Owlet, Inc. (NYSE:OWLT) Q4 2022 Earnings Call Transcript

Owlet, Inc. (NYSE:OWLT) Q4 2022 Earnings Call Transcript March 15, 2023

Operator: Good afternoon. Thank you for attending the Owlet Earnings Conference Call. My name is Matt, and I will be your moderator for today’s call. I would now like to pass the conference over to our host, Mike Cavanaugh, Investor Relations. Mike, please go ahead.

Mike Cavanaugh: Thanks, Matt. Good afternoon, and thank you all for joining us today. Earlier today, Owlet, Inc. released financial results for the quarter ended December 31, 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 related 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 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’s 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. I will now turn the call over to Kurt Workman.

Kurt Workman: Thanks, Mike. Good afternoon to everyone joining us today. During our call today, you’re going to hear a lot of conviction about Owlet’s fundamentals and our vision for the future. I recognize that our confidence in our business conflicts with our reported financial results in 2022 due to the efforts required to rebuild our business. I’d like to take a minute upfront to address this. Throughout 2022, we made tremendous progress positioning Owlet for sustainable, profitable growth in 2023 and years into the future. We rebuilt our brand health, rebased our operating expenses, focused on rebuilding channel health and made milestone progress towards regulatory approval for both our medical device and de novo product applications.

A few weeks ago, with Owlet’s underlying business properly positioned, we raised $30 million of additional capital from both insiders and new investors, ensuring that we have the balance sheet to execute in 2023 from a position of strength. The investors who provided us with this new capital base their confidence on the fundamental improvements and strategy I’m going to discuss with you today. Our plan for 2023 is clear, positioning Owlet on the pathway to cash flow positive, profitable and long-term sustainable growth through category-defining products. There are a few underlying trends in our business that give me confidence that Owlet is on track to deliver this. Our brand health has returned to all-time highs, levels not seen since 2021.

NPS is at all-time highs and marketing spend at CPA has declined 80% since the start of 2022. Our channel sell-through growth quarter-over-quarter reaching nearly $20 million in gross revenue of sell-through in Q4. Inventory and channel is normalizing, and we expect sell-through to match sell-in by the end of Q2 with improvement in Q1. Our expenses are rightsized and this will demonstrate our rebased operating expenses in Q1 and Q2 with the plan to spend no more than $40 million in 2023 adjusted operating expenses, excluding stock-based compensation. We are aggressively focused on achieving profitability and improving working capital. We’re targeting to be EBITDA breakeven in the back half of the year and to see working capital continue to improve each quarter.

Owlet weathered a lot of change in 2022. Today, Owlet is now in a position to focus on execution, and we understand the best way to build trust with the market is to deliver results each quarter. As we progress through the year, we expect to deliver results that demonstrate that what we see internally, an organization that is on track to be profitable and growing with numerous avenues for future growth, including organic marketplace opportunities, regulatory clearances and new products for our connected nursery portfolio. Turning to our 2022 business results. After re-launching our flagship stock monitoring product in the U.S. in January and transitioning from our CAM 1 to CAM 2 in July, we achieved full year product portfolio revenues of $69.2 million within our targeted range, while retaining strong satisfaction, it’s notable that since January 2022, we’ve reduced the cost of our media acquisition spend, CPA by 80%.

Owlet is now the number one selling monitor on Amazon year-to-date in 2023. After effectively marketing and advertising our Dream portfolio re-launched in early 2022, we believe consumer satisfaction of our products and trust and belief in the Owlet brand is strong. The NPS of our product continues to improve throughout the course of the year with successful introduction of Dream Sock and our CAM 2 product transition. NPS across our portfolio is now at or above 2021 levels. Our Q4 reported revenue does not represent the current sell-through of our business. That is because the first half of 2022, sell-in was materially greater than sell-through as we re-entered the market and initially stocked all retail and distribution channels with our Dream products.

