Owlet, Inc. (NYSE:OWLT) Q3 2022 Earnings Conference Call November 14, 2022 4:30 PM ET
Company Participants
Mike Cavanaugh – Investor Relations, ICR Westwicke
Kurt Workman – Co-Founder, President and Chief Executive Officer
Kate Scolnick – Chief Financial Officer
Conference Call Participants
Charles Rhyee – Cowen and Company, LLC
James Suva – Citigroup Inc.
Operator
Good afternoon. Thank you for attending the Owlet Q3 Earnings Call. All lines will be muted during the presentation portion of the call with an opportunity for questions-and-answers at the end.
I’d now like to pass the conference over to your host, Mike Cavanaugh, with Investor Relations. Thank you. Mike, you may proceed.
Mike Cavanaugh
Good afternoon, and thank you for joining us today. Earlier today, Owlet Incorporated released financial results for the quarter ended September 30, 2022. The release is currently available on the Company’s website at investors.owletcare.com. Kurt Workman, Owlet’s Co-Founder, President and Chief Executive Officer; and Kate Scolnick, Chief Financial Officer, will host this afternoon’s call.
Before we get started, I would like to remind everyone that certain matters discussed in today’s conference call and/or answers that may be given to questions asked are forward-looking statements that are subject to risks and uncertainties relating to future events and/or the future financial performance of the Company. Actual results could differ materially from those anticipated in these forward-looking statements. The risk factors that may affect results are detailed in the Company’s most recent public filings with the U.S. Securities and Exchange Commission, including its Quarterly Report filed today November 14, 2022, and other reports filed with the SEC, which can be found on its website at investors.owletcare.com or on the SEC’s website at www.sec.gov.
The information provided in this conference call speaks only as of today’s live call. Owlet disclaims any intention or obligation except as required by law to update or revise any information, financial projections or other forward-looking statements, whether because of new information, future events, or otherwise.
Please also note that Owlet will refer to certain non-GAAP financial information on today’s call. You can find reconciliations of the non-GAAP financial measures to the most comparable GAAP measures in the Company’s earnings release, which is also available on the Company’s quarterly results page of its website.
With that, I will now turn the call over to Kurt Workman. Kurt?
Kurt Workman
Thank you, Mike, and good afternoon to everyone joining us. Today, I will share our results for the third quarter of 2022 and provide additional updates on our business, specifically around our three key areas of focus: Our dream product portfolio performance in the marketplace; progress towards regulatory authorizations and operational strides towards profitability. As noted in today’s earnings release, we delivered revenue of $17.4 million for the third quarter of 2022.
Highlights in the quarter included our strongest Prime Day event ever, significant distribution expansion development with U.S. retailers for 2023 and beyond, and the measured benefit of our marketing investments as we reposition back into leadership and growth in the connected nursery ecosystem. That said, as we discussed in our second quarter call, we are recognizing the headwinds from an uncertain macroeconomic environment as retailers focused on managing their working capital by reducing weeks of supply, which impacted our Q3 sell and demand compared to prior periods.
Moving forward, one of our highest operating priorities is working towards getting back to 45% to 50% gross margin in future periods through tighter management of promotional spend and supply chain costs. Outside of these factors, we believe consumer satisfaction of our product and trust and belief in the Owlet brand is strong, as we have continued to see baseline demand for our dream product portfolio improve over the course of this year.
Notably, in the fourth quarter, we significantly reduced media acquisition spend in the U.S., while growing the units sold to the end consumer quarter-over-quarter by more than 50%, in part due to July’s Prime Day performance. In July, we launched our next-generation camera and introduced the new predictive Sleep Technology into our Sock and Cam. The new Dream Duo 2 has already been named Best Baby Monitor by BestProducts.com. With this launch, we brought the Duo in as a new offering into 600 existing target doors and added over 1,200 new Walmart doors to our retail footprint.
Our brand health remains strong. According to an independent third-party survey, we have the number one unaided brand awareness and number one in ad recall in our category in the third quarter. Additionally, 53% of our customers find out about Owlet from a friend according to our survey from owletcare.com in September. We were the number one Baby Monitor brand on Amazon in the U.S. for Q3 based on revenue. Most importantly, we believe we were able to meaningfully improve a parent’s experience and confidence in caring for their baby.
Turning to our regulatory clearance work. We believe in making the highest quality care available to every baby by democratizing access to technology and information that has previously been limited to clinical settings. We have completed significant clinical work to be in the position to file FDA submissions for our monitoring platforms, which have cleared, will unlock further long-term opportunity and growth for Owlet.
