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

FORM 10-Q

(Mark One)
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended January 2, 2021
or

☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to
Commission File Number: 001-38603

SONOS, INC.
(Exact name of registrant as specified in its charter)

Delaware |  | 03-0479476 |
(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.) |
614 Chapala Street | Santa Barbara | CA | 93101
(Address of Principal Executive Offices) |  |  | (Zip Code)

(805) 965-3001
Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:

Title of each class | Trading Symbol(s) | Name of each exchange on which registered
Common Stock, $0.001 par value | SONO | The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer | ☒ | Accelerated filer | ☐
Non-accelerated filer | ☐ | Smaller reporting company | ☐
|  | Emerging growth company | ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Table of contents
As of January 30, 2021, the registrant had 119,740,268 shares of common stock outstanding.

Table of contents
TABLE OF CONTENTS

|  | Page
PART I. FINANCIAL INFORMATION |
Item 1. | Financial Statements (unaudited) |
| Condensed consolidated balance sheets | 4
| Condensed consolidated statements of operations and comprehensive income | 5
| Condensed consolidated statements of stockholders' equity | 6
| Condensed consolidated statements of cash flows | 7
| Notes to condensed consolidated financial statements | 8
Item 2. | Management’s discussion and analysis of financial condition and results of operations | 21
Item 3. | Quantitative and qualitative disclosures about market risk | 33
Item 4. | Controls and procedures | 34
PART II. OTHER INFORMATION |
Item 1. | Legal proceedings | 35
Item 1A. | Risk factors | 35
Item 2. | Unregistered sales of equity securities and use of proceeds | 51
Item 6. | Exhibit index | 52
SIGNATURES | 53

Table of contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

SONOS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except par values)
| As of
| January 2, 2021 |  | October 3, 2020
Assets |  |  |
Current assets: |  |  |
Cash and cash equivalents | $ | 677,834 |  |  | $ | 407,100 |
Restricted cash | 198 |  |  | 191 |
Accounts receivable, net of allowances | 113,616 |  |  | 54,935 |
Inventories | 88,194 |  |  | 180,830 |
Prepaids and other current assets | 21,076 |  |  | 17,321 |
Total current assets | 900,918 |  |  | 660,377 |
Property and equipment, net | 64,170 |  |  | 60,784 |
Operating lease right-of-use assets | 41,462 |  |  | 42,342 |
Goodwill | 15,545 |  |  | 15,545 |
Intangible assets, net | 25,975 |  |  | 26,394 |
Deferred tax assets | 1,886 |  |  | 1,800 |
Other noncurrent assets | 16,904 |  |  | 8,809 |
Total assets | $ | 1,066,860 |  |  | $ | 816,051 |
Liabilities and stockholders’ equity |  |  |
Current liabilities: |  |  |
Accounts payable | $ | 239,760 |  |  | $ | 250,328 |
Accrued expenses | 96,433 |  |  | 45,049 |
Accrued compensation | 29,424 |  |  | 44,517 |
Short-term debt | 24,937 |  |  | 6,667 |
Deferred revenue, current | 16,382 |  |  | 15,304 |
Other current liabilities | 48,828 |  |  | 31,150 |
Total current liabilities | 455,764 |  |  | 393,015 |
Operating lease liabilities, noncurrent | 42,268 |  |  | 50,360 |
Long-term debt | — |  |  | 18,251 |
Deferred revenue, noncurrent | 52,459 |  |  | 47,085 |
Deferred tax liabilities | 2,434 |  |  | 2,434 |
Other noncurrent liabilities | 3,726 |  |  | 7,067 |
Total liabilities | 556,651 |  |  | 518,212 |
Commitments and contingencies (Note 7) |  |  |
Stockholders’ equity: |  |  |
Common stock, $0.001 par value | 121 |  |  | 114 |
Treasury stock | (26,004) |  |  | (20,886) |
Additional paid-in capital | 633,335 |  |  | 548,993 |
Accumulated deficit | (96,200) |  |  | (228,492) |
Accumulated other comprehensive loss | (1,043) |  |  | (1,890) |
Total stockholders’ equity | 510,209 |  |  | 297,839 |
Total liabilities and stockholders’ equity | $ | 1,066,860 |  |  | $ | 816,051 |

The accompanying notes are an integral part of these condensed consolidated financial statements.
4

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SONOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(unaudited, in thousands, except share and per share amounts)
| Three Months Ended
| January 2, 2021 |  | December 28, 2019
Revenue | $ | 645,584 |  |  | $ | 562,083 |
Cost of revenue | 346,159 |  |  | 334,463 |
Gross profit | 299,425 |  |  | 227,620 |
Operating expenses |  |  |
Research and development | 52,346 |  |  | 52,526 |
Sales and marketing | 74,453 |  |  | 77,423 |
General and administrative | 35,242 |  |  | 30,209 |
Total operating expenses | 162,041 |  |  | 160,158 |
Operating income | 137,384 |  |  | 67,462 |
Other income (expense), net |  |  |
Interest income | 36 |  |  | 998 |
Interest expense | (265) |  |  | (453) |
Other income, net | 4,257 |  |  | 4,424 |
Total other income (expense), net | 4,028 |  |  | 4,969 |
Income before provision for income taxes | 141,412 |  |  | 72,431 |
Provision for income taxes | 9,120 |  |  | 1,656 |
Net income | $ | 132,292 |  |  | $ | 70,775 |
Net income attributable to common stockholders: |  |  |
Basic | $ | 132,292 |  |  | $ | 70,775 |
Diluted | $ | 132,292 |  |  | $ | 70,775 |
Net income per share attributable to common stockholders: |  |  |
Basic | $ | 1.14 |  |  | $ | 0.65 |
Diluted | $ | 1.01 |  |  | $ | 0.60 |
Weighted-average shares used in computing net income per share attributable to common stockholders: |  |  |
Basic | 115,610,523 |  |  | 108,984,683 |
Diluted | 130,644,147 |  |  | 118,415,968 |
Total comprehensive income |  |  |
Net income | $ | 132,292 |  |  | $ | 70,775 |
Change in foreign currency translation adjustment | 847 |  |  | (519) |
Comprehensive income | $ | 133,139 |  |  | $ | 70,256 |

The accompanying notes are an integral part of these condensed consolidated financial statements.
5

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SONOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(unaudited, in thousands, except share amounts)
| Three Months Ended January 2, 2021
| Common Stock |  | Additional Paid-In Capital |  | Treasury Stock |  | Accumulated Deficit |  | Accumulated Other Comprehensive Loss |  | Total Stockholders’ Equity
| Shares |  | Amount |  |  | Shares |  | Amount |  |  |
Balance at October 3, 2020 | 113,915,233 |  |  | $ | 114 |  |  | $ | 548,993 |  |  | (1,571,138) |  |  | $ | (20,886) |  |  | $ | (228,492) |  |  | $ | (1,890) |  |  | $ | 297,839 |
Issuance of common stock pursuant to equity incentive plans | 7,075,338 |  |  | 7 |  |  | 69,498 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 69,505 |
Repurchase of common stock related to shares withheld for tax in connection with vesting of restricted stock unit awards ("RSUs") | — |  |  | — |  |  | — |  |  | (307,980) |  |  | (5,118) |  |  | — |  |  | — |  |  | (5,118) |
Stock-based compensation expense | — |  |  | — |  |  | 14,844 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 14,844 |
Net income | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 132,292 |  |  | — |  |  | 132,292 |
Change in foreign currency translation adjustment | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 847 |  |  | 847 |
Balance at January 2, 2021 | 120,990,571 |  |  | $ | 121 |  |  | $ | 633,335 |  |  | (1,879,118) |  |  | $ | (26,004) |  |  | $ | (96,200) |  |  | $ | (1,043) |  |  | $ | 510,209 |
| Three Months Ended December 28, 2019
| Common Stock |  | Additional Paid-In Capital |  | Treasury Stock |  | Accumulated Deficit |  | Accumulated Other Comprehensive Loss |  | Total Stockholders’ Equity
| Shares |  | Amount |  |  | Shares |  | Amount |  |  |
Balance at September 28, 2019 | 109,623,417 |  |  | $ | 110 |  |  | $ | 502,757 |  |  | (1,020,775) |  |  | $ | (13,498) |  |  | $ | (208,377) |  |  | $ | (64) |  |  | $ | 280,928 |
Issuance of common stock pursuant to equity incentive plans | 1,561,696 |  |  | 1 |  |  | 7,968 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 7,969 |
Repurchase of common stock | — |  |  | — |  |  | — |  |  | (372,149) |  |  | (5,078) |  |  | — |  |  | — |  |  | (5,078) |
Stock-based compensation expense | — |  |  | — |  |  | 13,204 |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 13,204 |
Net income | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 70,775 |  |  | — |  |  | 70,775 |
Change in foreign currency translation adjustment | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (519) |  |  | (519) |
Balance at December 28, 2019 | 111,185,113 |  |  | $ | 111 |  |  | $ | 523,929 |  |  | (1,392,924) |  |  | $ | (18,576) |  |  | $ | (137,602) |  |  | $ | (583) |  |  | $ | 367,279 |

The accompanying notes are an integral part of these condensed consolidated financial statements.
6

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SONOS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
| Three Months Ended
| January 2, 2021 |  | December 28, 2019
Cash flows from operating activities |  |  |
Net income | $ | 132,292 |  |  | $ | 70,775 |
Adjustments to reconcile net income to net cash provided by operating activities |  |  |
Depreciation and amortization | 7,982 |  |  | 9,105 |
Stock-based compensation expense | 14,844 |  |  | 13,204 |
Other | (1,050) |  |  | 1,471 |
Deferred income taxes | 12 |  |  | 51 |
Foreign currency transaction gain | (1,633) |  |  | (1,924) |
Changes in operating assets and liabilities: |  |  |
Accounts receivable, net | (56,650) |  |  | (31,411) |
Inventories | 93,495 |  |  | 107,343 |
Other assets | (7,330) |  |  | (11,853) |
Accounts payable and accrued expenses | 33,271 |  |  | (39,416) |
Accrued compensation | (15,481) |  |  | (14,568) |
Deferred revenue | 5,633 |  |  | 4,879 |
Other liabilities | 9,128 |  |  | 11,184 |
Net cash provided by operating activities | 214,513 |  |  | 118,840 |
Cash flows from investing activities |  |  |
Purchases of property and equipment, intangible and other assets | (11,333) |  |  | (15,914) |
Cash paid for acquisition, net of acquired cash | — |  |  | (35,622) |
Net cash used in investing activities | (11,333) |  |  | (51,536) |
Cash flows from financing activities |  |  |
Repayments of borrowings | — |  |  | (1,667) |
Payments for repurchase of common stock | — |  |  | (5,078) |
Proceeds from exercise of common stock options | 69,505 |  |  | 7,969 |
Payments for repurchase of common stock related to shares withheld for tax in connection with vesting of restricted stock units | (5,118) |  |  | — |
Net cash provided by financing activities | 64,387 |  |  | 1,224 |
Effect of exchange rate changes on cash, cash equivalents and restricted cash | 3,174 |  |  | 1,254 |
Net increase in cash, cash equivalents and restricted cash | 270,741 |  |  | 69,782 |
Cash, cash equivalents and restricted cash |  |  |
Beginning of period | 407,291 |  |  | 338,820 |
End of period | $ | 678,032 |  |  | $ | 408,602 |
Supplemental disclosure |  |  |
Cash paid for interest | $ | 166 |  |  | $ | 472 |
Cash paid for taxes, net of refunds | $ | 2,672 |  |  | $ | 517 |
Cash paid for amounts included in the measurement of lease liabilities | $ | 8,102 |  |  | $ | 4,304 |
Supplemental disclosure of non-cash investing and financing activities |  |  |
Purchases of property and equipment in accounts payable and accrued expenses | $ | 7,814 |  |  | $ | 7,908 |
Right-of-use assets obtained in exchange for new operating lease liabilities | $ | 1,509 |  |  | $ | 74,683 |

The accompanying notes are an integral part of these condensed consolidated financial statements.
7

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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Business Overview and Basis of Presentation
Description of business
Sonos, Inc. and its wholly owned subsidiaries (collectively, “Sonos,” the “Company,” “we,” “us” or “our”) designs, develops, manufactures, and sells audio products and services. The Sonos sound system provides customers with an immersive listening experience created by the design of its speakers and components, a proprietary software platform, and the ability to stream content from a variety of sources over the customer’s wireless network or over Bluetooth.
The Company’s products are sold through third-party physical retailers, including custom installers of home audio systems, select e-commerce retailers, and its website sonos.com. The Company’s products are distributed in over 50 countries through its wholly owned subsidiaries: Sonos Europe B.V. in the Netherlands, Beijing Sonos Technology Co. Ltd. in China, Sonos Japan GK in Japan, and Sonos Australia Pty Ltd. in Australia.
Basis of presentation and preparation
The accompanying condensed consolidated financial statements are unaudited. The condensed consolidated balance sheet as of October 3, 2020 has been derived from the audited consolidated financial statements of the Company. The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information, and in management’s opinion, includes all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the Company’s financial position, its results of operations, and its cash flows for the interim periods presented. The results of operations for the three months ended January 2, 2021 are not necessarily indicative of the results to be expected for the full fiscal year or any other period.
The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended October 3, 2020 (the “Annual Report”), filed with the Securities and Exchange Commission (“SEC”) on November 23, 2020.
The Company operates on a 52- week or 53- week fiscal year ending on the Saturday nearest September 30 each year. The Company’s fiscal year is divided into four quarters of 13 weeks, each beginning on a Sunday and containing two 4-week periods followed by a 5-week period. An additional week is included in the fourth fiscal quarter approximately every five years to realign fiscal quarters with calendar quarters. This last occurred in the fourth quarter of the Company’s fiscal year ended October 3, 2020 and will reoccur in the fiscal year ending October 3, 2026. The three months ended January 2, 2021 and December 28, 2019 spanned 13 weeks each. As used in this Quarterly Report on Form 10-Q, “fiscal 2021” refers to the fiscal year ending October 2, 2021 and “fiscal 2020” refers to the fiscal year ended October 3, 2020.
Use of estimates and judgments
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the amounts reported and disclosed in the condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, the Company evaluates its estimates and judgments compared to historical experience and expected trends.
In March 2020, the outbreak of the novel coronavirus (COVID-19) was declared a pandemic. While the nature of the situation is dynamic, the Company has considered the impact when developing its estimates and assumptions noted above. Actual results and outcomes may differ from management's estimates and assumptions.
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
2. Summary of Significant Accounting Policies
There have been no changes in the Company’s significant accounting policies, recently adopted accounting pronouncements or recent accounting pronouncements pending adoption from those disclosed in the Annual Report, except as noted below.
Recently adopted accounting pronouncements
In June 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, and it subsequently issued amendments to the initial guidance (collectively referred to as "Topic 326"), which provide a new impairment model that requires measurement and recognition of expected credit losses for most financial assets and certain other instruments, including accounts receivable. The Company adopted this standard effective October 4, 2020, using a modified retrospective approach. Under the new standard, the allowance for credit losses is based on the Company's assessment of collectibility of accounts, including consideration of the age of invoices, each customer's expected ability to pay and collection history, customer-specific information and current economic conditions that may impact a customer's ability to pay. The adoption of this standard did not have a material impact on the Company's consolidated financial statements.
In November 2018, the FASB issued ASU No. 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606. This standard resolves the diversity in practice concerning whether certain transactions between collaborative arrangement participants should be accounted for as revenue under Accounting Standards Codification 606, Revenue from Contracts with Customers ("Topic 606"). This standard specifies when a participant is a customer in a collaboration, adds guidance for unit of account to align with Topic 606 and provides presentation guidance for collaborative arrangements. The Company adopted this standard in the first quarter of fiscal 2021. The adoption did not have a material impact on the Company's consolidated financial statements.
Recent accounting pronouncements pending adoption
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. This standard simplifies the accounting for income taxes by removing certain exceptions to the general principles in Accounting Standards Codification Topic 740 ("ASC 740") as well as by improving consistent application of the topic by clarifying and amending existing guidance. This standard is effective for the Company in the first quarter of fiscal 2022, with early adoption permitted. The Company is currently evaluating the timing of adoption and impact on the Company's consolidated financial statements.
3. Fair Value Measurements
The carrying values of the Company’s financial instruments, including accounts receivable and accounts payable, approximate their fair values due to the short period of time to maturity or repayment. The carrying values of the Company’s long-term debt approximate their fair values as of January 2, 2021 and October 3, 2020 as the debt carries a variable rate or market rates that approximate those currently available to the Company.
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The following table summarizes fair value measurements by level for the assets measured at fair value on a recurring basis as of January 2, 2021 and October 3, 2020:

| January 2, 2021
(In thousands) | Level 1 |  | Level 2 |  | Level 3 |  | Total
Assets: |  |  |  |  |  |  |
Money market funds (cash equivalents) | $ | 391,388 |  |  | $ | — |  |  | $ | — |  |  | $ | 391,388 |

| October 3, 2020
(In thousands) | Level 1 |  | Level 2 |  | Level 3 |  | Total
Assets: |  |  |  |  |  |  |
Money market funds (cash equivalents) | $ | 281,380 |  |  | $ | — |  |  | $ | — |  |  | $ | 281,380 |

