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spk02: Ladies and gentlemen, thank you for standing by and welcome to the Ergo fourth quarter 2020 earnings conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question at that time, please press star then one on your touchtone telephone. As a reminder, today's program may be recorded. I would now like to introduce your host for today's program, Nick Ledeco, Vice President of Investor Relations. Please go ahead.
spk05: Good afternoon, everyone, and welcome to the IRGO fourth quarter and full year 2020 earnings conference call. The press release and slides to accompany this call are available on our investor relations website at ir.irgo.com. As a reminder, both this live call and the digital replay will be available on our IR website. Joining me on today's call are Christian Gormson, President and Chief Executive Officer, and Adam Loponis, Chief Financial Officer. Christian and Adam will provide prepared remarks, and then we will open the call to the Q&A. Before we begin, I'd like to remind you that some of the matters discussed in this conference call will contain forward-looking statements regarding future events as outlined in our slides. We wish to caution you that such statements are based on management's current expectations and beliefs and forward-looking in nature and are subject to risks and uncertainties, and actual events or results may differ materially. The factors that could cause actual results or events to differ materially include, but are not limited to, factors referenced in our press release today, as well as our filings with the SEC. We will also be discussing certain non-GAAP financial results on today's call. Please refer to today's press release and slide deck for a full GAAP to non-GAAP reconciliation. With that said, I will now turn the call over to Christian.
spk01: Thank you, Nick. And good afternoon, everyone. We're very pleased with our fourth quarter and full year 2020 performance, which caps off a truly incredible year for ERGO. On that note, I would like to thank all of my colleagues at ERGO for their focus and execution, despite the challenging circumstances for everyone. Thank you. Given that we pre-announced our fourth quarter 2020 net revenues and gross system shifts, I will summarize the drivers of that performance and then turn it over to Adam, who will provide a more detailed review of our fourth quarter financial performance and then provide full year 2021 guidance. Starting on slide five, we delivered fourth quarter net revenue growth of approximately 111%, gross system shift growth of approximately 68%, and a return accrual rate of approximately 24%, down nearly 10 points year over year. Revenue and volume growth in the fourth quarter were driven by several factors. First, and as expected, we saw increased consumer demand during the holiday buying season. The typical increase in interest around the holidays was magnified by our broader media reach, combined with the sheer scale of online shopping in the U.S. Our broader media reach was driven by strong performance of our national TV advertising, which we believe continues to succeed at large because of our differentiated focus on creativity and empowering messaging compared to others in the hearing aid space. As expected, TV advertising rates came down from their peaks during the presidential election. As we saw the rates decline to more normalized levels, we ramped media spend accordingly. Combined with holiday promotions, the efforts drove high-quality leads and inbound calls. Increased national advertising also attracted an increased number of insurance customers, enabling continued penetration of a large, fast-growing, and mostly untapped segment of the hearing aid market. As a reminder, We typically target insurance customers with call-outs on our national advertising, building awareness that consumers may be eligible for a hearing aid at no cost. However, the magnitude of insurance orders we received as a result of holiday advertising was ahead of our expectations, particularly in a quarter that is seasonally more cash-paid weighted. And lastly, The consumer adoption of hearing aids and receiving clinical support online continue to increase. If 2020 has taught us anything, it's that telecare is here to stay. We are excited to lead the hearing aid industry in the growing shift of consumer preferences. We believe Eargo has the most established telecare support and service infrastructure in the hearing industry. Built through over three years of interactions with the consumer, and a real-time feedback loop that we constantly use to improve the user experience. We are committed to further investing in telecare clinical support to better help our customers solve for their hearing loss and further increase this important competitive advantage. Moving to slide six. As we've stated, we've developed the Eargo business model to grow at the lowest cost of customer acquisition possible. We are incredibly pleased with the extent to which we diversified our customer base in 2020 from largely a cash-paid business to one with a healthy mix of insurance and repeat customers, all largely driven by the same media. Insurance and repeat customers generally convert at higher rates and return at lower rates, which has the multiplying benefit of driving up net revenue growth while driving down our overall cost of customer acquisition. Looking specifically at our insurance opportunity, we believe there are approximately 12 million adults in the US over 50 who have both hearing loss and access to hearing aid benefits under certain health insurance plans. We are currently targeting approximately 1.3 million of that total and have only scratched the surface of that market opportunity. As of December 31, 2020, our insurance customer install base represents approximately 1% of our current addressable insurance market, providing what we believe is a multi-year runway for continued efficient growth. Let me now turn it over to Adam for his review of our financial results.
