Earnings Call: Q4 2020

Nov 18, 2020

Ladies and gentlemen, thank you for standing by, and welcome to the Sonos 4th Quarter and Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer I would now like to hand the conference over to your speaker today, Cameron McLaughlin, Vice President, Investor Relations. Thank you. Please go ahead. Thank you. Good afternoon, and welcome to Sonos' 4th quarter and fiscal 2020 earnings conference call. Hi, I'm Cameron McLaughlin and with me today are Sonos' CEO, Patrick Spence and CFO, Brittany Bagley. Before I hand it over to Patrick, I'd like to remind everyone that today's discussion will include forward looking statements regarding future events and our future financial performance. These statements reflect our views as of today only and should not be considered as representing our views of any subsequent date. These statements are also subject to material risks and uncertainties that could cause actual results to differ materially from expectations reflected in the forward looking statements. A discussion of these risk factors is fully detailed under the caption Risk Factors in our filings with the SEC. During this call, we will also refer to certain non GAAP financial measures. For information regarding our non GAAP financials and a reconciliation of GAAP to non GAAP measures, please refer to today's press release regarding our Q4 fiscal 2020 results posted to the Investor Relations portion of our website. As a reminder, the press release, a supplemental earnings slide presentation and conference call transcript will be available on our Investor Relations website at investors. Sonos.com. I will now turn the call over to Patrick. Thanks, Cameron, and good afternoon, everyone. We ended fiscal 2020 on an exceptional note and delivered meaningfully ahead of our expectations. In light of the uncertainty and challenges presented throughout this past year, the entire team at Sonos has risen to the occasion and proven an ability to creatively adapt and persevere. I'm extremely proud of what our team has accomplished 2020, and I am more energized than ever about our future. Before we get into the results, I wanted to take a step back and remind everyone of the business model that we've really built the whole company around. I believe we have hit an important inflection point that proves that our unique model delivers for both customers and investors. You'll recall that our approach has been to build a system of awesome products and services that deliver a whole home and now beyond the home audio experience, whether you start with one product, which is what most customers do, or start with many. This creates a virtuous cycle where customers return to add additional Sonos products to their home over time. Obviously, what's important in this model is that we're able to do 2 things. The first is that we've shown ability to add new homes, and the second is that we get existing customers to add additional products. As challenging as 2020 has been for everyone, our model has proven resilient. In terms of attracting new customers, we just delivered the 15th year in a row where we've grown the number of homes we're in by 20% or more, ending this year with nearly 11,000,000 households globally. Even with this strong growth in new homes, we continue to see 2.9 products per home in fiscal 2020. And when it comes to existing customers adding additional products, we have typically seen 35% to 40% of our annual product registrations coming from existing customers who are adding another Sonos product to their home. This year, it hit 41% as the launch of Move was a particular success with our existing customers. I believe we're at an inflection point in the 4th quarter because we are seeing the kind of free cash flow and adjusted EBITDA this model can deliver as it scales. In fiscal 2020, we delivered a record 8.2% adjusted EBITDA margin and that rises to 10.6% if you exclude tariffs. We are on track to deliver 12% to 14% adjusted EBITDA margins next year, which is ahead of our prior targets. We achieved our 15th consecutive year of revenue growth and we are planning to accelerate revenue growth in fiscal 2021. We attribute the success to our business model that makes Sonos a system for your whole home, not just a single product solution and to our consistent approach to innovative new products. Our new product launches are resonating with a record number of new customers as well as with our existing customers who repurchased from us at a record rate. We remain committed to maintaining a relentless focus on innovation in our traditional hardware segment and you'll see continued innovation and experimentation in services as we believe there's plenty of opportunity given our highly engaged customer base. For example, in April, we launched Sonos Radio, an ad supported streaming radio service available free to all of our customers. On Sonos, radio represents nearly half of total listening time globally. Sonos Radio comes preloaded in the Sonos app, bringing all streaming radio into one place from the moment you set up, along with constantly refreshed mixes of new and original programming curated by Sonos. We've experienced early customer success and Sonos Radio is