Akili, Inc. (NASDAQ:AKLI) Q3 2023 Earnings Conference Call November 9, 2023 4:30 PM ET

Company Participants

Caty Reid - Vice President Marketing & Communications

Matt Franklin - President & Chief Operating Officer

Scott Kollins - Chief Medical Officer

Santosh Shanbhag - Chief Financial Officer

Conference Call Participants

Vikram Purohit - Morgan Stanley

Charles Rhyee - TD Cowen

Rahul Rakhit - LifeSci Capital

Operator

Good afternoon, ladies and gentlemen and welcome to the Akili Interactive Labs Third Quarter 2023 Earnings Call. [Operator Instructions] This call is being recorded on Thursday, November 9, 2023.

I'd now like to turn the call over to Caty Reid. Please go ahead.

Caty Reid

Thank you, Andrew. Good afternoon and welcome to Akili's earnings call for the third quarter of 2023. This is Caty Reid, Vice President of Marketing and Communications for Akili and I'm joined on today's call by Akili's CEO, Matt Franklin; our Chief Medical Officer, Dr. Scott Kollins; and our Chief Financial Officer, Santosh Shanbhag. We issued our earnings release after the market closed today. You can access the release on the Investor Relations section of our website, along with the earnings slides that we'll reference during today's call. This call is being recorded and will make a replay available on our website shortly after today's event.

During today's call, we'll make forward-looking statements regarding future events, expectations, plans, prospects of the financial performance of the company. These forward-looking statements are based upon and assumptions that while considered reasonable by the company's management and involve certain risks and uncertainties. The company's actual results may differ materially from those expressed or implied by any such forward-looking statements as a result of various important factors. Factors that might cause such differences include but are not limited to, those risks and uncertainties set forth in our Q3 2023 Form 10-Q that we're filing today as well as other subsequent filings with the SEC. Information provided on today's call reflects our views only as of today, November 9 and should not be relied upon as representative of our views as of any subsequent date. We explicitly disclaim any obligation to update or revise any forward-looking statements or our outlook.

Also during today's call, we will refer to certain non-GAAP financial measures. Management does not intend the presentation of these non-GAAP financial measures to be considered in isolation or as a substitute for results prepared in accordance with the GAAP but as a complement to provide greater transparency. A reconciliation of the historical non-GAAP financial measures to our GAAP financial measures is included in our earnings slides and in our earnings release.

If you're following along with the slides, please turn now to Slide 3 as I hand the call over to Matt for his prepared remarks. Matt?

Matt Franklin

Thank you, Caty and thanks to those joining us on the call. Before I highlight some of the key accomplishments from Q3 I wanted to take a moment to step back and touch on the reason why we do what we do. It's not widely appreciated but it's estimated that 11 million adults or nearly 1 in 20 adults in the U.S. are affected with ADHD. For decades, ADHD was considered a childhood condition, leaving adults with ADHD struggling to understand and find resources for their symptoms or not even realizing that there was a label for their daily challenges. Thankfully, over the past several years, there's been a growing awareness of the individual and public health burden of adult ADHD.

In addition to being a risk factor for a host of other psychiatric conditions like depression, substitute abuse and suicide, ADHD is also associated with a wide range of other vocational and social challenges, such as chronic employment issues, lower average salaries, high rates of divorce and greater risk for incarceration. These outcomes are real and devastating to individuals and their families. ADHD treatment has traditionally involved medication and cognitive behavioral therapy, or CBT.

Each of these treatments has particular strength, whereas medications such as stimulants help to manage the core symptoms of distractability and impulsivity, CBT targets the habits and skills needed for executive functioning as well as the emotional and interpersonal self-regulation. Each of these treatments also has significant limitations such as medication side effects or the variable quality of CBT in routine clinical practice. Despite the clear need for effective treatment, it's estimated that only 13% of adults with ADHD are receiving any professional treatment. These gaps in care stem from a wide range of factors from the ongoing stimulant shortage to many barriers to behavioral treatments such as limited reimbursement and chronic specialty provider shortages.

