Owlet, Inc. Q2 FY2022 Earnings Call

Good afternoon and thank you for joining us today. Earlier today, Owlet Incorporated released financial results for the quarter ended June 30, 2022. The release is currently available on the company’s website at investors.owletcare.com. Kurt Workman, Owlet’s Co-Founder 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 in the US Securities and Exchange Commission, including its Quarterly Report filed May 13, 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 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 most comparable GAAP measures in the company’s earnings press release, which is also available on the company’s quarter results page of its website.

Thank you, Mike. Good afternoon to all who are joining us today. As always, we're grateful to you and the millions of parents who continue to root for and support Owlet as we work to build a connected nursery ecosystem. My remarks this afternoon will focus on our results for the second quarter and year-to-date and our plan forward as we work to deliver on our vision for every day and every parent. We remain steadfast and committed to that, and we're proud of the business we've built. Later in the call, I'll detail our approach for the remainder of the year, how we're navigating current headwinds and updates we're making to our business as we work toward profitability. In the second quarter of 2022, Owlet generated net revenues of $18.3 million, which fell short of the guidance we shared in Owlet’s last earnings announcement. We did not achieve the gross billings results as we expected in Q2, largely due to two main reasons. First, I'll address the Owlet-specific dynamics and second discuss the macroeconomic headlines. Since we will be referencing this throughout the call, we refer to sell-in as a measure of the number of units retailers purchased from Owlet to stock their shelves, and sell-through is when the unit is actually sold to the end consumer. Q2 was our first full quarter of dream product availability online and in-store at all of our retail partners, including Owlet online and with our Amazon distribution partners. Following the launch of the dream products in January, much of the initial sell-in and online in-store availability of our dream products took place late in Q1. From Q1 to Q2, we experienced over 40% growth in sell-through units for our dream products across our channels. While this rate of growth was good from an initial product launch standpoint, it was a slower pace of sell-through than we had expected and consequently, we had more aggressive Q2 selling expectations. Additionally, along with many consumer brands, in Q2, Owlet began experiencing the effects of macro headwinds with retailers adjusting their projections and ordering cadence in terms of weakening demand as they began to defensively position their balance sheets compared to last year. This combination of factors resulted in lower-than-expected gross billings for the second quarter of $22.7 million. With the second quarter revenue results and current macroeconomic factors in mind, we're realigning our operating plan for the second half of 2022. Owlet's three primary areas of focus are: first, achieving strong sell-through of our core products, including our Sock and Camera lines; second, making strides in our medical device submissions; and finally, efficiently managing our balance sheet and expenses to reach breakeven adjusted EBITDA. Our focus on achieving strong sell-through of our core products is to drive top-line revenue. We are seeing encouraging signs of our underlying strategy for our Dream products taking hold that affirm our product-market fit and demand. The sell-through rate over the past few months is similar to and starting to pace ahead of the volume we did in 2020, that is the same business we took public. We're confident in our ability to continue our brand leadership in the connected nursery ecosystem and the market fit for the value proposition of our dream product. Additionally, we started the year with a brand-new product. We now have an average of four-plus stars on all of our products, which is extremely important to ongoing consumer sales. Dream Duo was recently named as the Best Baby Monitor by CBS News, and the number of expecting parents adding dream products to their baby registry continues to grow. Post-purchase metrics, including net promoter score remains strong and rival what we previously saw with the Smart Stock. We continue to drive new levels of marketing support and retail partnership with the Owlet brand. Our recent Amazon Prime Day in July was Owlet’s best ever, where the number of units sold were double our internal forecast and Owlet ranks as the number one baby monitor on Amazon in the US. We're also expanding to about 1,200 Walmart doors and adding the Dream Duo as a product offering to 600 existing Target doors. Internationally, we're pleased with the progress we've made in launching our product in parts of Asia, with the South Korea market opening this month. Year-to-date international gross billings are up over 60%. Combined, we believe these are leading indicators with a solid foundation of sell-through that we will build on with consumers and retailers through the remainder of the year. In July, we launched our newest technologies domestically, including the next-generation nursery Owlet Cam 2, and the predictive Sleep Technology tool. We're continuing to load into our retail partners through the remainder of Q3, and Cam 2 will officially launch in international markets this quarter as well. The dream platform we're building today for our sock line is part of what we will leverage in our medical devices, expanding on our core technologies to accelerate adoption and add use cases for our monitoring technologies. Our team is working on several medical device submissions, including in the U.S. and internationally. Notably, we plan to submit our 510(k) application to the FDA for our BabySat device in the coming weeks. BabySat is intended to be a prescription product for use with sick babies under the care of a physician and will address the most vulnerable population. With existing CPT codes available, we believe the BabySat could be reimbursable, which will also improve accessibility to this critical technology. We have also recently aligned with the FDA on our submission for our software as a medical device features as an over-the-counter product that offers heart rate and oxygen notifications on top of the existing Dream Socks’ sleep tracking capabilities. We believe we are on track to submit our application in Q4. Finally, international clearances are part of our measure of success as we work towards submissions in Europe. Adding cleared medical devices to our offering will further enhance the Owlet value proposition and better empower parents to provide care at home. I believe we have the right team in place to execute against these submissions and we will continue to report on these milestones in future calls. The third area of focus for Owlet is to efficiently manage our operating model as we navigate the sell-in and sell-through demand trends effectively with our retail partners and macroeconomic headwinds, and as we resolve the working capital hangover from the FDA warning letter process. Prior to taking our company public, we were driving lean leverage in our business and adapted our investment strategy when we went public last July. In 2021 and the first half of 2022, we invested in scaling our business, marketing spend and future investment in our product portfolio. Based on macroeconomic conditions in the market, we are adjusting our 2022 operating plan to reduce our operating costs and accelerate our plans to drive the business to breakeven adjusted EBITDA in 2023. Towards these goals in late July, we implemented a restructuring program to streamline our organizational structure, reduce operating expenses, and manage and conserve our cash resources. So in the second half of 2022, we're focusing on being the baby monitor of choice for families, which includes further enhancements and improvements to the Dream Sock and adding features that make this the monitor for every baby. This means we're elongating our launch timing for some of our new product portfolio initiatives like Smart Crib; however, it remains an important part of our future roadmap. We believe this focus on operating efficiency will allow us to better control our destiny and be more nimble in the face of a changing economy and business environment. We're optimistic these pivots will put the business on track for profitability sooner as we build on the foundation of our core technologies, accelerating adoption and expanding use cases with medical devices. Finally, I want to take a moment to thank Mike Abbott for his years of service at Owlet. Mike announced today that he's resigning from his role as President and Board member at Owlet to spend more time with his family and pursue new opportunities. Mike joined Owlet over 4.5 years ago, and in his time here, he was instrumental in our expansion to a global public company. We wish him well in his next chapter. I'm grateful for a 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. Our vision is that every family has access to the tools and technology they need to keep babies safe, healthy, and happy. Thank you again for your continued support of Owlet and our mission. I look forward to sharing more updates in future calls. Kate, I'll now turn the time over to you.