now the 4th most listened to service on Sonos. We continue to experience tremendous demand for our products in fiscal 2020. The strong demand has been especially notable for our newest products, Move, Arc, 1SL, sub, amp and port, and we saw demand exceed our expectations and our supply for 5 of our key products in the 4th quarter. We've made progress addressing the strong demand we are seeing, although we don't fully expect to catch up on demand for AMP and ARC specifically until next quarter. Our products continue to rank as the leading products in the premium home audio category in fiscal 2020. We've experienced particularly strong growth in our installer channel throughout fiscal 2020 and expect this channel to continue to be a strong contributor as we look forward. The Sonos brand is by far the leading choice amongst installer professionals. In fact, according to a 2020 CE Pro report of the brand sold by the top 100 installation professionals, Sonos is the leading brand in wireless speakers, soundbars and subwoofers. Our 92% share in the wireless audio category among these industry professionals, according to the report, significantly outpaces our competitors and underscores the strength of our brands, the quality of our products and our dominant competitive position in the categories we serve. Furthermore, our commitment to investing in product innovation and new capabilities continues to add to the strength of our intellectual property. We are on track to be granted close to 200 new patents in 2020, up from 147 granted in 2019. According to the most recent 1790 Analytics patent scorecard, which measures the strength of patent portfolios, Sonos ranked number 3 in the electronics category. Our gross margin expansion illustrates the value proposition of our products and we are continuing to drive our product differentiation through investments organically and inorganically. As a premium audio platform, we exited fiscal 2020 with gross margin, excluding the effective tariffs, of 45.6%, an increase of 370 basis points from last year. We are getting more creative and more productive in our sales and marketing so that we can leverage our spend to deliver record new customers and continue building a powerful consumer brand. Sonos is delivering the profitability that we've been talking about since our IPO well in advance of when we thought we would actually achieve it. We are doing that while driving expected 13% revenue growth at the midpoint next year on a comparable 52 week basis. All of you know we've been focused on and investing in direct to consumer and we've seen a significant acceleration in our direct to consumer channel in fiscal 2020. DTC revenue increased 84% year over year and represented a record 21% of total revenue. That's up from 12% last year. The investments we made in this channel and our marketing strategies positioned us to capture this opportunity and drive strong sales and margin even in the face of retail store closures during the year. According to a recent FeatureSource report, only 25% of audio hardware owners in key markets said they were comfortable buying audio products online prior to the COVID-nineteen pandemic. But during the pandemic, this has increased to 63%. While some of that revenue may shift back to in store, we believe a significant portion of sales will remain online and that our direct to consumer business will continue to represent a growing portion of revenue over time. As we look forward to fiscal 2021, we see tremendous momentum and opportunity and are focused on the following strategic priorities and strategies. First, continuing to deliver innovative new products and beginning to deliver more on the services side. Just last week, we introduced Sonos Radio HD, a new ad free, high definition streaming subscription tier of Sonos Radio for 7.99 dollars a month. Sonos Radio HD features even more exclusive content directly in the Sonos app, now in lossless CD quality audio, the highest quality of any radio streaming service. With this new service, we focused on making one of our customers' most valued listening experiences, radio, easier and better. Radio HD exclusive content debuted with Dolly Parton and Songteller Radio. The new HD station will evolve with Dolly's hits, favorite artists and special commentary on songs and moments throughout her career. Sonos Radio HD is a complementary offering to the 100 plus streaming music services offered on our platform today, and we look forward to developing more direct paid relationships with our households over time. We are committed to launching at least 2 new products per year and are well on track as we look out at our fiscal 2021 product roadmap. As you know, we don't share details of the products we're working on for competitive reasons, but we're confident that these new products will resonate with customers regardless of whether COVID-nineteen has us spending more time at home or not. This confidence comes from the resilience we've seen in our business model and our customer base this year. 2nd, we will continue to focus on the expansion of our direct to consumer efforts and engaging even deeper with our customers. We are increasingly focused on direct distribution engagement