spk03: Thanks, Christian. Given Christian's thorough discussion of revenue drivers, I will start with gross system shift. As a reminder, we define a gross system as two hearing aids, a charging case, and starter accessories shipped at a single unit. Fourth quarter gross system shift were 12,096, up 67.7% year over year and 20% sequentially, driven by increased consumer demand during holiday buying season, strong performance of national advertising, increased penetration of insurance market, and strong growth in repeat customers. Fourth quarter return accrual rate was 24.4% compared to 34.0% in the fourth quarter of 2019 and 25.2% in the third quarter of 2020. The 9.6 point Year-over-year reduction in our return rate was driven by the mixed shift in volumes towards lower returning insurance and repeat customers. Moving to non-GAAP gross margin and operating expenses. Our discussion of financial metrics at the gross margin line and below will be on a non-GAAP basis, which excludes stock-based compensation expenses. Please refer to our GAAP to non-GAAP reconciliation included in today's earnings release. fourth quarter non-GAAP gross margin was 70.8% compared to 55.3% in the fourth quarter of 2019 and 70.2% in the third quarter of 2020. The year-over-year gross margin expansion is primarily due to higher customer ASP driven by the mix shift to Neo HiFi, lower return accrual rates, and lower COGS. Fourth quarter non-gap sales and marketing expenses were $14.5 million, or 64.6% of net revenues, compared to $11 million, or 100.3% of net revenues in the fourth quarter of 2019. We continue to invest in sales and marketing to expand our teams and deploy new media while generating significant leverage, driven by a more efficient media spend and improved customer mix. Non-GAAP research and development expenses were $3.9 million, or 17.4% of net revenues, compared to $4.0 million, or 37.8% of net revenues in the fourth quarter of 2019. We are rebuilding some of our long-term R&D capabilities and ramping personnel hiring after slowdowns these initiatives during the initial uncertainty related to the COVID-19 pandemic. We also had some ERGO 5 design verification build costs in Q4 that contributed to R&D costs. We expect to continue to increase our R&D spend going forward to fuel long-term growth and ensure we stay ahead of the innovation curve. Non-GAAP general and administrative expenses were $4.7 million, or 21% of net revenues, compared to $3.5 million, or 32.7% of net revenues, in the fourth quarter of 2019. We saw an increase in G&A expense due to higher costs associated with being a public company. Non-GAAP net operating loss for the fourth quarter of 2020 was negative 7.2 million compared to a non-GAAP net loss of negative 12.6 million in the fourth quarter of 2019. Cash and cash equivalents as of December 31st, 2020 were $212.2 million This includes approximately $148 million in net proceeds from our IPO completed in October of 2020. We believe our cash on hand is sufficient to fund our current operating plans, as well as the investment initiatives across sales and marketing and R&D that we have outlined during our recent public offering. Now turning to 2021 guidance. We expect net revenue for the full year of 2021 to be in a range between $87 million and $93 million. This reflects our confidence in the continued customer adoption of ERGO, led by robust volume growth with stable customer ASBs and stable return accrual rates as compared to the full year of 2020. Given our better than expected revenues in the fourth quarter of 2020, we expect first quarter 2021 net revenues to be down sequentially. We remain on track to launch IRGO 5 in the second quarter of 2021 with material revenue contribution from IRGO 5 to begin ramping in the third quarter of 2021. Moving to non-GAAP gross margin guidance. We expect our ability to refurbish returned IRGO 5 units will begin to drive gross margin expansion in the back half of the year. Therefore, we expect full-year 2021 non-GAAP gross margin to be between 70% and 72%. Moving to operating expenses. While we are not providing specific operating expense guidance, we do anticipate full-year 2021 stock-based compensation expense of approximately $20 million to $25 million, up from approximately $5 million for the full year of 2020. We plan to disclose the quarterly amounts of stock-based compensation expense by line item in our quarterly earnings releases in 2021. I'd now like to turn it back to Christian for summary and closing remarks.