Thank you, and good afternoon, everyone. Turning to our Q2 results. Gross billing for the quarter was $22.7 million, below our expectations for the quarter. As Kurt stated, it's our first full quarter for our dream products in the marketplace, and we did not see the anticipated rate of sell-in and sell-through following our successful launch into retailers in Q1. In addition, retailers began to reduce our inventory projections as they work to reposition their balance sheets more defensively in response to macro headwinds. Q2 product promotions and discounts were $2.5 million, relatively consistent with the prior year, which included $2.3 million associated with our July Amazon Prime Day. Return adjustments for Q2 2022 were $1.8 million, a 41% reduction from the first quarter and in line with the prior year. Direct-to-consumer return rates normalized to levels similar to our smart fact products, which we believe is driven by consumers’ better understanding of the dream value proposition. Within this, approximately $1 million was for adjustments related to FDA return-to-vendor activity associated with our Smart Sock product. In summary, Q2 net revenues were $18.3 million, including the impact of adjustments such as promotions, discounts, and other allowances. Cost of goods sold in Q2 was $11.7 million, and gross profit was $6.6 million. Q2 gross margin was 36.1% compared to a 54.2% gross margin in the prior year. Compared to the same period in 2021, our gross margin was impacted by macro inflationary pressures, including product costs, shipping, and fulfillment. In addition, promotions, discounts, and returns remained at similar levels to the prior year. Operating expenses for the second quarter of 2022 were $27 million compared to $19.4 million for the same period in 2021. The increase in year-over-year operating expenses was primarily due to planned increases in spending associated with the scaling of the business, public company costs, and stock-based compensation. In July, the company implemented a restructuring program to streamline the company's organizational structure, reduce operating expenses, and manage and conserve cash resources to strive for profitability. As part of the restructuring program, we commenced a workforce reduction of approximately 74 employees that is expected to be substantially completed in Q3, and we expect to incur costs of approximately $1.1 million consisting primarily of severance, one-time termination benefits, and other related costs. As a result of the restructuring actions, we expect to reduce run-rate operating costs, excluding share-based compensation and incentive compensation, to approximately $15 million to $19 million per quarter by the fourth quarter of 2022. Operating loss and net loss for the second quarter of 2022 were $20.4 million and $11.7 million respectively, as compared with a $5.9 million operating loss and a $5.3 million net loss for the same period in 2021. Q2 adjusted EBITDA loss was $16.7 million compared to an adjusted EBITDA loss of $2.6 million for the same period in 2021. Turning to the balance sheet, cash and cash equivalents as of June 30th were approximately $37 million. Accounts receivable were $24 million, up $7.4 million sequentially from $16.6 million in Q1. Inventory at the end of Q2 was $29.4 million, up $4.7 million sequentially from $24.7 million in Q1. Nearly all return authorizations for return to vendor were closed for retailers at the end of the second quarter. The company is in the process of working with its customers to apply liabilities against outstanding invoices where applicable. From a working capital perspective, we planned to heavily utilize existing inventory on hand. Regarding our financing arrangements, we did not meet our revenue covenant for the second quarter, which was waived by Silicon Valley Bank. As part of our waiver agreement, our liquidity covenant was reduced to $22.5 million, and our line of credit was reduced to $5 million. The waiver agreement is intended to function as a bridge arrangement and we're actively working with SVB on further restructuring our loan and line of credit, including amending future financial covenants, which we expect to complete during the third quarter. All of our outstanding partnerings with SVB are represented as a current liability on the June 30th, 2022 balance sheet, including our second-quarter earnings release. Looking ahead, as currently outlined, we have three primary areas of focus: achieving sell-through of our core products, making strides in our medical device submissions, and officially managing our operational plans towards breakeven and profitability. While we continue to believe in and invest in our strong relationships with our retail partners, we're entering the back half of the year with caution given retailer signals on reducing inventory and managing balance sheets more defensively and cautious consumer spending in this macro environment. Given our reduced forecasting visibility, we are not providing revenue guidance for Q3. We are planning for Q3 operating expenses to be lower sequentially, reflecting operating expense actions that began in mid-July.

