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spk06: Good day and welcome to the ERGO third quarter 2022 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Nick Ladeko, Senior Vice President, Corporate Strategy and Investor Relations. Please go ahead, sir.
spk04: Good afternoon, everyone, and welcome to the ERGO third quarter 2022 conference call. As a reminder, this call is being broadcast live and a 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 Loponos, Chief Financial Officer. Before we begin, I'd like to remind you that some of the matters discussed in the conference call will contain forward-looking statements regarding future events as outlined in our press release today. We wish to caution you that such statements are based on management's current expectations and beliefs, are forward-looking in nature, 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 include, but are not limited to, factors referenced in our press release today, as well as our filings with the SEC. Before turning the call over to Christian, I want to make note that we have posted a historical gap to non-gap reconciliation table on our IR website in the events and presentations section. With that said, I will now turn the call over to Christian.
spk01: Thank you, Nick, and thank you, everyone, for joining us today. When we spoke to you on our second quarter call, we reported on a transitionary quarter. We had recently settled the DOJ investigation, cured our SEC filing delinquency, significantly reduced our cash burn, and reached a major financing milestone in announcing the strategic commitment of up to $125 million from Patient Square Capital. Turning to the first quarter 2022, I'm pleased to report that we have made initial but meaningful steps in improving our cash paid business performance while making progress on our most important business priorities. As a reminder, those priorities include refining and expanding our physical retail strategy, accessing insurance coverage for Eargo hearing aids, including potentially regaining insurance coverage of Eargo hearing aid devices for government employees under the FEHB program, optimizing our cash paid business, and continuing to invest in innovation. I will elaborate on each of these priorities separately. But before I do, let me first comment briefly on our active rights offering of 375 million shares of common stock. This offering, through which we intend to raise up to an additional $37.5 million in proceeds before expenses, stands to represent a major step forward for the company. During our annual meeting of stockholders on October 12th, we received the stockholder approval necessary on all proposals to conduct the rights offering. We then launched the rights offering on October 31st and are currently accepting subscriptions from shareholders of record as of October 24th. Adam will provide more details on this shortly, but we urge all shareholders interested in participating in the rights offering to submit their indications promptly. If you hold your shares of common stock in street name through a broker, dealer, or other nominee, then your broker, dealer, or other nominee is a record holder of the shares you own, and you should promptly contact them should you wish to participate. The last day for non-U.S. holders to subscribe is November 10th, and the last day for U.S. holders to subscribe is November 17th. Before you invest, you should read the final prospectus dated October 27, 2022, relating to the offering filed with the Securities and Exchange Commission. Now, turning to our operational updates, beginning with our retail strategies. As many of you are aware, the final FDA rule establishing a new regulatory category for OTC hearing aids became effective October 17, 2022, allowing certain hearing aids to be sold in person without the supervision, prescription, or other order, involvement, or intervention of a licensed hearing practitioner. In preparation for this regulatory change, Yergo conducted pilots to better understand how to build the optimal consumer experience for purchasing a hearing aid in a retail environment. Offering hearing aids through retail outside of typical clinics has never been done before, so this diligence was critical from our perspective. In our view, when shopping for a hearing solution, consumers deserve a world-class in-person experience that includes four core elements. Number one, education and proper merchandising. Two, self-administered hearing screening. Three, expert sales consultation. Four, outstanding post-purchase support. Following the testing and refining of this experience in a pilot with Victra, one of America's largest wireless retailers, we agreed to expand the partnership, making Eargo available for purchase in their approximately 1,500 stores nationwide. Let me briefly outline how the consumer in Victra stores meets the four core elements I just mentioned. From an education and merchandising perspective, Soon, every Victra store will include an interactive display that generates awareness in a clean and inviting way. The display contains educational content about Eargo devices and general hearing health that consumers can also request be emailed to them directly. The interactive display also includes Eargo's self-administered hearing screen and there are demo devices for customers to handle. Store guests can engage with Victra sales consultants to learn more about Eargo, experience Eargo's virtually invisible devices up close, and see how easy it is to use the portable charger and mobile app. Victra sales consultants are trained on Eargo features and benefits, so they can guide Victra guests through the hearing journey. Consumers can then purchase in-store or take a follow-up call with an ERGO expert. Following purchase, customers receive the same outstanding post-purchase support from our client care team for as long as they own the product. We're thrilled to be able to expand consumer access to ERGO through this partnership with Victron, a leader in connecting technology to life in a trustworthy way. While the partnership is in its infancy and it is too early to comment on expected performance, we believe together we can help more people hear better. We also commend the FDA for releasing the final OTC rule, which we believe will help improve hearing health for the over 45 million adults in the US with