4. Revenue and Geographic Information
Disaggregation of revenue
Revenue by geographical region includes the applicable service revenue for software upgrades and cloud-based services attributable to each region and is based on ship-to address, as follows:

| Three Months Ended
| January 2, 2021 |  | December 28, 2019
(In thousands) |  |  |
Americas | $ | 367,239 |  |  | $ | 303,194 |
Europe, Middle East and Africa (“EMEA”) | 240,007 |  |  | 212,738 |
Asia Pacific (“APAC”) | 38,338 |  |  | 46,151 |
Total revenue | $ | 645,584 |  |  | $ | 562,083 |

Revenue is attributed to individual countries based on ship-to address and includes the applicable service revenue for software upgrades and cloud-based services attributable to each country. Revenue by significant countries is as follows:

| Three Months Ended
| January 2, 2021 |  | December 28, 2019
(In thousands) |  |  |
United States | $ | 330,896 |  |  | $ | 277,273 |
Germany | 58,145 |  |  | 58,988 |
Other countries | 256,543 |  |  | 225,822 |
Total revenue | $ | 645,584 |  |  | $ | 562,083 |

Revenue by product category includes the applicable service revenue for software upgrades and cloud-based services attributable to each product category. Revenue by major product category is as follows:

| Three Months Ended
| January 2, 2021 |  | December 28, 2019
(In thousands) |  |  |
Sonos speakers | $ | 527,516 |  |  | $ | 466,677 |
Sonos system products | 97,759 |  |  | 61,521 |
Partner products and other revenue | 20,309 |  |  | 33,885 |
Total revenue | $ | 645,584 |  |  | $ | 562,083 |

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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
5. Balance Sheet Components
Accounts receivable, net of allowances
Accounts receivable, net of allowances, consist of the following:

| January 2, 2021 |  | October 3, 2020
(In thousands) |  |  |
Accounts receivable | $ | 164,912 |  |  | $ | 73,757
Allowance for credit losses | (1,538) |  |  | (1,307) |
Allowance for sales incentives | (49,758) |  |  | (17,515) |
Accounts receivable, net of allowances | $ | 113,616 |  |  | $ | 54,935

Inventories, net
Inventories consist of the following:

| January 2, 2021 |  | October 3, 2020
(In thousands) |  |  |
Finished goods | $ | 79,213 |  |  | $ | 172,184
Component parts | 8,981 |  |  | 8,646 |
Inventories | $ | 88,194 |  |  | $ | 180,830

The Company writes down inventory as a result of excess and obsolete inventories, or when it believes that the net realizable value of inventories is less than the carrying value.
Intangible assets
The following table reflects the changes in the net carrying amount of the components of intangible assets associated with the Company's acquisition activity:

| January 2, 2021
| Gross Carrying Amount |  | Accumulated Amortization |  | Net Carrying Value |  | Weighted-Average Remaining Life
(In thousands, except weighted-average remaining life) |  |  |  |  |  |  |
Technology | $ | 7,875 |  |  | $ | (2,018) |  |  | $ | 5,857 |  |  | 3.31
Other | 39 |  |  | (21) |  |  | 18 |  |  | 0.92
Total finite-lived intangible assets | 7,914 |  |  | (2,039) |  |  | 5,875 |  |  | 3.30
In-process research and development and other intangible assets not subject to amortization | 20,100 |  |  | — |  |  | 20,100 |  |  |
Total intangible assets | $ | 28,014 |  |  | $ | (2,039) |  |  | $ | 25,975 |  |  |

The following table summarizes estimated future amortization expense of the Company's intangible assets as of January 2, 2021:
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)

Fiscal years ending | Future Amortization Expense
(In thousands) |
Remainder of fiscal 2021 | $ | 1,478 |
2022 | 1,955 |
2023 | 1,253 |
2024 | 1,020 |
2025 | 169 |
2026 and thereafter | — |
Total future amortization expense | $ | 5,875 |

Accrued expenses
Accrued expenses consist of the following:

| January 2, 2021 |  | October 3, 2020
(In thousands) |  |  |
Accrued advertising and marketing | $ | 26,681 |  |  | $ | 10,609 |
Accrued taxes | 20,300 |  |  | 6,252 |
Accrued inventory | 12,130 |  |  | 2,843 |
Accrued manufacturing, logistics and product development | 17,765 |  |  | 9,753 |
Accrued general and administrative expenses | 10,935 |  |  | 10,068 |
Other accrued payables | 8,622 |  |  | 5,524 |
Total accrued expenses | $ | 96,433 |  |  | $ | 45,049 |

Deferred revenue
Amounts invoiced in advance of revenue recognition are recorded as deferred revenue on the condensed consolidated balance sheets. Deferred revenue primarily relates to revenue allocated to unspecified software upgrades and cloud-based services.
The following table presents the changes in the Company’s deferred revenue for the three months ended January 2, 2021 and December 28, 2019:

| January 2, 2021 |  | December 28, 2019
(In thousands) |  |  |
Deferred revenue, beginning of period | $ | 62,389 |  |  | $ | 56,449 |
Recognition of revenue included in beginning of period deferred revenue | (3,357) |  |  | (3,238) |
Revenue deferred, net of revenue recognized on contracts in the respective period | 9,809 |  |  | 8,435 |
Deferred revenue, end of period | $ | 68,841 |  |  | $ | 61,646 |

The Company expects the following recognition of deferred revenue as of January 2, 2021:

| For the fiscal years ending |  |
| 2021 |  | 2022 |  |  | 2023 |  | 2024 |  | 2025 and Beyond |  | Total
(In thousands) |  |  |  |  |  |  |  |  |  |  |
Deferred revenue expected to be recognized | $ | 12,488 |  |  | $ | 14,772 |  |  | $ | 12,844 |  |  | $ | 10,793 |  |  | $ | 17,944 |  |  | $ | 68,841 |

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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
Other current liabilities
Other current liabilities consist of the following:

| January 2, 2021 |  | October 3, 2020
(In thousands) |  |  |
Reserve for returns | $ | 23,723 |  |  | $ | 14,195 |
Short-term operating lease liabilities | 10,831 |  |  | 10,910 |
Product warranty liability | 6,446 |  |  | 3,628 |
Other | 7,828 |  |  | 2,417 |
Total other current liabilities | $ | 48,828 |  |  | $ | 31,150 |

The following table presents the changes in the Company’s warranty liability for the three months ended January 2, 2021 and December 28, 2019:

| January 2, 2021 |  | December 28, 2019
(In thousands) |  |  |
Warranty liability, beginning of period | $ | 3,628 |  |  | $ | 3,254 |
Provision for warranties issued during the period | 6,277 |  |  | 5,080 |
Settlements of warranty claims during the period | (3,459) |  |  | (2,633) |
Warranty liability, end of period | $ | 6,446 |  |  | $ | 5,701 |

6. Debt
The Company's debt obligations consist of the Secured Credit Facility with J.P. Morgan Chase Bank, N.A. (the “Credit Facility”) and the J.P. Morgan Chase Bank, N.A. Secured Term Loan (the "Term Loan").
The Company’s short- and long-term debt obligations as of January 2, 2021 and October 3, 2020 were as follows:

| January 2, 2021 |  | October 3, 2020
(In thousands, except percentages) |  |  |  |  |  |  |
Term loan (1) | 2.4 | % |  | $ | 25,000 |  |  | 2.4 % |  | $ | 25,000 |
Unamortized debt issuance costs (2) |  |  | (63) |  |  |  |  | (82) |
Total indebtedness |  |  | 24,937 |  |  |  |  | 24,918 |
Less short-term portion |  |  | (24,937) |  |  |  |  | (6,667) |
Long-term debt |  |  | $ | — |  |  |  |  | $ | 18,251 |

(1)Due in October 2021 and bears interest at a variable rate equal to an adjusted LIBOR plus 2.25%, payable quarterly. Subsequent to the first quarter of fiscal 2021, the Company repaid all of its outstanding principal balance. For more information, refer to Note 14. Subsequent Event.
(2)Debt issuance costs are recorded as a debt discount and recorded as interest expense over the term of the agreement.
The Credit Facility allows the Company to borrow up to $80.0 million, restricted to the value of the borrowing base, which is based on the value of inventory and accounts receivable and is subject to quarterly redetermination. The Credit Facility matures in October 2021 and may be drawn as Commercial Bank Floating Rate Loans (at the higher of prime rate or adjusted LIBOR plus 2.50%) or Eurocurrency Loans (at LIBOR plus an applicable margin). As of both January 2, 2021 and October 3, 2020, the Company did not have any outstanding borrowings and had $0.1 million and $0.5 million, respectively, in undrawn letters of credit that reduce the availability under the Credit Facility.
Debt obligations under the Credit Facility and the Term Loan require the Company to maintain a consolidated fixed charge ratio of at least 1.0, restrict distribution of dividends unless certain conditions are met, such as having
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
a fixed charge ratio of at least 1.15, and require financial statement reporting and delivery of borrowing base certificates. As of January 2, 2021 and October 3, 2020, the Company was in compliance with all financial covenants. The Credit Facility and the Term Loan are collateralized by eligible inventory and accounts receivable of the Company, as well as the Company's intellectual property including patents and trademarks.
7. Commitments and Contingencies
Legal proceedings
From time to time, the Company is involved in legal proceedings in the ordinary course of business, including claims relating to employee relations, business practices and patent infringement. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict, and the Company’s view of these matters may change in the future as the litigation and events related thereto unfold. The Company expenses legal fees as incurred. The Company records a provision for contingent losses when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. An unfavorable outcome to any legal matter, if material, could have an adverse effect on the Company’s operations or its financial position, liquidity or results of operations.
On January 7, 2020, the Company filed a complaint with the U.S. International Trade Commission ("ITC") against Alphabet Inc. ("Alphabet") and Google LLC ("Google") and a lawsuit in the U.S. District Court for the Central District of California against Google. The complaint and lawsuit each allege infringement of certain Sonos patents related to its smart speakers and related technology. On February 6, 2020, the ITC initiated a formal investigation into the Company’s claims. Google and Alphabet filed an initial answer in the ITC action on February 27, 2020 and an amended answer on April 3, 2020, denying infringement and alleging that the asserted patents are invalid. The ITC case is set for trial towards the end of February 2021, and we expect, based on the trial schedule as of the date of this filing, an initial determination from the administrative law judge in the ITC case on or about May 11, 2021. On March 4, 2020, the California District Court stayed the district court proceeding pending resolution of the ITC investigation. On March 11, 2020, Google filed an answer in the California District Court, denying infringement and alleging that the asserted patents are invalid. On September 28, 2020, Google filed for a declaratory judgement of non-infringement in the U.S. District Court for the Northern District of California related to five different Sonos patents. On September 29, 2020, the Company filed a lawsuit against Google in the U.S. District Court for Western District of Texas, alleging infringement of those five Sonos patents and seeking monetary damages and other non-monetary relief. On December 1, 2020, the Company filed a lawsuit against Google in the regional court of Hamburg, Germany, alleging infringement of a Sonos patent related to control of playback of media by mobile and playback devices and seeking non-monetary relief.
On June 11, 2020, Google filed a lawsuit in the U.S. District Court for the Northern District of California against the Company, alleging infringement of five Google patents generally related to noise cancellation, digital rights management, media search and wireless relays and seeking monetary damages and other non-monetary relief. On November 2, 2020, the California District Court granted Sonos’ motion and dismissed Google’s allegation of infringement of one of such five Google patents, a patent generally related to media search, finding that the invention at issue is patent ineligible. On June 12, 2020, Google filed lawsuits in District Court Munich I against Sonos Europe B.V. and Sonos, Inc., alleging infringement of two Google patents generally related to digital rights management and search notifications, and seeking monetary damages and an injunction preventing sales of any infringing Sonos products. On August 21, 2020, Google filed a lawsuit against Sonos, Inc. in Canada, alleging infringement of one Google patent generally related to noise cancellation technology. On August 21, 2020, Google filed a lawsuit against Sonos Europe B.V. and Sonos, Inc. in France, alleging infringement of two Google patents generally related to digital rights management and search notifications, and seeking monetary damages and an injunction preventing sales of any infringing Sonos products. In August 2020, Google filed a lawsuit against Sonos Europe B.V. and Sonos, Inc. in the Netherlands alleging infringement of a Google patent related to search notifications, and seeking monetary damages and an injunction preventing sales of any infringing Sonos products. In September 2020, Google filed a lawsuit against Sonos Europe B.V. in the Netherlands, alleging infringement of a Google patent related to digital rights management, and seeking monetary damages and enforcement of an injunction preventing sales of any infringing Sonos products. A range of loss, if any, associated with these matters is not probable or reasonably estimable as of January 2, 2021 and October 3, 2020.
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
On March 10, 2017, Implicit, LLC (“Implicit”) filed a patent infringement action in the United States District Court, District of Delaware against the Company. Implicit is asserting that the Company infringed on two patents in this case. The Company denies the allegations. There is no assurance of a favorable outcome and the Company’s business could be adversely affected as a result of a finding that the Company patents-in-suit are invalid and/or unenforceable. A range of loss, if any, associated with this matter is not probable or reasonably estimable as of January 2, 2021 and October 3, 2020.
The Company is involved in certain other litigation matters not listed above but does not consider these matters to be material either individually or in the aggregate at this time. The Company’s view of the matters not listed may change in the future as the litigation and events related thereto unfold.
On May 13, 2020, the Company was granted a temporary exclusion from the August 2019 Section 301 Tariff Action (List 4A) ("Section 301 tariffs") for its component products. On July 23, 2020, the Company was granted a temporary exclusion from Section 301 tariffs for its core speaker products. These exclusions eliminated the tariffs on the Company's component and core speaker products imported from China until August 31, 2020 and entitled the Company to a refund for the tariffs paid since September 2019, the date the Section 301 tariffs were imposed. On August 28, 2020, the United States Trade Representative granted an extension through December 31, 2020 of the exclusion for the Company’s core products, with the Section 301 tariffs for our core products automatically reinstating on January 1, 2021. The exclusion for the Company’s component products was not extended past August 31, 2020, with the Section 301 tariffs for our component products automatically reinstating on September 1, 2020. Tariff refund claims are subject to review and approval by U.S. Customs and Border Protection. As of January 2, 2021, the Company recognized $4.5 million in refunds based upon acceptance of the Company's refund request, recognized as a reduction to cost of revenue, and the outstanding refund receivable was approximately $2.7 million which is recorded in other current assets on the condensed consolidated balance sheets. As of January 2, 2021, the remaining outstanding tariff refund the Company expects to recover was approximately $29.2 million. The Company did not record these potential refunds due to uncertainty of the timing of acceptance of approval and will be recognized as a reduction to cost of revenue if and when acceptance occurs.
8. Stockholders' Equity
Share repurchase program
On November 17, 2020, the Board of Directors authorized a common stock repurchase program of up to $50.0 million. No shares of the Company's stock were repurchased under this program during the three months ended January 2, 2021.
The Company withholds shares of common stock from certain employees in connection with the vesting of restricted stock unit awards issued to such employees to satisfy applicable tax withholding requirements. Such withheld shares are treated as common stock repurchases in our consolidated financial statements as they reduce the number of shares that would have been issued upon vesting.
9. Stock-based Compensation
2018 Equity Incentive Plan
In July 2018, the Board adopted the 2018 Equity Incentive Plan (the “2018 Plan”). The 2018 Plan became effective in connection with the Company's initial public offering ("IPO"). The number of shares reserved for issuance under the 2018 Plan increase automatically on January 1 of each year beginning in 2019 and continuing through 2028 by a number of shares of common stock equal to the lesser of (x) 5% of the total outstanding shares of the Company’s common stock and common stock equivalents as of the immediately preceding December 31 (rounded to the nearest whole share) and (y) a number of shares determined by the Company's board of directors (the "Board").
Stock options
Pursuant to the 2018 Plan, the Company issues stock options to employees and directors. The fair value of the stock options is based on the Company’s closing stock price on the trading day immediately prior to the date of grant. The option price, number of shares, and grant date are determined at the discretion of the Board. For so long
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
as the option holder performs services for the Company, the options generally vest over 48 months, on a monthly or quarterly basis, with certain options subject to an initial annual cliff vest, and are exercisable for a period not to exceed ten years from the date of grant.
The summary of the Company’s stock option activity is as follows:

| Number of Options |  | Weighted-Average Exercise Price |  | Weighted Average Remaining Contractual Term |  | Aggregate Intrinsic Value
|  |  |  |  | (In years) |  | (In thousands)
Outstanding at October 3, 2020 | 28,422,940 |  |  | $ | 12.03 |  |  | 5.6 |  | $ | 99,053 |
Granted | — |  |  | — |  |  |  |  |
Exercised | (6,173,671) |  |  | 11.26 |  |  |  |  |
Forfeited | (311,443) |  |  | 14.16 |  |  |  |  |
Outstanding at January 2, 2021 | 21,937,826 |  |  | $ | 12.21 |  |  | 5.5 |  | $ | 245,191 |
At January 2, 2021 |  |  |  |  |  |  |
Options exercisable | 18,512,188 |  |  | $ | 11.78 |  |  | 5.1 |  | $ | 214,871 |
Options vested and expected to vest | 21,533,731 |  |  | $ | 12.17 |  |  | 5.5 |  | $ | 241,587 |