Hi. This is Steve Braun, on for Charles. Just had a quick question on the guidance that you just provided on the back half of the year. It seems like you're a little bit more cautious on consumer spending and the outlook for the rest of 2022. Given what we've been seeing with some moderation in the producer price index and also inflation this month, can you unpack some of the assumptions there and kind of what's going into that outlook?

Yes. Kate, do you want to take that one?

Yes, sure. I think part of what we've tried to provide is similar discussion as we launched new products at the beginning of the year. What we've been able to manage is really the perception and adoption of that product. The NPS scores, the consumer ratings, and the overall transition to the Dream product platform, that sell-in for us really happened late in Q1. We are monitoring very closely, the sell-through in Q2, which happened at the rate that we described but was slower than anticipated, which also created slower sell-in for ourselves. So a lot of the dynamic that we're talking about is Owlet-specific, but we're also looking at the macro conditions that our retailers have expressed to us as well as consumer spending. So I think just given both of those dynamics, we're entering the back half with optimism around our portfolio, but also with the macro environment that other retailers and the consumer spending index are presenting. So we don't have a unique point of view on it, but we're sharing that caution that others express.

I guess to start out on the demand front, could you talk about when things started to slow? I think we're hearing from others at least on the consumer front that it seemed like most of that began in June, but just kind of curious to hear what you're seeing? And then also, if you could talk about trends, how that's kind of continued in July and into August? That would be helpful.