spk01: Thanks, Adam. I must admit that I'm proud of our execution on financial metrics, including the leverage that we're creating on our investments. On slide nine, we take a step back and review our accomplishments in 2020, which was quite simply a record year for ERGO across all key performance measures. The one theme that underpins 2020 is innovation. We believe we have proven we can innovate the entire hearing aid experience for consumers through every facet of their journey. From a product perspective, we launched the highest quality, best sounding hearing aid in our history with our fourth generation Diego Neo HiFi. In awareness generation, we launched innovative new creative and national TV, that speaks to the consumer in their language. In clinical support, we further invested in telecare and added new tools for consumers to engage with us digitally, further distancing our competitive lead in telecare support for hearing loss. In distribution, we opened a new channel for consumers to acquire hearing aids at low or no cost through insurance, driving down our return rate and improving the efficiency of our business. And lastly, we raised significant capital to support the execution of our business plan and the opportunity to help even more people hear better. Our accomplishments in 2020 give us high confidence in our ability to deliver our 2021 business plan and financial objectives. We believe our improved customer mix, sophisticated demand generation capabilities, continued scale up of national advertising and the launch of year go five will result in another year of robust consumer adoption. More importantly, the cross functional innovation we saw in 2020 gives us confidence. We will continue to innovate this large under penetrated hearing aid market over the next several years. In summary, we could not be more excited about what the future holds for Yirgo as we remain focused on our mission of helping more people hear better. That concludes my prepared remarks, and I would like to turn the call back to the operator for Q&A.
spk02: Certainly. Ladies and gentlemen, if you have a question at this time, please press star and then 1 on your touchtone telephone. If your question has been answered and you'd like to remove yourself from the queue, please press the pound key. Our first question comes from the line of Robbie Markets from J.P. Morgan. Your question, please.
spk04: Hi, everyone. This is Saranod for Robbie. Congrats on the great quarter. So, you know, I know you gave some commentary here on the guidance, but can you just help me understand what's built into your assumptions here in terms of your base case for 2021 guidance and the first quarter remedy, sequential declines? And I can understand that COVID benefits of caseloads pick up and you benefit even if caseloads come down. So it's kind of a win-win. But just what's involved sort of in your base case here?
spk01: Okay. Again, thank you for the question here. And let me start overall what all our guidance is built on, and Adam's going to give the details for Q1. Okay. But overall, you know, I think we've been pretty clear in our communication that all our guidance is based on what we have already done. So it's really driven off what we know we can do in terms of driving awareness and driving demand through advertising. That's point number one. How we can continue to penetrate the federal insurance opportunity, that's driving a big part of our growth. The product launchers. that we have been doing historically and that we know are coming are of course also included in our guidance. And then really how, and especially coming into 21, this lever of repeat customers. So that's what's in the model. We're not modeling any of the additional opportunities that we see in this marketplace. So that's not included in our guidance. So further expansion of insurance, international, et cetera, be that physical, retail experiences. None of those factors are included in our guidance. So Adam, do you want to?
spk03: Sure. Thanks, Christian. Just to add a bit more color coming on, the idea here is in Q1, we actually have a pretty big sequential ramp up. If you look at where we are versus prior year, we had, that was our first big quarter of insurance volume in Q1 of 2020. And really we see, you know, that, that growth in QN 2020 grew almost a sequential 140%. So we, we obviously know there's a difficult comp there as well. The other thing to keep in mind is we didn't in last year, we did have sequential growth Q4 to Q1 of 19 to 20. But we also had the launch of the Ergo Hi-Fi will be launching in year ago five here in Q2 of 2021. If you look at the full year, if you kind of think about the sequential performance, we expect sequential improvements each quarter going forward after Q1. So I'd expect to be about a 47 to 50
spk01: And of course, that would entail significant year-over-year growth in Q1. So although sequentially down from our record quarter, it's still a very strong year-over-year growth.
spk04: Great. Thank you. And just one follow-up on the year-ago 5 launch. With that coming around just around the corner here, what kind of impact do you think that's sort of going to have on the P&L? Could we expect any fluctuations in return rates as
spk01: know some people upgrade from from their existing systems to the five yeah and and very thoughtful our focus is really is how are we going to drive the best user experience and and this is what makes us so excited about uh year ago five that we truly believe has a lot of revolutionary benefits that's not the main emphasis here So we're really focused on how we're going to bring this to market in the best possible way. Will there be some short-term movements on our KPIs for sure? And I know Adam has basically a rundown of those, but, but long-term we, you know, Eargo 5 is a new platform that will enable, you know, further improvements on operating metrics. But that's more on a long-term basis. And I think more short-term variations here, Adam.