Over the past year, we have greatly increased our communication with the FDA, maintaining frequent conversations and meetings, obtaining what we believe is a clear line of site for [two device] submissions, one of which as we announced in October, we’ve already submitted. We filed a 510(k) premarket notification to the FDA for a new prescription monitoring device for infants. The device which we internally call BabySat, uses pulse oximetry technology, and is intended to be prescribed by physicians to assist in-home monitoring of babies under a physician’s care.
The device provides alerts to parents when their baby’s heart rate or oxygen saturation level or SpO2 does not fall within prescribed ranges. BabySat represents significant advantage to the large wired hospital monitoring technologies on the market today with its wireless wearable form factor and cloud connected data integration designed for home use. Additionally, in the coming weeks, we plan to file a second submission to the FDA for a software-as-a-medical device as an over-the-counter product that offers opportunistic heart rate and oxygen notifications in conjunction with the existing Dream Socks’ sleep monitoring capabilities.
After multiple meetings with FDA over the past 12 months regarding our Sock technology, we have recently aligned with FDA to submit a de novo application that will include both the display of heart rate and oxygen currently in the Dream Sock and additional opportunistic notification features as a software-as-a-medical device. FDA has signaled they do not intend additional enforcement while we work towards the submission. We view this as a positive step towards creating best-in-class digital health products. We’ve provided more information about our correspondence with the FDA in our 10-Q filed for this quarter.
We’ve completed a broad range of clinical studies to support these submissions and to further validate the accuracy and safety of our product. These studies addressed various aspects of our devices monitoring capabilities, including accuracy across many important metrics tested by reputable third-party labs and clinicians, including confirming that our socks’ monitoring pulse oximetry technology meets regulatory requirements across different skin pigmentations.
We also tested this accuracy under motion conditions, meaning the socks’ reading maintains accuracy with movement. Demonstrating the safety and efficacy of the products, clinical studies and third-party testing has confirmed study results of certain product aspects such as skin sensitivity, design controls and cybersecurity.
In summary, these studies and product testing represent years of work and investment by Owlet, demonstrating hospital grade quality devices yet the simplicity for home care. We believe the FDA authorizations would position Owlet to better help parents navigate the chasm between the hospital and the home, and increase our ability to use our large and growing data set as a critical tool for pediatric care. I look forward to sharing more updates on these submissions as we have news to share.
Finally, we remain steadfast and focused on operational strides towards profitability. In the first half of 2022, our focus was getting our dream product portfolio into the market and we spent heavily in marketing and promotions to build back and reposition effectively in the marketplace. As we shared on our last call, due to the changing macroeconomic conditions in the market, we adjusted our operating plan to drive the business to breakeven adjusted EBITDA in 2023.
We implemented significant cost reduction activities in late July to streamline our organizational structure, reducing operating expenses and managing and conserving our cash resources. While the baseline restructuring was mostly completed in Q3, during the quarter, we worked through some of the spend and other costs already committed for the back half of the year. We will continue to reduce costs through Q4 and in early 2023 to meet our operating plan goals.
In addition to further reducing our operating expenses, we are proactively working to further improve our cash balances and we are actively negotiating an amendment to our facility with SVB that would expand our access to working capital. Owlet has also been pursuing access to additional capital to add to our balance sheet.
Over the past 12 months, Owlet has shown operational resilience with the vision and commitment to be the long-term leader impacting pediatric health. As we bring 2022 to a close, we believe the volatility in our business caused by the FDA warning letter will be behind us and we can focus in 2023 with renewed opportunity for category leadership, future growth and more consistent operational performance.
We are determined to execute as best we can through this near-term macroeconomic uncertainty and remain focused on the milestones that will best position us for the strongest long-term potential for a healthy, profitable business. In a few weeks, Owlet will celebrate the 10-year anniversary mark from when my Co-Founders and I built our first prototype sock.
It’s an understatement to say we’ve come so far since then, surpassing 1.5 million babies monitored, delivering immense peace of mind to parents and helping families sleep better. It’s extremely gratifying to me that our mission continues to expand and resonate with a growing community of parents and caregivers around the world. I’m grateful for our passionate team that’s been dedicated to improving lives and helping parents navigate this incredibly important part of their journey.
Owlet is empowering parents with the information they need to better deliver care at home, and our vision is that every family has access to the tools and technology they need to keep babies safe, healthy and happy. I’m still in awe of the continuing outpouring of support and strong word-of-mouth from parents and we are thankful we can be there to walk this journey alongside these parents. Thank you for your continued support of Owlet.
Kate, over to you.
