So we'll go ahead and get started. Thanks, everybody, for joining. My name is Adam Tindle, and this is part of my connected devices coverage here at Raymond James. Very excited to have two leading CEOs in consumer technology to discuss innovation in consumer technology. So Matt McRae from Arlo and Patrick Spence from Sonos. In terms of our format, would love to keep it very open-ended, if possible. If you do have questions, please feel free to raise your hand. We've got some unique perspectives up here. So maybe just starting with an intro. Welcome, both Patrick and Matt. If you could just start with an introduction of maybe your background and a little bit of a company overview. I know a lot of us are familiar with the products, but some company background as well.
Go ahead. Go ahead.
Okay, I'll start. So I'm Matt McRae, CEO of Arlo. My background is mostly been in consumer electronics, connectivity, way back, DSL modems, routers, all of that. And most recently, in the last three business I've been in, it's been on consumer electronics that connect to the cloud and drive service revenue or some kind of value from that connectivity. Most recently, I was at VIZIO, and built some of the first smart TVs in the world and actually did some of the first streaming deals in the world. And now I'm at Arlo, where has a lot of parallels in that most of the user experience and the value you get from our product comes from the connectivity, the cloud storage, the AI capabilities we have on the system.
Products are typically smart—what we call smart security products, so cameras and sensors, that use the cloud platform, to provide everything from, like I said, cloud storage to object detection, to audio listening, audio analytics, emergency services, and everything else. And we've been on a journey changing from kind of a pure hardware company to a company that we talk about being services first.
I am Patrick Spence, the CEO of Sonos. My first 14 years were at a little company in Canada called Research in Motion. Joined when there were 150 people prior to what we became known for, called the BlackBerry. Did a whole host of different jobs there, starting with selling to banks and brokerages on Wall Street, in fact, running around here, slinging pagers at that point, which was pretty great. Became the CrackBerry, as many people know. And ultimately ended with me leading the sales and marketing team and doing $20 billion in revenue in my last year, which, when you grow up in that environment, and you go from zero to $20 billion, you don't realize how hard it is to get back to $20 billion.
So I joined Sonos after that, when it was about 200 people, $200 million, and we've subsequently scaled. We'll do about $1.6 billion-$1.7 billion in revenue this year. We're in over 15 million homes, and we make wireless audio systems, and so our goal is to fill every home with music. We've gone outside the home as well, so really trying to expand into a broader TAM, and we do it in a unique way, where people get started with one product and add more over time. And so our model is different than anybody else I can think of in consumer electronics, ultimately, in that way.
We now have an average of 3.05 products per home that we're in, and we expect to be able to expand that, over time through new product innovation, and then just customers coming back and adding more and more products to their home. So...
You're skipping ahead to the financial model.
Sorry, sorry.
I mean, come on. So I'm gonna bucket the conversation. We've got a maximum of 60 minutes. Kind of four different areas. We're gonna start with innovation, because, of course, that's the key focus here. We're gonna touch briefly on financial models of the companies. We're gonna get into consumer trends, which I know is something that everybody here cares deeply about, especially as we enter holiday season. And then we're gonna finish with forward evolution. So Patrick, why don't we kick off with innovation? Because it's been a little bit different at Sonos. It's been more about extending your brand into new areas and products. Talk about that process, how you determine which adjacencies are most likely to be successful, considering consumer behavior is pretty difficult to predict compared to commercial.
Yeah, and, and not only that, we typically enter what most people would term red oceans as we go into it. And so we've really, we kind of took it from the core of reinventing wireless audio and kind of the home speaker, and then we've looked at, how to expand into other categories of audio and bring kind of leverage the core capabilities and our initial innovation into those other categories. So we've gone into, you know, we started in components to be able to wirelessly enable your existing speaker systems. Then, we started to integrate the speaker, and basically, we've created a speaker with a computer inside of it. Then, we've gone into soundbars, and then as well into portable products now, and then there's four other categories we're expanding into.
We've announced one, which is professional, the commercial side, which is big. And we're trying to leverage with each one, we're trying to leverage what we've learned in the previous category and some of the core of Sonos and the Sonos system, as we call it, so that each of the products makes the system better for all of those customers. And so that's kind of been our mentality. And I've found, I think the difference is, like in the first couple of steps that we've taken, you know, we had a fully integrated team, hardware team, software team, kind of working together, and they would move in kind of a serial nature from one category to the next.
We've changed that subsequently to actually be able to do parallel development processes and make sure that we're doing at least two new products every single year. That's really important, to Adam's point, to make sure that we are really creating a couple story moments every year, where existing customers come back and buy more, or new customers get introduced to the story. So we've got multiple teams that are working and very focused on a particular category that they're going after and trying to drive innovation in that category. We've added those four new teams, really, over the last couple of years, so we've been in an investment mode in terms of really trying to break into new categories and find new revenue pools that way.
... You've made some recent announcements around new product categories. I think on the earnings call, you even provided some potential quantification for what that could mean. Do you wanna maybe just touch on those announcements and the expected tailwind to the business?
Sure. So we publicly said that we would be going into four new categories. We announced one last year called Professional. We haven't announced the other three categories at this point, but what we did say is that we will enter a new one in the second half of our financial year, which means April to September, and that it will do at least $100 million in new revenue. So we gave that color, which is very unlike us, because typically, we don't talk about our roadmap. But we thought it was important to give that color, given the investments we've been making, and people can see the investments because you see it in our R&D line, but you don't know what's coming from a, from a return, in the revenue side.