hearing loss. As part of ERGO's commitment to innovation in connection with the OTC ruling, we also submitted a 510 pre-market notification seeking FDA clearance of expanded labeling for ERGO 5 and 6 hearing aids as self-fitting before the final OTC rule was announced. If cleared, this would allow ERGO to expand the marketing claims of ERGO 5 and 6 to include the self-fitting designation. Lastly, we're currently in the process of updating our labeling on Eargo devices to meet the new OTC requirements and expect to be able to comply with all applicable OTC regulatory requirements, including labeling, in advance of the April 14, 2023 deadline for currently marketed devices. Turning to an update on accessing insurance coverage of Eargo hearing aids, including potential insurance coverage of ERGO for government employees under the FEHB program. Since resolving the DOJ investigation last quarter, our focus has been on establishing dialogue with third-party payers and individual FEHB carriers with the objective of aligning on and establishing go-forward processes and required documentation to support the resumption of insurance coverage for ERGO devices. Internally, our focus has been on enhancing our compliance and risk management processes and building out our infrastructure across revenue lifecycle management and claims processing to support reentry into the insurance market. Beginning in September, we resumed accepting both FEHB and non-FEHB insurance as a method of direct payment in certain limited circumstances. specifically in situations when the customer has undergone additional testing by an independent, licensed healthcare provider with supporting documentation. As part of this updated process, all customers seeking to use insurance as a payment method are required to receive in-person hearing evaluations before we can accept an order or submit an insurance claim for reimbursement. We also began submitting claims on these insurance orders for reimbursement during the quarter. The volume of these submissions is currently small, and we are very early in our process. A majority of the claims we have submitted since instituting this process are still pending responses from the payers, and a portion of the claims we have submitted for reimbursement have been denied and are currently in the appeals process. In addition, it is important to note that the new regulatory category of OTC hearing aids is not covered under certain insurance plans as currently written. These carriers would need to update their coverage policies to reflect the newly established OTC category before we could access insurance coverage for OTC hearing aids, And it is our understanding that the third-party FEHB carrier that administers approximately two-thirds of all FEHB benefits nationwide currently does not intend to cover OTC devices following the recent OTC final rule. I want to emphasize that it is early in the process, in this process, and we do not expect to see any significant volume for insurance orders until we have better clarity on individual insurance plan requirements for coverage and reimbursement post-OTC final rule. We also continued focusing on optimizing our cash pay business in the third quarter. We're pleased with our sequential net revenue growth of approximately 9.1% and the stability of our cash pay business as further evidenced by an approximately 16.2% sequential growth in gross cash pay shipments shipped. Most recently, we improved conversion to over 23.0% in the third quarter of over three percentage points sequentially, reflecting a more efficient media spend. Overall, our progress in the third quarter reflects our commitment to our strategic initiatives. We are pleased with our incremental traction against these objectives and look forward to providing a further update on our next call. Let me now turn it over to Adam for a more detailed summary of the next steps in our financing process and our third quarter financial results.
spk05: Thanks, Christian. I'll start first with an update on the status and timing of the rights offering, one of our major company initiatives for the remainder of 2022. Following our significant milestone of securing a commitment of up to $125 million from Patient Square Capital in the second quarter, we entered Q3 with a focus on obtaining stockholder approval to conduct the rights offering of 375 million shares of common stock to existing stockholders pursuant to the terms of the transaction agreement with PatientSquare. At our annual meeting of stockholders, held on October 12, 2022, we received the required stockholder approval to enable the rights offering, and we intend to complete the offering by November 25, 2022, or within 150 days of closing the first tranche investment, and in any event, by December 24, 2022. We recently announced the record dates to the rights offering as October 24, 2022. Before you invest, you should read the final perspectives relating to the offering filed with the Securities and Exchange Commission on October 28, 2022. Now moving to a summary of third quarter 2022 financial results. I will provide all financial comparisons on a sequential basis, given the difficult year-over-year comp as a result of the impacts the DOJ investigation had on our third quarter 2021 financial results. As Christian mentioned, we began re-accepting insurance as a method of direct payment in a limited capacity, but do not expect a significant volume of insurance orders at this time. We are also seeking clarity on plan requirements post-OTC rule. Third quarter 2022 net revenue was $7.9 million, up approximately 9.1% sequentially. The increase was primarily driven by an increase in growth systems shift. Third quarter 2022 growth system shift were 5,156, up 15.7% sequentially. The increase was driven by an increased conversion rate and more targeted media spend. Third quarter 2022 return accrual rate was 32.3%, down one percentage point sequentially. Moving to non-GAAP growth margin and non-GAAP operating expenses. Our discussion of financial metrics of the gross margin line 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 and the historical GAAP to non-GAAP reconciliation table on our IR website in the events and presentations section. Third quarter non-GAAP gross margin was 24.5%. compared to 35.2% in the second quarter of 2022. The sequential gross margin decline was