As of January 2, 2021 and October 3, 2020, the Company had $13.7 million and $16.9 million, respectively, of unrecognized stock-based compensation expense related to stock options, which is expected to be recognized over a weighted-average period of 1.4 and 1.5 years, respectively.
Restricted stock units ("RSU")
Pursuant to the 2018 Plan, the Company issues RSUs to employees and directors. The fair value of RSUs is based on the Company's closing stock price on the trading day immediately preceding the date of grant. RSUs typically have an initial annual cliff vest, and then vest quarterly over the service period, which is generally four years. The summary of the Company’s unvested RSU activity is as follows:

| Number of Units |  | Weighted-Average Grant Date Fair Value |  | Aggregate Intrinsic Value
|  |  |  |  | (In thousands)
Unvested at October 3, 2020 | 11,647,951 |  |  | $ | 10.50 |  |  | $ | 180,543 |
Granted | 2,501,828 |  |  |  |  |
Vested | (901,667) |  |  |  |  |
Forfeited | (251,801) |  |  |  |  |
Unvested at January 2, 2021 | 12,996,311 |  |  | $ | 11.64 |  |  | $ | 303,984 |

As of January 2, 2021 and October 3, 2020, the Company had $113.4 million and $92.4 million of unrecognized stock-based compensation expense related to RSUs, which is expected to be recognized over a weighted-average period of 3.1 and 3.0 years, respectively.
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
Performance stock units ("PSU")
Pursuant to the 2018 Plan, the Company has issued and may issue certain PSUs that vest on the satisfaction of service and performance conditions. The Company estimates the fair value of PSUs on the grant date and recognizes compensation expense in the period it becomes probable that performance conditions will be achieved. On a quarterly basis, the Company re-evaluates the assumption of the probability that performance conditions will be satisfied and revises its estimates as appropriate as new or updated information becomes available. The summary of the Company’s unvested PSU activity is as follows:

| Number of Units |  | Weighted-Average Grant Date Fair Value |  | Aggregate Intrinsic Value
|  |  |  |  | (In thousands)
Unvested at October 3, 2020 | — |  |  | $ | — |  |  | $ | — |
Granted | 158,521 |  |  |  |  |
Vested | — |  |  |  |  |
Forfeited | — |  |  |  |  |
Unvested at January 2, 2021 | 158,521 |  |  | $ | 22.81 |  |  | $ | 3,708 |

As of January 2, 2021, the Company had $4.2 million of unrecognized stock-based compensation expense related to PSUs, which is expected to be recognized over a weighted-average period of 1.9 years.
Stock-based compensation
Total stock-based compensation expense by functional category was as follows:

| Three Months Ended
| January 2, 2021 |  | December 28, 2019
(In thousands) |  |  |
Cost of revenue | $ | 214 |  |  | $ | 282 |
Research and development | 6,258 |  |  | 5,116 |
Sales and marketing | 3,408 |  |  | 3,541 |
General and administrative | 4,964 |  |  | 4,265 |
Total stock-based compensation expense | $ | 14,844 |  |  | $ | 13,204 |

10. Income Taxes
The Company’s tax provision and the resulting effective tax rate for interim periods is determined based upon its estimated annual effective tax rate, adjusted for the effect of discrete items arising in that quarter. The impact of such inclusions could result in a higher or lower effective tax rate during a quarter, based upon the mix and timing of actual earnings or losses versus annual projections. In each quarter, the Company updates its estimate of the annual effective tax rate, and if the estimated annual tax rate changes, a cumulative adjustment is made in that quarter.
The Company recorded a provision for incomes taxes of $9.1 million and $1.7 million for the three months ended January 2, 2021 and December 28, 2019, respectively, related to foreign and U.S. federal and state income taxes. For the three months ended January 2. 2021 the Company's tax provision includes a discrete benefit of $10.2 million for U.S. share based compensation. For the three months ended December 28, 2019, the Company calculated its U.S. income tax provision using the discrete method as though the interim year to date period was an annual period. The application of the estimated annual effective tax rate ("AETR") method generally required by ASC 740 was impractical for the U.S. interim tax provision for the three months ended December 28, 2019 given that normal deviations in the projected pre-tax net income (loss) in the U.S. could have resulted in a disproportionate and unreliable effective tax rate under the AETR method.
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
For the three months ended January 2, 2021, the Company maintained a full valuation allowance on its deferred tax assets in the U.S. and the Netherlands due to its history of operating losses. It is possible that within the next 12 months there may be sufficient positive evidence to release a portion or all of the valuation allowance. Release of the valuation allowance in the U.S. and the Netherlands would result in a benefit to income tax expense for the period the release is recorded, which could have a material impact on net earnings. The timing and amount of the potential valuation allowance release are subject to significant management judgment, as well as prospective earnings in the U.S. and the Netherlands.
11. Net Income Per Share Attributable to Common Stockholders
Basic net income attributable to common stockholders per share is calculated by dividing net income attributable to common stockholders by the weighted-average number of shares of common stock outstanding less shares subject to repurchase. Diluted net income per share attributable to common stockholders adjusts the basic net income per share attributable to common stockholders and the weighted-average number of shares of common stock outstanding for the potentially dilutive impact of stock awards, using the treasury stock method.
The following table sets forth the computation of the Company’s basic and diluted net income per share attributable to common stockholders:

| Three Months Ended
| January 2, 2021 |  | December 28, 2019
(In thousands, except share and per share data) |  |  |
Numerator: |  |  |
Net income attributable to common stockholders - basic and diluted | $ | 132,292 |  |  | $ | 70,775 |
Denominator: |  |  |
Weighted-average shares of common stock—basic | 115,610,523 |  |  | 108,984,683 |
Effect of potentially dilutive stock options | 8,105,916 |  |  | 6,751,412 |
Effect of RSUs | 6,927,708 |  |  | 2,679,873 |
Weighted-average shares of common stock—diluted | 130,644,147 |  |  | 118,415,968 |
Net income per share attributable to common stockholders: |  |  |
Basic | $ | 1.14 |  |  | $ | 0.65 |
Diluted | $ | 1.01 |  |  | $ | 0.60 |

The following potentially dilutive shares were excluded from the computation of diluted net income per share attributable to common stockholders because including them would have been antidilutive:

| Three Months Ended
| January 2, 2021 |  | December 28, 2019
Stock options to purchase common stock | 17,074,467 |  |  | 29,628,623 |
Restricted stock units | 5,489,890 |  |  | 4,278,556 |
Total | 22,564,357 |  |  | 33,907,179 |

12. Restructuring Plan
On June 23, 2020, the Company initiated a restructuring plan as part of its efforts to reduce operating expenses and preserve liquidity due to the uncertainty and challenges stemming from the COVID-19 pandemic (the "2020 restructuring plan"). As part of the 2020 restructuring plan, the Company eliminated approximately 12% of its global headcount and closed its New York retail store and six satellite offices in order to better align resources to provide further operating flexibility and more efficiently position the business for its long-term
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
strategy. Activities under the 2020 restructuring plan were substantially completed in the first quarter of fiscal 2021.
Total pre-tax restructuring and related costs under the 2020 restructuring plan were $26.4 million, which was incurred in fiscal 2020. For the assets deemed to be impaired as part of the 2020 restructuring, the Company estimated fair value using an income-approach based on management’s forecast of future cash flows expected to be derived from the property. In the first quarter of fiscal 2021, the Company negotiated the early termination of a facility lease that was part of the 2020 restructuring and recorded a gain of $2.8 million, representing the difference between the related operating lease liability and previously accrued restructuring expenses versus the early termination payment. The gain was recognized as a credit in sales and marketing expenses on the condensed consolidated statements of operations and comprehensive income. The cash paid related to the settlement of the lease liability as part of the early termination is included within "Cash paid for amounts included in the measurement of lease liabilities" within the supplemental disclosure on the condensed consolidated statements of cash flows. The remaining restructuring and related costs incurred in the first quarter of fiscal 2021 were nominal.

| Costs incurred in the three months ended January 2, 2021
(In thousands) |
Employee related costs | $ | 190 |
Gain on early termination of facility lease | (2,801) |
Total | $ | (2,611) |

The following table represents the restructuring and related costs recorded in the Company's condensed consolidated statements of operations and comprehensive income:

| Three Months Ended
| January 2, 2021
(In thousands) |
Research and development | $ | 25 |
Sales and marketing | (2,636) |
Total | $ | (2,611) |

The following table summarizes the Company's restructuring activities recorded in accrued expenses and accrued compensation within the condensed consolidated balance sheets:

(In thousands) | Employee Related Costs |  | Other Restructuring Costs |  | Total
Balance at October 3, 2020 | $ | 1,620 |  |  | $ | 2,971 |  |  | $ | 4,591 |
Restructuring charges | 190 |  |  | (556) |  |  | (366) |
Cash paid | (1,224) |  |  | (1,928) |  |  | (3,152) |
Balance at January 2, 2021 | $ | 586 |  |  | $ | 487 |  |  | $ | 1,073 |

These costs required the Company to make certain judgments and estimates regarding the amount and timing of the 2020 restructuring plan and related impairment charges or recoveries. The estimated liability could change subsequent to its recognition as part of the 2020 restructuring plan, requiring adjustments to the expense and liability recorded. On a quarterly basis, the Company conducts an evaluation of the related liabilities and expenses and revises its assumptions and estimates as appropriate as new or updated information becomes available.
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SONOS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
13. Retirement Plans
The Company has a defined contribution 401(k) plan (the "401(k) Plan") for the Company’s U.S.-based employees, as well as various defined contribution plans for its international employees. Eligible U.S. employees may contribute up to 100% of their annual compensation under the 401(k) plan, but are limited to the maximum annual dollar amount allowable under the Internal Revenue Code of 1986, as amended (the "Code"). The Company matches contributions towards the 401(k) Plan and international defined contribution plans. The Company's matching contributions totaled $1.7 million and $1.6 million for the three months ended January 2, 2021 and December 28, 2019, respectively.
14. Subsequent Event
Subsequent to the first quarter of fiscal 2021, in January 2021, the Company repaid all of its outstanding principal balance of $24.9 million under the Term Loan that had an original maturity date of October 2021.
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Item 2. Management's discussion and analysis of financial condition and results of operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report.
We operate on a 52- week or 53- week fiscal year ending on the Saturday nearest September 30 each year. Our fiscal year is divided into four quarters of 13 weeks, each beginning on a Sunday and containing two 4-week periods followed by a 5-week period. An additional week is included in the fourth fiscal quarter approximately every five years to realign fiscal quarters with calendar quarters.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding future operations, are forward-looking statements. In some cases, forward-looking statements may be identified by words such as “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “expect,” “objective,” “plan,” “potential,” “seek,” “grow,” “target,” “if,” and similar expressions intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations, objectives and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the section titled “Risk Factors” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings, including our Annual Report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results may differ materially and adversely from those anticipated or implied in the forward-looking statements. You should read this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect. Except as required by law, we do not undertake any obligation to publicly update any forward-looking statements, whether as a result of new information, future developments or otherwise.
Overview
Sonos is one of the world's leading sound experience brands. As the inventor of multi-room wireless audio products, Sonos' innovation helps the world listen better by giving people access to the content they love and allowing them to control it however they choose. Known for delivering an unparalleled sound experience, thoughtful design aesthetic, simplicity of use and an open platform, Sonos makes a breadth of audio content available to anyone.
Our innovative products, seamless customer experience, and expanding global footprint have driven 15 consecutive years of sustained revenue growth since our first product launch. We generate revenue from the sale of our Sonos speaker products, including wireless speakers and home theater speakers, from our Sonos system products, which largely comprise of our component products, and from partner products and other revenue, including partnerships with IKEA and Sonance, Sonos and third-party accessories, licensing, advertising, and subscription revenue.
COVID-19 Impacts
In December 2019, the novel coronavirus (COVID-19) was reported in China and subsequently was declared a global pandemic in March 2020 by the World Health Organization. The impact of the pandemic has led to significant challenges to our global economy. Starting in March 2020, we implemented global travel restrictions and work-from-home policies for employees who have the ability to work remotely and continue to operate with these
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policies through the first quarter of fiscal 2021. As of the date of this report, these policies have not materially adversely affected our operations, financial reporting or internal controls.
Customer demand. As a result of the COVID-19 pandemic, beginning in fiscal 2020 and continuing into the first quarter of fiscal 2021, we saw strong performance in our direct-to-consumer sales channel, primarily driven by strong orders through our website.
Supply chain. Beginning in the second half of fiscal 2020 and continuing into the first quarter of fiscal 2021, COVID-19 had certain impacts on our supply chain. The COVID-19 pandemic has delayed our efforts to diversify our supply chain into Malaysia until the middle of 2021. In addition, the COVID-19 pandemic has had certain impacts on production in Malaysia as a result of periodic government-mandated shutdowns, travel restrictions, and reduced workforce availability. We have also continued to see industry-wide supply chain challenges that have resulted in delayed product availability. These industry-wide challenges included delays resulting from port congestion and limits on component supplies as a result of increased demand for consumer electronics products during the COVID-19 pandemic. We continue to invest in supply chain initiatives to meet increasing customer demand despite industry-wide capacity challenges as well as ongoing COVID-19 challenges in Malaysia. For additional information, refer to Part II, Item 1A. Risk factors.
Liquidity and capital resources. In response to the impacts of COVID-19, in the second quarter of fiscal 2020 we implemented a number of initiatives to maintain our liquidity and rationalize our operating expenses. In connection with these efforts, during the third quarter of fiscal 2020 on June 23, 2020, we initiated the 2020 restructuring plan to reduce operating expenses and preserve liquidity in the face of the COVID-19 pandemic, and to more efficiently position our business for our long-term strategy. As a result of these efforts we eliminated approximately 12% of our global headcount and closed our New York retail store and six satellite offices. Activities under the 2020 restructuring plan were substantially completed in our first quarter of fiscal 2021. Beginning in the second half of fiscal 2020, we saw strong performance across a number of our products and demand exceeded our expectations resulting in constrained product availability. Accordingly, beginning in our third quarter of fiscal 2020 and through the first quarter of fiscal 2021, we began reinvesting in our inventory to meet our increasing demand. We continue to maintain our liquidity and rationalize our operating expenses through certain initiatives such as travel restrictions and work-from-home policies. To the extent that disruption to the business continues, we will evaluate additional cost management initiatives, which will be dependent on the severity and duration of the COVID-19 pandemic.
We believe our existing cash and cash equivalent balances, cash flow from operations, and committed credit lines are sufficient to meet our long-term working capital and capital expenditure needs. As of January 2, 2021, we had cash and cash equivalents of $677.8 million, and an undrawn revolving credit facility of $80.0 million.
While the situation caused by COVID-19 is unprecedented and dynamic, we have considered its impact when developing our estimates and assumptions. Actual results and outcomes may differ from our estimates and assumptions. For additional information of risks related to COVID-19, refer to Part II, Item 1A. Risk factors.
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Key Metrics
In addition to the measures presented in our condensed consolidated financial statements, we use the following key metrics to evaluate our business, measure our performance, identify trends affecting our business and assist us in making strategic decisions. Our key metrics are total revenue, products sold, adjusted EBITDA and adjusted EBITDA margin. The most directly comparable financial measure calculated under U.S. GAAP for adjusted EBITDA is net income (loss). In the three months ended January 2, 2021 and December 28, 2019, we had net income of $132.3 million and $70.8 million, respectively.

| Three Months Ended
| January 02, 2021 |  | December 28, 2019
(In thousands, except percentages) |  |  |
Total revenue | $ | 645,584 |  |  | $ | 562,083 |
Products sold | 2,649 |  |  | 2,940 |
Adjusted EBITDA(1) | $ | 166,265 |  |  | $ | 93,219 |
Adjusted EBITDA margin(1) | 25.8 | % |  | 16.6 | %