Kate Scolnick
Thank you, and good afternoon, everyone. Turning to our Q3 results. Gross billings for the quarter were $23.4 million up from $22.7 million in Q2 sequentially. As we noted last quarter, we are experiencing selling macroeconomic headwinds with our retailers and their inventory management. However, we believe that recovering sell-through trends and brand awareness for our dream platform are all positive indications of the underlying strengths of the value proposition of our products with consumers.
Q3 product promotions and discounts were $3.2 million, primarily associated with seasonal and promotional activity across retailers that are taking place in Q4 and pricing changes at retailers related to our camera product transition. This compares to product promotions and discounts of $2.5 million sequentially in Q2.
Returns and allowance reserves for Q3 in 2022 were $2.7 million, 11.5% of gross billings. This compares to reserves sequentially in Q2 of $1.8 million. To provide some context for the increase in Q3 returns and allowances, we experienced some lumpiness in the returns and chargebacks claimed by our large retailers that exceeded our estimates this quarter. We are engaging with them to make sure root causes are understood and where necessary addressed.
While we believe the majority of the return to vendor program with retailers is behind us, we experienced some overhanging activity this quarter that we did not anticipate. Q3 revenues were $17.4 million, including the impact of adjustments such as promotions, discounts, returns and other allowances.
Cost of goods sold in Q3 was $12.7 million and gross profit was $4.6 million. Q3 gross margin was 26.6% compared to 36.1% gross margin sequentially. Cost and other items impacting our gross margin unfavorably in Q3 compared to Q2, primarily from the sequential increase in returns and allowances at an out-of-period inventory adjustment. In addition, the mix of products sold in Q3 shifted over 35% towards more camera units as we transition to our new products.
Year-to-date 2022, our gross margin was approximately 35%. The largest non-recurring cost impacts we’ve experienced year-to-date are the return to vendor program, elevated promotional discounts and product costs related to our FDA warning letter and launching our dream product.
As Kurt stated, one of our highest priorities in 2023 is gross margin improvement, and we are actively working to put the volatility of the FDA warning letter impact behind us. In addition to the non-recurring aspect of the cost of this past year, we are highly focused on the operational efficiency levers within our control to improve margins for next year with the goal of returning to 45% to 50% gross margins. Q3 operating expenses were $26.4 million compared to $28.6 million for the same period in 2021.
Within our Q3 expenses, we had a few discrete expenses worth noting. Q3 operating expenses included $1.2 million in severance charges, $850,000 in spend for regulatory submissions, and approximately $1 million in additional [indiscernible] marketing expenses, which we don’t expect to see in the fourth quarter. As part of our restructuring program in July, we reduced run rate operating expenses across the company from Q2 to Q3 and have specific projects tapering off by the end of the year.
We remain focused on driving our Q4 run rate operating expenses lower sequentially and are planning to exit Q4 at an expense run rate between $15 million to $19 million per quarter, excluding incentive expense and stock-based compensation. Operating loss and net loss for Q3 2022 were $21.8 million and $19.4 million respectively as compared with $13.8 million operating loss and $34.5 million net loss for the same period in 2021. Q3 adjusted EBITDA loss was $18.4 million compared to adjusted EBITDA loss of $11.4 million for the same period in 2021.
Turning to the balance sheet, cash and cash equivalents as of September 30 were approximately $23.2 million, accounts receivable were $20.5 million down $3.5 million sequentially from $24 million in Q2. Inventory at the end of Q3 was $23.8 million, down $5.6 million sequentially from $29.4 million in Q2.
Looking ahead, over the course of this year, we have actively worked to best position our dream portfolio for success in the connected nursery category. We had significant success with Prime Day in July. We positioned ourselves for category success with all of our key retail partners for the holiday season. For the areas that are within our control, we are focused on driving the activities that maximize achieving sell-through of our core products, and therefore driving balance and retail inventory, making strides in our medical device submissions and efficiently managing our operational plans towards breakeven and profitability.
As we are operating in a challenging macroeconomic environment that has demonstrated higher volatility and unexpected disruptions, we are cautious this may impact consumer demand and increase inflationary costs. We navigated through very difficult circumstances over the last 12 months and we will continue to find the best ways to adapt to the undulate macroeconomic environment.
For the full-year of 2022, we are forecasting revenue between $69 million and $74 million in revenue and gross margin between 32% and 37%. As I mentioned earlier, we are targeting our run rate operating expenses exiting the fourth quarter of this year in a range of $15 million to $19 million, excluding incentive expense and stock-based compensation. Beyond 2022, we are focused on improving the consistency of our operating results and executing against the priorities that will deliver the long-term benefits for our business.