primarily due to an increase in cost of goods sold per product due to a change in product mix and an increase in inventory reserves related to certain slow-moving inventory items. Third quarter non-GAAP sales and marketing expenses were $10.6 million, or 134.5% of net revenues, compared to $12.0 million, or 166.2% of net revenues, in the second quarter of 2022. The decrease in sales and marketing as a percentage of net revenues was due to a continued reduction in advertising and marketing spend, as well as a higher lead conversion rate. Non-GAAP research and development expenses were $4.3 million, with 53.8% of net revenues, compared to $4.5 million, or 61.6% of net revenues in the second quarter of 2022. Non-GAAP general and administrative expenses were $10.0 million, or 126.8% of net revenues, compared to $16.0 million, or 220.5% of net revenues in the second quarter of 2022. The decrease was primarily due to financing costs incurred in the second quarter of 2022 related to the convertible debt transaction on patient score capital and a net decrease in accrued professional fees. Non-GAAP net operating loss for the third quarter of 2022 was $23 million, compared to non-GAAP net loss of $29.9 million for the second quarter of 2022. Moving to the balance sheet. We had cash and cash equivalents of $88.1 million at September 30, 2022. This compares to $110.5 million as of December 31, 2021. Our cash burn in the third quarter of approximately $19 million was better than our previously disclosed quarterly cash burn expectation, as reduced third-party payments were partially offset by payments associated with the patient-squared capital transaction of approximately $4 million. Moving to cash burn guidance. We continue to expect fourth quarter cash burn to be between $20 and $25 million, with the potential to achieve cash burn in the lower half of that range. I will now turn it back to Christian for closing commentary.
spk01: Thanks, Adam. The third quarter was pivotal in continuing to lay the groundwork for future Eargo's success, including the stability of our cash pay business and developing an early reentry point in the insurance market. In addition, over the last few weeks, we have established a significant physical retail presence through our partnership with Victron. With our innovative product, Recent business progress and our recent capital raise, we believe we have the potential to return Ergo to a growth mode and continue to feel positive about the future of Ergo. I will now turn the call over to the operator for Q&A. Thank you.
spk06: Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. And we'll take our question from Margaret Katzner with William Blair.
spk03: Hi, guys. This is actually Mike Don for Margaret today. Thanks for taking the question. Can you guys just talk about the dynamics of repeat customers in the quarter and what percent of gross shipments do they make? And then maybe what is your outlook for this channel, particularly given the potential increase in competition with the recent OTC Act?
spk05: Hi, this is Adam. Thanks for the question, and I'm happy to talk about it. Look, we continue to see repeat being a strong performance in Q3, and that actually was part of the ASP headwinds that we saw because of that. But it was just above 25%, between 25% and 30%, I believe it was about 27% to 28% in the quarter, up from the previous quarter by a couple of points. But we don't expect the OTC to have any negative impact on that at this time, and we haven't seen that in our performance since the rule came out.
spk03: Got it. Thank you. And then maybe just one, I can appreciate it's a bit difficult to provide guidance, but given the noise in the macro environment, can you talk about expectations for the business in 2023, maybe just qualitatively and What would make you comfortable in providing guidance in the future?
spk01: No, no, I think I'll start this off, right? You know, our focus has been bringing stability to a year ago and making sure that we position the company for where we see future growth levers while maintaining the cash pay business. I think we have, as we talked about, done really well on that. We are ready to start working on more of the retail side with the Victor partnership. It's too early, given where we are right now on that front. And I think we will learn a lot over the following quarters to see how that whole business model actually behaves and at what point we can actually provide a reliable guidance to the street on the impact on our business. So again, early on that one. I think the other piece is, as I also mentioned, on the insurance side. And I think we have a strong belief that both insurance and retail are long-term growth drivers of the industry, and we're seeing nothing in the current market that points to anything else. And our focus is more on getting in and building that. But given the new regulations, I think, especially on the insurance side, it will take longer to figure out how exactly insurance is going to be working in the new structure of the market, hence why we're not providing guidance. In the macro environment, before I'll hand it over to Adam, For more specific comments, in the macro environment, we have not seen any meaningful slowdown. We're continuing to monitor the same kind of traffic interest, and behaviors. So we're definitely optimistic about the future growth potential of the industry. And we believe that Ergo is well positioned to address this sort of omni-channel strategy that we have laid out. And Adam, I don't know if there's any further guidance to when we can give guidance. I think it's just premature at this point.
spk05: I think you said it well, Christian. I think it was clearly the desire to get back into a more normal course of business upon which we could guide. So the two areas that I'm looking for is building out that track record of understanding what comes out of the insurance as well as what comes out of the retail partnerships. So if we learn more about those two areas, that would be the trigger for me to be able to reissue guidance.
spk02: Got it. Thanks, guys. Thank you.
spk06: Thank you. And that will conclude today's question and answer session, and we'll also conclude today's teleconference. We do appreciate your participation, as everyone may now disconnect.
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