(1)For additional information regarding adjusted EBITDA and adjusted EBITDA margin (which are non-GAAP financial measures), including reconciliations of net income, to adjusted EBITDA, see the sections titled “Adjusted EBITDA and adjusted EBITDA margin” and "Non-GAAP financial measures” below.
Products Sold
Products sold represents the number of products that are sold during a period, net of returns, and includes the sale of products in the Sonos speakers and Sonos system products categories, as well as module units sold through our partnerships with IKEA and Sonance from our Partner products and other revenue category. Products sold excludes accessories, which have not materially contributed to our revenue historically. Growth rates between products sold and revenue are not perfectly correlated because our revenue is affected by other variables, such as the mix of products sold during the period, promotional discount activity and the introduction of new products that may have higher or lower than average selling prices.
Adjusted EBITDA and Adjusted EBITDA Margin
We define adjusted EBITDA as net income adjusted to exclude the impact of stock-based compensation expense, depreciation, interest, other income (expense), taxes, and other items that we do not consider representative of our underlying operating performance.
We define adjusted EBITDA margin as adjusted EBITDA divided by revenue. See “Non-GAAP financial measures” below for information regarding our use of adjusted EBITDA and adjusted EBITDA margin and a reconciliation of net income to adjusted EBITDA.
Non-GAAP Financial Measures
To supplement our condensed consolidated financial statements presented in accordance with U.S. GAAP, we monitor and consider adjusted EBITDA and adjusted EBITDA margin, which are non-GAAP financial measures. These non-GAAP financial measures are not based on any standardized methodology prescribed by U.S. GAAP and are not necessarily comparable to similarly titled measures presented by other companies.
We use these non-GAAP financial measures to evaluate our operating performance and trends and make planning decisions. We believe that these non-GAAP financial measures help identify underlying trends in our business that could otherwise be masked by the effect of the expenses and other items that we exclude in these non-GAAP financial measures. Accordingly, we believe that these non-GAAP financial measures provide useful information to investors and others in understanding and evaluating our operating results, enhance the overall understanding of our past performance and future prospects, and allow for greater transparency with respect to key financial metrics used by our management in its financial and operational decision making. Adjusted EBITDA and adjusted EBITDA margin are non-GAAP financial measures, and should not be considered in isolation of, or as alternatives to, measures prepared in accordance with U.S. GAAP. There are a number of limitations related to the use of adjusted EBITDA rather than net income, which is the nearest U.S. GAAP equivalent of adjusted EBITDA,
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and the use of adjusted EBITDA margin rather than operating margin, which is the nearest U.S. GAAP equivalent of adjusted EBITDA margin. These non-GAAP financial measures have certain limitations which:
•exclude depreciation and amortization, and although these are non-cash expenses, the assets being depreciated may be replaced in the future;
•exclude stock-based compensation expense, which has been, and will continue to be, a significant recurring expense for our business and an important part of our compensation strategy;
•do not reflect interest income, primarily resulting from interest income earned on our cash and cash equivalent balances;
•do not reflect interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces cash available to us;
•do not reflect the effect of foreign currency exchange gains or losses, which is included in other income (expense), net;
•do not reflect the provision for or benefit from income tax that may result in payments that reduce cash available to us;
•do not reflect non-recurring expenses and other items that are not considered representative of our underlying operating performance which reduce cash available to us; and
•may not be comparable to similar non-GAAP financial measures used by other companies, because the expenses and other items that we exclude in our calculation of these non-GAAP financial measures may differ from the expenses and other items, if any, that other companies may exclude from these non-GAAP financial measures when they report their operating results.
Because of these limitations, these non-GAAP financial measures should be considered along with other operating and financial performance measures presented in accordance with U.S. GAAP.
The following table presents a reconciliation of net income to adjusted EBITDA:

| Three Months Ended
| January 2, 2021 |  | December 28, 2019
(In thousands, except percentages) |  |  |
Net income | $ | 132,292 |  |  | $ | 70,775 |
Add (deduct): |  |  |
Depreciation and amortization | 7,982 |  |  | 9,105 |
Stock-based compensation expense | 14,844 |  |  | 13,204 |
Interest income | (36) |  |  | (998) |
Interest expense | 265 |  |  | 453 |
Other income, net | (4,257) |  |  | (4,424) |
Provision for income taxes | 9,120 |  |  | 1,656 |
Restructuring and related expenses (Note 12) | (2,611) |  |  | — |
Legal and transaction related costs (1) | 8,666 |  |  | 3,448 |
Adjusted EBITDA | $ | 166,265 |  |  | $ | 93,219 |
Revenue | $ | 645,584 |  |  | $ | 562,083 |
Adjusted EBITDA margin | 25.8 | % |  | 16.6 | %

(1)Legal and transaction-related costs consist of expenses related to our intellectual property ("IP") litigation against Alphabet and Google as well as legal and transaction costs associated with our acquisition activity, which we consider non-recurring expenses and do not consider representative of our underlying operating performance.
Factors Affecting Performance
New product introductions. Since 2005, we have released a number of products in multiple audio categories. We intend to introduce new products that appeal to a broad set of consumers, as well as bring our differentiated listening platform and experience to all the places and spaces where our customers listen to the breadth of audio content available, including inside and outside their homes.
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Seasonality. Historically, we have experienced the highest levels of revenue in the first fiscal quarter of the year coinciding with the holiday shopping season and our promotional activities.
Channel strategy. We are focused on reaching and converting prospective customers through third-party retail stores, e-commerce retailers, custom installers of home audio systems, and our website sonos.com. We are investing in our e-commerce capabilities and in-app experience to drive direct sales. Sales through our direct-to-consumer channel, primarily through sonos.com, increased in the three months ended January 2, 2021 compared to the three months ended December 28, 2019. We believe the growth of our own e-commerce channel will continue to be important to supporting our overall growth and profitability as consumers continue the shift from physical to online sales channels. Our physical retail distribution relies on third-party retailers. While we seek to increase sales through our direct-to-consumer sales channel, we expect that our future sales will continue to be substantially dependent on our third-party retailers. We will continue to seek retail partners that can deliver differentiated in-store experiences to support customer demand for product demonstrations.
For additional information regarding factors affecting performance, refer to Risk factors in Part II, Item 1A. of this Quarterly Report on Form 10-Q, the Risk factors in Part I, Item 1A. of our Annual Report, and to Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors Affecting Our Performance" in our Annual Report.
Components of Results of Operations
Revenue
We generate substantially all of our revenue from the sale of Sonos speakers and Sonos system products. We also generate a portion of revenue from Partner products and other revenue sources, such as module revenue from our IKEA partnership, architectural speakers from our Sonance partnership, and accessories such as speaker stands and wall mounts, as well as professional services and licensing revenue. We attribute revenue from our IKEA partnership to our APAC region, as our regional revenue is defined by the shipment location. Our revenue is recognized net of allowances for returns, discounts, sales incentives, and any taxes collected from customers. We also defer a portion of our revenue that is allocated to unspecified software upgrades and cloud-based services. Our revenue is subject to fluctuation based on the foreign currency in which our products are sold, principally for sales denominated in the euro and the British pound. The introduction of new products may result in an increase in revenue but may also impact revenue generated from existing products as consumers shift purchases to new products.
Cost of Revenue
Cost of revenue consists of product costs, including costs of our contract manufacturers for production, component product costs, shipping and handling costs, tariffs, duty costs, warranty replacement costs, packaging, fulfillment costs, manufacturing and tooling equipment depreciation, warehousing costs, hosting costs, and excess and obsolete inventory write-downs. In addition, we allocate certain costs related to management and facilities, personnel-related expenses, and other expenses associated with supply chain logistics. Personnel-related expenses consist of salaries, bonuses, benefits, and stock-based compensation expenses.
Gross Profit and Gross Margin
Our gross margin has fluctuated and may, in the future, fluctuate from period to period based on a number of factors, including the mix of products we sell, the channel mix through which we sell our products, fluctuations of the impacts of our product and material cost saving initiatives, the foreign currency in which our products are sold, and tariffs and duty costs implemented by governmental authorities.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, and general and administrative expenses.
Research and development. Research and development expenses consist primarily of personnel-related expenses, consulting and contractor expenses, tooling, test equipment, prototype materials, and related overhead costs. To date, software development costs have been expensed as incurred because the period between achieving
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technological feasibility and the release of the software has been short and development costs qualifying for capitalization have been insignificant.
Sales and marketing. Sales and marketing expenses consist primarily of advertising and marketing activity for our products and personnel-related expenses, as well as trade show and event costs, sponsorship costs, consulting and contractor expenses, travel costs, product display expenses and related depreciation, customer experience and technology support tool expenses, revenue related sales fees from our direct-to-consumer business, and overhead costs.
General and administrative. General and administrative expenses consist of personnel-related expenses for our finance, legal, human resources and administrative personnel, as well as the costs of professional services, information technology, litigation, patents, related overhead, and other administrative expenses.
Other Income (Expense), Net
Interest income. Interest income consists primarily of interest income earned on our cash and cash equivalents balances.
Interest expense. Interest expense consists primarily of interest expense associated with our debt financing arrangements and amortization of debt issuance costs.
Other income (expense), net. Other income (expense), net consists primarily of our foreign currency exchange gains and losses relating to transactions and remeasurement of asset and liability balances denominated in currencies other than the U.S. dollar. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates.
Provision for Income Taxes
We are subject to income taxes in the United States and foreign jurisdictions in which we operate. Foreign jurisdictions have statutory tax rates different from those in the United States. Accordingly, our effective tax rate will vary depending on the relative proportion of foreign to U.S. income, the utilization of foreign tax credits and changes in tax laws.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided when it is more likely than not that the deferred tax assets will not be realized. We have established a full valuation allowance to offset our U.S. and certain foreign net deferred tax assets due to the uncertainty of realizing future tax benefits from our net operating loss carryforwards and other deferred tax assets. It is possible that within the next 12 months there may be sufficient positive evidence to release a portion or all of the valuation allowance. Release of the valuation allowance in the U.S. and the Netherlands would result in a benefit to income tax expense for the period the release is recorded, which could have a material impact on net earnings. The timing and amount of the potential valuation allowance release are subject to significant management judgment, as well as prospective earnings in the U.S. and in the Netherlands.
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Results of Operations
The following table sets forth our condensed consolidated results of operations for the periods indicated. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.

| Three Months Ended
| January 02, 2021 |  | December 28, 2019
(Dollars in thousands) | $ |  | % |  | $ |  | %
Revenue | $ | 645,584 |  |  | 100.0 | % |  | $ | 562,083 |  |  | 100.0 | %
Cost of revenue (1) | 346,159 |  |  | 53.6 |  |  | 334,463 |  |  | 59.5 |
Gross profit | 299,425 |  |  | 46.4 |  |  | 227,620 |  |  | 40.5 |
Operating expenses |  |  |  |  |  |  |
Research and development (1) | 52,346 |  |  | 8.1 |  |  | 52,526 |  |  | 9.3 |
Sales and marketing(1) | 74,453 |  |  | 11.5 |  |  | 77,423 |  |  | 13.8 |
General and administrative (1) | 35,242 |  |  | 5.5 |  |  | 30,209 |  |  | 5.4 |
Total operating expenses | 162,041 |  |  | 25.1 |  |  | 160,158 |  |  | 28.5 |
Operating income | 137,384 |  |  | 21.3 |  |  | 67,462 |  |  | 12.0 |
Other income (expense), net |  |  |  |  |  |  |
Interest income | 36 |  |  | — |  |  | 998 |  |  | 0.2 |
Interest expense | (265) |  |  | — |  |  | (453) |  |  | (0.1) |
Other income, net | 4,257 |  |  | 0.7 |  |  | 4,424 |  |  | 0.8 |
Total other income (expense), net | 4,028 |  |  | 0.6 |  |  | 4,969 |  |  | 0.9 |
Income before provision for income taxes | 141,412 |  |  | 21.9 |  |  | 72,431 |  |  | 12.9 |
Provision for income taxes | 9,120 |  |  | 1.4 |  |  | 1,656 |  |  | 0.3 |
Net income | $ | 132,292 |  |  | 20.5 | % |  | $ | 70,775 |  |  | 12.6 | %
Adjusted EBITDA (2) | $ | 166,265 |  |  | 25.8 | % |  | $ | 93,219 |  |  | 16.6 | %

(1)Amounts include stock-based compensation expense as follows:

| Three Months Ended
| January 02, 2021 |  | December 28, 2019
(In thousands, except percentages) | $ |  | % |  | $ |  | %
Cost of revenue | $ | 214 |  |  | — | % |  | $ | 282 |  |  | 0.1 | %
Research and development | 6,258 |  |  | 1.0 |  |  | 5,116 |  |  | 0.9 |
Sales and marketing | 3,408 |  |  | 0.5 |  |  | 3,541 |  |  | 0.6 |
General and administrative | 4,964 |  |  | 0.8 |  |  | 4,265 |  |  | 0.8 |
Total stock-based compensation expense | $ | 14,844 |  |  | 2.3 | % |  | $ | 13,204 |  |  | 2.3 | %

(2) Adjusted EBITDA is a financial measure that is not calculated in accordance with U.S. GAAP. See the sections titled “Adjusted EBITDA and adjusted EBITDA margin” and “Non-GAAP financial measures” above.
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Comparison of the Three Months Ended January 2, 2021 and December 28, 2019
Revenue
Comparison of the three months ended January 2, 2021 and December 28, 2019

| Three Months Ended |  | Change
| January 2, 2021 |  | December 28, 2019 |  | $ |  | %
(In thousands, except percentages) |  |  |  |  |  |  |
Sonos speakers | $ | 527,516 |  |  | $ | 466,677 |  |  | $ | 60,839 |  |  | 13.0 | %
Sonos system products | 97,759 |  |  | 61,521 |  |  | 36,238 |  |  | 58.9 | %
Partner products and other revenue | 20,309 |  |  | 33,885 |  |  | (13,576) |  |  | (40.1) | %
Total revenue | $ | 645,584 |  |  | $ | 562,083 |  |  | $ | 83,501 |  |  | 14.9 | %

Total revenue increased 14.9% for the three months ended January 2, 2021 compared to the three months ended December 28, 2019. The growth was driven by strong overall demand for our higher-priced products, partially offset by the continuing impact of constrained product availability due to industry-wide supply chain challenges.
Sonos speakers revenue represented 81.7% of total revenue for the three months ended January 2, 2021. The category increased 13.0% compared to the three months ended December 28, 2019 led by the continued success of Arc and Move. Sonos system products represented 15.1% of total revenue for the three months ended January 2, 2021 and increased 58.9% compared to the three months ended December 28, 2019. The increase was driven by the continued success of Sonos AMP and Port. Partner products and other revenue represented 3.1% of total revenue for the three months ended January 2, 2021 and decreased by 40.1% compared to the three months ended December 28, 2019. This decline was driven by IKEA as the retailer slowed ordering modules given lighter foot traffic in stores and modified retail experience due to COVID-19 and as a result of cyclical product launches in this business model.
Revenue for the three months ended January 2, 2021 compared to the three months ended December 28, 2019 increased 21.1% in the Americas, increased 12.8% in EMEA, and decreased 16.9% in APAC due to the recognition of IKEA-related revenue in that region which declined compared to the three months ended December 28, 2019.
In constant currency U.S. dollars, total revenue increased by 11.6% for the three months ended January 2, 2021 compared to the three months ended December 28, 2019. We calculate constant currency growth percentages by translating our prior-period financial results using the current period average currency exchange rates and comparing these amounts to our current period reported results.

| Three Months Ended |  |
| January 2, 2021 |  | December 28, 2019 |  | Change
(products sold units in thousands) |  |  |  |  |  |  |
Total products sold | 2,649 |  |  | 2,940 |  |  | (291) |  | (9.9) | %

The volume of products sold decreased for the three months ended January 2, 2021 compared to the three months ended December 28, 2019 driven by a decrease in the partner products and other revenue category, due to the decline in sales by IKEA. The volume of products decreased while revenue increased primarily due to product mix as there was a shift to higher-priced products for the three months ended January 2, 2021 compared to the three months ended December 28, 2019.
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Cost of Revenue and Gross Profit
Comparison of the three months ended January 2, 2021 and December 28, 2019

| Three Months Ended |  | Change
| January 2, 2021 |  | December 28, 2019 |  | $ |  | %
(In thousands, except percentages) |  |  |  |  |  |  |
Cost of revenue | $ | 346,159 |  |  | $ | 334,463 |  |  | $ | 11,696 |  |  | 3.5 | %
Gross profit | $ | 299,425 |  |  | $ | 227,620 |  |  | $ | 71,805 |  |  | 31.5 | %
Gross margin | 46.4 | % |  | 40.5 | % |  |  |  |