spk03: Yeah, and I think we've talked about it a fair amount, but obviously one of the things we're really excited about with Year Go 5 is the ability to become refurbished and use refurbished product. When there are returns, it'll help drive a tailwind to gross margin. That will take a number of months to ramp up, so we expect that impact to really be more felt towards the fourth quarter. So in the short term, we do expect modest growth gross profit headwinds in terms of the Ergo 5 launch and the kind of ramping into using up some of the initial inventory of prototype parts before we actually turn on the In terms of the revenue implications, right now we're modeling it to be, obviously, we're going to have, there's going to be some benefits from repeat customers buying more of the Ergo 5, and we expect that to continue to ramp throughout the year. But we haven't modeled in a change in return rate specifically around Ergo 5. Obviously, we expect to see a benefit there, but we have not built that into our model.
spk04: Great. Thank you.
spk02: Thank you. Our next question comes to the line of Bob Hopkins from Bank of America. Your question, please. Bob, you might have your phone on mute. Looks like he might have disconnected. Larry Beagleson from Wells Fargo, your question, please.
spk07: Hi, it's Leigh calling in for Larry, and thanks for taking my question. Just on the revenue guidance for 2021, can you give any color around relative growth of the three segments, insurance, cash pay, and the repeat business? And I have a follow-up to that.
spk01: No, no. Overall, as I think we've spoken about, you know, we see an opportunity – to grow all our customer types here. So that's really the emphasis. And that's also inherently, I think, in terms of more detailed guidance. Adam, what are we comfortable sharing here? No, absolutely.
spk03: I mean, what we saw, we actually, in the back half of 2020, had roughly 45% of the volume came from insurance, a little bit more than that in Q3, a little bit less in Q4. The way we're modeling 2021 is basically a continuation of that similar behavior in terms of the insurance to a mixed percentage of the business. So we expect it to continue to grow in all three segments, as Christian said, and we expect the mix to be kind of weighted towards about 45% insurance throughout the year.
spk07: Okay, that's helpful. And then just on the rest of P&L, you mentioned, you know, gross margin impact from refurbishment will be later in the year. So it sounds like should we expect, you know, a tick down in the gross margin kind of in the early part of the year and then a return to the higher end of the range towards the latter part? And also any commentary around spending cadence this year given the launch that you have? Thanks.
spk03: That's great. I can provide the commentary. I think, look, I mean, obviously, we felt really good about the gross margins in Q4. And I'd expect Q1 and the beginning part of Q2 to be in line with kind of, you know, where we've been trending in the middle of the range. I expect the dip to come to, you know, launches are always good. One week can affect a quarter in launch timing, but I expect a slight dip in Q2 and into Q3 as we have the prototype parts and that you don't have the refurbishment. And then exiting Q4 at the upper end or slightly a tick above the range for Q4 versus the full year. in terms of gross margin. Looking down the P&L, I mean, our big focus, as Christian's always said, is we're going to be responsible about our growth, but we don't want to do any... Our main focus is making sure as we drive growth, we are also seeing contribution improvements. So we don't want to see any of our metrics as a percent of revenue go the opposite direction year on year. So we're mindful of that, but we're also mindful that the primary focus is driving the growth, and we just want to make sure we continue to keep an eye on... increasingly increasing the goal towards profitability in the long term.
spk01: And just a minor addition to Adam's commentary here around prototypes, you know, around launch. Of course, we're not launching on prototypes, but we are spending obviously dollars currently on prototypes to really do detailed user testing. we will be expensing those as part of the launch, right? So that's more where it's coming from. Of course, all the products are going to be on volume production parts, and we feel great about that, but we need to flush this through the P&L right around the exact launch timing.
spk07: Great. Thanks, Dan.
spk02: Thank you. Our next question comes from the line of Margaret Ketzer from William Blair. Your question, please.
