Eargo, Inc. (EAR) Q1 2021 Earnings Call Transcript

Eargo, Inc. (EAR)
Q1 2021 Earnings Call
May 12, 2021, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Eargo first-quarter 2021 earnings conference call. [Operator instructions] As a reminder, today's conference call is being recorded. I will now turn the conference over to your host, Mr. Nick Laudico, vice president of investor relations.

Sir, you may begin.

Nick Laudico -- Vice President of Investor Relations

Good afternoon, everyone, and welcome to the Eargo first-quarter 2021 earnings conference call. The press release and slides to accompany this call are available on our investor relations website at ir.eargo.com. Please note, we have also provided supplemental historical financial information at the end of the slide presentation. 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. 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, 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 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 non-GAAP financial results on today's call. Please refer to today's press release and slide presentation for a full GAAP to non-GAAP reconciliation. With that said, I will now turn the call over to Christian.

Christian Gormsen -- President and Chief Executive Officer

Thank you, Nick, and good afternoon, everyone. Following a record fourth quarter, I'm pleased to report that we again delivered outstanding performance in the first quarter of 2021 further increasing our confidence in our 2021 guidance and longer-term financial objectives. Before turning the call over to Adam for a more detailed review of our first-quarter financial performance and 2021 guidance, I will briefly highlight some of our key revenue and volume growth drivers and provide an update on the upcoming launch of Eargo 5, all on those revolutionary product efforts. Starting on Slide 5, we delivered strong first-quarter net revenue growth of approximately 74%.

Our first-quarter growth was particularly impressive given that we did not have the benefit of a new product launch or growth from repeat customers compared to the first quarter of 2020. We also delivered gross systems shipped growth of over 66% and a return accrual rate of approximately 23%, an improvement of 8 points year over year. Both revenue and volume growth in the first quarter were supported by several drivers. First is the further penetration into the insurance market.

Our insurance opportunity remains large and underpenetrated as we are still only serving less than 2% of what we consider to be our immediately addressable insurance market. Secondly, growth was also driven by the continued scale-up of both digital marketing and our national media presence, driving consumer awareness of both our innovative products and the Eargo brand. These investments once again delivered volume growth across both cash pay and insurance customers, as we leverage our media dollars to attract multiple customer types and achieve scalability on operating expenses. We know national advertising is a successful tool in attracting these diverse customer types and building consumer awareness of Eargo's innovative products, our distribution model, and telecare approach to audiology.

What we continue to be impressed by are the ways in which our team continuously leverages data analytics to methodically balance the mix of digital, TV, and traditional offline media. During the second quarter, we are investing in creative, website, support, and training ahead of the late second-quarter launch of Eargo 5, preparing to introduce this game-changing product to both new and existing customers. Supporting all of this growth is what we believe is the most established and integrated telecare model in the hearing industry today, an important part of our competitive moat. Our platform is simple, convenient, personalized, scalable, and completely transforms the consumer journey.

Consumers can schedule telecare appointments with our licensed hearing professionals before purchase, offering convenient clinical support and hearing screening in the comfort of their own home. This has proven to be a powerful conversion tool that we plan to further leverage with the launch of Eargo 5. But it doesn't stop with product purchase. This innovative infrastructure and highly trained team of telecare licensed hearing professionals work just as hard post-purchase to engage customers to ensure an outstanding customer experience and build long-term Eargo brand loyalty.

It is becoming more evident that telecare is here to stay, not just in hearing but across healthcare. As a pioneer in bringing a vertically integrated telecare experience to hearing care, we believe we are all well-positioned to lead the disruption of this large and underpenetrated market as more consumers realize that is simply a better, more efficient way to solve for hearing loss. We will continue to invest in telecare to extend our competitive advantage and support our long-term revenue growth expectations. Turning now to Slide 6, and a key growth driver for the second half of the year, Eargo 5.

We are incredibly excited as we approach the initial launch of our most revolutionary product ever, late in the second quarter. As we've discussed, Eargo 5 will be operating on a completely new platform across hearing instruments, charger, and mobile app. We have tested the product with a range of experienced users and the response has been nothing short of outstanding. Starting with the fundamentals of helping people hear better, our users have told us that Eargo 5 delivers significant sound quality and feedback cancellation improvements over an already impressive Neo HiFi.