For 2023, our goals are to execute a best-in-class product portfolio with a broad U.S. retail footprint and growing international presence. Our revenue target growth rate for 2023 is 13% to 16%, assuming relatively stable macroeconomic conditions and retailer balance sheets. We estimate our market penetration in 2022 at 0.09% and we are targeting 0.13% in 2023, improving gross margin to a range of 45% to 50%. In 2022, we estimate that non-recurring costs from the FDA warning letter activity should impact in our margins by at least 800 basis points to 900 basis points. In addition, we are focused on driving operational efficiencies that we believe will have margin benefit.
Reducing our operating expenses with the objective of turning the business towards adjusted EBITDA margin breakeven in 2023 and executing against our plan for regulatory authorizations, we don’t know the timing of when our regulatory submissions maybe approved. Therefore, to be conservative, our current 2023 revenue and margin growth targets do not include benefit from achieving any authorizations.
Thank you for your time today. Operator, let’s open it up for questions.
Question-and-Answer Session
Operator
We’ll now begin the Q&A session. [Operator Instructions] The first question is from the line of Charles Rhyee with Cowen. You may proceed.
Charles Rhyee
Hey, guys. Thanks for taking the questions. I guess, maybe to start. Kate, you mentioned that there was an out-of-period inventory adjustment also in the quarter. How much was that?
Kate Scolnick
Yes. The out-of-period inventory adjustment was about the third of the margin impact that we had in the quarter.
Charles Rhyee
Okay. And then you talked about the $2.7 million returns and that’s a little bit more than you expected. How much is left in terms of what’s out there that could be returned at this point?
Kate Scolnick
Yes. To further characterize that, so some of that – a small portion of that was product return and some of that – that was related to Smart Sock, some of it is – some administrative items that we’re working through. We believe that based on the conversations that we have with retailers that they have returned what they expect to return. However, these are large retailers. They do have large locations, and so it is within their purview to return anything that they do have within their warehouses. So based on the tremendous slowdown that has really moved to a trickle, we do not anticipate that we will see much more from them, but we’re continuing that dialogue to make sure that’s the case.
Charles Rhyee
Okay. And then I missed it. You talked about some of these one-time items, $1.2 million severance and $850,000 for regulatory submission. What was the third item?
Kate Scolnick
Yes. And we had $1 million in marketing and additional marketing – partner marketing expenses in the quarter that we don’t expect to see in the fourth quarter.
Charles Rhyee
Okay. So when you talk about the big drivers to gross margin, you’re saying like a third is sort of this out-of-period inventory adjustment. A third – another portion is from the mix because we ended up having more camera revenue, which is lower margin than a Sock. Is that the right way to think about it?
Kate Scolnick
That’s right, yes.
Charles Rhyee
And then some of these…
Kate Scolnick
Increase in returns.
Charles Rhyee
Increase in returns?
Kate Scolnick
Yes.
Charles Rhyee
Okay. Is that roughly about a…
Kate Scolnick
Yes. So the margin was really – yes, so about a third, a third, a third on the margin.
Charles Rhyee
Okay. If we were to add that back, what would you estimate gross margin would’ve been roughly ignoring the Sock piece, I guess.
Kate Scolnick
Some other small – yes, outside of a couple of other small items, I would say sequentially relatively flat.
Charles Rhyee
Okay. And then – and I guess, obviously in this macro environment you’re having retailers kind of tighten their days and inventory. So how much would you say the revenue impact is tied just to that versus any maybe perhaps change in actual demand for the product?
Kurt Workman
So Charles, I’ll jump in on that one. I think when we compare Q3 of this year to prior years, it’s higher than 2020 and I would say just shy of 2021. So the underlying demand was pretty strong and we saw one of our best Prime Days ever. So I think that’s a big part of it. The fact that a lot of the first half revenue was load-in revenue to those retailers after having removed product from the shelf. This was really our first kind of full quarterback to market and we felt really good about the demand this quarter. And so I think as we move forward and we rebalanced those inventory levels, we’ll see that revenue will sort of follow sell-through trends, whereas I think that was a big – one of the big headwinds this quarter.
Charles Rhyee
But the revenue guidance for the full-year $69 million to $74 million, I think the midpoint would imply, I’m just going to do the rough math here that fourth quarter could be down sequentially. Can you talk through that a little bit?
Kate Scolnick
Yes. That’s correct. I think – yes, what I would say is that, we’re just on the precipice here of the holiday season. We best position ourselves with all of the retailers and with especially Amazon here to get through the next few weeks. So a lot depends on how things go, right, over the next several weeks. So we’re just sitting here with a lot of information that’ll be on the other side of that, and we’re just trying to best position ourselves in Q4 that we’ll see what we sold in and what we may see sell-through in Q4 to be in a balance. If we could put that better than that, terrific, if we’re within that range, that would be an outcome that would be fair just given this macroeconomic environment and what we’re hearing in terms of inventory management from retailers across the board from the different types of companies that sell in there.