spk06: Hey, guys. Good afternoon. Thanks for taking the time today. I wanted to follow up on insurance. Obviously, it's been a huge success since launch, and it only seems to get better. So I was hoping to get some color around whether that scale is associated with rampant advertising versus better awareness versus better targeting. And then if you guys can also give us a comment on kind of the broader trend in hearing aid coverage. My understanding is that kind of coverage is starting to improve broadly nationally, but you tell me.
spk01: All right, Margaret. Thank you. No, clearly the highlight of Q4 in terms of, you know, the pretty significant beat we came out was the outperformance of insurance. We went out, you know, in Q4, as we spoke about on our early guidance. But, you know, we went out with, you know, pretty aggressive, you know, added media, given the holiday promotions, focused on the cash pay. And we saw a nice sequential growth on cash pay. As expected, but what really, you know, positively, you know, surprised us was the impact of insurance, we saw insurance follow. And we actually saw nice sequential growth. Remember Q3 was a very strong insurance quarter that we were very pleased with, but also uncertain on whether we would maintain that momentum. And we managed to accelerate that momentum. So I think the key thing behind the insurance that we're looking at right now with federal employees is awareness. So when we are on more national media, we see it's driving awareness. It's basically having people call in and contact us to understand their potential eligibility. So it's really about driving awareness. So how do we think this scales? This is, of course, something that we're looking very, very carefully at looking into this year and forward. We know from an overall penetration point of view, as I covered in the prepared remarks, we have barely scratched the surface. We have approximately 1% penetration of that specific opportunity. So we know that a lot, but we also know that it is an awareness game. So how are we going to be driving this efficiently? So that's why we're absolutely being conservative around how fast we can ramp it and grow it. We feel very good with the guidance that we're giving, but of course it's a key area for us to work on. So that was on the scaling. In terms of trends on coverage, there's a lot of talk about it. I think there's also a lot of enrollment that has been happening. Concretely, we're not really seeing any specific added benefits to specific health plans. It is an area that we're starting to look into. But also remember, right now, we're not selling to general health care plans or Medicare Advantage plans. So it's an area we're looking into, but we're not necessarily seeing increased coverage. I think we're seeing more focus and attention on hearing as a category, and we believe that there's potential, but we haven't seen anything that indicates that coverage is necessarily going up.
spk06: Okay. Yeah, useful. And then I wanted to talk about return rates as well. I understand the majority of the decrease in return rates in 2020 was attributed to mix. But are you seeing return rates within the individual segment categories fall as well? And I guess more specifically, what did you see here out of that in 2020 and what are you assuming in 2021?
spk03: Margaret, that's a great question. And just to kind of provide color on that, I mean, the majority of the movement by far is that mixed shift. And so we did see modest improvements in cash pay and even insurance throughout the years. We continue to refine, but that would be measured in cash. in a fraction of the total improvement. We haven't modeled the business in 2021 to see improvements in any one of the customer types. And we've held them next relatively stable. So most of our revenue growth is really attributable to volume growth in 2021 model.
spk06: Okay, got it. And just kind of longer term, where do you guys expect that return rate to end up? Realizing that mixes is one factor, but maybe you guys can do other things in terms of close rates and so on to improve it.
spk01: Thanks, guys. I think back to how we built the model, I think we have been tracking ahead of where we believe we're almost at the level where we can where we can see ourselves ending up. It doesn't mean that we think there's no more opportunity, because this is ultimately a user experience. And the lower the return rate goes, it's a better user experience. So it's something that will always be a top priority for us. So we are at that level. Obviously, this is going to be impacted as we expand on our channel structure and focus more on omnichannel. We know repeat. is going to come in. That's going to help us give us more tailwind to do driving it down, but also looking longer term, hopefully, you know, getting more into retail opportunities and other areas that's going to be changing sort of a nature of it. But, but right now we are essentially, you know, we're already leading the hearing industry in terms of return rates. So we're doing really well. But it's going to be a continued focus, but we're not guiding any further improvements on return rates.
spk06: Perfect. Thanks, guys.
spk02: Thank you. This does conclude the question and answer session of today's program. I'd like to hand the program back to Nick Lidico for any further remarks.
spk05: Thanks, Operator, and thank you, everyone, that joined us on the call today. This concludes the EARGO quarter and full year 2020 earnings conference call.
spk02: Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.
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