to ensure we are delivering a great end to end experience for our customers. We have seen consumers are willing to engage and transact with a trusted brand like Sonos and expect that to only continue to increase over time. We will continue to efficiently evolve our marketing strategies, making our brand even more accessible and showcasing content and experiences. This fall, we launched an innovative, multifaceted strategic marketing campaign with Disney leading up to the widely anticipated premiere of the 2nd season of The Mandalorian. As we spend more time at home, our living rooms have become a hub for entertainment and we worked with Disney to provide an even more immersive experience for one of the best sounding series streaming today. This campaign was an excellent example of 2 powerful brands coming together to promote their premium products and services to shared fans around the world. We are excited to share more insight into our evolving marketing strategies at our first Investor Day in March. 3rd, we will continue to strengthen and expand our partnerships. We've been pleased with the results of our IKEA partnership and the opportunity it has created to introduce new consumers to the Sonos brand and platform. We will look to continue to evolve our partnerships with IKEA and you should expect to see additional IKEA products launched next year. And finally, we remain focused on delivering sustainable profitable growth and expanding our adjusted EBITDA margins. We believe that our leadership in the category, coupled with our strategies to drive accelerated direct to consumer growth, position us to deliver strong profit margins and cash flow going forward. Let me now turn the call over to Britney to provide more details on our results and our outlook. Thank you, Patrick. Let me add some additional color on our strong Q4 and fiscal 2020 results and fiscal 2021 outlook. Starting with the Q4, we significantly outperformed on both revenue and profit. Adjusted EBITDA increased dramatically to $46,400,000 from a loss of $2,800,000 last year. Excluding tariffs, adjusted EBITDA was $48,900,000 We delivered tremendous operating expense leverage and gross margin expansion during the quarter, culminating in a record 13.7% adjusted EBITDA margin. We were able to drive this performance through our impressive gross margin expansion and OpEx leverage. Gross margin increased 530 basis points to 47.5%. We were largely exempt from tariffs for the quarter except for a rate of 7.5% on our component products in September and 25% on our accessories throughout the quarter which are captured in our partner products and other revenue category. These results show the underlying power of our margins driven by mix shift into higher margin products and channels, product and material cost reductions, leverage on the higher sales volumes and no promotional activity during the quarter. Revenue in the 4th quarter increased 16% year over year to nearly $340,000,000 which was up 36% sequentially as we continued to experience strong demand for our new and existing products. As a reminder, we had an extra week in fiscal 2020, which hit in the Q4. Excluding the impact of this 14th week, which we believe contributed approximately $25,000,000 during the quarter, revenue increased 7% year over year. Our direct to consumer channel increased 67% from the prior year, which helped support both revenue and margin in the quarter. Turning now to our fiscal 2020 results. Our outperformance in the 4th quarter resulted in top line growth and significantly higher profitability than we guided to at the beginning of the year. Adjusted EBITDA increased 22 percent to a record $109,000,000 and adjusted EBITDA margin increased 100 and 20 basis points, a record 8.2%. As good as these numbers are, they still include $32,000,000 in tariff, of which we will receive a refund of approximately $30,000,000 and largely mitigate the ongoing impact in fiscal 2021. Excluding tariffs, fiscal 2020 adjusted EBITDA would have been $141,000,000 or 10.6 percent adjusted EBITDA margin. This profitability is meaningfully ahead of our original outlook of 5.3% to 5.9% even on less revenue than expected. The revenue impact was a result of reduced retail partner orders from the effects of COVID-nineteen and demand outstripping supply. Despite this, the strong adjusted EBITDA margin performance resulted from gross margin expansion and OpEx control. And we delivered this while continuing to invest in our products. Gross margin for the year increased 130 basis points to 43.1%. Excluding tariffs, gross margin increased 370 basis points to a record 45.6% driven by mix shift into higher margin products and channels along with ongoing material cost reductions. In fiscal 2020, we achieved our 15th consecutive year of revenue growth. We delivered 5% revenue growth or 3% excluding the 53rd lease generating total revenue of 1.326 $1,000,000,000 As Patrick discussed, the continued strength in our business has been the result of successful new product launches, strong growth in new households, as well as increased repurchasing by our existing households. Direct to consumer revenue increased 84% and represented a record 21% of total revenue compared to 12% last