So we gave that color for the first time ever in terms of doing that, and I think investors were appreciative of that, at least the ones that we talked to, in trying to provide some of that color. But, yeah, I think over the next couple of years, the investments that we've been making over the past two or three will begin to pay off in spades, and obviously, we do it in a more challenged consumer environment, which we'll talk about too.
And then with the $100 million, do you wanna maybe speak to how you came up with that as-
Sure, yeah
the level of visibility into something like that?
Good call. Yeah, so the interesting thing about our business is, and we'll—I know we're, we're kinda hit topics, but about 45% of our sales come from existing customers every year, adding another product to their system. And so when we look at a new product in a new category, we look at what can we expect from existing customers and how many they will buy, and then what do we, we—what can we expect based on our historicals and our brand positioning and the innovation we're bringing of winning of new customers, if you will, and the general dollars that are going into that category.
For this product, we've made assumptions, kinda worked through both sides of that based on our experience, and come up with a number, $100 million, of what we think we can do in the first, less than half a year of that product.
Unsolicited feedback, but I'm a Sonos customer. I was very unhappy using my AirPods on the plane, so maybe if you had something that could go in my ears, that would be,
That's a great idea. I've never heard that one.
All right, Matt. So innovation at Arlo has been less about this kind of extending your brand into new areas and products. You have done obviously some of that, but I would say it's more about business model evolution. Can you talk about the pivot towards subscription, and some of the risk factors that you considered? In other words, dropping free cloud storage, the impact on camera sales. It was a bold move, and what got you over the hump to implement that strategy?
Yeah, it's a large move, you know, to reinvent a company as it's public, which has been the journey we've been on for three years and basically finished. So we're in a completely different spot than we were in 2018, 2019. If you talk about innovation, if you looked at Arlo back in 2018, 2019, we were basically a hardware company. We had some services that had just been deployed, but most of our innovation, in fact, I would say 95% of our innovation was around building the best smart security cameras and devices in the world. We still do that. That's still a big focus for us, but the cultural change inside the company is now one where that product is really a physical instantiation of our service.
It's the way that we actually create that relationship with that end user. And so while innovation is a cycle we still are running with on our hardware business, I would say 60%-70% of our innovation is now on services. Give you an idea of just a couple of metrics. When we spun out from NETGEAR, which is kinda where we got initiated from as a public company, about 5% of our users were acquiring service. So most were buying hardware, and they were happy with the hardware on its own, and we only had about 5% actually signing up for a recurring revenue service. Today, that's close to 65% of people who purchase. So we've really inverted the company over. It was a journey, Adam.
As you know, it's, you know, there's a lot of stress, there's a lot of... It's a long journey 'cause we had to go through the product cycles to get there. But we had a lot of passion and a lot of data that supported the users, especially in a security context, value that monthly recurring payment and the value they're getting from our services. Like I said, it's, it's cloud storage, it's also some robust AI features and a lot of other things that'll be, you know, coming over the next 12-18 months on an innovation cycle on the services side. But that transition required not just the change in the platform and the technology, but required a cultural change at the company from thinking about: How do we win our customers every 30 days?
Every month, how do we make sure that they subscribe again? Instead of just selling them a piece of hardware and trying to walk away, how do we, you know, continue to sell them additional devices, expand the ecosystem very much like you are, and knowing that they have a chance to cancel with us every 30 days, and it's important for us to actually earn that customer. So the good news is, where we are now, we've got, you know, great attach rates, a growing services business, and a world-class churn rate of close to 1.2%. So we're in a very different spot than we were 2018, 2019.
I guess a similar question that I just asked Patrick, but more in services: How do you determine the adjacencies that are most likely to be successful from-
Yeah
a services perspective, and then can you tie in some current examples?
Yeah. For us, it's really understanding why consumers engage with Arlo and starting there and matching that with our vision. So our vision is that everybody has a right to feel safe, and so when we look at expanding into adjacent categories or additional products within an existing category, we wanna make sure it's core to making people feel safer, especially in this world that we're in today. So we've moved from just security cameras a long time ago, expanding that into doorbells and floodlights and other things that are real close adjacencies to the core security cameras. But we've recently moved into a broader security system that includes sensors for fire and water leak and other things to really push that out. And we've launched an app called Arlo Safe-...
Which actually is our first service that doesn't require a hardware purchase. It's just an app you download, and it can keep you and your family safe while you're on the go. But all of those, as you can tell, are relatively close to our vision around making sure that everybody has a right to feel safe.
I guess a question for both of you. You know, both Sonos and Arlo have been innovating but doing so at scale, which is, I'd imagine, very different than just prototyping in the early days. Talk about what you've learned in acceleration at scale, and maybe tie in the evolution of your go-to-market strategy with this.
Oh, sure. Yeah, so scale for us meant a couple of things. One was diversifying our revenue base as well. So when we spun and came out as our own company, we had about 85% of our sales were from traditional retail, and now it's about 44%. So scale for us meant deeper partnerships, strategic accounts. I think we may come up and talk about this, but launching our own website to go DTC to our customers directly, and that generated not only a wider purview, but a lot more scale.