As we rebuild brand health through 2022, sell-through continued to improve, growing nearly 47% from the first half to the second half of 2022 and giving us confidence that our brand and products resonate with consumers. However, inventory and channel is substantially greater than our targeted 10 to 14 weeks, which resulted in materially less sell-in in Q4. As a result, our reported revenue does not represent the current sell-through across our channels. We expect a similar effect in Q1 2023 as inventory and channel normalizes. Looking to Q2, we expect sell-in to begin to align with sell-through. In partnership with our retailers, we are highly focused on sell-through and recognize managing inventory in the channel is essential to maintaining strong brand health, better margins and delivering consistent results.

2022 gross margins were 34% and within our targeted range for the year. There were multiple factors that adversely affected gross margins in 2022, which we believe will not be present in 2023. Headwinds for margins last year were primarily related to the return to vendor program we offer to all domestic retailers as a result of the FDA warning letter, the substantial write-off of prior generation inventory deemed obsolete, additional promotions to support the launch of our Dream portfolio, elevated PPV costs incurred due to supply chain shortages in 2021 and inventory adjustments and reconciliations cleanup. In retrospect, this was an unprecedented and costly operational challenge for a company of our size to execute, and we did our best under very difficult circumstances.

Moving forward, one of our biggest operating priorities is working towards getting back to 40% to 50% gross margin in future periods through tighter management of promotional spend and supply chain costs. It’s important to note that the contract cost of manufacturing our product has not increased, which gives us confidence in our ability to return to these prior gross margin levels in the future. For 2022, total operating expenses were $95 million – $95.1 million, excluding stock-based compensation, sequentially declining each quarter through the year. In the first half of 2022, our focus is 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.

We were able to successfully position our Dream portfolio back into the number one position in key retailers by mid-year and have also been able to improve customer experience and satisfaction with our products to previous levels while putting together two FDA submissions and two European submissions for medical device clearance. Over the last two quarters, we’ve taken multiple steps to significantly reduce our day-to-day operational spending. The effects of these expense run rate improvements, including headcount reductions, variable spend controls and finishing programs related to regulatory clearances were somewhat masked in Q3 and Q4 due to cleanup adjustments such as bad debt reserves and other items incurred in prior periods, and as such, the improvements we’ve made are not yet fully reflected in the financial statements.

We exited the fourth quarter with operating expenses, excluding stock-based compensation of $19.6 million when factoring out bad debt reserves and onetime expenses such as costs from our financing activities, severance, regulatory clearances and out-of-period expenses, the underlying spend to operate the company was $15.2 million, marking a significant improvement to prior periods. As we shared in 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’ve streamlined our organizational structure from 227 employees last year to under 100 employees today. We are targeting run rate operational expenses under $13 million in Q1, excluding stock-based compensation and adjustments and financing transaction costs.

We will continue to find opportunities to reduce costs in the first half of 2023 to maintain operating expenses under $40 million in 2023, excluding stock-based compensation and Q1 financing transaction costs. Over the past 12 months, Owlet has shown operational resilience with the vision and commitment to be the long-term leader impacting pediatric health. In February, as I previously mentioned, we raised $30 million in capital to support our balance sheet, and we are working to restructure our lending commitments for access to working capital. Our 2023 planning will be to limit cash burn under $15 million as we strive for profitability and cash flow positive in the back half of the year. As we set the foundation for profitability and gain FDA clearances, we believe Owlet has a very healthy high-growth opportunity.

The most critical accomplishments towards Owlet’s digital health care future is the work we’ve done to pursue regulatory clearances for our products in 2022. As stated in prior calls, 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. Our team has completed significant work, which enabled us to file FDA submissions for our monitoring platforms, which is cleared, will unlock further long-term opportunity and growth for Owlet. Over the past year, we’ve greatly increased our communication with the FDA, maintaining frequent conversations and meetings and developing two clear distinct paths forward for our submission. In October of 2022, 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 with the 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 fall €“ does not fall within prescribed ranges. BabySat represents significant advantages 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. In December, we filed a second submission to the FDA for a software as a medical device as an over-the-counter product that offers heart rate and oxygen notifications in conjunction with the existing Dream Sock sleep monitoring capabilities.