year. The Americas grew at 11% and EMEA declined 3% or 2% on a constant currency basis, primarily stemming from a tougher market environment throughout the year. APAC increased 2% as IKEA slowed down ordering due to COVID-nineteen and their products, but was also negatively impacted by reduced orders from our physical retail partners affected by COVID-nineteen and rebounded. Sonos system products revenue increased 17%, driven by the continued strength of our installer channel and component products AMP and ports. Partner products and other revenue increased 12%, driven by the strength of our other products in this category. Our operating expenses for the year showed investment in R and D as we continue to support new products and customer experiences, including integrating the Smiths acquisition. We showed leverage across sales and marketing and G and A when we take into account the restructuring and new expenses. R and D excluding restructuring and severance as a percentage of revenue increased 220 basis points. Our software and consumer experience continues to differentiate our products and in fiscal 2020 more than 50% of our R and D investments was allocated to engineering. Sales and marketing excluding restructuring and severance costs as a percentage of revenue decreased 120 basis points. This was on top of a 4 20 basis point year over year decrease in fiscal 2019. We benefited from differentiated high impact creatives and the adoption of more efficient direct to consumer marketing. G and A excluding restructuring and severance IP litigation and transaction related costs as a percentage of revenue decreased forty basis points in fiscal 2020, primarily due to leverage on the higher sales volume in the quarter. Our model continues to generate strong we saw another significant increase this year. We generated cash flows from operating activities of 162,000,000 dollars and free cash flow of $129,000,000 up 32% from $97,000,000 last year. We ended the year with $407,000,000 in cash, which puts us in a strong position to invest organically in our business, pursue M and A and return capital to shareholders through share repurchases. We completed the $50,000,000 share repurchase authorization that our Board approved in September 2019 at an average price of $13.18 We announced today that the Board has authorized another $50,000,000 share repurchase program. We continue to see significant value in our stock, particularly in light of our increased profitability, growth and execution. We are confident in the earnings power of our model and believe that there are significant value creation opportunities that lie ahead. Now let's look ahead to what we expect to be an excellent fiscal 2021 with ongoing increases in profitability, a rebound in top line growth on the back of strong demand. While we remain cognizant of the uncertainty in the broader environment and with COVID-nineteen, we are expecting a strong fiscal 2021 regardless with impressive adjusted EBITDA margin expansion as we reduce our exposure to tariffs and further scale our OpEx. Our fiscal 2021 outlook is for adjusted EBITDA in the range of $170,000,000 to $205,000,000 This represents 12% to 14% adjusted EBITDA margin, an expansion of 380 basis points to 5.80 basis points. This is significantly above prior expectations for fiscal 2021. This also excludes the impact of any refunded tariff given the uncertainty of timing. Gross margin is expected to be in the range of 45.3% to 45.8% with minimal impact from tariffs. We have continued to make progress on diversifying our manufacturing and remain on track to have our full shift in Malaysia completed by the summer. As a result, we do not expect a meaningful tariff expense in fiscal 2021. We also expect to maintain our direct to consumer business at similar levels to fiscal 2020 despite our expectations that physical stores will remain open. In addition, we expect stable margins compared to fiscal 2020 as we see limited additional benefit in products or channel mix, offset by increased shipping and logistics costs. Total revenue for fiscal 2021 is expected to be in the range of $1,440,000,000 to $1,500,000,000 which represents growth of 9% to 13%. Excluding the 53rd week from fiscal 2020, this represents growth of 11% to 15% for the year. The stronger than expected guidance shows how well our business is performing as we look ahead to next year. Let me share some color now as it relates to the Q1 of fiscal 2021. While we don't give quarterly guidance, we thought it would be helpful to provide some additional information, especially given the supply chain constraints as demand has continued to outpace our expectations. We are investing in expedited air freight shipments in order to better meet the demand and have as much product available as possible in the Q1. Even with that, as Patrick mentioned, we will continue to be low on stock for some key products in the Q1. Accordingly, we anticipate that the Q1 of fiscal 2021 will contribute slightly less total revenue as a percentage of the total fiscal year compared to the Q1 of last year. We have also been expanding capacity in light of the demand and expect that by the end of the second quarter, we will be fully in stock across