What's interesting is on the services side, scale for us has also meant being able to A/B test, iterate very quickly, drive cohort analysis, 'cause once you have enough scale, you can start dividing your customer base into very specific areas and making sure you're optimizing not only their experience, but our ability to sign them up. So that's one. The other one I would say with scale is, as we broke through 2 million subscribers earlier this year, that's afforded us the ability to kind of look at different go-to-market business models. So one we announced earlier this month is something we call the Total Security subscription, where we're actually bundling the hardware and the service into one low monthly payment with no upfront fee. So the hardware is just bundled into the service fee as you go forward.
Again, very difficult to do until you've reached a level of scale that gives you the ability to try alternative business models for a customer segment like smart security.
Yeah, and I think for us, you know, it's reaching, and I think this is always, like the hard thing, I saw this at BlackBerry as well, is knowing you've reached like a critical mass, where then you have the right to go and innovate in another category and kind of bring your 'cause there, there's always this tension of, do you like double down on what you're focused on right now, or do you expand into something else? And part of—to Matt's point, part of what we're always thinking about is that diversification as well, and making sure that we have a little more diversification of our revenue streams, and that, like our, where are our customers allowing us to go play? And so looking at how we leverage those investments, how we leverage our team, but also how we set ourselves up.
So it is a cultural thing as well in terms of getting teams that can be very focused and go move against against the new mission. And it, and it's interesting because we very much, as well, have been playing with: how do you bring a package, and I really think of it as Sonos as a service, together? And so we've been experimenting with Sonos as a service in something we call Sonos Flex, in the Netherlands, where people can buy everything bundled together-
Right
... which we, you know, have found to be pretty interesting as well. But it is a big cultural change to get the subscription service, how you support that differently, and move from that. So I think so much of this is how you evolve the culture of the company to actually support what it is you want to achieve for customers and the business model.
I'm gonna ask one more, and then we'll break for audience questions. If you do have a question, please think about it now. I expect at least one. No pressure. Let's talk about big tech. That's obviously a topic for each of you constantly. Talk about how to manage the tricky situation in both partnering and competing with the big tech vendors.
Well, we...
Go ahead, Patrick.
We're laughing because we've even sued one of our partners for IP infringement as we go through this. So I think maybe it's my Canadian-ness, but our masterful ability to both navigate the relationship and also, like, have to deal with some of the hard issues. We've dealt with this with Amazon, Google, Apple along the way, and we were the first brand that Apple actually, when we introduced a new product earlier this year called the Era 300, with Spatial Audio, Apple Music actually promoted our product, and that was the first time ever Apple had promoted a non-Apple piece of hardware in getting through it.
So I think in all of these things, we've been able to find that there's certain areas in which we're strategically aligned, and a lot of, you know, the services. So we work with all of the big tech music services, we work with their voice services as well, because they all want to be part of a great solution and really into the kind of 15—we're in over 15.3 million homes now, into these homes that are highly desirable, and then there's parts of their business that will compete with us, you know, as well, and that we have to go.
I think the reality is that these are massive, you know, conglomerates at this point that, have different competing agendas, even inside the company, and it's really a matter of how you, look at the big picture and, you know, not take it as a one-size-fits-all kind of thing. And so we've been able to kind of manage all of that. It's tricky, it takes some time, but I think it's important really for the customer at the end of the day. One of the things we've been very focused on is making sure that if you buy Sonos, you'll be able to use any of the music services that are out there, and you're not tied to one particular service or platform.
Obviously, I think most of the big tech plays are a little bit conflicted by the fact they're trying to push often their own service. So we use that as our advantage, because it's better for the customer.
That would be a novel idea in TV, too, for set-top box, just as-
That's a good idea.
Saying.
I know TVs.
Oh, yeah. Yes, you do.
So I 100% agree. So it's, you know, the old term, a frenemy, or a competition, or whatever phrase you wanna use. We view, you know, each of the different groups in some of these large companies, almost as separate companies, 'cause you deal with them very individually, and they've been smart to realize that each in their... You know, each of those silos in their company need to be successful in their own right, and so often, the right thing happens on most cases. But we do partner with them on voice, even cloud services. We compete with them from a product perspective. And Amazon, in that case, is also one of our top channels. So it's kinda divide and conquer a little bit.
And the fact is, just like you were saying, I mean, if you focus on the consumer user experience and what, why you're partnering with them, and make sure you do that better than them by having a real focus to it, that you'll win in the end where it matters, and you'll derive value from that relationship in multiple areas, and then you focus on where to compete with them as well. Often, what we try and do is we try to find our point of differentiation. You mentioned one of them, which is being open, right? Often, just like you were saying, Patrick, they try and push their own service.
Yep.
So they're trying to even if they are kind of open, so on some industry standard, they're really closed in their offering to the marketplace, where we try and remain as open as possible, which is a key differentiator. Also, I would tell you especially in our space, in the smart security space, we try and really differentiate ourselves around data privacy and security. Often these companies are using the data from a given product to go sell advertising or something else. When you're pitching security, like Arlo is, having the sense of security that we are not using your data for any unknown purposes, don't have the security breaches you see from some of the others, it matters a lot.
So what we do is we try and find the points of differentiation, and we partner where we think we can drive value.
All right, we covered a lot. Surely, there's a question out there.