It's been kind of a unique year for Owlet, right, because we were out of the market for a quarter in Q4 of last year where we weren't selling products. We launched the Dream Sock in Q1, and it took us a full quarter to get back to market, get back into all of our stores and all of our online channels. In Q2, we were measuring sell-through growth. I think our hope was we'd be moving at a faster clip. We'd be back in the market faster, and the sell-through would ramp faster. Overall, in terms of just general sell-through growth, we've seen really good improvement from Q1 to Q2, and July was our best Prime Day ever. We saw really good sell-through in July as well. There’s kind of two stories here: we did have some retailers pull back on their forecast and reduce the amount of inventory they were willing to hold as part of our expansion activities and growth with them. We've heard similar sentiments moving forward about being more cautious about how much inventory they're going to hold and how that's flowing. Hopefully that answers your question; there’s sort of good momentum because we're re-entering the market.

And just to make sure on the inventory front, what are you guys doing to manage that? Are you adjusting any sort of production schedules, or is inventory generally in good shape? What can you comment there?

We're working with our partners to make sure that we're bringing the inventory down. That's one of our goals to bring it more in line with where sell-through and sell-in is today. We're also working with our partners to continue to sell through the product and to grow the business.

Okay. My final question is about how quickly you expect to reach breakeven. I assume this might affect growth, so are you currently waiting for the macro situation to improve before ramping up investments again, or what are your thoughts on that?

Yes. Kate, do you want to pick that?

Yes. So John, the investments that we were making in the first half that were contributing to the run rate of operating expense were investing in the product portfolio for next year. For example, bringing out our Smart Crib will elongate the time to market. Some of the other investments would correlate to discretionary spending. We did have a reduction in force, so we brought back the number of employees that we have much closer to where we were in 2020. In the back half of the year, our operating expense run rate will be much lower than it was in the first half, lower in Q3 than Q2, and then again lower in Q4 to try to exit the year in that range of $15 million to $19 million in operating expense, excluding stock-based comp. In terms of our breakeven and getting into profitability, we had said that we were targeting kind of exiting 2023, and as long as we maintain that run rate, we'll be much earlier in the year next year. We'll see how things moderate with the macro and when we're able to turn back on marketing and sales. We’ll continue to look at that.

Okay. And then I’d just like to clarify, I assume you’ve cleared out most of the high-cost inventory from last year?

Yes. So the inventory that we had from last year is primarily associated with the Smart Crib. We believe we're through that process of return to vendor. We're either selling that back into the market or have that in inventory on our balance sheet, but that process is nearly complete.

There was some commentary in the press release indicating that gross margins were affected by increased returns. Can you explain that? I thought the returns were mostly from October, November, and December of last year. Maybe my memory is not accurate or there might be other factors involved. Is that the situation, or could those returns persist?

The return rate that we saw in Q2 as it relates to the run rate of our product, our general sales returns, was back to where our original product was. On a sequential basis, that rate actually declined, where we had costs related to returns that were around the return to vendor program. About $1.1 million against gross sales was related to the return to vendor program, and we won't see that again; that's part of the rework program and that hit our gross margin in the quarter.

And then did I hear on your last answer to the prior question, you said breakeven was a goal for 2023? Was that like exiting or full-year in totality? How should we think about that timing and comment?

We'll try to bring it earlier into ‘23. Our primary goal is to reduce operating expenses considerably in the back half of this year. The actions that we took and the changes in the product portfolio will help us accelerate that much earlier into 2023.

That profitability definition, is that like earnings per share or EBITDA? How did you define profitability or capital?

Adjusted EBITDA.

Yeah, thank you. I just want to reiterate our commitment to our mission of empowering parents to really give care at home. I think Owlet does that in a unique way. It's what motivates our employees and our partners, and the commitment that we see there is incredible. We're excited about the progress we're making with Dream Sock and the growth in Dream Sock. We look forward to putting our FDA submissions in very soon, and I believe the business is in a much healthier track with the restructuring that Kate mentioned. So thank you for joining. We appreciate your support, and looking forward to the next update.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for being with us today. Have a lovely day ahead. You may disconnect your lines now.