all our products. As you may know, many supply chain constraints are a broader industry wide challenge and not unique to Sonos. We see impacts on everything from component availability to keying our availability and port congestion as well as higher shipping and logistics costs, all of which we are actively working through. Operating expense is expected to be relatively consistent on a dollar basis as compared to the Q4 fiscal 2020, except for the increased sales and marketing investments typical in the Q1. The Q1 is seasonally our highest promotional quarter. This along with the fact we will continue to be exempt from the majority of tariffs through the Q1 should result in a similar gross margin profile as the Q1 fiscal 2020 if you also excluded the tariff. The benefit of mix is largely offset by the increased logistics costs in the quarter. We have factored all of this color into our annual revenue gross margin and our adjusted EBITDA guidance and look forward to talking more about the quarter, our Q1 earnings call. As I reflect on our fiscal 2020, I am impressed by the resilience of our business model. Despite early challenges in physical retail, our products continue to resonate with both new and existing customers and we launched incredibly successful new products. These will drive continued strong performance in fiscal 2021 and beyond. We did all of this while making some hard decisions to lower expenses, still investing in R and D for the future and delivering record profitability and cash flow. Our strong growth, margin expansion and significant increase in adjusted EBITDA for fiscal 2021 puts us in a position to continue to deliver profitability and growth. Our strong balance sheet will enable us to invest in the business and return capital through share repurchases. We have a stronger business than we did a year ago and a bright outlook. I'm very excited about executing on this in the next year. I'm also excited to share that we are planning a virtual investor event on March 9. We will spend time on our strategies and reintroduce updated long term financial targets. Be on the lookout for more details in the coming weeks. And with that, I would like to turn the call over to questions. Your first question comes from the line of Jon Babcock with Bank of America. Your line is open. Hey, good evening and thanks for taking my questions. Starting out, I was wondering if you could talk a little bit about some of the supply constraints that you guys are seeing. I mean, obviously, I think different companies are seeing it in different ways. So I was wondering if you might be able to provide a little bit more color about what exactly is impacting Sonos specifically? Yes. So I would say we continue to see demand outperform our expectations, which continues to put pressure on our supply chain even as we increase our capacity. And then much like other companies in the industry, as I mentioned, we're seeing everything from challenges with component availability, container availability, congestion in port to higher shipping and logistics costs. Okay. Thank you. And is there obviously, like it looks like from the website that you have pretty strong back orders on a couple of your products and you mentioned that it's going to take a little while to get those back down to a normalized level. I was wondering given that if you could provide any sort of initial color on sort of the holiday season demand that you're seeing so far, recognizing you might be able to might not be able to say much, but just want to see what I might be able to get? I think the best guidance that we can give is that, due to the fact that we are constrained a bit on inventory, we're expecting Q1 revenue to be slightly lower as a percentage of total year revenue than what we saw last year. But we are investing in things like airfreight and doing everything we can to get as much supply into Q1 as we can. And then we do keep the website pretty updated in terms of shipping dates and how things are stretching out. Okay. Thanks for that. And then just last question before I turn it over, I was wondering if you could talk about the reception that you're seeing so far for the Sonos Radio HD. Yes. So we've just launched that one, obviously, John, so just last week. We're excited to really test our first in the new service out into the world, but it is super early at this point. So we'll talk a little more about that at our first Investor Day coming up in March and kind of the way we're thinking about services. But we're excited about it and have seen a good initial response and more to come on that. It's early days. Okay. Thank you. Your next question comes from the line of Katy Huberty with Morgan Stanley. Your line is open. Thank you. Congrats on a really strong quarter. I wonder if we can come back to the holiday season and just hear how you're thinking about promotions, your retail partners, stocking inventory and linearity of demand, which is typically pretty back end loaded in a December quarter. How is that different this year given what's expected to be more of a stretched out period of demand and more business going direct versus through retail partners? It's a great question. I think it's a lot of what you