The de novo application includes both the display of heart rate and oxygen currently in the Dream Sock and additional notification features as software-as-a-medical device. We are currently in the review process with the FDA and are working to respond promptly to any questions or clarifications that come up. We’ve also made substantial progress towards our U.K. and CE Medical applications and continue to maintain our MDSAP and ISO 1345 certifications passing several audits in 2022. I look forward to sharing more updates on these submissions when we have news to share. We believe the FDA authorizations will position Owlet to better help parents navigate the gap between hospital and the home and increase our ability to use our large and growing data set as a critical tool for pediatric care.

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. Thank you for your continued support of Owlet. Kate, over to you.

Karen H. Ilagan/Shutterstock.com

Kate Scolnick: Thank you, and good afternoon, everyone. Turning to our Q4 and fiscal 2022 results. Gross billings for the fourth quarter were $15.4 million, down from $23.4 million in Q3 sequentially. Q4 product promotions and discounts were $2 million, primarily associated with seasonal and promotional activity for owlet.com and Q1 retail promotional discounts. This compares to product promotions and discounts of $3.2 million sequentially in Q3. Returns and allowance reserves for Q4 2022 were $1.5 million, 10.7% of gross billings. This compares to reserves sequentially in Q3 of $2.7 million, 11.5% of gross billings. Q4 revenues were $12 million, including the impact of adjustments such as promotions, discounts, returns and other allowances.

Cost of goods sold in Q4 was $8.6 million and gross profit was $3.3 million. Q4 gross margin was 27.5% compared to 26.6% gross margin sequentially. Costs and other items impacting our gross margin unfavorably in Q4 were from inventory adjustments and obsolete inventory, PPV and promotions. Year-to-date, 2022, our gross margin was approximately 33.7% within our targeted range. As Kurt detailed, the largest nonrecurring cost impacts we experienced in 2022 were related to the return to vendor program, elevated promotional discounts and product costs related to our FDA warning letter and launching our Dream products. One of our highest operational 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 nonrecurring aspects of the cost this past year, we are highly focused on the operational efficiency levers within our control to improve margins with the goal of returning to 40% to 50% gross margins in the future. Q4 operating expenses were $24.1 million compared to $26.4 million sequentially. Excluding stock-based compensation, Q4 operating expenses were $19.6 million. Within our Q4 expenses, we had a few discrete expenses worth noting. Q4 operating expenses included $2.4 million in preliminary bad debt reserves subject to change, $600,000 in fundraising transaction costs, $500,000 in spend toward our regulatory submissions and approximately $400,000 in partner and marketing expenses from prime periods, which we don’t expect to see in the future.

We also took a $300,000 write-off for retail store displays related to buybuy BABY stores, and we are monitoring their financial situation closely. Excluding stock-based compensation items, we believe are onetime in nature, operating expenses were $15.2 million in Q4. Operating loss and net loss for Q4 2022 were $20.7 million and $19.5 million. Q4 adjusted EBITDA loss was $15.2 million. Turning to the balance sheet, cash and cash equivalents as of December 31 were approximately $11.2 million. Accounts receivables were $16 million, down $4.5 million sequentially from $20.5 million in Q3. Inventory at the end of Q4 was $18.5 million, down $5.3 million sequentially from $23.8 million in Q3. Looking ahead, over the course of 2022, we actively work to best position our Dream portfolio for success in the connected nursery category and made two regulatory submissions of our products that have the opportunity to open new markets and empower more parents globally.

For the areas with that are within our control, we are focused on driving the activities that maximize supporting and achieving sell-through of our core products and therefore driving balance in retail inventory for future selling opportunities, making strides in our medical device clearances and efficiently managing our operating plan towards breakeven and profitability. We navigated through a very difficult circumstances over the last 12 months, and we will continue to find the best ways to adapt to any uncertainty in this macroeconomic environment. Recently, we have successfully raised $30 million in capital to support our balance sheet and meet our operational goals in 2023. We’ve been customers of Silicon Valley Bank for a long time, and we were impacted along with everyone else given this past week’s events.