Eargo 5 will also deliver more audiological gain, allowing the device to fit more people with hearing loss at the more severe end of the moderate hearing loss category. Moving beyond the fundamentals, Eargo 5 will also feature a smaller physical design, allowing us to fit more people, who previously may not have been good candidates for an in-the-canal design and/or improve just for existing users such as me. But the feature we are most excited about is Eargo 5's in-situ hearing screen and profile adjustment capabilities. Customers will be able to measure hearing loss in real time and real situations versus inside an audio booth, using the hearing aid itself either by themselves or while conducting a telecare appointment with one of our licensed hearing professionals.

They can then calibrate their devices or work with our licensed hearing professionals to adjust the profiles and sound settings, which are pushed to the hearing aid in real time, while the device is in the ear canal. This is a new level of consumer experience, making an already easy-to-use product even easier while delivering the highest level of personalization. Other features include a custom-designed lithium-ion battery co-developed with the world leader in microbatteries VARTA out of Germany, inductive charging with no metal contacts, and waterproof functionality, all of which we believe will further improve the day-to-day functionality of the device that sits in a harsh environment inside the ear canal. In parallel with the launch of Eargo 5, we are also launching a totally redesigned mobile companion app that will take user experience to new levels.

This app will enable many of the functions I just described such as in-situ hearing assessment and profile adjustments, as well as embedded telecare scheduling and video call functions, deepening the connection between the consumer and our licensed hearing professionals. We believe the launch-related investments we are making in the second quarter will support an exciting Eargo 5 introduction to consumers and we continue to expect a late second-quarter launch with material revenue contribution beginning in the third quarter. Before turning the call over to Adam, I want to deliver a special thank you to our R&D and software teams, who have worked tirelessly to make this product everything we hoped it would be. We are incredibly fortunate to have such impressive and dedicated professionals driving the future of Eargo and helping more people hear better.

Let me now turn it over to Adam for his review of our financial results.

Adam Laponis -- Chief Financial Officer

Thanks, Christian. Given Christian's thorough discussion of revenue drivers, I will start with gross systems shipped. As a reminder, we define the system as two hearing aids: a charging case and starter accessories shipped as a single unit. First-quarter 2021 gross systems shipped were 11,704, up 66.5% year over year.

The year-over-year change was driven by strong performance of our data-driven approach to demand generation, national advertising, and increased penetration of the insurance market. As expected, gross systems shipped were slightly down sequentially due to the strong holiday promotion volumes in the fourth quarter and a product launch in the second quarter of this year as compared to first-quarter launches in previous years. First-quarter 2021 return accrual rate was 23.2%, compared to 28.2% in the first quarter of 2020 and 24.2% in the fourth quarter of 2020. The reduction in our return rate was driven primarily by a higher mix of insurance customers.

Moving to non-GAAP gross margin and non-GAAP 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 expense. Please refer to our GAAP to non-GAAP reconciliation included in today's earnings release. First-quarter non-GAAP gross margin was 72.2%, compared to 63.2% in the first quarter of 2020 and 70.8% in the fourth quarter of 2020.

The year-over-year gross margin expansion was primarily due to a decrease in sales returns as a percentage of gross systems shipped, higher average selling prices, and lower cost of goods sold. First-quarter non-GAAP sales and marketing expenses were $15.0 million or 68% of net revenues, compared to $10.7 million or 84.7% of net revenues in the first quarter of 2020. The increase was driven by expanded investments in demand generation, including national advertising, as well as Eargo 5 launch preparations. Non-GAAP research and development expenses were $3.7 million or 16.8% of net revenues, compared to $2.6 million or 20.9% of net revenues in the first quarter of 2020.

Non-GAAP general and administrative expenses were $5 million or 24.8% of net revenues, compared to $5.8 million or 46.1% of net revenues in the first quarter of 2020. On a non-GAAP basis, we experienced an increase in G&A due to higher costs associated with being a public company. These increases, however, were offset by IPO cancellation expenses incurred back in Q1 of 2020. Non-GAAP net operating loss for the first-quarter 2021 was negative $8.2 million, compared to a non-GAAP net loss of negative $11.2 million in the first quarter of 2020.

Finally, we had cash and cash equivalents of $201.6 million at March 31, 2021. Now, turning to guidance. Due to our high degree of confidence in our ability to drive growth and capitalize on the momentum in our business, we are raising full-year 2021 net revenue guidance to $89 million to $93 million, up from $87 million to $93 million. We expect revenue growth to be driven by robust volume growth with stable customer ASPs and stable return accrual rates as compared to how we exited 2020.

Looking at revenue cadence for the remainder of the year, we expect the second half of 2021 to generate approximately 52% of full-year revenue. Turning to gross margin guidance. We are reiterating GAAP gross margin guidance of between 68% to 71%. We are also reiterating non-GAAP gross margin guidance of between 70% and 72%.