These barriers to care underscore the critical need for scalable evidence-based mental health solutions. To address this treatment gap in ADHD, in June, we launched Endeavor OTC as a non-prescription subscription-based treatment for adults who've been struggling with ADHD. What's exciting about Endeavor OTC is that we believe it combines the best parts of each of these leading treatments. Like medication, Endeavor OTC delivers the same high-quality treatment each time. And like a behavioral therapy, Endeavor OTC targets the core mechanisms of attention dysfunction in the brain in order to drive sustained change.

Now with more than a full quarter on the market, it's clear that the launch of Endeavor OTC has fundamentally changed the trajectory of our business. You can see on Slide 4, in Q3 2023, Endeavor OTC was downloaded by about 177,000 individuals contributing just over $530,000 of the more than $700,000 in total Q3 revenues, a 500% increase in total revenues over Q2 2023. This gives us confidence that the clinical need is real and that there is strong demand from adults with ADHD. By removing the prescription requirement and engaging individuals struggling with ADHD directly, we've also been able to transform our business economics.

Q3 saw a dramatic improvement in our gross margins, crossing from negative gross margins in Q2 2023 to positive gross margins in Q3 2023. Santosh will provide additional detail on our expectations for gross margins during his update in a few moments. These gross margin improvements, coupled with operating expense reductions announced with our September restructure have allowed us to extend our cash runway from the first quarter of 2025 into the second half of 2025, while continuing to fund focused regulatory product development and promotional activities.

Going forward, armed with the confidence that the clinical need is real, the demand from consumers is there and that we have the ability to drive revenue with our direct marketing efforts. Our focus in 2024 will be on accelerating profitability. First, this means continuing to drive down user acquisition costs by optimizing our marketing mix. Here, we've made solid progress and we'll continue to utilize our data science capabilities to optimize our messaging and channel effectiveness. In parallel, we'll work to systematically improve free trial conversion and monthly retention. The products and engineering teams have identified a road map of enhancements based directly on user feedback and have prioritized a regular cadence of product updates to tailor Endeavor OTC for the adult audience and to improve the overall treatment experience.

Stating even more cleanly, in 2024, we'll be focusing on conserving our cash balance while we optimize our consumer funnel which will enable us to spend more aggressively on profitable revenue growth in the future.

Now, I'll hand it over to Scott to provide more detail on our regulatory activities.

Scott Kollins

Thanks, Matt. As you can see on Slide 5, we have continued to execute on our regulatory strategy that we previously reported. In May, we submitted our adolescent age expansion 510(k) application to the FDA for EndeavorRx, our pediatric prescription product for ADHD and we're continuing to work with the FDA in seeking ultimate clearance for this label expansion. For Endeavor OTC, we submitted our 510(k) application to FDA for our adult OTC indication and this submission was received by FDA on October 30. The submission is currently undergoing review by FDA. We were also excited to present our adult study findings for the first time at the annual meeting of the American Academy of Child and Adolescent Psychiatry last month in New York City.

The summary of this presentation was published in the conference proceedings. Progress has also continued with our collaboration with Shionogi for the development of a pediatric ADHD product in Japan. The Phase III study for pediatric ADHD in Japan which includes both a randomized phase and a longer-term follow-up phase is expected to be complete by the end of Q1 2024. Shionogi plans to submit the results of this trial for regulatory approval to Japan's Pharmaceuticals and Medical Devices Agency in 2024. Finally, a mutual decision was made to terminate our agreement with TALi for the development of a pediatric ADHD product for children younger than 8 years of age.

I'll now hand it off to Santosh for an update on our financials.

Santosh Shanbhag

Thank you, Scott and hello, everyone. As I had indicated in our call in September, we plan to continue to monitor and share 3 critical metrics for Endeavor OTC: active subscribers, billings and average revenue per paying user or ARPU. Slide 6 shows the performance of Endeavor OTC on each of these metrics for the third quarter of 2023 and which is the first full quarter of Endeavor OTC on the market. There were 7,535 active subscribers in the quarter. These are the total number of Endeavor OTC users with a paid subscription in the period. Additionally, in the third quarter of 2023, Endeavor OTC generated about $0.5 million in billings with an average revenue per paying user of $93. Now keep in mind that ARPU reflects a blend of what our customers pay between monthly and annual subscriptions.