The increase in cost of revenue for the three months ended January 2, 2021 compared to the three months ended December 28, 2019 is driven by the increase in revenue, as well as expedited air freight shipping and an overall increase in shipping costs incurred as related to industry-wide supply chain dynamics, partially offset by a reduction in tariff expenses resulting from our exemption from tariffs during the quarter, recognition of $4.5 million in refunds from tariffs paid in prior periods, as well as product and material cost savings associated with successful cost negotiations.
Gross margin increased 590 basis points for the three months ended January 2, 2021 compared to the three months ended December 28, 2019. The increase was primarily due to a reduction in tariff expenses resulting from our exemption from tariffs during the quarter and our recognition of $4.5 million in refunds from tariffs paid in prior periods. Excluding the net effects of tariffs in both periods, gross margin would have been 45.9%, an increase of 190 basis points, for the three months ended January 2, 2021 compared to the three months ended December 28, 2019. This improvement was driven by a shift into higher margin products and channels, as well as product and material cost savings associated with successful cost negotiations. The increase was partially offset by increased shipping costs incurred related to broader industry-wide supply chain dynamics. We calculate gross margin excluding the effects of tariffs by removing the net impact of tariffs imposed on goods imported from China to the U.S. from gross profit divided by total revenue.
Research and Development
Comparison of the three months ended January 2, 2021 and December 28, 2019

| Three Months Ended |  | Change
| January 2, 2021 |  | December 28, 2019 |  | $ |  | %
(In thousands, except percentages) |  |  |  |  |  |  |
Research and development | $ | 52,346 |  |  | $ | 52,526 |  |  | $ | (180) |  |  | (0.3) | %
Percentage of revenue | 8.1 | % |  | 9.3 | % |  |  |  |

Research and development expenses decreased $0.2 million, or 0.3%, for the three months ended January 2, 2021 compared to the three months ended December 28, 2019. This decrease was led by a decrease in product development expenses related to the costs of diversifying our manufacturing into Malaysia in the prior year, partially offset by higher personnel-related expenses due to higher bonus and stock-based compensation.
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Sales and Marketing
Comparison of the three months ended January 2, 2021 and December 28, 2019

| Three Months Ended |  | Change
| January 2, 2021 |  | December 28, 2019 |  | $ |  | %
(In thousands, except percentages) |  |  |  |  |  |  |
Sales and marketing | $ | 74,453 |  |  | $ | 77,423 |  |  | $ | (2,970) |  |  | (3.8) | %
Percentage of revenue | 11.5 | % |  | 13.8 | % |  |  |  |

Sales and marketing expenses decreased $3.0 million, or 3.8%, for the three months ended January 2, 2021 compared to the three months ended December 28, 2019. This decrease was primarily due to cost savings associated with the 2020 restructuring plan of $6.3 million. This decrease was partially offset by a $3.6 million increase in marketing expenses.
General and Administrative
Comparison of the three months ended January 2, 2021 and December 28, 2019

| Three Months Ended |  | Change
| January 2, 2021 |  | December 28, 2019 |  | $ |  | %
(In thousands, except percentages) |  |  |  |  |  |  |
General and administrative | $ | 35,242 |  |  | $ | 30,209 |  |  | $ | 5,033 |  |  | 16.7 | %
Percentage of revenue | 5.5 | % |  | 5.4 | % |  |  |  |

General and administrative expenses increased $5.0 million, or 16.7%, for the three months ended January 2, 2021 compared to the three months ended December 28, 2019 primarily due to an increase of $8.7 million in legal fees paid in connection with our IP litigation, partially offset by various other general and administrative costs such as savings associated with global travel restrictions and work-from-home policies due to COVID-19.
Interest Income, Interest Expense and Other Income, Net
Comparison of the three months ended January 2, 2021 and December 28, 2019

| Three Months Ended |  | Change
| January 2, 2021 |  | December 28, 2019 |  | $ |  | %
(In thousands, except percentages) |  |  |  |  |  |  |
Interest income | $ | 36 |  |  | $ | 998 |  |  | $ | (962) |  |  | (96.4) | %
Interest expense | $ | (265) |  |  | $ | (453) |  |  | $ | 188 |  |  | (41.5) | %
Other income, net | $ | 4,257 |  |  | $ | 4,424 |  |  | $ | (167) |  |  | (3.8) | %

Interest income for the three months ended January 2, 2021 compared to the three months ended December 28, 2019 decreased due to lower yields in our cash and cash equivalents. Interest expense for the three months ended January 2, 2021 compared to the three months ended December 28, 2019 decreased primarily due to a lower principal balance. The decrease in other income, net for the three months ended January 2, 2021 compared to the three months ended December 28, 2019 was due to foreign currency exchange losses.
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Provision for Income Taxes
Comparison of the three months ended January 2, 2021 and December 28, 2019

| Three Months Ended |  | Change
| January 2, 2021 |  | December 28, 2019 |  | $ |  | %
(In thousands, except percentages) |  |  |  |  |  |  |
Provision for income taxes | $ | 9,120 |  |  | $ | 1,656 |  |  | $ | 7,464 |  |  | *
* not meaningful |  |  |  |  |  |  |

The provision for income taxes increased from $1.7 million for the three months ended December 28, 2019 to $9.1 million for the three months ended January 2, 2021.
For the three months ended January 2, 2021, we recorded a provision for incomes taxes of $3.5 million for certain profitable foreign entities and $15.8 million for U.S. federal and state income for a total provision of $19.3 million before discrete items. This was offset by a discrete income tax benefit of $10.2 million resulting from U.S. share-based compensation.
For the three-months ended December 28, 2019, we recorded a provision for income taxes of $0.5 million for certain profitable foreign entities and $1.8 million for U.S. state income tax for a total provision of $2.3 million before discrete items. This was offset by a discrete income tax benefit of approximately $0.6 million as a result of a favorable release of uncertain tax positions in the U.S. coinciding with the issuance of the Base Erosion and Anti-Abuse Tax Regulations.
Liquidity and Capital Resources
Our operations are financed primarily through cash flows from operating activities, net proceeds from the sale of our equity securities and borrowings under our Term Loan and Credit Facility. As of January 2, 2021, our principal sources of liquidity consisted of cash flows from operating activities, cash and cash equivalents of $677.8 million, including $148.3 million held by our foreign subsidiaries, proceeds from the exercise of stock options and borrowing capacity under the Credit Facility. In accordance with our policy, the undistributed earnings of our non-U.S. subsidiaries remain indefinitely reinvested outside of the United States as of January 2, 2021, as they are required to fund needs outside of the United States. In the event funds from foreign operations are needed to fund operations in the United States and if U.S. tax has not already been previously provided, we may be required to accrue and pay additional U.S. taxes to repatriate these funds.
In response to the impacts of COVID-19, in the second quarter of fiscal 2020 we implemented a number of initiatives to maintain our liquidity and rationalize our operating expenses. In connection with these efforts, during the third quarter of fiscal 2020 on June 23, 2020, we initiated the 2020 restructuring plan to reduce operating expenses and preserve liquidity in the face of the COVID-19 pandemic, and to more efficiently position our business for our long-term strategy. As a result of these efforts we eliminated approximately 12% of our global headcount and closed our New York retail store and six satellite offices. Activities under the 2020 restructuring plan were substantially completed in our first quarter of fiscal 2021. Beginning in the second half of fiscal 2020, we saw strong performance across a number of our products and demand exceeded our expectations resulting in constrained product availability. Accordingly, beginning in our third quarter of fiscal 2020 and through the first quarter of fiscal 2021, we began reinvesting in our inventory to meet our increasing demand. We continue to maintain our liquidity and rationalize our operating expenses through certain initiatives such as travel restrictions and work-from-home policies. To the extent that disruption to the business continues, we will evaluate additional cost management initiatives, which will be dependent on the severity and duration of the COVID-19 pandemic.
We believe our existing cash and cash equivalent balances, cash flows from operations and committed credit lines will be sufficient to meet our long-term working capital and capital expenditure needs for at least the next 12 months. Our future capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenue growth, the timing and extent of spending on research and development efforts and other business initiatives, our planned sales and marketing activities, the timing of new product introductions, market acceptance of our products and overall economic conditions. To the extent that current and anticipated sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in increased dilution to our stockholders. The incurrence of additional debt financing would result in increased debt
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service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations.
Debt Obligations
Our debt obligations consist of the Credit Facility, the Term Loan and debt acquired in our acquisition of Snips. Our short- and long-term debt obligations as of January 2, 2021 and October 3, 2020 were as follows:

| As of
| January 2, 2021 |  | October 3, 2020
(In thousands, except percentages) |  |  |  |  |  |  |
Term Loan (1) | 2.4 | % |  | $ | 25,000 |  |  | 2.4 % |  | $ | 25,000 |
Unamortized debt issuance costs (2) |  |  | (63) |  |  |  |  | (82) |
Total indebtedness |  |  | 24,937 |  |  |  |  | 24,918 |
Less short-term portion |  |  | (24,937) |  |  |  |  | (6,667) |
Long-term debt |  |  | $ | — |  |  |  |  | $ | 18,251 |

(1)Due in October 2021, bears interest at a variable rate equal to an adjusted LIBOR plus 2.25%, payable quarterly.
(2)Debt issuance costs are recorded as a debt discount and recorded as interest expense over the term of the agreement.
The Credit Facility allows us to borrow up to $80.0 million restricted to the value of the borrowing base which is based on the value of our inventory and accounts receivable and is subject to quarterly redetermination. The Credit Facility matures in October 2021 and may be drawn as Commercial Bank Floating Rate Loans (at the higher of prime rate or adjusted LIBOR plus 2.50%) or Eurocurrency Loans (at LIBOR plus an applicable margin). As of both January 2, 2021 and October 3, 2020, we did not have any outstanding borrowings and had $0.1 million and $0.5 million, respectively, in undrawn letters of credit that reduce the availability under the Credit Facility.
Debt obligations under the Credit Facility and the Term Loan require that we maintain a consolidated fixed charge ratio of at least 1.0, restrict distribution of dividends unless certain conditions are met, such as having a fixed charge ratio of at least 1.15, and require financial statement reporting and delivery of borrowing base certificates. As of January 2, 2021 and October 3, 2020, we were in compliance with all financial covenants. The Credit Facility and the Term Loan are collateralized by eligible inventory and accounts receivable, as well as our intellectual property including patents and trademarks.
Cash Flows
The following table summarizes our cash flows for the periods indicated:

| Three Months Ended
| January 2, 2021 |  | December 28, 2019
(In thousands) |  |  |
Net cash provided by (used in): |  |  |
Operating activities | $ | 214,513 |  |  | $ | 118,840 |
Investing activities | (11,333) |  |  | (51,536) |
Financing activities | 64,387 |  |  | 1,224 |
Effect of exchange rate changes | 3,174 |  |  | 1,254 |
Net increase in cash, cash equivalents and restricted cash | $ | 270,741 |  |  | $ | 69,782 |