Based upon recent announcements from SVB did confirm their loan agreement and credit facility remain in place, we currently have access to our deposits, and we are in the process of amending our loan agreement and line of credit as previously disclosed. For 2023, given current inventory levels and expectations for our Q2 promotions, we’re currently forecasting Q1 revenues to be sequentially down from Q4. As we support continued sell-through, inventory momentum with our retailers, we anticipate selling revenue will sequentially improve through the year after Q1. We’ll provide additional outlook when we report our Q2 earnings call. For the full year, we plan to improve gross margins above 2022 levels. In 2022, we estimate that nonrecurring costs from the FDA warning letter activity to impacted our margins by at least 800 to 900 basis points.

And we plan to reduce our operating expenses for the full year below $40 million, excluding stock-based compensation. We have the objective of turning the business towards adjusted EBITDA margin breakeven between Q3 and Q4 in 2023. Thank you for the time today. Operator, let’s open up for questions.

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Q&A Session

Operator: Absolutely. The first question is from the line of Charles Rhyee with TD Cowen. Your line is now open.

Charles Rhyee: Hey, guys. Thanks for taking the question. Kate, I just want to talk through this the sell-through and sell-in issue. Obviously, the guidance range you gave for 4Q was €“ it fairly wide. It was like roughly 12 to 17. And if we think between the bond to top end there, that’s like call it the $5 million. And you attribute a lot of it to the first half, the sell-in was huge and then it accounts for that 21.5, and let’s say, the 18 in the second quarter. What was the sell-through that in the first half of the year? Like can you give us a sense like the magnitude – I mean, were we selling through maybe $5 million, $6 million in the first quarter? Because it seems like a lot to rightsize in the back half of this year and into the first quarter. If you can just kind of give us a sense of that.

Kate Scolnick: Yes. I don’t – Kurt, do you want to make any comment on that. I think from a color perspective, if you recall, our initial launch into the market was at the very end, the sell-in was at the very end of Q1, as we talked about loading into retailers and the distribution into Q1. And so really sell-through did not take place until Q2. Kurt, I don’t know if you want to make another comment beyond that.

Kurt Workman: Yes. I would just say it was substantial, right? So we – after the warning letter, we took all the products back to repackage, reprogram those units to position for the Dream Sock launch. And we did that, but it was sort of throughout the first quarter, right? So we didn’t get into all of our retailers by the end, but there was significant load-in to get back to previous levels of Smart Sock inventory in retail. But our sell-through did not start off as strongly as our previous Smart Sock sell-through was moving in Q3 of 2021. And so that created an inventory imbalance. We did everything we could in Q1 and Q2 to push sell-through as fast as we could and continue to sell into retailers in Q2. And the sell-through just took a little longer to materialize. I think the good news is that by Q4 and now moving into this year, sell-through levels are getting back to those previous levels that we had before.

Charles Rhyee: Okay. So does that mean, right? So if you’re saying in the first quarter, you expect it to be sequentially down to support the sell-through. Does that – will our inventory levels be back to then 10 to 14 weeks? And then if that’s the case, should we expect then a significant step-up in revenue in the second quarter or in the rest of the year? I mean, is that – or is it still more kind of a slope up?

Kurt Workman: I think what you’ll see is a step function Q1 to Q2. And part of that is that we’re reducing inventory levels this quarter and moving forward by 15% to 20%. We’re also growing sell-through. And as we move into Q2 with Mother’s Day and Father’s Day, we expect that to grow with Prime Day – heading into Prime Day in July, and so there’s inventory needs for Prime day as well. So there is quite a few catalysts in Q2 based on reducing inventory levels, growing sell-through and the promotional events that support it. So we do expect a step-up – a nice step up from Q1 to Q2.

Charles Rhyee: Okay. And then my last question would be, in this $40 million OpEx, excluding stock-based comp, what is your assumption a, for stock-based compensation, I guess? But secondly, what would you expect for the exit rate? Like – I mean because you talked about breaking even. So it’s kind of like, would we expect fourth quarter to be actually positive so we’re basically front-loading the OpEx loss? And is that all coming from gross margin then versus…