referenced, which is people are seeing the holiday quarter start a bit earlier this year. We have relatively good visibility into the holiday quarter and demand from both our retail partners and then with the increased direct to consumer business what we're seeing on our own website. We ran our first promo last weekend on news. So that was a bit earlier than we normally do. And I think that's consistent with what other partners and retailers are seeing. So I think you'll probably see less back end loading this Q1 than you have seen in other Q1. And then as we think about fiscal 2021, I know you don't give specific quarterly guidance, but should we expect profits to continue to be concentrated in your Q1 or do the strong Q4 'twenty results set up as a precursor to smoothing out some of that earnings, linearity that has been very front end loaded in past years? Yes. I mean, I think the best that I can do is we gave a little bit of color on both revenue, gross margin and OpEx for Q1. So any quarter where we have significantly higher revenue, we do tend to have better flow through all the way down to EBITDA. But I think if you take the color and the shaping around Q1 and sort of flow it through the rest of the year, because everything we know about Q1 is factored into that guidance, you'll see that it's a pretty nice increase in in profitability for the whole year. Okay, great. And then just last question, should we think about you being able to lower sales and marketing expenses again in fiscal 2021 or as you invest in direct to consumer and some of the retail channels open up again, will that return to year on year growth? Yes. We have guided to basically flat gross margin. That's the midpoint for 2021. And so you will see the EBITDA margin expansion coming from OpEx leverage. Okay. So we should think about R and D continuing to grow and really seeing significant leverage on the sales and marketing and G and A line again? We're not calling the shape of OpEx for fiscal year 2021, but you can see that because we're expanding EBITDA so nicely that we have to be getting leverage on our OpEx as we go through the year. Okay, great. Thank you so much. Your next question comes from the line of Rod Hall with Goldman Sachs. Your line is open. Rod Hall with Goldman Sachs, your line is open. Your next question comes from the line of Adam Tindle with Raymond James. Your line is open. Thanks. Good afternoon and congrats as well on the strong finish to the fiscal year. Patrick, I just wanted to start on the fiscal 2021 plan where you're balancing both growth and incremental profitability. Company is cash flow positive. You're in a net cash position. Just curious why pursue further EBITDA margin expansion in fiscal 2021 versus perhaps investing more heavily? I acknowledge that you're still planning for growth, but maybe just touch on the plans, different plans that you evaluated and why this is the right mix versus a more investment heavy approach? Yes. Hey, Adam. It's been something we've talked about for a long time, as you know, which is this philosophy of sustainable profitable growth as we approach it. And so there's often things, particularly in the hardware world that companies do that sometimes can run for a quarter or 2 and you can show good numbers for a quarter or 2. But we believe in more sustainably building that and building it in a consistent way, right? We've been at this 15 years now. We've really our business and we're showing the power of our model, whether we've had to work through the Great Recession or through a pandemic, through competitors coming in and copying our intellectual property and coming into our category. And so we've, I think, found a good balance in terms of where we are and we've hit a scale point where I believe that we're doing what we can to drive the kind of growth that makes sense for us as a company in terms of reaching these new customers and servicing our existing customers and really making sure we're doing that in a sustainable way. We will continue to look for opportunities where we might want to invest more. We may want to make acquisitions, as Brittany talked about, too, to add to what we're doing as we go through that. And I think having the balance between what we're pursuing on the revenue side and then as well on the profitability side enables us to do that and to do it in a way that builds the company for decades to come, not just a quarter or 2. That's helpful. Thanks. And maybe as a follow-up, Britney, on the fiscal 2021 plan on the gross margin line, I think you talked about expecting the flat year over year ex tariffs. As I think about the obvious kind of moving parts on a year over year basis, fiscal 2020 that you're comparing to had a obviously strong mix of highest ASP products that you're comparing to. I think you're guiding DTC to the same level in 'twenty one versus 'twenty, so not an incremental tailwind on go to market. You also have the Malaysia facility coming on board and I don't know if there's maybe some incremental cost to that. So just thought about some a number of different headwinds. What are the good guys that keep gross margin flat year over year? Yes. It would really be product mix. So we're carrying through