Now let's take a look at our third quarter financials on Slide number 7. From a revenue perspective, we recognized $702,000 in total revenues in the third quarter which was 5x more than the total revenues recognized in the second quarter of 2023. This growth was driven primarily by revenues associated with Endeavor OTC within the adult ADHD market. Total billings, a non-GAAP financial measure that we believe provides helpful information regarding the economic contribution of the subscriptions in the period were $699,000 in the third quarter of 2023 compared to $170,000 in the second quarter. Once again, the growth was driven primarily by billings associated with Endeavor OTC. Next, gross margins. Gross margins were 60% in the third quarter of 2023 compared to negative 32% in the prior quarter. The launch of Endeavor OTC that inherently has a lower cost of distribution has enabled us to change the gross margin profile for the company.

We expect gross margins to fluctuate over the upcoming quarters. For example, we may see a benefit to gross margins with the implementation of our in-house prescription dispensing as well as transitioning from a prescription to a non-prescription model for the pediatric population. On the other hand, we will likely see an impact to gross margins when we transition from paying 15% app store fees to paying 30% app store fees on Endeavor OTC sales when we meet certain revenue thresholds. However, we expect to be between 60% and 70% gross margins by the end of 2025.

Moving on to expenses. We incurred approximately $19 million of GAAP total operating expenses and about $15 million of non-GAAP total operating expenses in the third quarter. The increase in expenses you see on the slide compared to the prior quarter was primarily driven by an increase in marketing spend, supporting customer acquisition of Endeavor OTC and was partially offset by the savings associated with the headcount reduction we announced in September. Note that severance costs related to the restructuring are excluded from the non-GAAP total operating expenses.

A GAAP to non-GAAP reconciliation is available in the appendix of our slide presentation. GAAP net loss was about $16 million in the third quarter compared to GAAP net loss of approximately $12 million in the second quarter of this year. Non-GAAP net loss was approximately $14 million in the third quarter compared to a non-GAAP net loss of about $13 million for the second quarter of this year. And last but not least, from a capital standpoint, we ended the quarter with approximately $86 million of cash, cash equivalents and short-term investments.

In summary, we believe the third quarter financials shows us that Endeavor OTC has changed the trajectory for the business from a total revenue perspective, total billings as well as from a gross margins perspective. Now please turn to Slide 8 on financial guidance. We are reaffirming guidance we had previously provided around the projected 2023 and 2024 non-GAAP total operating expenses as well as our gross margins and cash runway into the second half of 2025. Moving forward, as Matt mentioned earlier, in 2024, our focus will be on lowering customer acquisition costs, or CAC and improving unit economics before we invest in revenue growth. This will mean improving CAC and retention before we increase investments in marketing to drive revenues.

With that, I'll hand it back to Matt to wrap up our prepared remarks and then open it up to questions. Matt?

Matt Franklin

Thank you, Santosh. To sum it up, we've made great progress as evidenced by the strong consumer demand and accelerated revenue trajectory that we reported in Q3. Again, it's clear that the strategic shift to a non-prescription model has been a game changer for Akili and while we're pleased with the progress, we're not satisfied. We'll continue to work to optimize how we drive awareness and adoption with adults and systematically improve the treatment experience for our users who directly benefit from our products.

With that, I'll hand it back to the operator to help us take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Your first question comes from Vikram Purohit from Morgan Stanley. Please go ahead, sir.

Vikram Purohit

So the question we have is in order to convert the EndeavorRx for pediatric to OTC use, what kind of data set do you need to prepare -- need to provide to the FDA?

Scott Kollins

Thank you for the question. So that process, we are in the midst of working collaboratively with the FDA to define what data requirements might exist and we'll know more about that as the process unfolds in 2024.

Operator

Your next question comes from Charles Rhyee from TD Cowen.

Charles Rhyee

Can you hear me?

Matt Franklin

Yes, we can.