This guidance reflects our confidence in continued consumer adoption through the remainder of 2021, particularly with the launch -- initial launch of Eargo 5 in late Q2. I would now like to turn it back to Christian for summary closing remarks.

Christian Gormsen -- President and Chief Executive Officer

Thanks, Adam. We are very pleased with our results for the first quarter of 2021 and how this momentum positions us for our strong 2021. We remain focused on executing our strategic initiatives this year, including driving volume growth through customer mix, scale-up of both digital and offline demand generation, and of course, the launch of Eargo 5. Our initial progress on these initiatives gives us increased confidence in achieving our full-year revenue and gross margin guidance.

We remain focused on our mission of helping more people hear better and couldn't be more excited for what the future holds for Eargo. That concludes my prepared remarks, and I would like to turn the call back to the operator for Q&A.

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question comes from Robbie Marcus of J.P. Morgan. Your line is open.

Robbie Marcus -- J.P. Morgan -- Analyst

Great. Thanks for the question, and congrats on a nice quarter. Maybe to start, a couple of things. The first was, how did the mix of patients look in the quarter? You exceeded expectations, was just hoping to get a better sense of was it repeat customers, was a new direct-to-consumer customers? And how much was due to the insurance channel?

Christian Gormsen -- President and Chief Executive Officer

Good to talk, Robbie. Christian here. We saw growth in both cash pay and insurance. We did not see a lot of repeat, so that was significantly lower than we'd seen in prior quarters as expected.

So that was sort of the development. So again, where we are pleased is the fact that we were able to grow both cash pay and insurance and specifically on the mix item.

Adam Laponis -- Chief Financial Officer

Yes. Again, it goes back – so, Robbie, we were pretty close to where we were during that Q3 last year in the high-40s on insurance. The mix came in pretty much in line with expectations, and we talked about it, I believe, in prior conversations. We expect the full-year 2021 insurance mix to be roughly where it was in the back half of 2020 to go over the mid-40s.

Robbie Marcus -- J.P. Morgan -- Analyst

Got it. OK. So it implies pretty nice direct-to-consumer growth as well in the quarter. So maybe second from me to return rate, I think it was a record low for you at 23%.

Maybe you could just touch on what drove that. And I think in the past, we've been thinking maybe something like 25% was the low, but how low do you think this can trend down now as you're breaking barriers toward the bottom end here?

Christian Gormsen -- President and Chief Executive Officer

Yeah. No, no. You put it right. We are ahead of our own expectations and I think this is really due to the diligence of our support team and how do we really keep optimizing the user experience.

We're not changing our overall assumptions on what we can do. With return rate, there will be fluctuations from time to time here. We definitely got a little bit of benefit by the slightly better mix that Adam just talked about on the insurance side. Again, it's early to say.

We will keep hunting this one, but we're not changing our assumptions on where we can take the return rates going forward.

Robbie Marcus -- J.P. Morgan -- Analyst

Got it. And if I could squeeze one more in here. On guidance, you beat by $2 million versus the $3 million in first quarter. You raised the low end of guidance by $2 million as well.

I know you typically have a very conservative approach toward setting expectations, but just want to make sure, anything to read into that or it was just the low end and not the midpoint that went up? Or is it just really early in the year still?

Christian Gormsen -- President and Chief Executive Officer

No, no. And again, we've been getting some great support and guidance here. And we feel great and given the strength of Q1, we feel even better about our full-year guidance. But it is like you said, we're one quarter into a year, and it's definitely tumultuous year that we are looking into.

So we don't want to get ahead of ourselves, but we do feel very good about where we are right now. So that's the logic.

Robbie Marcus -- J.P. Morgan -- Analyst

OK. Great. Thanks again.

Christian Gormsen -- President and Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from Margaret Kaczor of William Blair. Your line is open.

Margaret Kaczor -- William Blair -- Analyst

Good afternoon, everyone. Thanks for taking the questions. I was hoping to start a little bit on the April trends or even at the beginning of May. Are you guys seeing any pullback potential demand as audiologist clinics open up or patients begin to return there, or you're actually seeing maybe more demand as patients start to go to restaurants and be mobile and try to be more in groups?

Christian Gormsen -- President and Chief Executive Officer

Those are all valid crisis there. Again, we don't give specific quarterly guidance in terms of what we're doing here, we're definitely seeing -- there's always moving pieces in that sort of demand landscape. I would say, we're really benefiting here from having multiple ways of driving our demand, be that through digital, be that through TV, be that through more direct mail activities as well. So we're not seeing any major changes that are changing any of our outlooks in terms of the business here.

