SEC Filing | Eargo, Inc.

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Form 10-Q

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM

10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2021

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from

Commission File Number:

001-39616

Eargo, Inc.

(Exact Name of Registrant as Specified in its Charter)


Delaware		27-3879805
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

2665 North First Street, Suite 300 San Jose, California		95134
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (650)

351-7700

1600 Technology Drive, 6th Floor

San Jose, California 95110

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.0001 per share	EAR	The Nasdaq Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation

S-T

(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a

non-accelerated

filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule

12b-2

of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule

12b-2

of the Exchange Act). Yes ☐ No ☒

As of

May

, 2022, the registrant had 39,354,874 shares of common stock, par value $0.0001 outstanding.

Table of Contents


		Page
	EXPLANATORY NOTE		1
	SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS		2
PART I.	FINANCIAL INFORMATION		4
Item 1.	Financial Statements		4
	Condensed Consolidated Balance Sheets (Unaudited)		4
	Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)		5
	Condensed Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit) (Unaudited)		6
	Condensed Consolidated Statements of Cash Flows (Unaudited)		8
	Notes to Unaudited Condensed Consolidated Financial Statements		9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		25
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		42
Item 4.	Controls and Procedures		43
PART II.	OTHER INFORMATION		45
Item 1.	Legal Proceedings		45
Item 1A.	Risk Factors		45
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		81
Item 3.	Defaults Upon Senior Securities		82
Item 4.	Mine Safety Disclosures		82
Item 5.	Other Information		82
Item 6.	Exhibits		83

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EXPLANATORY NOTE

As of and for the three months ended September 30, 2021, Eargo, Inc. was an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act, and a

“non-accelerated

filer,” as defined under Rule

12b-2

of the Exchange Act.

As of December 31, 2021, Eargo, Inc. ceased to qualify as an emerging growth company and was deemed to be a “large accelerated filer,” as defined under Rule

12b-2

of the Exchange Act.

On the cover page of this Quarterly Report filed on Form

10-Q,

we have checked the boxes indicating our status as an emerging growth company and

non-accelerated

filer because such statuses applied for the period covered by this Quarterly Report, which as a result has been prepared in accordance with the requirements applicable to emerging growth companies and

non-accelerated

filers. However, due to the delayed filing of this Quarterly Report on Form

10-Q,

as reported on Form

12b-25

dated and filed on November 16, 2021, as of December 31, 2021, Eargo, Inc. is deemed to be a large accelerated filer. Therefore, our Annual Report filed on Form

10-K

for the fiscal year ended December 31, 2021 will reflect that we are now deemed to be a large accelerated filer and such Annual Report will be prepared in accordance with the requirements applicable to large accelerated filers.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form

10-Q

contains forward-looking statements about us and our industry that involve substantial risks, uncertainties and assumptions. All statements other than statements of historical facts contained in this Quarterly Report on Form

10-Q,

including statements regarding our strategy, future financial condition, future operations, projected costs, prospects, plans, objectives of management and expected market growth, are forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “aim,” “anticipate,” “assume,” “believe,” “contemplate,” “continue,” “could,” “design,” “due,” “estimate,” “expect,” “forecast,” “goal,” “guidance,” “intend,” “likely,” “may,” “objective,” “plan,” “ongoing,” “positioned,” “possible,” “potential,” “predict,” “project,” “seek,” “shall,” “should,” “target,” “will,” “would” and other similar expressions that are predictions of or indicate future events and future trends, or the negative of these terms or other comparable terminology. These forward-looking statements include, but are not limited to, statements about:

•

the impact on our business of the civil settlement agreement with the U.S. government that resolved the investigation by the U.S. Department of Justice (the “DOJ”) related to insurance reimbursement claims submitted to various federal employee health plans under the Federal Employee Health Benefits (“FEHB”) program, and the extent to which we may be able to validate and establish processes to support the submission of claims for reimbursement to health plans under the FEHB program in the future, if at all, and our ability to obtain, maintain or increase insurance coverage for our hearing aids in the future;

•

the timing or results of claims audits and medical records reviews by third-party payors;

•

the expense, timing and outcome of the purported securities class action litigation alleging that certain of our disclosures about our business, operations and prospects, including reimbursements from third-party payors, violated the federal securities laws and the purported derivative action alleging that our directors breached their fiduciary duties by failing to implement and maintain an effective system of internal controls;

•

our ability to continue to maintain the listing of our securities on The Nasdaq Stock Market LLC (“Nasdaq”), including our ability to execute a plan to regain compliance with the Nasdaq requirements regarding the timely filing of periodic financial reports with the Securities and Exchange Commission (the “SEC”);

•

estimates of our future revenue and expenses, including the extent of any losses we incur from hearing aids delivered to customers where we have not submitted an insurance claim and may not receive payment;

•

estimates of our future capital needs and our ability to raise capital on favorable terms, if at all, including the timing of future capital requirements and the terms or timing of any future financings;

•

our expectations with regard to changes in the regulatory landscape for hearing aid devices, including the anticipated implementation of a pending

over-the-counter

(“OTC”) hearing aid regulatory framework and potential Medicare coverage for certain hearing aids, as well as any potential actions insurance providers may take following any regulatory changes;