Charles Rhyee

Okay, great. I just wanted to ask a little bit about how you're pursuing, acquiring customers? What are the main channels that you're using right now? And what are you finding most effective? Is it simple through like what is it through certain types of patient forums or is it just through social media? Maybe give a little bit of a sense on the main channels that you're pursuing at the moment? And what are you finding most effective so far?

Matt Franklin

Yes. Charles, this is Matt. Thanks for the question. Appreciate it. Not surprisingly similar to other companies with a consumer health focus, our primary focus today is on direct digital marketing. So emphasizing search marketing and then through many of the common platforms that we use today, Instagram and other similar platforms. In addition to that, we have started to build our own organic content. So through blog posts, contributing to the dialogue around adult ADHD treatments and helping those who are impacted live more successfully, the goal there is to drive more traffic to our internally controlled website.

So I think you'll see us continue to add additional channels over time. But as we indicated, our focus is really on a methodical improvement utilizing our data science background and capabilities to really analyze the effectiveness of each of these channels of each of these campaigns and to optimize as we go. So it's test and learn and optimize is really the key focus for us today.

Charles Rhyee

That's great. And when you're bringing on these patients onboarding new subscribers, I guess, in this case, a couple of questions. Are you capturing information regarding what kind of treatments if any, they are currently on. And curious to see if a lot of these new patients are already on some type of treatment, whether it's a stimulant, like Adderall, or they're kind of -- they're not taking any treatment currently.

Matt Franklin

Yes. Good question. So from an initial onboarding experience, we do not capture detailed clinical information or treatment history. We do capture demographics. There's some qualifying questions that we do ask to ensure that they're appropriate for this treatment. But we do offer an adult registry. Scott, do you want to give a little bit of detail about what we offer here?

Scott Kollins

Yes. So as Matt said, in the product itself, we don't gather that information but we actually, just in the last couple of weeks have gotten approval and we've launched a product registry for the adult OTC product, just like we have with our pediatric registry which has now enrolled more than 100 participants. And so the plan there for users that are interested, they can sign up for that, provide additional information and then we can gather outcomes on them over time.

Charles Rhyee

Okay. And then just 2 more quick questions. First, I think you said you have a little over 7,500 active subs. I think sort of first time downloads was more like 177,000 and what is the difference in conversion.

Matt Franklin

From the previous quarter or just kind of wanted to clarify.

Charles Rhyee

Yes. It seems like you have a lot more first-time downloads. Just trying to see are there any hurdles in getting someone to fully -- to subscribe to the product. Or like when you're seeing your funnel, where do you see people drop off and not follow through?

Matt Franklin

Yes, I understand. We haven't provided a detailed breakdown of sort of the top of the funnel, all the stages in the process. Overall, conversion, as you mentioned, from sort of initial download to paid subscription is healthy. It's actually quite good compared to the benchmarks in the health and fitness space. So again, we're very pleased given the early stages. For us, the key steps, the key moments that we focus on as we download, we do offer a 7-day free trial period. So optimizing that first download to free trial experience and then making sure that, that trial experience results in that paid subscription. So those are the kind of the key moments that we're focused on improving that overall conversion.

Charles Rhyee

Okay. And then maybe one last for Santosh. If we think about sort of the OpEx reduction expected next year versus this year, how should we think about that mix between R&D, SG&A and, I guess, gross margin?

Santosh Shanbhag

Yes, that's a great question, Charles. So remember, in 2023, a large part of our operating expenses included the costs incurred with the sales force as well as market access. So with the reduction that we announced earlier this quarter, those costs will not continue to exist in next year's operating expenses. But we do expect our marketing expenses to go up compared to where we were earlier this year, so you should anticipate that.

On the R&D side, as you can imagine, clinical trials will not -- we will not have any more clinical trials per se next year other than the registry that Scott talked about. We will invest in product and product development, that will be a key part of our investments next year. At a higher level, I would say the operating expenses really are to help us get a much better understanding and make the customer acquisition cost a lot more efficient. So our focus next year will be on the unit economics and that's where our investments will be.

Operator

Your next question comes from Rahul Rakhit from LifeSci Capital.