a pretty nice product mix from our fiscal year 2020 as well as channel mix. Product mix can go up and down for us depending on what products we have in the market, what's selling well, what new products we introduced, so that's always a balance and one of the main drivers in our gross margin. But you've got product and you've got channels being supportive of consistent gross margins year over year. We're looking at it ex tariff. So we've really mitigated that as a headwind to our gross margins. And then as I said, we are expecting a bit of an increase in freight and logistics as we go, especially through Q1. Okay. Maybe just a quick housekeeping one for you. On the Q1 revenue comment, would revenue also decline year over year or does that still grow year over year? I would expect it still to grow year over year. You've got quite a bit of room to sort of take our comments about the revenue shaping and still end up with growth. That's helpful. Thank you. Your next question comes from the line of Matt Sheerin with Stifel. Your line is open. Yes. Thank you and good afternoon. Just another question regarding your guidance for the December quarter on revenue, which is below the seasonality that you've seen in recent years due to the supply constraints that you talked about. But does that also factor in continued challenges within your retail channel customers because of COVID related shut shutdowns, etcetera? And how do you see that environment? And as we look to the March quarter, does that lessen the likelihood of some any inventory overhang that you typically have seen in the March quarter because of the retailers in the December quarter? We're not assuming a big shutdown of physical retail again, but what we saw as we went through the last wave was that our DTC business was really able to pick up the demand from that. And so that's how we're thinking about Q1 and factoring in sort of everything we see right now from the retail landscape. And yes, given our inventory challenges right now, I really hope we're not talking about inventory overhang as we get into Q2. But if we were, because we really got our supply chain up and running, it solved some challenges. Okay. Thank you. And then, Patrick, regarding the early success of the radio, Sonos Radio so far and then moving that to a revenue generating model, how should we think about your long term strategy in terms of generating revenue outside of the traditional hardware? Are you still sort of in the kicking the tires phase on various projects before we start to see some traction? Or what's the thinking there? Yes. Thanks, Matt. I think it is very much we're past kicking the tires, but we're just getting started in terms of where we are. And we've seen some promising engagement so far from customers on both the ad supported radio that we launched earlier this year and now radio HD, and we're learning. And so we're kind of taking that into account and and understand what customers like, what kind of experiences we can build that are unique to Sonos. And we've got a bunch of ideas in this category and I look forward to sharing a little more on that when we get together in March for the Investor Day. Okay. And just a follow-up, are these initiatives a drag on margins right now? Or is that just part of the investments? And at some point, we see some margin expansion because they're either cash flow breakeven or profitable? Probably early at this too early at this point to say, but we're obviously investing in that, but that's all factored into what you're seeing from an R and D investment level. Okay. Thank you. Yes, Matt, I would just note that when we do our March 9 Investor Day, we're going to be bringing back our long term targets and updating them for everything we know right now. So that will be a good time to talk about gross margins beyond the fiscal year 2021 guidance we're giving right now. Your next question comes from the line of Brent Thill with Jefferies. Your line is open. Thank you. It's a lot of results with profitability. You mentioned the direct to consumer is doing very well. But when you look at the other factors that are helping drive the margin profile going forward, can you just highlight where you think beyond DTC, what other big drivers you're seeing that are helping result in this great progress forward on the bottom line? Product mix is the other one that we were calling out. So product mix is always a big driver for us as gross margin. We've done some work in ongoing material cost reductions, and that's really what you're seeing coming through in addition to the channel mix. And is radio in any of the revenue guidance or is that excluded because it's too early to make a call? Everything we know about all of our products is included in our fiscal year 2021 guidance. So we do not break out anything for that one specifically because as you can imagine having just launched it, it's pretty small. Great. Thanks. Your next question comes from the line of Rod Hall with Goldman Sachs. Your line is open. Yes. Thanks for the chance again. Sorry about that earlier. So nice quarter. I guess I wanted to ask about the fiscal 'twenty one guidance and visibility and kind of maybe what you're assuming there, Britney, when