•

our ability to attract and retain customers;

•

our expectations concerning additional orders by existing customers;

•

our expectations regarding the potential market size and size of the potential consumer populations for our products and any future products, including our ability to obtain, maintain or increase insurance coverage of and reimbursement of insurance claims for Eargo hearing aids, which is substantially dependent on, among other things, the outcomes of our efforts to validate and establish processes to support the submission of claims for reimbursement from various federal health plans, any third-party payor audits and pending regulations;

•

our ability to release new hearing aids and the anticipated features of any such hearing aids and our ability to transition our existing customers to new hearing aids, including when older models are discontinued;

•

developments and projections relating to our competitors and our industry, including competing products;

•

our ability to maintain our competitive technological advantages against new entrants in our industry;

•

the pricing of our hearing aids;

•

our expectations regarding the availability, supply, cost and inflationary pressures related to the component parts of our hearing aids;

•

our expectations regarding the ability to make certain claims related to the performance of our hearing aids relative to competitive products;

•

our commercialization and marketing capabilities and expectations;

•

our relationships with, and the capabilities of, our component manufacturers, suppliers and freight carriers;

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•

the implementation of our business model and strategic plans for our business, products and technology;

•

the scope of protection we are able to establish and maintain for intellectual property rights covering our products, including the projected terms of patent protection;

•

our ability to effectively manage our business in light of the civil settlement agreement with the U.S. government, third-party payor claims audits and medical records reviews, purported securities class action and derivative litigations, and pending regulations;

•

our ability to retain existing talent and attract new, highly skilled talent;

•

our estimates regarding the

COVID-19

pandemic, including but not limited to, its duration and its impact on our business and results of operations; and

•

our future financial performance.

We have based these forward-looking statements largely on our current expectations, estimates, forecasts and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. In light of the significant uncertainties in these forward-looking statements, you should not rely upon forward-looking statements as predictions of future events. Although we believe that we have a reasonable basis for each forward-looking statement contained in this Quarterly Report on Form

10-Q,

we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur at all. You should refer to the section titled “Risk Factors” for a discussion of important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. Except as required by law, we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

Eargo, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except share and per share amounts)


	September 30,			December 31,
	2021			2020
ASSETS
Current assets:
Cash and cash equivalents	$	156,442		$	212,185
Accounts receivable, net		14,960			3,793
Inventories		6,274			2,739
Prepaid expenses and other current assets		1,892			3,740

Total current assets		179,568			222,457
Operating lease right-of-use assets		7,607			1,079
Property and equipment, net		9,792			8,034
Intangible assets, net		1,835			—
Goodwill		873			—
Other assets		1,210			1,062

Total assets	$	200,885		$	232,632

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	10,998		$	6,020
Accrued expenses		10,502			9,583
Sales returns reserve		15,619			4,326
Settlement liability		34,372			—
Long-term debt, current portion		1,667			—
Other current liabilities		4,094			2,448
Deferred revenue, current portion		17			311
Lease liability, current portion		676			1,030

Total current liabilities		77,945			23,718
Lease liability, noncurrent portion		6,879			166
Long-term debt, noncurrent portion		13,484			14,837

Total liabilities		98,308			38,721

Commitments and contingencies (Note 6)
Stockholders’ equity:
Preferred stock, $0.0001 par value per share; 5,000,000 shares authorized as of September 30, 2021 and December 31, 2020, respectively; zero shares issued and outstanding as of September 30, 2021 and December 31, 2020, respectively		—			—
Common stock; $0.0001 par value; 110,000,000 shares authorized as of September 30, 2021 and December 31, 2020, respectively; 39,270,448 and 38,246,601 shares issued and outstanding as of September 30, 2021 and December 31, 2020, respectively		4			4
Additional paid-in capital		413,889			392,965
Accumulated deficit		(311,316	)		(199,058	)

Total stockholders’ equity		102,577			193,911

Total liabilities and stockholders’ equity	$	200,885		$	232,632

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

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Eargo, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Loss

(Unaudited)

(In thousands, except share and per share amounts)


	Three months ended September 30,						Nine months ended September 30,
	2021			2020			2021			2020
Revenue, net	$	(22,869	)	$	18,186		$	22,062		$	46,776
Cost of revenue		7,552			5,434			20,311			15,295

Gross profit (loss)		(30,421	)		12,752			1,751			31,481
Operating expenses:
Research and development		7,296			2,871			17,222			7,888
Sales and marketing		24,444			12,354			63,202			34,041
General and administrative		16,887			5,163			32,806			14,498

Total operating expenses		48,627			20,388			113,230			56,427

Loss from operations		(79,048	)		(7,636	)		(111,479	)		(24,946	)
Other income (expense), net:
Interest income		2			3			19			26
Interest expense		(269	)		(279	)		(798	)		(1,422	)
Other income (expense), net		—			(187	)		—			(87	)
Loss on extinguishment of debt		—			(1,627	)		—			(1,627	)

Total other income (expense), net		(267	)		(2,090	)		(779	)		(3,110	)

Loss before income taxes		(79,315	)		(9,726	)		(112,258	)		(28,056	)
Income tax provision		—			—			—			—

Net loss and comprehensive loss	$	(79,315	)	$	(9,726	)	$	(112,258	)	$	(28,056	)

Net income (loss) attributable to common stockholders, basic and diluted	$	(79,315	)	$	—		$	(112,258	)	$	(18,216	)

Net income (loss) per share attributable to common stockholders, basic and diluted	$	(2.02	)	$	—		$	(2.90	)	$	(57.73	)

Weighted-average shares used in computing net income (loss) per share attributable to common stockholders, basic and diluted		39,195,211			398,895			38,765,151			315,546

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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Eargo, Inc.