Yes. For Patrick: So how much of your growth is new customers versus new products to existing customers versus upgrading products? And the reason I ask, I'm a customer-
Yep
... I've got a lot of your products in my home, but I've had the same products for probably six years.
Yep.
Maybe it's my own naivety for not sort of looking to see why I should upgrade, but, like, what's, I'm just trying to get a sense for what the upgrade cycle looks like for your customers and what the motivation is to upgrade.
It's very long. So we are the opposite of most consumer electronics companies that are trying to drive you to upgrade, you know, every so often. I would much rather you continue to use that product for 10 years is fine, and you tell your friends and family how great it is, because I believe that'll pay off in the long term, you know, for us. And I also believe that over time, we'll find other services, the way Matt and his team have, to layer on top of that. And so 45% of our sales every year come from existing customers adding a new Sonos product. And so we're up to 3.05 products per home at this point in time, but we don't see very many, like, upgrades.
Like, that's not a really material part of our business at this point yet. We've been at it for 20 years. And so, like, a lot of our products, we started shipping 18 years ago, a lot of those are actually still in use. We're gonna do work to try and show people like benefits of things like the Era 300 and Spatial Audio and all that. Like, we wanna see more people upgrade over time just to get a better experience. So there are better experiences out there, but that's on us to make sure that you're getting that compelling message. And the nice thing in our model is that those customers are also telling their friends and family. So our number one driver of new homes, new customers, is our existing customers telling their friends and family, still, after 20 years at this.
So we're also finding effective ways to get new customers through social media, but I am so proud of the fact that it's existing customers and their experience that continue to drive those new homes for us. And that 40%-45% has been consistent for years in terms of the amount of our revenue every year that comes from existing customers adding more. And so we just released more cohort data for the latest 3 years of cohorts, and they're buying in similar ways to the cohorts before that, which shows that over time, they add more and more to their system. The people that started with us 18 years ago are still adding to their systems as well.
And so we think we have a pretty unique model, overall in the business, and I'm happy if you use your products for 10, 15, as many years as you can, because I truly believe, like, in this day and age, there's not a lot of products where people get that value, and then they can say, "Okay, when it's time to upgrade or time to, you know, do a second house or a new house, they're gonna choose Sonos again."
Any other questions? On that point, Patrick, you, you've experimented with the idea of, kinda more subscriptions, Sonos Radio being an example. So for Brian, as a customer, having that, you know, 10-year life cycle of hardware, if you were able to get some sort of maybe monthly, recurring revenue stream, that would be particularly interesting for investors.
Yep.
Maybe just speak to your experience.
Sure. So, the other thing that the probably the thing I'm most excited about is Sonos Pro, which is our—you know, putting our, I guess, toe in the water around what we think is a greenfield space of like small and medium businesses, and selling Sonos as a service to those small and medium... as a bundle that allows them as well the ability to choose the music that their employees can actually play as well for a monthly fee. And our support team can remote monitor as well. So we're able to basically sell that peace of mind that you're gonna have great quality music playing in your business in your locations all the time. And we continue to upgrade Sonos all the time.
We're working on the app, we're working on making things better, and so this gives us like a better, I think, approach, a better financial model to being able to do that. And so for professional and for commercial customers, we've got Sonos Pro that we've started, and then I mentioned Flex, that we've got running in the Netherlands, and we'll take elsewhere, which is for consumers. And we found, in the Netherlands at least, for those that are renting their house and younger, a willingness to buy Sonos as a service, which is bundles. We've put like three separate bundles together, that they can actually go and rent on a no-commitment basis, and so that allows us to get in there and develop some recurring, you know, revenue from it.
I still think our model is one where there is recurring model, there is lifetime value in it. It's just over, like, a longer period of time as you think about the way people come in and purchase it, and it's not as, you know, maybe as satisfying for investors as like a monthly fee as we go through it. So, we get that feedback. And we're always experimenting with what other services could we layer on top, and looking at that, and Sonos Radio is one. It's our most listened-to service on the platform these days. It really creates a Sonos experience that means you're running with music, great music out of the box, which is great. And it's helped us build really a subscription service, which is new for us, right?
'Cause we come from a world of the hardware, software, but not subscription services. So we're building that muscle so that as we come up with other things that we can offer as subscriptions, we can layer those on, and we know what we're doing.
Well, here's a guy who knows what he's doing-
Yeah.
on that as well.
Totally. Yep.
Since you mentioned financial models, let's talk about that, Matt. You just wanna summarize the evolution of the financial profile of Arlo as services has become a bigger portion of mix, and where you see the model moving forward. And I see Kurt's in the audience. I don't know if you wanna-
My CFO is in the audience. So if he raises his hand, you know why. Yeah, I mean, it's, it's a complete transformation of the business, if you've, if you've been following us for a while. So, you know, moving from a gross margin on a hardware business that can fluctuate around, we now are sitting on a services business that just crossed $200 million of ARR a year, and the subscription part of that, which is the vast majority of that service revenue, or, or all of that from an ARR perspective, is running at 88% gross margins, and it's growing nearly 50% per year. So it's a, it's a fast-moving, fast-growing subscription business, very high margins, very low churn.