I think we -- what we really have built, Margaret, is a model that is really resilient to sort of large macro changes and I think we also have the ability to adapt our media mix and how we focus our business based on what it's telling us. So this is something we track real time and we're making adjustments real time, but we are not giving sort of specific guidance to the quarter here.

Margaret Kaczor -- William Blair -- Analyst

OK. Fair enough. I had to try. So as we think of Eargo 5 -- and I'll have one more, too.

But as I think of Eargo 5 and that launch, I know you guys talked about it being more material in the back half of this year. What have you guys traditionally seen when you've launched a new product? Does that give you a short-term bolus, is it a long-term bolus? Does it help you on close rates? What are the metrics we should be looking at for success for that launch?

Christian Gormsen -- President and Chief Executive Officer

Yes. So really, what we've seen, and I think the best example we have was the launch of Eargo HiFi last year in Q1. It's really a long-term impact. So for us, what's going to be key with Eargo 5, it's a brand new platform, everything is new around us and we do believe it has a lot of potential.

The key is not to drive a short-term impact or a spike in Q3, but it's really -- this is a platform that we will be driving going forward. So that's really our emphasis. I think that's also the case here. I would say, what is the user reception? Are we dividing that and where we really see this as -- we see it on conversion rate.

The other piece we see is really on returning customers, right? And I think this is where we do have expectations that we can drive a higher level of returning customers when we launch Eargo 5. And then the rest is more how do we really continue to build the long-term growth of Eargo. And this is an important platform in terms of improving also our telecare approach given all the higher degree of personalizations and integrations that we can do.

Margaret Kaczor -- William Blair -- Analyst

OK. And then just one last one for me. I was hoping to touch on competition a little bit, just because we've started getting more questions around that. Have you seen any changes to the competitive environment either today or in the future and that could be some of the online services companies like hear.com or some of the other manufacturers maybe outside of the Big Five that could be looking at you and saying, oh, I can just go ahead and copy you, guys? Thanks.

Christian Gormsen -- President and Chief Executive Officer

Expected of you. Yeah, exactly. Now, there's obviously a lot of things happening in the hearing industry and I think it's proving the potential of this industry in general across hear.com, across Lively, Bose with their recent release, Sonova's recent acquisition of Sennheiser consumer. So there's definitely a lot of activity in this space.

Back to my earlier comments about Eargo, I think we are not seeing that impact our business. To be fair, none of this outside Bose's announcement is new. If we had to count them around Lively has been around for a long time. So this is not anything, it's not a new dynamic.

In the industry, I think it's just more visibility. And so the industry, which is something we will always applaud. So we haven't seen anything that is sort of making us think extra hard about what we're doing. I think, if anything, we're feeling more confident that what we are building being fully vertically integrated is still a very differentiated and a unique value proposition that will hopefully continue to push our leadership in terms of driving penetration into this industry.

Margaret Kaczor -- William Blair -- Analyst

Great. Thanks.

Christian Gormsen -- President and Chief Executive Officer

Thank you.

Operator

Thank you. [Operator instructions] Our next question comes from Larry Biegelsen of Wells Fargo. Your line is open.

Larry Biegelsen -- Wells Fargo Securities -- Analyst

Good afternoon, guys. Thanks for taking the question. A couple to start on Eargo 5. So, Christian, what still needs to be done before you launch? And have you decided if there's going to be a price premium?

Christian Gormsen -- President and Chief Executive Officer

Good questions as always, Larry. Where we are with Eargo 5 is planning the back end of the ramp, so this is more of the logistics supply chain piece of it. We have gone through our registrations and all of it, right. We are constantly monitoring all of the feedback we're getting from test users in terms of sort of the software experience, but from a hardware point of view, we're fully locked in and it's more a ramp, right? So now it's really tuning on the software and how do we actually position this the right way.

Earlier question to Margaret, our focus here is really how do we bring this new platform out in a way that allows us to continue to delight our customers? So that's really the timeline piece of it or the remaining blocks in front of us. On the price point, we've debated this a lot. We believe it's very, very important to drive more access into this category, so we're not going to be introducing Eargo 5 at a premium and this is not our lack of confidence in the products. On the contrary, we do believe by bringing out a revolutionary product at a similar price point to what we're seeing today, we can drive hopefully even stronger conversions and motivate more people to get into the industry.