Charles Rhyee
Got it. And last question for me is on the FDA submission for BabySat and then also for OTC. Currently, obviously we’re seeing a big spike in RSV, and curious whether with BabySat that is something you can market for detection of given, right, obviously it has kind of flu like symptoms. Is that something that you can talk about under Dream Sock? I’m guessing no, but once – with BabySat and maybe OTC, is that something you can talk about more openly perhaps?
Kurt Workman
That’s a good question. And what I would say is that, yes, I mean the RSV pandemic right now is really – it’s really unfortunate, it’s affecting a lot of hospitals and a lot of families. It’s a big deal. We don’t have any indications specifically for RSV, like the treatment or diagnosis or prediction of RSV, but we do measure baby’s oxygen saturation. That’s a pretty critical metric for home monitoring for babies who are – for BabySat for babies who are sick or high risk, and for the Dream Sock just for parents to know have additional information and kind of opportunistically know if that goes lower. And so the products will be really helpful with any situation where oxygen plays a role, which that can sometimes be the case in RSV.
Charles Rhyee
Okay. And then lastly, you talked about submitting for OTC in the next few weeks. I missed that earlier part. You said, you are sort of straight with the FDA in terms of necessary information. Any other discussions needed before submitting?
Kurt Workman
So we’ve done a pre-sub starting in Q4 of last year. We’ve had pre-sub meetings every quarter. And we’ll probably have a few more informal check-ins just on like those little piece of this submission. But at a high level, we feel very aligned with what’s needed for that submission.
Charles Rhyee
Okay. Great. Appreciate all the comments. Thanks.
Kurt Workman
Yes. Thanks, Charles.
Operator
Thank you. [Operator Instructions] The next question is from the line of Jim Suva with Citigroup. You may proceed.
James Suva
Thank you. In your prepared comments, I believe one of you made a comment about a little bit more returns that you weren’t expected, and then you mentioned that you kind of sorted it all out. Just curious was there a general theme to the reason or rationale behind those returns or something that we can kind of grasp a little bit? Thank you.
Kate Scolnick
Hi, Jim. Sure. So we’re in the process of working through some of the information that we got back on the returns and allowances for the quarter. We take that information and a lot of that happens actually after we close our quarter. So some of that information came in October and we’re working through that. And so we take a return in allowance for that and then getting the information afterwards.
What I would say at a high level is that given the – going back to the return to vendor program that we conducted over the last several quarters, there is a lot of inventory that came back from the retailers and there was a lot of activity that we had to work through and a lot of information that came back from them through their portals. So it was not a perfect science in terms of the information and the pace of information from them. So some of that came back in what I would say, a batch and we need to work through that with them. And it just – some of it, it just exceeded our estimation of what we were going to get this quarter.
James Suva
Okay. And Kate, if I hear you correctly, are you saying that it wasn’t like a bad battery or bad velcro or bad misaligned screen or something, it’s more excess inventory they wanted to remove off, or are you saying more that you still have to work through all the information?
Kate Scolnick
Yes. It was not physical to the product, no. So in some cases there was some additional product that was included, in some cases there is some charges that are related to how product is received or something regarding the status of the product when it is received in a warehouse of those kind of administrative allowances. So it had nothing to do with the physical nature of the product.
James Suva
Great. Thank you. And then if I heard your outlook correctly, and maybe you can correct me if I’m wrong. Revenues for next year, [are you still] 13% to 16% off the base of what you just gave for guidance now of $69 million to $74 million in gross margins, 45% to 50%. Is that the guidance?
Kate Scolnick
Yes, it is for 2023, yes. Assuming stable macroeconomic conditions and relative to retailer health, yes.
James Suva
Okay. And then no FDA approvals coming through that would be additive if that occurred. You’re not baking in a percentage of hopeful probability?
Kate Scolnick
Correct. We were not predicting timing on that. So we have no assumptions in the margin or revenue for FDA submission clearance.
James Suva
Okay. Got you. That’s good to have that cleared out there that way nobody misunderstands in case they have an assumption. Thank you so much for your details and clarifications.
Kate Scolnick
Thanks.
Operator
Thank you. [Operator Instructions] There are no additional questions waiting at this time. With that, we will conclude today’s Owlet Q3 earnings call. Thank you for joining today. Please enjoy the rest of your night.
Be the first to comment