Rahul Rakhit

I wanted to ask this before but I was just wondering if -- since I last asked if you any additional learnings kind of around the pricing strategy. And if there's been any kind of early trends on users opting for 1 month versus 2 months versus full year subscription.

Matt Franklin

Yes. Thanks, Rahul, it's Matt. So from that perspective, we continue along the lines of optimizing. We continue to experiment. There haven't been significant shifts from previous quarter and we do offer that annual subscription of around $130, a monthly subscription at $25 per month. That's remained stable. The mix between annual and monthly has also remained fairly consistent in the last several months. So that's settling into sort of a steady state there as well. We will continue to experiment and offer different value propositions to different user segments over time. And it's just kind of a core part of our focus in the unit economics for next year.

Rahul Rakhit

Got it. Okay. And I was just wondering, you mentioned that Shionogi is going to be looking to submit PMDA later. Is that going to trigger a milestone payment as well or even just broadly, if you can just help us understand potential for milestone payments through this Shionogi partnership would be helpful.

Santosh Shanbhag

Yes. The Shionogi milestone is not triggered by the submission but more by the outcome of the review by the NDA. So that's where the milestone gets triggered, Rahul.

Rahul Rakhit

Got it. And do you have an idea typically how long that PMDA submission review process last?

Santosh Shanbhag

It would be a wild guess. I mean it's a regulatory body. They do have a reasonable process. I think it's -- I would say it's similar to what you would see in the U.S. but there are no specific dates or milestones that they march towards unfortunately.

Rahul Rakhit

Understood. Appreciate that. And 1 or 2 more from me. I know we talked about this before but with the COVID-19 emergency mandate ending, I think, in the next week or more. I just wanted to clarify that with the 510(k) form that you guys submitted, you're now still able to continue providing Endeavor OTC to adult patients? How does that really work?

Scott Kollins

Yes. So per the guidance that the FDA issued around the transition out of that enforcement discretion we've sort of met the requirements. So we submitted our 510(k) before the deadline which was November 7. And while it is under review, we are able to continue to market until we hear something back from them.

Rahul Rakhit

Got it. Really appreciate it. And then the last one for me was I know on the last call, you kind of mentioned the percentage of subscribers that play the full recommended 25 minutes as well as those, the monthly retention. I was wondering if you could just kind of comment on those metrics for this quarter as well.

Matt Franklin

Yes. Those continue to remain strong and healthy, in line with those that we presented last time. And again, in line with comparable benchmarks. Clearly, that will also be an opportunity for improvement over time. But yes, it remains healthy.

Operator

[Operator Instructions] Next question is from Charles Rhyee from TD Cowen.

Charles Rhyee

I just had one more follow-up question. Obviously, we're seeing good traction in terms of subscribers. I guess 2 questions, probably still short. Not a long time to have a good sense but in terms of sort of the average length of subscription, how would you -- how should we think about that in terms of people coming on board? And then secondly, is sort of the directional increase of new subscribers? Is this -- should we think of it sort of linearly growing? Or do you -- or given sort of your expectations on outreach, would you expect that to maybe accelerate at a faster pace?

In other words, how should we think about, I guess, revenue growth and subscriber growth over the next coming periods?

Matt Franklin

Yes. So we have not provided guidance on revenue for 2024 nor have we provided forecast for demand going forward. From a characteristic perspective, as Santosh mentioned, as I've mentioned, our focus is going to be deemphasizing growth for the sake of growth and focusing more on optimizing profitability, right, on that user economic basis. So I'll again point towards those comments as far as setting expectations for how rapid growth will be.

Santosh also provided guidance on our operating expense expectations for next year. So that could potentially help you there. From the retention and renewal perspective, really, honestly, too early. We have just a few months. Every single month, more and more users come up for renewals. So we are really still learning and gathering data. Clearly, that could be helpful in the future and that is something we would hopefully be able to provide going forward. But bear with us here, let us get a couple of more quarters under our belt before we share any kind of expectations or detailed metrics around that.

Operator

[Operator Instructions] There are no further questions at this time. Please proceed with any closing remarks.

Matt Franklin

I think that's great. Thank you very much for your time on the call and look forward to seeing next quarter.

Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.