So it's something that we, from a strategic point of view, are very proud of being able to do -- and again, very consistent with what we baked into our guidance here just to pre-empt that question.

Larry Biegelsen -- Wells Fargo Securities -- Analyst

Christian, just to follow up, how derisked do you think the late Q2 launch is? Based on what you said that there are some software tweaks, how derisked is the late Q2 launch?

Christian Gormsen -- President and Chief Executive Officer

You know, I feel very comfortable or else we wouldn't be talking about this openly on this call, right? I'm wearing the hearing aids, as we speak, right. I think for us, it's more, how do we scale the launch and that's why we're also saying, we will see material revenue impact in Q3. But from a product readiness point of view, both from a hardware point of view, from an acoustic point of view, I've never felt that around where we are, but obviously, there's a lot of things that you need to tie together at the end of the day, but sort of core hardware plus core audiological, this is at the best I've felt with any Eargo product launch.

Larry Biegelsen -- Wells Fargo Securities -- Analyst

Christian and maybe Adam, I'm trying to understand kind of the guidance and the Eargo 5 impact, because the benefit seems so clear and you said, kind of this is the biggest product launch in the company's history. So why would there be an inflection in the business given these large number of improvement? Your guidance seems to imply a modest sequential increase in dollar sales. If I look at that 52% for this year that you talked, Adam, that's lower than what we saw in 2019, in 2020. So help me reconcile what seems like a pretty important and should be successful launch for you guys with the guidance you gave.

Christian Gormsen -- President and Chief Executive Officer

Yes. Now, maybe I start, and I'll definitely let Adam give you the nuance here. I think, what's been so important in everything that we've done from a guidance point of view since we started exploring the public markets with you has really been, we want to base it on what we have seen historically if we don't want to make assumptions to pushing things to a new level, right? That does not mean we're not going to lean into opportunities, we will always do that. And I also believe that we have proven that we will do that.

But in terms of basing our guidance on higher conversion rates or higher adoption, I think we would be putting a lot of risk into our guidance and that's not what we've set out to do. But Adam, you can probably provide more on that.

Adam Laponis -- Chief Financial Officer

Christian said it well. I think, Larry, my approach, the team's approach has always been -- let's put in the guidance things we know we can achieve, and we feel very confident. And so we are -- you can hear it -- if you can't hear it from tone, I'll say it directly, we feel very good about having opportunity to meet and exceed our guidance for 2021. I think, for me, the biggest -- tuning the things on, thinking about it as we built this are really around, let's not get ahead of ourselves on the pricing, let's not get ahead of ourselves on the RC rate, let's not get ahead ourselves in the volume, but we see opportunity across the board to outperform in every area on a full-year basis.

Larry Biegelsen -- Wells Fargo Securities -- Analyst

Got it. And just last from me. Christian, how are you thinking about the timelines for opportunities outside of the DTC models such as the omnichannel opportunity in international and other insured markets? Thanks for taking the questions.

Christian Gormsen -- President and Chief Executive Officer

Yes. Now, this is another part that we've really been doubling down on our investments in through Q1 and into Q2. So first of all, I believe in all of these opportunities. As we've spoken about before, specifically, given the construction and plan designs within the insurance markets, we're not expecting any meaningful insurance to happen inside this year, but there are a lot of moving elements in the marketplace right now given that obviously the world is opening up more and more and people can get out and about more, which is also opening some of the additional omnichannel opportunities.

When and to what scale that's going to happen is hard to predict, but it's something that we are very focused on, we are building our teams to be able to execute on it. But I can't give any guidance on specific timing here other than when something happens, we definitely believe that we are in the ready spot to participate when opportunities come up. I hope that's a fair way of putting it.

Larry Biegelsen -- Wells Fargo Securities -- Analyst

Got it. Thanks for taking the questions, guys.

Operator

Thank you. I'm showing no further questions at this time, I'd like to turn the call back over to Mr. Laudico for any closing remarks.

Nick Laudico -- Vice President of Investor Relations

Thanks, operator, and thank you, everyone, for joining us on the call today. This concludes the Eargo first-quarter 2021 earnings conference call.

Operator

[Operator signoff]

Duration: 34 minutes

Call participants:

Nick Laudico -- Vice President of Investor Relations

Christian Gormsen -- President and Chief Executive Officer

Adam Laponis -- Chief Financial Officer

Robbie Marcus -- J.P. Morgan -- Analyst

Margaret Kaczor -- William Blair -- Analyst

Larry Biegelsen -- Wells Fargo Securities -- Analyst

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