And it's, you know, it's—I'll tell you, it's very different to have a business where when you start the first day of a quarter, a significant portion, you know, nearly 80%-85% of your entire gross margin as a company, you're actually starting with on day one, and then you're trying to build from there, instead of starting from zero in a hardware business and trying to sell your first piece of hardware and make sure you make your quarter. So it's given predictability to us. It's expanded operating margin quite a bit for us, profitability expansion as we go forward. And it's completely, completely changed the, the way we think about a company and the way we run our business.
Patrick, do you wanna maybe walk us through Sonos' financial model?
Yeah.
And how it might evolve?
Sure. And so, you know, so thankfully, we're a little different than most consumer electronics companies, that we don't start at zero, we start kind of at 45%, right? Where we know our existing customers are gonna come back and add additional products that's been proven for the last, you know, 20 years. So that is unique. We don't take that for granted. It's earned through all the innovation, everything we've done. And then one of the things as we go into these new categories is diversification, so that we're in a variety of different categories that allow us to better weather cyclical storms. So the more we can diversify our revenue streams, the better I think it'll be for our business in terms of predictability, stability as we go through it.
And then we do want to, you know, be able to have more recurring revenue over time, which is why we're trying things like Pro and Flex, because I believe that allows us for, you know, more stability and predictability in the business and allows us to reinvest in even more in innovation, which would be great. But really, our model today does hinge on lifetime value, and we're very focused on, okay, what is that customer acquisition cost up front? We can expect them to be, you know, moving to multiple products in the future. We believe that most homes can move to four to six. If you look today, 40% of our customers have one product. If we can get them to where multi-product homes are at 4.4, that's a $6 billion revenue opportunity right there.
We have a team that's very focused on our direct-to-consumer efforts and customer relationship management to try and get those single-user homes moved into multi-product, because we think that's a huge opportunity, and we have a direct relationship with customers 'cause they open the app every day and are using it, and we can use that to communicate with them.
Sonos is a cash-generative business as well, and you've made a handful of acquisitions under your tenure. Maybe talk about the process to M&A as it relates to technology innovation, and if you wanna provide some examples of how the acquired technology has manifested itself in product evolution, things like Snips come to mind, for example.
Yeah. So our roadmap and kind of our promise is what is our guiding light on that front, and so we're always looking for companies that can help us accelerate that. And so, Snips is a great example, where very unique, it's today now the Sonos Voice Control. And so it's a very unique company, a lot of AI, ML experts in Paris, in fact, and they, they had this vision of a voice agent, but would run mostly locally on the device, so it's the most private voice assistant that there is out there. You don't go to the cloud. You know, Matt mentioned before, differentiation against big tech. This is very different than what Google or Amazon or some of the others do.
And so, it is the most used voice assistant on our platform, and it has the highest Net Promoter Score as well because it's so quick, right? And it's very music-focused. So where big tech said, "We're gonna go, you know, with our voice system and try and solve everything," we said: We're gonna solve the audio domain, and we're gonna do that and, like, just be really deep and do a really good job in that. And so that's worked out pretty well. And that team, you know, wouldn't have been able to get that product into the world unless we acquired them, quite frankly, and they wanted to see it delivered on that front.
One of the things I'm most proud of is that of the five acquisitions we've made, all of those founders, all of those teams remain with Sonos, and some of them happened as much as four years ago. And then another really cool one was this company, Chirp, in London. Somehow, we ended up acquiring all these companies in Europe. So when we brought out our first, like, true ultra-portable speaker, the Roam, they helped us create this solution where if your music's playing on a Sonos speaker, you just take your Roam and swipe by it, and it picks up the music and starts playing on your Roam as well, which nobody else has.
And so we look for experiences that these teams can deliver that we think will be accretive to what we're trying to do, and we made our biggest one last year around a company called Mayht, which has reinvented the transducer, which is really the heart of the speaker. And it's an area where all the experts for the last 20 years have said, like: "There's no room for innovation, you know, you can't do anything different or new." And these two young guys and their team in the Netherlands came up with a completely different way to do it that is lower power, you know, more output, lighter weight, better for the environment as well, and should allow us to do new form factors and enter some new areas as well.
So I'm super excited for that one and saw some crazy stuff when I was with them last week in Amsterdam. But I think it all has to fit with the roadmap, and we all know most, you know, most acquisitions don't end up well, but we do a lot of vetting to make sure that there are kind of people, people that wanna build great products, are in it for the long term, and so far, we've found good fit.
Perfect. Let's move on to the third to last topic here in consumer trends and thinking, near term, Matt. There's been a variety of data points following Black Friday, Cyber Monday. It was good, it was not good, depending on who you listen to, right? Maybe just walk us through your view of the state of the consumer overall, for this holiday season. And if you can put that into perspective versus prior years, that'd be helpful.
Yeah, this is obviously a question we get a lot, especially, especially mid-quarter, which is always fun. But on the, you know, on the last earnings call, we had mentioned that the Amazon Deal Days, which is one of the first data points you see in kinda the Q4, 'cause it's kinda October, it's the first time you see the consumers reacting to the first promotions inside the quarter, was actually relatively strong. You saw Amazon report that it was strong. It was strong for us above forecast. So what we're seeing is resilience. It's a term I've used, I think, on the last three earnings calls, and it continues. We made some moves early in the year, kinda rebalancing price.