Cash flows from operating activities
Net cash provided by operating activities of $214.5 million for the three months ended January 2, 2021 consisted of net income of $132.3 million, non-cash adjustments of $20.2 million and a net increase in cash related to changes in operating assets and liabilities of $62.1 million. Non-cash adjustments primarily consisted of
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stock-based compensation expense of $14.8 million, depreciation and amortization of $8.0 million, partially offset by foreign currency transaction gain and other non-cash adjustments. The net increase in cash related to operating assets and liabilities was primarily due to a decrease in inventory of $93.5 million due to the continuing impact of constrained product availability due to industry-wide supply chain challenges; accounts payable and accrued expenses increased $33.3 million primarily due to an increase in accrued marketing expenses, partially offset by decrease in accounts payable due to decrease in inventory; an increase in other liabilities of $9.1 million; and an increase in deferred revenue of $5.6 million. The increase in operating assets and liabilities was partially offset by an increase in accounts receivable of $56.7 million due to seasonality; a decrease in accrued compensation of $15.5 million primarily due to the payment of bonuses in the first quarter of fiscal 2021; as well as an increase in other assets of $7.3 million.
Cash flows from investing activities
Cash used in investing activities for the three months ended January 2, 2021 of $11.3 million was due to payments for property, equipment, intangible and other assets. These payments were primarily comprised of manufacturing-related tooling and test equipment to support the launch of new products, acquired intellectual property, as well as other assets.
Cash flows from financing activities
Cash provided by financing activities for the three months ended January 2, 2021 of $64.4 million was due to proceeds from the exercise of stock options of $69.5 million, offset by payments for repurchases of common stock related to shares withheld for taxes associated with vesting of RSUs of $5.1 million.
Commitments and Contingencies
At January 2, 2021, we had $54.0 million in non-cancelable purchase commitments for inventory that we expect to purchase in the remainder of fiscal 2021.
Off-Balance Sheet Arrangements
We have not entered into any off-balance sheet arrangements, except as described above, and do not have any holdings in variable interest entities.
Critical Accounting Policies and Estimates
Our unaudited condensed consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these unaudited condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates.
Other than items discussed in Note 2 of our condensed consolidated financial statements, there have been no material changes to our critical accounting policies as compared to the critical accounting policies and significant judgments and estimates disclosed in our Annual Report.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to financial market risks, including changes in currency exchange rates and interest rates. For quantitative and qualitative disclosures about market risk, refer to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in our Annual Report. Our exposure to market risk has not changed materially, except as follows:
Foreign Currency Risk
Our inventory purchases are primarily denominated in U.S. dollars. Our international sales are primarily denominated in foreign currencies and any movement in the exchange rate between the U.S. dollar and the currencies in which we conduct sales in foreign countries could have an impact on our revenue, principally for sales denominated in the euro and the British pound. A portion of our operating expenses are incurred outside the
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United States and are denominated in foreign currencies, which are also subject to foreign currency exchange rate fluctuations. In certain countries, where we may invoice customers in the local currency, our revenues benefit from a weaker dollar and are adversely affected by a stronger dollar. The opposite impact occurs in countries where we record expenses in local currencies. In those cases, our costs and expenses benefit from a stronger dollar and are adversely affected by a weaker dollar.
We do not currently use foreign exchange contracts or derivatives to hedge any foreign currency exposures. The volatility of exchange rates depends on many factors that we cannot forecast with reliable accuracy. Our continued international expansion increases our exposure to exchange rate fluctuations and, as a result, such fluctuations could have a significant impact on our future results of operations.
For the three months ended January 2, 2021 and December 28, 2019, we recognized a gain from foreign currency of $4.3 million and $4.4 million, respectively. Based on transactions denominated in currencies other than respective functional currencies as of January 2, 2021, a hypothetical adverse change of 10% would have resulted in an adverse impact on Income before provision for income taxes of approximately $9.0 million for the three months ended January 2, 2021.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required under Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (“Exchange Act”) as of January 2, 2021. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by this Quarterly Report on Form 10-Q.
Changes in Internal Control
There were no changes in our internal control over financial reporting in management's evaluation pursuant to Rule 13a-15(f) during the quarter ended January 2, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may become involved in legal proceedings or be subject to claims arising in the ordinary course of our business. Other than the matters described in Note 7 of the notes to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, we were not a party to any legal proceedings that in the opinion of our management, if determined adversely to us, would individually or taken together have a material adverse effect on our business, operating results, financial condition or cash flows. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors.
Item 1A. Risk Factors
Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below, as well as the other information in this Quarterly Report on Form 10-Q, including our condensed consolidated financial statements and the related notes, and the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” before making an investment decision. The occurrence of any of the events or developments described below could materially and adversely affect our business, financial condition, results of operations and growth prospects. In such an event, the market price of our common stock could decline, and you may lose all or part of your investment. Additional risks and uncertainties not currently known to us or that we currently believe are not material may also impair our business, financial condition, results of operations and growth prospects.
Economic, Industry and Strategic Risk
Our business has been and is expected to continue to be materially and adversely affected by the ongoing COVID-19 pandemic.
To date, COVID-19 and related preventative and mitigation measures have negatively impacted the global economy, disrupted consumer spending and global supply chains, and created significant volatility and disruption of financial markets. Our business and operating results in fiscal 2020 and the first quarter of fiscal 2021 were affected as a result of, among other things, challenges we and our retail partners faced and continue to face in anticipating the global demand for our products given uncertainties caused by the COVID-19 pandemic, as well as the temporary closure of some of the retail stores in our end-markets. Although retail stores began to reopen in the third quarter of fiscal 2020 in some of our end-markets, many remain subject to operational restrictions which may impact customer purchasing behavior and, in the event of a COVID-19 resurgence in such end-markets, some such stores have and others may in the future close again.
The COVID-19 pandemic has also had certain impacts on our supply chain. The COVID-19 pandemic has delayed our efforts to diversify our supply chain into Malaysia until the middle of 2021. In addition, the COVID-19 pandemic has had certain impacts on production in Malaysia as a result of periodic government-mandated shutdowns, travel restrictions, and reduced workforce availability. We have also continued to see industry-wide supply chain challenges that have resulted in delayed product availability. These industry-wide challenges included delays resulting from port congestion and limits on component supplies as a result of increased demand for consumer electronics products during the COVID-19 pandemic. These impacts on our supply chain have adversely impacted, and may continue to adversely impact, our ability to meet our product demand, result in additional costs, result in customer dissatisfaction in the event of continued inventory shortages or may otherwise adversely impact our business and results of operations.
COVID-19 has negatively impacted the global economy to date and is likely to cause further global economic disruption. While the duration and severity of the economic impacts of COVID-19 are unknown, it is possible that such economic impacts may be prolonged and continue beyond the development of any vaccines or therapeutics. In particular, any recession, depression or other sustained adverse market event resulting from COVID-19 may result in high levels of unemployment and associated loss of personal income, decreased consumer confidence, and lower discretionary spending, which could materially and adversely affect our business, results of operations, financial position and cash flows.
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The extent of the impact of the COVID-19 pandemic on our business and operating results is uncertain and difficult to predict, as information is rapidly evolving with respect to the duration and severity of the pandemic and the response to contain it.
The home audio and consumer electronics industries are highly competitive.
The markets in which we operate are extremely competitive and rapidly evolving, and we expect that competition will intensify in the future. Our competition includes established, well-known sellers of speakers and sound systems such as Bang & Olufsen, Bose, Samsung (and its subsidiaries Harman International and JBL), Sony and Sound United (and its subsidiaries Denon and Polk), and developers of voice-enabled speakers and systems such as Amazon, Apple and Google. We could also face competition from new market entrants, some of whom might be current partners of ours.
In order to deliver products that appeal to changing and increasingly diverse consumer preferences and to overcome the fact that a relatively high percentage of consumers may already own or use products that they perceive to be similar to those that we offer, we must develop superior technology, anticipate increasingly diverse consumer tastes and rapidly develop attractive products with competitive selling prices. In addition, many of our current and potential partners have business objectives that may drive them to sell their speaker products at a significant discount compared to ours. Amazon and Google, for example, both currently offer their speaker products at significantly lower prices than Sonos One, Sonos Beam, Sonos Arc and Sonos Move. Many of these partners may subsidize these prices and seek to monetize their customers through the sale of additional services rather than the speakers themselves. Even if we are able to efficiently develop and offer innovative products at competitive selling prices, our operating results and financial condition may be adversely impacted if we are unable to effectively anticipate and counter the ongoing price erosion that frequently affects consumer products or if the average selling prices of our products decrease faster than we are able to reduce our manufacturing costs.
Most of our competitors have greater financial, technical and marketing resources available to them than those available to us, and, as a result, they may develop competing products that cause the demand for our products to decline. Our competitors have established, or may establish, cooperative relationships among themselves or with third parties to increase the abilities of their products to address the needs of our prospective customers, and other companies may enter our markets by entering into strategic relationships with our competitors. A failure to effectively anticipate and respond to these established and new competitors may adversely impact our business and operating results.
Further, our current and prospective competitors may consolidate with each other or acquire companies that will allow them to develop products that better compete with our products, which would intensify the competition that we face and may also disrupt or lead to termination of our distribution, technology and content partnerships. For example, if one of our competitors were to acquire one of our content partners, the consolidated company may decide to disable the streaming functionality of its service with our products.
If we are unable to compete with these consolidated companies or if consolidation in the market disrupts our partnerships or reduces the number of companies we partner with, our business would be adversely affected.
To remain competitive and stimulate consumer demand, we must successfully manage frequent new product introductions and transitions.
Due to the quickly evolving and highly competitive nature of the home audio and broader consumer electronics industry, we must frequently introduce new products, enhance existing products and effectively stimulate customer demand for new and upgraded products in both mature and developing markets. For example, in June 2020, we introduced Arc, our premium smart soundbar, Sonos Five and the next generation of our Sub. The successful introduction of these products and any new products depends on a number of factors, such as the timely completion of development efforts to correspond with limited windows for market introduction. We face significant challenges in managing the risks associated with new product introductions and production ramp-up issues, including accurately forecasting initial consumer demand, effectively managing any third-party strategic alliances or collaborative partnerships related to new product development or commercialization, as well as the risk that new products may have quality or other defects in the early stages of introduction or may not achieve the market acceptance necessary to generate sufficient revenue. New and upgraded products can also affect the sales and profitability of existing products. Accordingly, if we cannot properly manage the introduction of new products, our
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operating results and financial condition may be adversely impacted, particularly if the cadence of new product introductions increases as we expect.
We have a recent history of losses and expect to incur increased operating costs in the future, and we may not achieve or sustain profitability or consistent revenue growth.
We have experienced net losses in our recent annual periods. In the fiscal years ended October 3, 2020, September 28, 2019 and September 29, 2018, we had net losses of $20.1 million, $4.8 million and $15.6 million, respectively. We had an accumulated deficit of $228.5 million as of October 3, 2020. We expect our operating expenses to increase in the future as we expand our operations and execute on our product roadmap and strategy. We plan to make significant future expenditures related to the expansion of our business and our product offerings, including investments in:
•research and development to continue to introduce innovative new products, enhance existing products and improve our customers’ listening experience;
•sales and marketing to expand our global brand awareness, promote new products, increase our customer base and expand sales within our existing customer base; and
•legal, accounting, information technology and other administrative expenses to sustain our operations as a public company.
We need to increase our revenue to achieve and maintain profitability in the future and we cannot assure you that we will be able to increase our revenue, particularly in a global recession or depression. For example, the COVID-19 pandemic and related disruptions and uncertainties in the global economy and in consumer spending have had certain adverse impacts on our revenue in the second, third, and fourth quarters of fiscal 2020. Our ability to achieve revenue growth will depend in part on our ability to execute on our product roadmap and our strategy and to determine the market opportunity for new products. New product introductions may adversely impact our gross margin in the near to intermediate term due to the frequency of these product introductions and their anticipated increased share of our overall product volume. The expansion of our business and product offerings also places a continuous and significant strain on our management, operational and financial resources. In the event that we are unable to grow our revenue, or in the event that revenue grows more slowly than we expect, our operating results could be adversely affected and our stock price could be harmed.
Our investments in research and development may not yield the results expected.
Our business operates in intensely competitive markets characterized by changing consumer preferences and rapid technological innovation. Due to advanced technological innovation and the relative ease of technology imitation, new products tend to become standardized more rapidly, leading to more intense competition and ongoing price erosion. In order to strengthen the competitiveness of our products in this environment, we continue to invest heavily in research and development. However, these investments may not yield the innovation or the results expected on a timely basis, or our competitors may surpass us in technological innovation, hindering our ability to timely commercialize new and competitive products that meet the needs and demands of the market, which consequently may adversely impact our operating results as well as our reputation.
If we are not successful in continuing to expand our direct-to-consumer sales channel by driving consumer traffic and consumer purchases through our website, our business and results of operations could be harmed.
We have invested significant resources in our direct-to-consumer sales channel, primarily through our website, and our future growth relies, in part, on our continued ability to attract consumers to this channel, which has and will require significant expenditures in marketing, software development and infrastructure. If we are unable to continue to drive traffic to, and increase sales through, our website, our business and results of operations could be harmed, particularly during the COVID-19 pandemic during which physical retail stores may be closed or significantly modify their retail experience. The continued success of direct-to-consumer sales through our website is subject to risks associated with e-commerce, many of which are outside of our control. Our inability to adequately respond to these risks and uncertainties or to successfully maintain and expand our direct-to-consumer business via our website may have an adverse impact on our results of operations.
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If we are unable to accurately anticipate market demand for our products, we may have difficulty managing our production and inventory and our operating results could be harmed.
We must forecast production and inventory needs in advance with our suppliers and manufacturers; our ability to do so accurately could be affected by many factors, including changes in customer demand, new product introductions, sales promotions, channel inventory levels, uncertainty related to the duration and impact of COVID-19, and general economic conditions. If demand does not meet our forecast, excess product inventory could force us to write-down or write-off inventory or to sell the excess inventory at discounted prices, which could cause our gross margin to suffer and impair the strength of our brand. In addition, excess inventory may result in reduced working capital, which could adversely affect our ability to invest in other important areas of our business such as marketing and product development. If our channel partners have excess inventory of our products, they may decrease their purchases of our products in subsequent periods. If demand exceeds our forecast, as it did in the third and fourth quarters of fiscal year 2020 and the first quarter of fiscal 2021, and we do not have sufficient inventory to meet this demand, we may experience decreased revenue or customer dissatisfaction as a result of any continued inventory shortages or we may have to rapidly increase production which may result in reduced manufacturing quality and customer satisfaction as well as higher supply and manufacturing costs that would lower our gross margin. Any of these scenarios could adversely impact our operating results and financial condition.
Our efforts to expand beyond our core product offerings and offer products with applications outside the home may not succeed and could adversely impact our business.
We may seek to expand beyond our core sound systems and develop products that have wider applications outside the home, such as commercial or office. Developing these products would require us to devote substantial additional resources, and our ability to succeed in developing such products to address such markets is unproven. It is likely that we would need to hire additional personnel, partner with new third parties and incur considerable research and development expenses to pursue such an expansion successfully. We may have less familiarity with consumer preferences for these products and less product or category knowledge, and we could encounter difficulties in attracting new customers due to lower levels of consumer familiarity with our brand. As a result, we may not be successful in future efforts to achieve profitability from new markets, services or new types of products, and our ability to generate revenue from our existing products may suffer. If any such expansion does not enhance our ability to maintain or grow our revenue or recover any associated development costs, our operating results could be adversely affected.
We experience seasonal demand for our products, and if our sales in high-demand periods are below our forecasts, our overall financial condition and operating results could be adversely affected.
Given the seasonal nature of our sales, accurate forecasting is critical to our business. Our fiscal year ends on the Saturday closest to September 30, the holiday shopping season occurs in the first quarter of our fiscal year and the typically slower summer months occur in the fourth quarter of our fiscal year. Historically, our revenue has been significantly higher in our first fiscal quarter due to increased consumer spending patterns during the holiday season. Any shortfalls in expected first fiscal quarter revenue, due to macroeconomic conditions, product release patterns, a decline in the effectiveness of our promotional activities, supply chain disruptions or for any other reason, could cause our annual operating results to suffer significantly. In addition, if we fail to accurately forecast customer demand for the holiday season, we may experience excess inventory levels or a shortage of products available for sale, which could further harm our financial condition and operating results.
The success of our business depends in part on the continued growth of the voice-enabled speaker market and our ability to establish and maintain market share.
We have increasingly focused our product roadmap on voice-enabled speakers. We introduced our first voice-enabled speaker, Sonos One, in October 2017, our first voice-enabled home theater speaker, Sonos Beam, in July 2018, and our first Bluetooth-enabled portable speaker with voice control, Sonos Move, in September 2019. In June 2020, we introduced Arc, our voice-enabled premium home theater speaker. If the voice-enabled speaker markets do not continue to grow or grow in unpredictable ways, our revenue may fall short of expectations and our operating results may be harmed, particularly since we incur substantial costs to introduce new products in advance of anticipated sales. Additionally, even if the market for voice-enabled speakers does continue to grow, we may not be successful in developing and selling speakers that appeal to consumers or gain sufficient market acceptance. To succeed in this market, we will need to design, produce and sell innovative and compelling products and partner
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with other businesses that enable us to capitalize on new technologies, some of which have developed or may develop and sell voice-enabled speaker products of their own as further described herein.
If market demand for streaming music does not grow as anticipated or the availability and quality of streaming services does not continue to increase, our business could be adversely affected.
A large proportion of our customer base uses our products to listen to content via subscription-based streaming music services. Accordingly, we believe our future revenue growth will depend in significant part on the continued expansion of the market for streaming music. The success of the streaming music market depends on the quality, reliability and adoption of streaming technology and on the continued success of streaming music services such as Apple Music, Pandora, Spotify and TuneIn. If the streaming music market in general fails to expand or if the streaming services that we partner with are not successful, demand for our products may suffer and our operating results may be adversely affected.
If we are unable to protect our intellectual property, the value of our brand and other intangible assets may be diminished, and our business may be adversely affected.
We rely and expect to continue to rely on a combination of confidentiality and license agreements with our employees, consultants and third parties with whom we have relationships, as well as patent, trademark, copyright and trade secret protection laws, to protect our proprietary rights. In the United States and certain other countries, we have filed various applications for certain aspects of our intellectual property, most notably patents. However, third parties may knowingly or unknowingly infringe our proprietary rights or challenge our proprietary rights, pending and future patent and trademark applications may not be approved, and we may not be able to prevent infringement without incurring substantial expense. Such infringement could have a material adverse effect on our brand, business, financial condition and results of operations. We have initiated legal proceedings to protect our intellectual property rights, and we may file additional actions in the future. For example, on January 7, 2020, we filed a complaint with the U.S. International Trade Commission against Alphabet and Google and a lawsuit in the U.S. District Court for the Central District of California against Google, alleging patent infringement of certain Sonos patents related to our smart speakers and related technology. In addition, on September 29, 2020, we filed a lawsuit against Google in the U.S. District Court for Western District of Texas, alleging infringement of five Sonos wireless audio patents. The cost of defending our intellectual property has been and may in the future be substantial, and there is no assurance we will be successful. Our business could be adversely affected as a result of any such actions, or a finding that any patents-in-suit are invalid or unenforceable. These actions have led and may in the future lead to additional counterclaims or actions against us, which are expensive to defend against and for which there can be no assurance of a favorable outcome. Further, parties we bring legal action against could retaliate through non-litigious means, which could harm our ability to compete against such parties or to enter new markets.
In addition, the regulations of certain foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States. As our brand grows, we may discover unauthorized products in the marketplace that are counterfeit reproductions of our products. If we are unsuccessful in pursuing producers or sellers of counterfeit products, continued sales of these products could adversely impact our brand, business, financial condition and results of operations.
We currently are, and may continue to be, subject to intellectual property rights claims and other litigation which are expensive to support, and if resolved adversely, could have a significant impact on us and our stockholders.
Companies in the consumer electronics industries own large numbers of patents, copyrights, trademarks, domain names and trade secrets, and frequently enter into litigation based on allegations of infringement, misappropriation or other violations of intellectual property or other rights. As we gain an increasingly high profile and face more intense competition in our markets, and as we introduce more products and services, including through acquisitions and through partners, the possibility of intellectual property rights claims against us grows. Our technologies may not be able to withstand any third-party claims or rights against their use, and we may be subject to litigation and disputes. The costs of supporting such litigation and disputes is considerable, and there can be no assurance that a favorable outcome would be obtained. We may be required to settle such litigation and disputes, or we may be subject to an unfavorable judgment in a trial, and the terms of a settlement or judgment against us may be unfavorable and require us to cease some or all our operations, limit our ability to use certain technologies, pay substantial amounts to the other party or issue additional shares of our capital stock to the other party, which would dilute our existing stockholders. Further, if we are found to have engaged in practices that are in violation of a third
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party’s rights, we may have to negotiate a license to continue such practices, which may not be available on reasonable or favorable terms, or may have to develop alternative, non-infringing technology or discontinue the practices altogether. In the event that these practices relate to an acquisition or a partner, we may not be successful in exercising any indemnification rights available to us under our agreements or in recovering damages in the event that we are successful. Each of these efforts could require significant effort and expense and ultimately may not be successful.
If we are not able to maintain and enhance the value and reputation of our brand, or if our reputation is otherwise harmed, our business and operating results could be adversely affected.
Our continued success depends on our reputation for providing high-quality products and consumer experiences, and the “Sonos” name is critical to preserving and expanding our business. Our brand and reputation are dependent on a number of factors, including our marketing efforts, product quality, and trademark protection efforts, each of which requires significant expenditures.
The value of our brand could also be severely damaged by isolated incidents, which may be outside of our control. For example, in the United States, we rely on custom installers of home audio systems for a significant portion of our sales but maintain no control over the quality of their work and thus could suffer damage to our brand or business to the extent such installations are unsatisfactory or defective. Any damage to our brand or reputation may adversely affect our business, financial condition and operating results.
Conflicts with our channel and distribution partners could harm our business and operating results.
Several of our existing products compete, and products that we may offer in the future could compete, with the product offerings of some of our significant channel and distribution partners who have greater financial and technical resources than we do. To the extent products offered by our partners compete with our products, they may choose to market and promote their own products over ours or could end our partnerships and cease selling or promoting our products entirely. Any reduction in our ability to place and promote our products, or increased competition for available shelf or website placement, especially during peak retail periods, such as the holiday shopping season, would require us to increase our marketing expenditures and to seek other distribution channels to promote our products. If we are unable to effectively sell our products due to conflicts with our distribution partners or the inability to find alternative distribution channels, our business would be harmed.
The expansion of our direct-to-consumer channel could alienate some of our channel partners and cause a reduction in product sales from these partners. Channel partners may perceive themselves to be at a disadvantage based on the direct-to-consumer sales offered through our website. Due to these and other factors, conflicts in our sales channels could arise and cause channel partners to divert resources away from the promotion and sale of our products. Further, to the extent we use our mobile app to increase traffic to our website and increase direct-to-consumer sales, we will rely on application marketplaces such as the Apple App Store and Google Play to drive downloads of our mobile app. Apple and Google, both of which sell products that compete with ours, may choose to use their marketplaces to promote their competing products over our products or may make access to our mobile app more difficult. Any of these situations could adversely impact our business and results of operations.
Competition with our technology partners could harm our business and operating results.
We are dependent on a number of technology partners for the development of our products, some of which have developed or may develop and sell products that compete with our products. These technology partners may cease doing business with us or disable the technology they provide our products for a variety of reasons, including to promote their products over our own. For example, we are currently manufacturing and developing voice-enabled speaker systems that are enhanced with the technology of our partners, including those who sell competing products. We introduced Sonos One, Sonos Beam, Sonos Move and Sonos Arc, which feature built in voice-enabled speakers powered by Amazon’s Alexa or Google’s Google Assistant technology. One or more of our partners could disable their integration, terminate or not renew their distribution agreement with us, or begin charging us for their integration with our voice-enabled products. For example, our current agreement with Amazon allows Amazon to disable the Alexa integration in our voice-enabled products with limited notice. We cannot assure you that we will be successful in establishing partnerships with other companies that have developed voice-control enablement technology or in developing such technology on our own.
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If one or more of our technology partners do not maintain their integration with our products or seek to charge us for this integration, or if we have not developed alternative partnerships for similar technology or developed such technology on our own, our sales may decline, our reputation may be harmed and our business and operating results may suffer.
Competition with our content partners could cause these partners to cease to allow their content to be streamed on our products, which could lower product demand.
Demand for our products depends in large part on the availability of streaming third-party content that appeals to our existing and prospective customers. Compatibility with streaming music services, podcast platforms and other content provided by our content partners is a key feature of our products. To date, all our arrangements have been entered into on a royalty-free basis. Some of these content partners compete with us already, and others may in the future produce and sell speakers along with their streaming services. Additionally, other content partners may form stronger alliances with our competitors in the home audio market. Any of our content partners may cease to allow their content to be streamed on our products for a variety of reasons, including as a result of our offering competing services, to promote other partnerships or their products over our products, or to seek to charge us for this streaming. If this were to happen, demand for our products could decrease, our costs could increase and our operating results could be harmed.
Operational Risks
We are dependent on a limited number of contract manufacturers to manufacture our products and our efforts to diversify manufacturers may not be successful.
We depend on a limited number of contract manufacturers to manufacture our products, with our key manufacturer, Inventec Appliances Corporation (“Inventec”), manufacturing a majority of our products. We have also historically manufactured our products in China and in early fiscal 2020 began to diversify our supply chain through the addition of contract manufacturing in Malaysia. Our reliance on a limited number of contract manufacturers increases the risk that, in the event that any or all of such manufacturers experience an interruption in their operations, fail to perform their obligation in a timely manner or terminate agreements with us, we would not be able to maintain our production capacity without incurring material additional costs and substantial delays or we may be fully prevented from selling our products. Any material disruption in our relationship with our manufacturers would harm our ability to compete effectively and satisfy demand for our products and could adversely impact our revenue, gross margin and operating results.
In addition, there is no guarantee that our efforts to diversify manufacturers will be successful. Identifying and onboarding a new manufacturer takes a significant amount of time and resources. If we do not successfully coordinate the timely manufacturing and distribution of our products by such manufacturers, if such manufacturers are unable to successfully and timely process our orders or if we do not receive timely and accurate information from such manufacturers, we may have an insufficient supply of products to meet customer demand, we may lose sales, we may experience a build-up in inventory, we may incur additional costs, and our financial performance and reporting may be adversely affected. By adding manufacturers in other countries, we may experience increased transportation costs, fuel costs, labor unrest, impact of natural disasters and other adverse effects on our ability, timing and cost of delivering products, which may increase our inventory, decrease our margins, adversely affect our relationships with distributors and other customers and otherwise adversely affect our operating results and financial condition. In addition, any partial or full government-mandated shutdown resulting from COVID-19 has delayed and may further delay our efforts to diversify our supply chain or may cause supply chain disruptions notwithstanding any supply chain diversification efforts.
We depend on a limited number of third-party components suppliers and logistics providers.
