Eargo, Inc.
Q4 2020 Earnings Call Transcript

Published: 26 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Eargo Fourth Quarter 2020 Earnings Conference Call. I would now like to introduce Vice President, Investor Relations, Nick Laudico. Please go ahead.

[Nicholas Laudico:]

Good afternoon, everyone, and welcome to the Eargo 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.eargo.com. As a reminder, both this live call and a digital replay will be available on our IR website. Joining me on today's call are Christian Gormsen, President and Chief Executive Officer; and Adam Laponis, Chief Financial Officer. Christian and Adam will provide prepared remarks, and then we will open the call to Q&A.

[Christian Gormsen:]

Thank you and good afternoon, everyone. We're very pleased with our fourth quarter and full year 2020 performance, which caps off a truly incredible year at Eargo. On that note, I would like to thank all of my colleagues at Eargo for that 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 shipped 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 US. Our broader media reach was driven by strong performance of our national TV advertising, which we believe continues to succeed in 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 that 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 lower cost. However, the magnitude of insurance orders we received as a result of holiday advertising was ahead of our expectations, particular in a quarter that is seasonally more cash pay weighted.

[Adam Laponis:]

Thanks Christian. Given Christian's thorough discussion of revenue drivers, I will start with gross system ship. As a reminder, we define a growth system as two hearing aids, a charging case and starter accessories shipped in a single unit. Fourth quarter gross system shipped 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 and 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% year-over-year reduction in our return rate was driven by the mix shift in volumes towards lower returning insurance and repeat customers.

[Christian Gormsen:]

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 Eargo 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 Eargo 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 and telecare support for hearing loss. In distribution, we opened a new channel for consumers to acquire hearing aids at low cost through insurance, driving down our return rates 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 of national advertising, and the launch of Eargo 5 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 underpenetrated hearing aid market over the next several years. In summary, we could not be more excited about what the future holds for Eargo, 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.

[Operator:]

Our first question comes from the line of Robert Marcus from JP Morgan. Your question, please.

[Unidentified Analyst:]

This is Simon on for Robbie. Congrats on the great quarter. So 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 revenue sequential decline? I can understand that COVID benefits your input benefits cases pick up and you benefit in this case those comes down. So it's a win-win, but what's involved in your base case here?

[Christian Gormsen:]

Okay. Again, thank you for the question here. And let me let me start overall, what all our guidance is built on and Adam is going to give the details for Q1. But overall, 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 launches that we have been doing historically, and that we know what's coming, of course, also included in our in our guidance. And then really, and especially coming into 2021, this 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, further expansion of insurance, international, etcetera, that physical retail experiences, none of those factors are included in our guidance. So Adam, do you want to share?

[Adam Laponis:]

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 our first big quarter of insurance volume in Q1 of 2020. And really, we see that that growth in Q1 2020 growth was a sequential 240%. So 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 2019 to 2020. But we also had the launch of the Eargo HiFi, will be launching the Eargo 5 here in Q2 of 2021. If you look at the full year, and you think about this sequential performance, we expect sequential improvement each quarter going forward after Q1. So I'd expect to be about at a 47% to 53% on that back half split in terms of the full effect.

[Christian Gormsen:]

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.

[Unidentified Analyst:]

Great, thank you. And just one follow up on the Eargo 5 launch. With that coming around just around the corner here, what impact do you think that's going to have on the P&L? Could we expect any fluctuations in return rates as some people upgrade from their existing systems to the 5?

[Christian Gormsen:]

Yes, our focus is really is how are we going to drive the best user experience and this is what makes us so excited about Eargo 5, 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 long term, Eargo 5 is a new platform that will enable further improvements on operating metrics. But that's more on a long term basis. And I think more short term variations here. Adam?

[Adam Laponis:]

And I think we've talked about it a fair amount. But obviously, one of the things we're really excited about Eargo 5 the ability to become refurbished and use refurbished product. And when there are returns that will 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 gross profit headwinds in terms of the Eargo 5 launch ramping and using up some of the initial inventory of prototype parts before we actually turn on the refurbishment capabilities as we progress throughout the year. In terms of the revenue implications, right now we're modeling it to be -- obviously there's going to be some benefits from repeat customers by Eargo 5 and we expect that to continue to ramp throughout the year. But we haven't modeled in a change in return rates, specifically around Eargo 5. Obviously, we expect to see a benefit there, but we have not felt good, thinking .