you give that guidance. Are you assuming steady state in terms of the economy? Do you assume a rebound? I mean, how do you think about that? And did you consider not giving guidance at all? And then I have a follow-up to that. Yes. It's a great question. It's sort of hard to have a crystal ball on the economy or the world right now. And so we always try and share when we know. We share what we can share. That's generally been our philosophy on guidance. That's why we gave guidance for Q4 when we could and now we're giving you our best look at fiscal year 2021. Our guidance is a little bit wider than we would normally give to take into account a bit of that uncertainty. But Q1 is also our largest quarter and we can see what we can see on Q1 in our largest quarter and we can see what we can see on Q1 in terms of demand trends and the underlying demand for our products as we have looked at Q4 and then as we've looked at 'twenty one is quite high. And it's really the success of our camp move, our new products, plus what we have coming for the year that gives us confidence to come out with a guidance range. Okay. Thanks for that. And then I wanted to on DTC, you're indicating a similar percentage to this year, at 21% next year, but you've had this obviously a move up because of COVID. I'm just wondering your commentary earlier made it sound like you feel like that's a sustainable trend and I think I agree with that. So I'm curious why that percentage doesn't go up in the guidance, why not go ahead and increase it? Or do you feel like it's kind of outpacing what it should be right now and that's why you're holding it flat? We had a big benefit in fiscal year 2020 on DTC from the fact that physical retail was closed and e commerce and DTC was really the best available channel. So I think we're trying to be pretty balanced as we look at fiscal year 2021 between the fact that consumers are getting more comfortable buying products online, we've been investing in our DTC channel, we've been deepening those relationships. Those are all the pros. I think the challenge is the physical retailers have also adapted. They are doing curbside pickup and delivery and that continues to be an important channel for us. So we think being roughly flat year over year is a pretty nice result for our DTC business when we expect physical retail to be open and a strong partner in 2021. Great. Okay. Thanks a lot. Your next question comes from the line of Elliot Alba with D. A. Davidson. Your line is open. Great. Thank you. I just want to follow-up on the gross margin guidance. I guess, what are the assumptions surrounding the promotional landscape for fiscal 2021? And then kind of back to the DTC, kind of curious how that goes into forecasting and if there's any correlation you seen between some of the retail openings in your DTC business by geography? So I would say on our Q1 shaping, we called for our gross margin, if you exclude tariffs from both periods to be fairly consistent year over year. So you can imagine that that means we're not doing any sort of big swing from a promotional standpoint one way or the other given that type of consistency in our gross margins. And then yes, we certainly look pretty closely at our DTC business and how that continued perform in Q4 when physical retail had largely reopened and that's part of what's giving us the confidence in the 2021 guide on DTC. Okay, great. And then I guess what does the Disney partnership mean for Sonos and kind of what other similar partnerships could that look like in the future? Yes, I think it's a great one that shows our intent to go to an even broader mainstream audience and be able to bring our products to just an even wider array of people. We've seen such trends and such tailwinds around streaming, whether it be audio or video, and that plays right into what we're doing. And so we think based on what we've seen here and the kind of ambition that we have in terms of other new homes we think we can get into, We think there's an excellent way of doing it. We're obviously very selective in terms of the brands that we want to work with around this. But I think it is one of those effective ways of getting even more leverage as well out of our sales and marketing investments. So I'm very pleased with that and look forward to doing more in the future. Great. Thank you. There are no further questions at this time. I will turn the call back over to Patrick Spence. Thanks, David, and thanks to all of you for joining. As I mentioned, I think we've hit a real inflection point in terms of our model. Our model is working. It's working and has worked for 15 years in terms of getting us to this point, in terms of really being resilient in the face of the pandemic. And we're excited about what we have in store for the next year. We're excited to share more of our strategic thinking as we get to that March 9 Investor Day as well. And I just want to say a huge thank you to the entire Sonos team for what was delivering through a very challenging year, but adapting and being resilient in the face of everything that we were challenged with. So thank you and we'll talk to you again soon. Take care. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.