We are dependent on a limited number of suppliers for various key components used in our products, and we may from time to time have sole source suppliers. The cost, quality and availability of these components are essential to the successful production and sale of our products. We are subject to the risk of industry-wide shortages, price fluctuations and long lead times in the supply of these components and other materials, which risk may be increased by the impact of COVID-19. If the supply of these components were to be delayed or constrained, or if one or more of our main suppliers were to go out of business, alternative sources or suppliers may not be available
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on acceptable terms or at all. In the event that any of our suppliers were to discontinue production of our key product components, developing alternate sources of supply for these components would be time consuming, difficult and costly. In the event we are unable to obtain components in sufficient quantities on a timely basis and on commercially reasonable terms, our ability to sell our products in order to meet market demand would be affected and could materially and adversely affect our brand, image, business prospects and operating results.
We also use a small number of logistics providers for substantially all our product delivery to both distributors and retailers. If one of these providers were to experience financial difficulties or disruptions in its business, or be subject to closures or other disruptions as a result of COVID-19, our own operations could be adversely affected. Because substantially all of our products are distributed from and into a small number of locations and by a small number of companies, we are susceptible to both isolated and system-wide interruptions caused by events out of our control, including COVID-19 shutdowns. Any disruption to the operations of our distribution facilities could delay product delivery, harm our reputation among our customers and adversely affect our operating results and financial condition.
During the fourth quarter of fiscal 2020 and the first quarter of fiscal 2021, we saw certain constraints on the ability of our component suppliers and logistics providers to timely meet commitments in an environment of increased demand for consumer electronics products during the COVID-19 pandemic, including limits on component supplies and port congestion, which has, and may continue to, adversely impact our ability to meet our product demand, result in additional costs, or may otherwise adversely impact our business and results of operations.
We have limited control over the third-party suppliers and logistics providers on which our business depends. If any of these parties fails to perform its obligations to us, we may be unable to deliver our products to customers in a timely manner. Further, we do not have long-term contracts with all of these parties, and there can be no assurance that we will be able to renew our contracts with them on favorable terms or at all. We may be unable to replace an existing supplier or logistics provider or supplement a provider in the event we experience significantly increased demand. Accordingly, a loss or interruption in the service of any key party could adversely impact our revenue, gross margin and operating results.
We sell our products through a limited number of key channel partners, and the loss of any such channel partner would adversely impact our business.
We are dependent on our channel partners for a vast majority of our product sales. Best Buy, one of our key channel partners, accounted for 12% of our revenue in fiscal 2020. We compete with other consumer products for placement and promotion of our products in the stores of our channel partners, including in some cases products of our channel partners. Our contracts with our channel partners allow them to exercise significant discretion in the placement and promotion of our products, and such contracts do not contain any long-term volume commitments. If one or several of our channel partners do not effectively market and sell our products, discontinue or reduce the inventory of our products, increase the promotions of or choose to promote competing products over ours, the volume of our products sold to customers could decrease, and our business and results of operations would therefore be significantly harmed. As a result of the COVID-19 pandemic, many of our key channel partners have temporarily closed or reduced operations in their retail stores during fiscal 2020 and the first quarter of fiscal 2021 and may continue to do so in the future, which has had, and may continue to have, a material effect on our business and results of operations.
Revenue from our channel partners also depends on a number of factors outside our control and may vary from period to period. One or more of our channel partners may experience serious financial difficulty, particularly in light of store closures due to the COVID-19 pandemic, may consolidate with other channel partners or may have limited or ceased operations. Our business and results of operations have been, and may continue to be, significantly harmed by retail store closures by many of our key channel partners. Loss of a key channel partner would require us to identify alternative channel partners or increase our reliance on our direct-to-consumer channel, which may be time-consuming and expensive or we may be unsuccessful in our efforts to do so.
We have and may in the future continue to discontinue support for older versions of our products, resulting in customer dissatisfaction that could negatively affect our business and operating results.
We have historically maintained, and we believe our customers may expect, extensive backward compatibility for our older products and the software that supports them, allowing older products to continue to benefit from new software updates. We expect that as we continue to improve and enhance our software platform, this backward
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compatibility will no longer be practical or cost-effective, and we may decrease or discontinue service for our older products. We previously announced that certain legacy products will continue to work but will no longer receive software updates (other than bug fixes and patches) beginning in May 2020. To the extent we no longer provide extensive backward capability for our products, we may damage our relationship with our existing customers, as well as our reputation, brand loyalty and ability to attract new customers.
For these reasons, any decision to decrease or discontinue backward capability may decrease sales, generate legal claims and adversely affect our business, operating results and financial condition.
Product quality issues and a higher-than-expected number of warranty claims or returns could harm our business and operating results.
The products that we sell could contain defects in design or manufacture. Defects could also occur in the products or components that are supplied to us. There can be no assurance we will be able to detect and remedy all defects in the hardware and software we sell, which could result in product recalls, product redesign efforts, loss of revenue, reputational damage and significant warranty and other remediation expenses. Similar to other consumer electronics, our products have a risk of overheating and fire in the course of usage or upon malfunction. Any such defect could result in harm to property or in personal injury. If we determine that a product does not meet product quality standards or may contain a defect, the launch of such product could be delayed until we remedy the quality issue or defect. The costs associated with any protracted delay necessary to remedy a quality issue or defect in a new product could be substantial.
We generally provide a one-year warranty on all our products, except in the European Union ("EU") and select other countries where we provide a two-year warranty on all our products. The occurrence of any material defects in our products could expose us to liability for warranty claims in excess of our current reserves, and we could incur significant costs to correct any defects, warranty claims or other problems. In addition, our failure to comply with past, present and future laws regulating extended warranties and accidental damage coverage could result in reduced sales of our products, reputational damage, penalties and other sanctions, which could harm our business and financial condition.
Our international operations are subject to increased business and economic risks that could impact our financial results.
We have operations outside the United States, and we expect to continue to expand our international presence, especially in Asia. In fiscal 2020, 47.4% of our revenue was generated outside the United States. This subjects us to a variety of risks inherent in doing business internationally, including:
•fluctuations in currency exchange rates and costs of imposing currency exchange controls;
•political, social and/or economic instability, including related to the ongoing COVID-19 pandemic and the United Kingdom's withdrawal from the EU, commonly known as "Brexit";
•tariffs, trade barriers and duties;
•protectionist laws and business practices that favor local businesses in some countries;
•higher levels of credit risk and payment fraud and longer payment cycles associated with, and increased difficulty of payment collections from certain international customers;
•burdens and risks of complying with a number and variety of foreign laws and regulations, including the Foreign Corrupt Practices Act;
•laws and regulations may change from time to time unexpectedly and may be unpredictably enforced;
•potential negative consequences from changes in or interpretations of U.S. and foreign tax laws;
•the cost of developing connected products for countries where Wi-Fi technology has been passed over in favor of more advanced cellular data networks;
•reduced protection for intellectual property rights in some countries;
•difficulties and associated costs in managing multiple international locations; and
•delays from customs brokers or government agencies.
If we are unable to manage the complexity of our global operations successfully, or if the risks above become substantial for us, our financial performance and operating results could suffer. Further, any measures that we may
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implement to reduce risks of our international operations may not be effective, may increase our expenses and may require significant management time and effort. Entry into new international markets requires considerable management time and financial resources related to market, personnel and facilities development before any significant revenue is generated. As a result, initial operations in a new market may operate at low margins or may be unprofitable.
We have significant operations in China, where many of the risks listed above are particularly acute. China experiences high turnover of direct labor due to the intensely competitive and fluid market for labor, and if our labor turnover rates are higher than we expect, or we otherwise fail to adequately manage our labor needs, then our business and results of operations could be adversely affected.
We will need to improve our financial and operational systems to manage our growth effectively and support our increasingly complex business arrangements, and an inability to do so could harm our business and results of operations.
To manage our growth and our increasingly complex business operations, especially as we move into new markets internationally, we will need to upgrade our operational and financial systems and procedures, which requires management time and may result in significant additional expense. In particular, beginning in fiscal 2020 and through our first quarter of fiscal 2021, we are undergoing activities to replace our legacy enterprise resource management system in order to accommodate our expanding operations. We cannot be certain that we will institute, in a timely or efficient manner or at all, the improvements to our managerial, operational and financial systems and procedures necessary to support our anticipated increased levels of operations. Delays or problems associated with any improvement or expansion of our operational and financial systems could adversely affect our relationships with our suppliers, manufacturers, resellers and customers, inhibit our ability to expand or take advantage of market opportunities, cause harm to our reputation and result in errors in our financial and other reporting, any of which could harm our business and operating results.
A significant disruption in our websites, servers or information technology systems, or those of our third-party partners, could impair our customers’ listening experience or otherwise adversely affect our customers, damage our reputation or harm our business.
As a consumer electronics company, our website and mobile app are important presentations of our business, identity and brand and an important means of interacting with, and providing information to, consumers of our products. We depend on our servers and centralized information technology systems, and those of third parties, for product functionality, to manage operations and to store critical information and intellectual property. Accordingly, we allocate significant resources to maintaining our information technology systems and deploying network security, data encryption, training and other measures to protect against unauthorized access or misuse. Nevertheless, our website and information technology systems, and those of the third parties we rely on, are susceptible to damage, viruses, disruptions or shutdowns due to foreseeable and unforeseeable events. System failures and disruptions could impede the manufacturing and shipping of products, functionality of our products, transactions processing and financial reporting, and result in the loss of intellectual property or data, require substantial repair costs and damage our reputation, competitive position, financial condition and results of operations.
For example, we use Amazon Web Services (“AWS”) to maintain the interconnectivity of our mobile app to our servers and those of the streaming services that our customers access to enjoy our products. Because AWS runs its own platform that we access, we are vulnerable to both system-wide and Sonos-specific service outages at AWS. Our access to AWS’ infrastructure could be limited by a number of potential causes, including technical failures, natural disasters, fraud or security attacks that we cannot predict or prevent.
Additionally, our products may contain flaws that make them susceptible to unauthorized access or use. For example, we previously discovered a vulnerability in our products that could be exploited when a customer visited a website with malicious content, allowing the customer’s local network to be accessed by third parties who could then gain unauthorized access to the customer’s playlists and other data and limited control of the customer’s devices. While we devote significant resources to address and eliminate flaws and other vulnerabilities in our products, there can be no assurance that our products will not be compromised in the future. Any such flaws or vulnerabilities, whether actual or merely potential, could harm our reputation, competitive position, financial condition and results of operations.
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Any cybersecurity breaches or our actual or perceived failure to comply with such legal obligations by us, or by our third-party service providers or partners, could harm our business.
We collect, store, process and use our customers’ personally identifiable information and other data, and we rely on third parties that are not directly under our control to do so as well. While we take measures intended to protect the security, integrity and confidentiality of the personal information and other sensitive information we collect, store or transmit, we cannot guarantee that inadvertent or unauthorized use or disclosure will not occur, or that third parties will not, gain unauthorized access to this information. There have been a number of recent reported incidents where third parties have used software to access the personal data of their partners’ customers for marketing and other purposes.
If we or our third-party service providers were to experience a breach, disruption or failure of systems compromising our customers’ data, or if one of our third-party service providers or partners were to access our customers’ personal data without our authorization, our brand and reputation could be adversely affected, use of our products could decrease and we could be exposed to a risk of loss, litigation and regulatory proceedings. In addition, a breach could require expending significant additional resources related to the security of information systems and disrupt our operations.
The use of data by our business and our business associates is highly regulated in all our operating countries. Privacy and information-security laws and regulations change, and compliance with them may result in cost increases due to, among other things, systems changes and the development of new processes. If we or those with whom we share information fail to comply with laws and regulations, such as the General Data Protection Regulation (GDPR) and California Consumer Privacy Act (CCPA), our reputation could be damaged, possibly resulting in lost business, and we could be subjected to additional legal risk or financial losses as a result of non-compliance. Complying with such laws may also require us to modify our data processing practices and policies and incur substantial expenditures.
Changes in how network operators manage data that travels across their networks or in net neutrality rules could harm our business.
We rely upon the ability of consumers to access our service through the internet. If network operators block, restrict or otherwise impair access to our service over their networks, our service and business could be negatively affected. To the extent that network operators implement usage-based pricing, including meaningful bandwidth caps, or otherwise try to monetize access to their networks by data providers, we could incur greater operating expenses. Furthermore, to the extent network operators create tiers of internet access service and either charge us for or prohibit us from being available through these tiers, our business could be negatively impacted.
Further, in the past, internet service providers (“ISPs”) have attempted to implement usage-based pricing, bandwidth caps and traffic shaping or throttling. To the extent network operators create tiers of internet access service and charge our customers in direct relation to their consumption of audio content, our ability to attract and retain customers could be impaired, which would harm our business. Net neutrality rules, which were designed to ensure that all online content is treated the same by ISPs and other companies that provide broadband services, were repealed by the Federal Communications Commission ("FCC") effective June 2018. Although the FCC has preempted state jurisdiction on net neutrality, some states have taken executive action directed at reinstating aspects of the FCC’s 2015 order. Further, while many countries, including across the EU, have implemented net neutrality rules, in others, the laws may be nascent or non-existent. The absence or repeal of the net neutrality rules could force us to incur greater operating expenses, cause our streaming partners to seek to shift costs to us or result in a decrease in the streaming-based usage of our platform by our customers, any of which would harm our results of operations. In addition, given uncertainty around these rules, including changing interpretations, amendments or repeal, coupled with potentially significant political and economic power of local network operators, we could experience discriminatory or anti-competitive practices that could impede our growth, cause us to incur additional expense or otherwise negatively affect our business.
Our use of open source software could negatively affect our ability to sell our products and subject us to possible litigation.
We incorporate open source software into our products, and we may continue to incorporate open source software into our products in the future. Open source software is generally licensed by its authors or other third parties under open source licenses. Some of these licenses contain requirements that we make available source code
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for modifications or derivative works we create based upon the open source software and that we license such modifications or derivative works under the terms of a particular open source license or other license granting third parties certain rights of further use. Additionally, if a third-party software provider has incorporated open source software into software that we license from such provider, we could be required to disclose any of our source code that incorporates or is a modification of our licensed software. If an author or other third party that distributes open source software that we use or license were to allege that we had not complied with the conditions of the applicable license, we could be required to incur significant legal expenses defending against those allegations and could be subject to significant damages, enjoined from offering or selling our products that contained the open source software and required to comply with the above conditions. Any of the foregoing could disrupt and harm our business and financial condition.
Legal and Regulatory Risks
Changes in international trade policies, including the imposition of tariffs. have had, and may continue to have, an adverse effect on our business, financial condition and results of operations.
The U.S. government has imposed significant new tariffs on China related to the importation of certain product categories, including under the August 2019 Section 301 Tariff Action (List 4A) ("Section 301 tariffs"), which Section 301 tariffs have increased our cost of revenue and adversely impacted our results of operations. The Section 301 tariffs were imposed on our products effective September 2019 and were imposed at a rate of 15% which was reduced to a rate of 7.5% effective February 2020 as part of a “Phase One” agreement between the U.S. and China on trade matters. On May 13, 2020, we were granted a temporary exclusion from the Section 301 tariffs for our components products and, on July 23, 2020, we were granted a temporary exclusion from the Section 301 tariffs for our core speaker products. These exclusions eliminated the Section 301 tariffs on our core speaker and component products until August 31, 2020 and entitled us to an estimated refund of approximately $30 million in Section 301 tariffs we have paid since September 2019. On August 28, 2020, the U.S. Trade Representative granted an extension through December 31, 2020 of the exclusion for our core products. The exclusion for our component products was not extended past August 31, 2020, with the Section 301 tariffs for our component products automatically reinstating on September 1, 2020. The exclusion for our core products was not extended past December 31, 2020, with the Section 301 tariffs for our core products automatically reinstating on January 1, 2021.
In the event that future tariffs are imposed on imports of our products, we do not successfully obtain the refund to which we are currently entitled, we are not successful in any future exemption extension requests, the amounts of existing tariffs are increased, we experience prolonged COVID-19 shutdowns in Malaysia, our supply chain diversification efforts are further delayed or China or other countries take retaliatory trade measures in response to existing or future tariffs, our business may be impacted and we may be required to raise prices or make changes to our operations, any of which could materially harm our revenue or operating results. In response to the Section 301 tariffs (among other factors), in early fiscal 2020 we began to diversify our supply chain through the addition of contract manufacturing in Malaysia. In response to future new tariffs, we may further shift production outside of China, resulting in significant costs and disruption to our operations as we would need to pursue the time-consuming processes of recreating new supply chains, identifying substitute components and establishing new manufacturing locations.
We must comply with extensive regulatory requirements, and the cost of such compliance, and any failure to comply, may adversely affect our business, financial condition and results of operations.
In our current business and as we expand into new markets and product categories, we must comply with a wide variety of laws, regulations, standards and other requirements governing, among other things, electrical safety, wireless emissions, health and safety, e-commerce, consumer protection, export and import requirements, hazardous materials usage, product-related energy consumption, packaging, recycling and environmental matters. Compliance with these laws, regulations, standards and other requirements may be onerous and expensive, and they may be inconsistent from jurisdiction to jurisdiction or change from time to time, further increasing the cost of compliance and doing business. Our products may require regulatory approvals or satisfaction of other regulatory concerns in the various jurisdictions in which they are manufactured, sold or both. These requirements create procurement and design challenges that require us to incur additional costs identifying suppliers and manufacturers who can obtain and produce compliant materials, parts and products. Failure to comply with such requirements can subject us to
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liability, additional costs and reputational harm and, in extreme cases, force us to recall products or prevent us from selling our products in certain jurisdictions.
We may incur costs in complying with changing tax laws in the United States and abroad, which could adversely impact our cash flow, financial condition and results of operations.
We are a U.S.-based company subject to taxes in multiple U.S. and foreign tax jurisdictions. Our profits, cash flow and effective tax rate could be adversely affected by changes in the tax rules and regulations in the jurisdictions in which we do business, unanticipated changes in statutory tax rates and changes to our global mix of earnings. As we expand our operations, any changes in the U.S. or foreign taxation of such operations may increase our worldwide effective tax rate.
We are also subject to examination by the Internal Revenue Service ("IRS") and other tax authorities, including state revenue agencies and foreign governments. If any tax authority disagrees with any position we have taken, our tax liabilities and operating results may be adversely affected. While we regularly assess the likelihood of favorable or unfavorable outcomes resulting from examinations by the IRS and other tax authorities to determine the adequacy of our provision for income taxes, there can be no assurance that the actual outcome resulting from these examinations will not materially adversely affect our financial condition and results of operations. In addition, the distribution of our products subjects us to numerous complex and often-changing customs regulations. Failure to comply with these systems and regulations could result in the assessment of additional taxes, duties, interest and penalties. There is no assurance that tax and customs authorities agree with our reporting positions and upon audit may assess us additional taxes, duties, interest and penalties. If this occurs and we cannot successfully defend our position, our profitability will be reduced.
Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.
As of October 3, 2020, we had gross U.S. federal net operating loss carryforwards of $30.8 million, which expire beginning in 2035, and gross state net operating loss carryforwards of $26.9 million, which expire beginning in 2027, as well as $52.2 million in foreign net operating loss carryforwards, of which $37.6 million have an indefinite life and $14.6 million will expire in 2027. As of October 3, 2020, we also had U.S. federal research and development tax credit carryforwards of $41.8 million, and state research and development tax credit carryforwards of $31.8 million, which will expire beginning in 2025 and 2024, respectively. Because of the change of ownership provisions of Sections 382 and 383 of the Code, use of a portion of the Company's domestic net operating losses and tax credit carryforwards may be limited in future periods depending upon future changes in ownership. Further, a portion of the carryforwards may expire before being applied to reduce future income tax liabilities if sufficient taxable income is not generated in future periods.
Risks Related to Ownership of Our Common Stock
The stock price of our common stock has been and may continue to be volatile or may decline regardless of our operating performance.
The stock price of our common stock has been and may continue to be volatile. Since shares of our common stock were sold in our IPO in August 2018 at a price of $15.00 per share, the closing price of our common stock has ranged from $6.97 to $25.26 through January 2, 2021. The stock price of our common stock may fluctuate significantly in response to numerous factors in addition to the ones described in the preceding Risk Factors, many of which are beyond our control, including:
•overall performance of the equity markets and the economy as a whole;
•changes in the financial projections we or third parties may provide to the public or our failure to meet these projections;
•actual or anticipated changes in our growth rate relative to that of our competitors;
•announcements of new products, or of acquisitions, strategic partnerships, joint ventures or capital-raising activities or commitments, by us or by our competitors;
•additions or departures of key personnel;
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•failure of securities analysts to initiate or maintain coverage of us, changes in financial estimates by any securities analysts who follow our company or our failure to meet these estimates or the expectations of investors;
•rumors and market speculation involving us or other companies in our industry;
•sales of shares of our common stock by us or our stockholders particularly sales by our directors, executive officers and significant stockholders, or the perception that these sales could occur; and
•additional stock issuances that result in significant dilution to shareholders.
In addition, the stock market with respect to newly public companies, particularly companies in the technology industry, has experienced significant price and volume fluctuations that have affected and continue to affect the stock prices of these companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from our business and adversely affect our business.
We do not intend to pay dividends for the foreseeable future.
We have never declared or paid any cash dividends on our common stock, and we do not intend to pay any cash dividends in the foreseeable future. We anticipate that we will retain all our future earnings for use in the development of our business and for general corporate purposes. Any determination to pay dividends in the future will be at the discretion of the Board. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments. In addition, the terms of our credit facilities contain restrictions on our ability to declare and pay cash dividends on our capital stock.
Certain provisions in our corporate charter documents and under Delaware law may prevent or hinder attempts by our stockholders to change our management or to acquire a controlling interest in us.
There are provisions in our restated certificate of incorporation and restated bylaws that may make it difficult for a third party to acquire, or attempt to acquire, control of our company, even if a change in control were considered favorable by our stockholders. These anti-takeover provisions include:
•a classified Board so that not all members of the Board are elected at one time;
•the ability of the Board to determine the number of directors and fill any vacancies and newly created directorships;
•a requirement that our directors may only be removed for cause;
•a prohibition on cumulative voting for directors;
•the requirement of a super-majority to amend some provisions in our restated certificate of incorporation and restated bylaws;
•authorization of the issuance of “blank check” preferred stock that the Board could use to implement a stockholder rights plan;
•an inability of our stockholders to call special meetings of stockholders; and
•a prohibition on stockholder actions by written consent, thereby requiring that all stockholder actions be taken at a meeting of our stockholders.
In addition, our restated certificate of incorporation provides that the Delaware Court of Chancery is the exclusive forum for any derivative action or proceeding brought on our behalf; any action asserting a breach of fiduciary duty; any action asserting a claim against us arising pursuant to the Delaware General Corporation Law (the “DGCL”), our restated certificate of incorporation or our restated bylaws; or any action asserting a claim against us that is governed by the internal affairs doctrine. Our restated certificate of incorporation also provides that the federal district courts of the United States will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act of 1933, as amended.
Further, Section 203 of the DGCL may discourage, delay or prevent a change in control of our company. Section 203 imposes certain restrictions on mergers, business combinations, and other transactions between us and holders of 15% or more of our common stock.
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General Risk Factors
The loss of one or more of our key personnel, or our failure to attract, assimilate and retain other highly qualified personnel in the future, could harm our business.
We depend on the continued services and performance of our key personnel. The loss of key personnel, including key members of management as well as our product development, marketing, sales and technology personnel, could disrupt our operations and have an adverse effect on our ability to grow our business. In addition, the loss of key personnel in our finance and accounting departments could harm our internal controls, financial reporting capability and capacity to forecast and plan for future growth. Further, the market for highly skilled workers and leaders in our industry is extremely competitive. If we do not succeed in attracting, hiring and integrating high-quality personnel or in retaining and motivating existing personnel, we may be unable to grow effectively, and our financial condition may be harmed.
Natural disasters, geopolitical unrest, war, terrorism, pandemics, public health issues or other catastrophic events could disrupt the supply, delivery or demand of products, which could negatively affect our operations and performance.
We are subject to the risk of disruption by earthquakes, floods and other natural disasters, fire, power shortages, geopolitical unrest, war, terrorist attacks and other hostile acts, public health issues, epidemics or pandemics, including COVID-19, and other events beyond our control and the control of the third parties on which we depend. Any of these catastrophic events, whether in the United States or abroad, may have a strong negative impact on the global economy, us, our contract manufacturers, our suppliers or customers, and could decrease demand for our products, create delays and inefficiencies in our supply chain and make it difficult or impossible for us to deliver products to our customers. Further, our headquarters are located in Santa Barbara, California, in a seismically active region that is also prone to forest fires. Any catastrophic event that occurred near our headquarters, or near our manufacturing facilities in China or Malaysia, could impose significant damage to our ability to conduct our business and could require substantial recovery time, which could have an adverse effect on our business, operating results and financial condition.
We may need additional capital, and we cannot be certain that additional financing will be available.
Our operations have been financed primarily through cash flow from operating activities, borrowings under our J.P. Morgan Chase Bank, N.A. Secured Term Loan (the "Term Loan") and the Secured Credit Facility with J.P. Morgan Chase Bank, N.A. (the "Credit Facility") and net proceeds from the sale of our equity securities. We may require additional equity or debt financing to fund our operations and capital expenditures. Our ability to obtain financing will depend, among other things, on our development efforts, business plans, operating performance and the condition of the capital markets at the time we seek financing. We cannot assure you that additional financing will be available to us on favorable terms if and when required, or at all.
We may acquire other businesses or receive offers to be acquired, which could require significant management attention, disrupt our business, dilute stockholder value and adversely affect our operating results.
As part of our business strategy, we have and may in the future make investments in complementary businesses, products, services or technologies. These acquisitions and other transactions and arrangements involve significant challenges and risks, including not advancing our business strategy, receiving an unsatisfactory return on our investment, difficulty integrating and retaining new employees, business systems, and technology, or distracting management from our other business initiatives. If an arrangement fails to adequately anticipate changing circumstances and interests of a party, it may result in early termination or renegotiation of the arrangement. The success of these transactions and arrangements will depend in part on our ability to leverage them to enhance our existing products or develop compelling new ones. It may take longer than expected to realize the full benefits from these transactions and arrangements such as increased revenue or enhanced efficiencies, or the benefits may ultimately be smaller than we expected. These events could adversely affect our consolidated financial statements.
If we fail to maintain an effective system of internal controls in the future, we may experience a loss of investor confidence and an adverse impact to our stock price.
Pursuant to the Sarbanes-Oxley Act of 2002, we are required to document and test our internal control procedures and to provide a report by management on internal control over financial reporting, including management’s assessment of the effectiveness of such control. We previously reported and remediated material
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weaknesses in internal control over financial reporting. Completion of remediation does not provide assurance that our remediation or other controls will continue to operate properly. If we are unable to maintain effective internal control over financial reporting or disclosure controls and procedures, our ability to record, process and report financial information accurately, and to prepare consolidated financial statements within required time periods could be adversely affected, which could subject us to litigation or investigations requiring management resources and payment of legal and other expenses, negatively affect investor confidence in our consolidated financial statements and adversely impact our stock price.
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Item 2. Unregistered Sales of Equity Securities and Use of proceeds
Recent Sales of Unregistered Securities
None.
Issuer Purchases of Equity Securities
On November 17, 2020, the Board of Directors authorized a common stock repurchase program of up to $50.0 million. No shares of the Company's stock were repurchased under this program during the three months ended January 2, 2021. See Note 8. Stockholders’ Equity for further information.
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Item 6. Exhibit Index