We launched a new product that's actually a lower price segment for a couple of our key retailers. And so we knew this was coming and made some adjustments coming into Q4 that I think are resonating. So I would still use the term resilience. From a consumer perspective, we're-- they're buying, but I think they're looking for a deal, and so they're constantly looking for a promotion, a price point. We're seeing more sales on promotion instead of off in the quarter than we normally would. But I would tell you, on whole, it feels actually relatively similar to last Q4. If you remember, you know, we were coming out of COVID, things were running kinda hot, and the retailers kinda brake-checked around October, saying: Hey, we're not sure this holiday is gonna come out.
It turned out it came out okay, especially on a unit basis, maybe ASPs were down a little bit. We've kinda felt that all through 2023, where there's been a cautious consumer who's buying, but buying, maybe stepping down a little bit or maybe looking for a specific deal. But there's been resilience in the spending that we've seen to date.
Patrick, not necessarily on, December quarter-
Yeah.
but just your view on the consumer, especially
Yeah
being in the affordable premium category.
Yeah.
It'd be interesting.
Yeah. So I think the category, from everything we see, you know, continues to be challenged, so it's been down anywhere from 10%-20%, year-over-year. That's, you know, continued. We've seen heavy discounting. That has really happened throughout the year and continued into Black Friday, Cyber Monday. And I, I think it's, you know, more of the same from what we've seen in 2023, and we contemplated in our guidance that we gave a couple of weeks ago. We, you know, we haven't seen in our own portfolio any of that trade down, you know, type of idea that's there, at least to this point, in terms of what's there, and so our portfolio has held up. And what, what we've watched carefully this year is our share, our market share.
So usually, my criteria for are we being successful is are we growing revenue at low double digits? And that's, like, where we set our bar. But in times like these, where the category is down 10%, 20%, we're looking more at are we holding share? Because we don't go approach it and discount the way a lot of the legacy audio brands do. And this year we've, you know, held or gained share without discounting. And so we've been pretty strong in terms of both our brand and our portfolio. We feel pretty good about where we are right now relative to that competition. But, I mean, it's been heavy discounting for the entire year.
So it'll be interesting, in our guidance, we contemplated that things will continue to be pretty challenged in the audio segment for the, the rest of the year. And I think if anything, we've learned over the last 18 to 24 months is none of us know, you know, like, what, what comes. It's been very uncertain, and so we'll just plan that it'll continue this way, and we'll navigate the business, that way.
Matt, do you wanna touch on the state of competitive environment and your strategy on promotions this year?
Yeah. Our strategy really hasn't changed. I think it's... In some ways, it's similar. It's if you overreact to it, you end up shifting your own dynamic in the marketplace and actually harming yourself instead of just trying to either retain share or gain share in the environment you're in. We've been fortunate that through some of our rebalancing and pricing, and some of the things we've made actually has meant we've captured share. Some of that captured share, I think, is coming from a little bit of consolidation we're seeing from a competitive perspective. So some of the brands that were there last year for holiday are now off the shelf. One of the trends we're seeing is retailers really leaning in to the brands that are selling well and the brands that are investing in the channel.
So, we are, you know, have a bunch of promotions, again, not necessarily much deeper on a percentage basis than previous years, but a larger promotional calendar, because we determined at the beginning of the year that in this kind of environment, we should lean in and actually invest with some of the biggest retailers in the world, like Best Buy and Walmart, and that's paying dividends because often they'll invest back in you. So there's a bit of consolidation. I think our performance plus that has meant we've captured share year-over-year to date so far, and I think we'll see that continue. So I mean, when I look out to 2024, I don't think the environment changes much, and that should be the baseline case.
Maybe it recovers in the back half, but if I'm building an operating plan for next year, I'm not assuming that. I'm assuming we're gonna see a similar environment. And so the question for us and anybody in the space is: How do you win and keep your customer base and keep driving household formation? Which for us, as now primarily a services company, it's household formation that really matters because a household can become a subscriber, which becomes service revenue, which, you know, boosts the gross margin and operating margin of the company. So all through this period of this tumultuous quarters you've been talking about, we've been adding about 170,000 to 190,000 paid accounts per quarter, like clockwork, and so that's kind of our North Star.
Again, we don't think it's gonna get a lot better, but we do think we're gonna see additional consolidation and the retailers investing in their best, best partners, like a Sonos or like an Arlo, that can help the customer keep coming into the store.
... So we hit demand. I'm gonna touch on supply, and then we'll break for audience questions. So, I don't know who wants to start with this one, but if you wanna touch on the current state of the supply chain and maybe put this into perspective on what you're experiencing now versus, say, over the past one or two years.
Yeah, I'll, I'll start. I mean, for us, the supply chain is, I don't wanna say normal, but it's basically back to normal for us. I mean, there's a couple components that I think remain relatively tight and that you have to forecast it farther out, like batteries, and that's because of, you know, obviously, the battery consumption that's happening on a global basis with EV cars and everything else. But I would say 95% plus of the components we buy are readily available. A lot of the cost increases we saw two years ago, if you include things like freight, you know, a container was over $20,000 to bring from Asia to the West Coast, now it's back down to $2,000.
So a lot of the costs, a lot of the tightness from a component perspective is all backed out, and we saw that kinda tip over in the September-October timeframe about a year ago. And that's when we changed our footprint and went out and started making sure we get our cost to clients and start changing our freight format from, you know, nearly 80% air freight, because everything was stuck on the, on the ocean outside of Long Beach, to now almost completely inverting that, where we're 80% sea freight.