[Operator:]

Our next question comes from a line of Larry Eagleson from Wells Fargo. Your question, please.

[Unidentified Analyst:]

Hi, it's Lia calling in for Larry. And thanks for taking my question. Just on the revenue guidance for 2021, can you give any color relative to growth of the three segments, insurance, cash pay and repeat business? And I have a follow up to that.

[Christian Gormsen:]

Overall, as I think we've spoken about, 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, whatever you're comfortable sharing here.

[Adam Laponis:]

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 than Q4. The way we're modeling 2021 is a basically a continuation of that similar behavior, in terms of the insurance to mix percentage of the business. So we expect this to continue to grow and all through savings, as Christian said, and we expect the mix to be weighted towards about 45% insurance.

[Unidentified Analyst:]

Okay, that's helpful. And then to sum the rest of the P&L, you mentioned gross margin impact from refurbishment will be later in the year. So sounds like -- should we expect a tick down in the gross margin in the early part of the year and then return to the higher end of the range towards the latter part? And also, any commentary around spending cadence this year, given the launch you have. Thanks.

[Adam Laponis:]

That's right, I can provide the commentary. I think you, 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 where we've been trending in the middle of the range. I expect the dip to come -- launches are always one week and affect the quarter and launch timing, I expect a slight dip in Q2 and into Q3, as we had the prototype parts and the refurbishment and then exit in Q4 at the upper end in slightly tick above the range for Q4 versus the full year in terms of gross margin. Looking down to P&L, our big focus, as Christian's always says, 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 increasing the goal towards profitability in the long term.

[Christian Gormsen:]

And just a minor addition to Adam's commentary here around prototypes, around launch, of course, we're not launching on prototypes, but we are spending dollars currently on prototypes to really do detailed user testing. We will be expensing those as part of the launch. 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.

[Operator:]

Our next question comes from the line of Malgorzata Kaczor from William Blair. Your question, please.

[Malgorzata Kaczor:]

Hey, good afternoon, and thanks for taking the time today. I wanted to follow up on insurance. Obviously, it's been a huge success since launch. And that only seems to get better. So I was hoping to get some color around whether that scale was associated with brands and advertising versus better awareness, versus better targeting. And then, if you can also give us a comment on the broader trend in hearing aid coverage? My understanding is that coverage is starting to improve broadly nationally, but you tell me.

[Christian Gormsen:]

Clearly, the highlight of Q4 in terms of the pretty significant beat we came out was the outperformance of insurance. We went out in Q4, as we spoke about on our early guidance. But we went out with pretty aggressive 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 positively 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, the 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, how do we think this scales, and this is, of course, something that we're looking very, very carefully at looking into, 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, 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 under scaling. In terms of trends and 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's best potential, but we haven't seen anything that indicates that coverage is necessarily going up.

[Malgorzata Kaczor:]

Okay, useful. And then, I wanted to talk about return rates as well, as I understand majority of the decrease in return rates in 2020 was attributed to mix. But are you seeing return rates within the individual segment categories call as well? And more specifically, what did you see here out of that in 2020, and what are you seeing in 2021?

[Adam Laponis:]

Great question. And just to provide color on that. The majority of the movement, by far the best, is that mix 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 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 soon. So most of our revenue growth is really attributable to volume growth in 2021 model.

[Malgorzata Kaczor:]

Okay, got it. And, just longer term, where do you expect that return rate to end up? Realizing that mix is one factor, but maybe you can do other things in terms of close rates and so on to improve it?

[Christian Gormsen:]

No, 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 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 business can 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 driving it down, but also looking longer term, hopefully getting more into retail opportunities and other areas. That's going to be changing the nature of it. But right now, we are essentially --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, we're not guiding any further improvements on return rates.

[Operator:]

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Nicholas Laudico for any further remarks.

[Nicholas Laudico:]

Thanks, operator, and thank you everyone that joined us on the call today. This concludes the Eargo's fourth quarter and full year 2020 earnings conference call.

[Operator:]

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.