Exhibit number |  | Exhibit title |  | Incorporated by reference |  | Filed or furnished herewith
| Form | File no. | Exhibit | Filing date |
10.1 |  | Form of Performance Share Award Agreement under 2018 Equity Incentive Plan |  |  |  |  |  |  | X
31.1 |  | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and Rule 15d-14(a) of the Exchange Act |  |  |  |  |  |  | X
31.2 |  | Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and Rule 15d-14(a) of the Exchange Act |  |  |  |  |  |  | X
32.1* |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |  |  |  |  |  |  | X
32.2* |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |  |  |  |  |  |  | X
101 |  | The following financial statements from the Company's Quarterly Report on Form 10-Q for the quarter ended January 2, 2021, formatted in Inline XBRL: (i) Condensed consolidated balance sheets, (ii) Condensed consolidated statements of operations and comprehensive income, (iv) Condensed consolidated statements of stockholders' equity, (v) Condensed consolidated statements of cash flows and (vi) Notes to condensed consolidated financial statements, tagged as blocks of text and including detailed tags |  |  |  |  |  |  | X
104 |  | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |  |  |  |  |  |  | X

*The certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and are not deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, nor shall they be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.

|  | Sonos, Inc.
Date: February 10, 2021 | By: | /s/ Patrick Spence
|  | Patrick Spence
|  | Chief Executive Officer and Director
|  | (Principal Executive Officer)
Date: February 10, 2021 | By: | /s/ Brittany Bagley
|  | Brittany Bagley
|  | Chief Financial Officer
|  | (Principal Financial Officer and Principal Accounting Officer)

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