And we, you know, we went through the whipsaw that so many did in, you know, in the past couple of years, where we were paying, you know, I think 50 times the kind of price for certain components that you usually would pay, which was just crazy. And we, you know, we committed to a lot 'cause we're trying to grab, like, share, and there, there's all sorts of dynamics, which really, you know, you kinda go through... I think I've been through probably two or three times in the industry. And so we've been still working through that. We're not completely through that, but we're getting there. And now, of course, of so many components, there's too many. And so now we'll get the, the discount, on that side of it.
But definitely lead times are down, like, we have availability of the products. We've also been working through, like, rebalancing of retailer inventory, where they really started to reduce inventory, and so we went kinda negative on that during this year, where our registrations were actually positive, even though our unit sales were down. And so we burned through, like, a lot of inventory that's out there, so we feel like it's improving. Still have some room to go, as we go through this, but I think the worst is behind us on that front.
All right. You had plenty of time to come up with a question. Surely, somebody... I feel like people listening to the webcast can't appreciate that this is generally a full room.
Yeah, it's a good, a good room. Lots of typing.
Lots of typing.
They like to save the questions for the one-on-ones and the, yeah, free ones.
They're not shy on that, that's for sure. Okay, I'll keep going. Last topic is forward evolution, and maybe I'll lump this one in there. One of the evolution that's been happening is with big box retail channels, their inventory models have really been changing. Can you maybe just summarize that and where you see that landing on a go-forward basis? In other words, you know, could we move back to historical weeks of inventory that were much higher? Are we gonna move to another step lower? Any thoughts?
Go ahead, man.
For us, I mean, we use the term destocking, right? When they're trying to reach an inventory level. In our category, it happened faster than I think it happened in many other categories. So we saw that happen last year. So again, it was around that September-October timeframe when there was that brake check of, "Okay, is the consumer gonna be here this holiday?" And so a lot of the retailers were trying to destock to a year-end number. For some of them, it's not a calendar year, it's right afterwards, but roughly towards the end of the year. And then they had a, you know, a pretty good Q4, and we ended up right around where they wanted their weeks on hand to kinda remain.
So some categories, I know it's longer, you know, to kinda get to that number that maybe the new normal for some of these retailers. For us, it was basically done by January. And we see, you know, there, there's interesting moves around how much stock they have at a store level, because how many people are buying online and doing in-store pickup, and how many retailers are starting to fulfill local orders from in-store, and so there's this kind of still noise around that. So I don't know if I have a really good answer of what the right weeks of stock is for a specific retailer, but for us, at least through this calendar year, it's been relatively normalized. 'Cause I think in our category specifically, it was only about a three- or four-month kinda destock period and, and then, leveled out.
It was for us, it was more after the holiday that the retailers, you know, started to do that. I'd say the U.S. ones were actually ahead of the European ones.
That's true
... just like managing it in different ways and trying to, to really make sure they get that right. And, and I think from our perspective, we're trying to, you know, have them hold as little as possible, even to make sure that, you know, we can effectively send the inventory where we need to. DTC is now 25% of our business, so that's a pretty big chunk. Like, keep it ourselves and be able to deploy it as we need to, to the different retailers. And you know, I think the... I feel better when the retailers have less, and, like, we'll carry the balance of it and can actually manage that to make sure that it's matching the demand, as opposed to...
'Cause sometimes the retailers can kinda get out ahead of their own skis, and I'd rather be in control of that, quite frankly. And so some of the more normalized levels that they're at now, even though they may be lower than they were pre-pandemic, I'm still okay with it, 'cause I think, you know, then we can moderate it and be in control of it.
Yeah, I agree. The thing I would add is, in an environment where costs are declining, so Patrick had mentioned that there's too many components out there, tightening up the supply around lets you reflect the lower cost quicker into the marketplace. So this is it's probably the right spot to be in, as we'll see prices decline or costs decline through the year. And again, this may continue as we go into 2024.
... Patrick, you mentioned DTC. And one of the evolutions that you've both had is moving more from a physical retail environment, where you can walk into a Best Buy, I can hit the button and listen to a Sonos speaker and really fully appreciate it, or an Arlo camera and see, you know, the hand, battery-free and wire-free device. So maybe just talk about moving from an environment where a consumer can engage with the product via demos to educating that consumer via a digital channel.
Well, I think from our perspective, the number one factor there is people almost trusting, you know, a close friend or family member more than themselves necessarily, to even evaluate these kind of things. So there's still definitely a segment that will go and seek out a blue shirt at Best Buy, and that's where, like, we focus on that, and they typically, in audio, will recommend Sonos, and that's an important part of the journey for sure. We have an installer channel of people that are coming to houses, and that's about 21% of our business, and it's important that they be big Sonos advocates and be able to show people how that goes through. But I think the power...
What we've tapped into ourselves is the fact we have a day-to-day relationship with customers, the fact that there is a strong friends and family network that brings new customers in. And so with 45% of our sales coming from existing customers adding another product, you know, from my perspective, we should be capturing more and more of that over time. And again, 25% of our business today is DTC. So we have some new customers in there, but the majority is existing customers buying their next one. You know, why, why shouldn't, you know, all of those sales be going through DTC since we have a relationship with them, as well? And so it's interesting to watch these channels and the way, ultimately, that they evolve. But I think our model, and kind of product lends itself heavily to DTC.
