months ended June 30, 2018. In fiscal 2017, we amended a tax audit settlement agreement with the Dutch Tax Administration, which, among other things, resulted in a release of previously accrued tax liabilities for Sonos Europe B.V. that was partially offset by the establishment of a valuation allowance based on cumulative losses, resulting in a net tax benefit in the first nine months of fiscal 2017.

Liquidity and Capital Resources

Since our founding in 2002, our operations have been financed primarily through cash flow from operating activities, borrowings under our credit facilities and net proceeds from the sale of our equity securities. As of June 30, 2018, our principal sources of liquidity consisted of cash flow from operating activities, cash and cash equivalents of $124.4 million, including $16.4 million held by our foreign subsidiaries, 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 June 30, 2018, as they are required to fund needs outside 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 in order to repatriate these funds.



29


On August 6, 2018, upon the closing of our IPO, we received net proceeds of $90.6 million, after deducting underwriting discounts and commissions of $5.3 million. Additionally, offering costs incurred by us are expected to total approximately $4.6 million.

We believe our existing cash and cash equivalent balances, cash flow from operations, committed credit lines and net proceeds from our IPO will be sufficient to meet our working capital and capital expenditure needs for at least the next 24 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.

Credit Facilities

Credit Facility

In October 2015, we entered into a Credit Facility. The Credit Facility allows us to borrow up to $80.0 million, including up to $10.0 million for the issuance of letters of credit and up to $8.0 million for swing line loans. In connection with the Credit Facility, we incurred costs of $0.6 million which were recorded as an asset and amortized over the term of the agreement as interest expense. Borrowings under the Credit Facility may be drawn as CBFR Borrowings or Eurocurrency Borrowings, and mature in October 2020. CBFR Borrowings bear interest at a variable rate equal to the highest of (i) the prime rate or (ii) adjusted LIBOR plus 2.5%, minus the applicable margin, but in any case at a minimum rate of 1.25% per annum. Eurocurrency Borrowings bear interest at a variable rate based on the LIBOR plus the applicable margin. We are also required to pay an annual commitment fee on the average daily unused portion of the facility of 0.2%, based on the usage of the facility. We have the option to repay the borrowings under the Credit Facility without penalty prior to maturity. The Credit Facility requires us to comply with certain financial covenants, including requiring us to maintain a consolidated fixed charge coverage ratio of not less than 1.0, and nonfinancial covenants. As of June 30, 2018, we were in compliance with all covenants. Obligations under the Credit Facility are collateralized by our eligible inventory, accounts receivable and our intellectual property. As of June 30, 2018 and September 30, 2017, there were no outstanding borrowings, and $4.5 million and $4.4 million, respectively, in undrawn letters of credit that reduce the availability under the Credit Facility.

In July 2018, we amended the Credit Facility to, among other things, extend its term from October 2020 to October 2021 and provide for the $40.0 million New Term Loan, which increased our borrowing capacity thereunder from $80.0 million to $120.0 million. In connection with the amendment, we borrowed $40.0 million under the New Term Loan, which we used to pay off all outstanding borrowings, accrued interest and fees under the Amended Term Loan. The New Term Loan has a maturity date of October 2021 and bears interest at a variable rate equal to an adjusted LIBOR plus 2.25%. We will make our first principal payment under the New Term Loan in July 2019 and will make quarterly principal payments thereafter. We elected to pay interest on a semi-annual basis.

Term Loan

In March 2016, we entered into a $25.0 million, five-year Term Loan. The Term Loan initially bore interest at a variable rate equal to an adjusted LIBOR plus 10.0%, with a minimum rate of 10.5% per annum. In December 2016, we amended the Term Loan to increase the principal amount under the Term Loan by $15.0 million, to a total of $40.0 million, reduce the interest rate to a variable rate equal to an adjusted LIBOR plus 9.5% and change the prepayment penalty terms. We received net proceeds of $39.2 million, net of $0.8 million of debt issuance costs. The debt issuance costs are included in the carrying value of the Amended Term Loan as a debt discount. The effective interest rate on the Amended Term Loan was 11.5% and 10.7% as of June 30, 2018 and September 30, 2017, respectively. As of June 30, 2018 and September 30, 2017, we were in compliance with all covenants, and the carrying value of the Amended Term Loan was $39.7 million and $39.6 million, net of unamortized debt discount of $0.3 million and $0.4 million, respectively.

In July 2018, in connection with the entering into the New Term Loan described above, we terminated the Amended Term Loan and paid off all outstanding borrowings, accrued interest and fees thereunder.