Yeah, for us, it's interesting. I went from a business like VIZIO where, you know, people really wanted to have eyes on a product, even if all the settings and the retailers were completely wrong and looked terrible, but it was bright, and that's what people kind of bought on. To a product now, where it really is... You know, the user, yes, there's a camera. Sometimes they want to see how big it is, or there's some physicality to it, but users really are using our app, right? The entire experience you're having with Arlo is through the user interface on an app, on a mobile phone or on your laptop or anything else. Users use that, you know, our engagement is anywhere from 18, you know, eight to 15 times a day in the app.
So that means, I think it's a little bit easier for us to kind of show people what the experience would be on our website in DTC. Not to mention, DTC is critical for us because that's where all the subscriptions happen. You may buy at Best Buy, but when you sign up after the free trial, you're coming to arlo.com. So, it's just because the user experience is primarily in your hand, and it's on your mobile phone, we're able to replicate that, show you videos, and educate you on really what it looks like from DTC, and I think that's why it's one of our fastest growing channels.
So let's wrap up with some crystal ball stuff. Patrick, you've been kind of in the middle of, obviously, home audio and, and voice in the home as well. You mentioned, you know, the, the Sonos voice assistant, which I personally use and really,
Thank you.
-enjoy. Yes. Sounds better than Alexa, too.
Thank you.
Good voice. Talk about the evolution of voice in the home and where you see this going over the next three to five years.
Well, I think, yeah, especially with... So AI, I think, is at a point late in the hype cycle where there's a lot of hype, you know, right now. It'll go through a period, just like kind of like voice assistants did of, like, the trough of disillusionment, and then come back up to something that's usable. But I do think that there is something big that will happen around voice. We all know there should be those interactions, and you should be able to have, like, a more natural engagement with voice, and I believe that AI will enable that. I think today there's just too many failures when people do it, and then they feel embarrassed and, you know, like failures themselves in terms of engaging. But I believe there's almost like a...
There, there's the LLMs that you see today, but I think there's less value there, and I think there's actually more value in kind of like a personal language model that has all of your data and knows your, your data. And I think with our stuff running more privately than most of the big tech stuff and also on the edge, like in the speaker itself, there's some interesting possibilities for tapping into some of the more private data and understanding. Obviously, at the beginning, it's learning your routines and being able to play music when it believes that you should and what kind of music based on who's there.
But I ultimately believe you should be able to ask and have conversations with your speaker and then your portable and other products that we will make that will make your life that much better, quite frankly. So I do expect that there'll be a lot of breakthroughs 'cause it's just such a natural interaction interface versus, like, picking up our phone and some of the things that we do today. So I hold out a lot of hope in that space, and I think... I just being in Paris last week with our team, there's some really cool stuff that they're working on.
Matt, how about in video? Talk about the evolution of... So we did voice in the home, let's do video in the home. Where do you see that going over the next three to five years?
Yeah, I mean, video, you know, what's interesting is, in video, it's been AI for quite a while. In fact, you know, we launched our first AI service in 2018.
Mm.
So it's strange that, you know, AI is having this huge moment, and we've been actually selling AI services to consumers for five years. And of course, we don't call it AI, 'cause back in the early days, when you called it AI, it scared people. So, it's just computer vision, or it's object detection. But I think that there is a wave of innovation that's coming, right? We did the basics really well. Our AI capabilities are ahead of anybody else in our market segment, but it is still doing the basics just extraordinarily well.
I think there's a lot more sophisticated or what we would call context-aware ability, where you kind of understand what's happening in the home, you understand who's home, and you can start making decisions on a proactive basis, on a predictive basis, instead of just detecting something and having an action to it. So I think, you know, you'll start to see smarter platforms coming. We're planning on it, of taking AI kind of to that next level of user interaction, and everything else. So from a video perspective, that's one side. The other thing, because we're in the security industry, is, video is driving everything that's happening in security on a broader scale. So if you look at security and calls into 911 or the PSAPs, right?
You know, something like 90% of those are false alarms when it's a normal security system. If there's video or what we call video verification, so somebody can verify there's actually an issue, that drops dramatically. So the other side of the video discussion in our industry is we're seeing municipalities and 911 operators starting to demand that they will not respond to security systems unless there's a video component to it. So that's a whole different kind of tailwind-
Hmm
...that I think is happening in our industry, that's on top of the user experience portion of what's going on in video.
Very cool. Well, I think we're gonna wrap there. Maybe one last question, the bold prediction-
Right
... one that you guys didn't-
You go first.
... want me to put, in the script and adamantly didn't. But, if you could leave us with one bold prediction for 2024 and beyond?
I'll do the and beyond, which is: AI will disrupt the iOS, Android duopoly.
Ooh!
Well, that's a big one.
Ooh.
That's a big one.
Oh.
For us, one of the things we're seeing, and I think it's gonna accelerate, is the combination of smart home and security. We're starting to call it the secure smart home. But the bold prediction is, despite that, Matter still won't matter in 2024.
Oh, wow.
It's gonna take at least another year, partially because of the big guys not playing nice with each other.
Awesome discussion. That was a lot of fun.