Condensed Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit)

(Unaudited)

(In thousands, except share amounts)


	Convertible preferred stock				Common stock				Additional paid-in		Accumulated			Total stockholders’
	Shares		Amount		Shares		Amount		capital		deficit			equity
Balance December 31, 2020		—	$	—		38,246,601	$	4	$	392,965	$	(199,058	)	$	193,911
Stock-based compensation		—		—		—		—		5,449		—			5,449
Exercise of stock options		—		—		51,467		—		118		—			118
Net loss and comprehensive loss		—		—		—		—		—		(13,621	)		(13,621	)

Balance March 31, 2021		—		—		38,298,068		4		398,532		(212,679	)		185,857
Stock-based compensation		—		—		—		—		5,519		—			5,519
Exercise of stock options and release of restricted stock units		—		—		668,760		—		1,181		—			1,181
Issuance of common stock in connection with employee stock purchase plan		—		—		174,743		—		2,674		—			2,674
Net loss and comprehensive loss		—		—		—		—		—		(19,322	)		(19,322	)

Balance June 30, 2021		—		—		39,141,571		4		407,906		(232,001	)		175,909
Stock-based compensation		—		—		—		—		5,630		—			5,630
Exercise of stock options and release of restricted stock units		—		—		128,877		—		353		—			353
Net loss and comprehensive loss		—		—		—		—		—		(79,315	)		(79,315	)

Balance September 30, 2021		—	$	—		39,270,448	$	4	$	413,889	$	(311,316	)	$	102,577

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Eargo, Inc.

Condensed Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit)

(Unaudited)

(In thousands, except share amounts)


	Convertible preferred stock					Common stock				Additional paid-in		Accumulated			Total stockholders’
	Shares		Amount			Shares		Amount		capital		deficit			deficit
Balance December 31, 2019		11,825,812	$	152,880			265,943	$	—	$	3,100	$	(159,203	)	$	(156,103	)
Stock-based compensation		—		—			—		—		525		—			525
Exercise of stock options		—		—			4,188		—		8		—			8
Net loss and comprehensive loss		—		—			—		—		—		(11,738	)		(11,738	)

Balance March 31, 2020		11,825,812		152,880			270,131		—		3,633		(170,941	)		(167,308	)
Stock-based compensation		—		—			—		—		471		—			471
Exercise of stock options		—		—			10,335		—		18		—			18
Net loss and comprehensive loss		—		—			—		—		—		(6,592	)		(6,592	)

Balance June 30, 2020		11,825,812		152,880			280,466		—		4,122		(177,533	)		(173,411	)
Issuance of Series E convertible preferred stock, net of issuance costs of $4,056		10,513,921		67,267			—		—		—		—			—
Issuance of Series E convertible preferred stock, upon extinguishment of convertible notes (Note 7)		1,889,548		12,818			—		—		—		—			—
Gain on extinguishment of Series C and Series C-1 convertible preferred stock		—		(9,840	)		—		—		9,840		—			9,840
Stock-based compensation		—		—			—		—		1,367		—			1,367
Exercise of stock options		—		—			254,133		—		333		—			333
Net loss and comprehensive loss		—		—			—		—		—		(9,726	)		(9,726	)

Balance September 30, 2020		24,229,281	$	223,125			534,599	$	—	$	15,662	$	(187,259	)	$	(171,597	)

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Eargo, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)


	Nine months ended September 30,
	2021			2020
Operating activities:
Net loss	$	(112,258	)	$	(28,056	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,780			1,805
Stock-based compensation		15,850			2,363
Non-cash interest expense and amortization of debt discount		314			1,178
Non-cash operating lease expense		621			838
Bad debt expense		9,331			2,135
Loss on disposal of property and equipment		155			—
Loss on extinguishment of debt		—			1,627
Change in fair value of financial instruments		—			84
Changes in operating assets and liabilities:
Accounts receivable		(20,498	)		(2,660	)
Inventories		(3,535	)		(409	)
Prepaid expenses and other current assets		1,745			219
Other assets		(148	)		963
Accounts payable		5,175			579
Accrued expenses		639			783
Sales returns reserve		11,293			(636	)
Settlement liability		34,372			—
Other current liabilities		1,646			362
Deferred revenue		(294	)		(217	)
Operating lease liabilities		(687	)		(883	)
Other liabilities		—			(127	)

Net cash used in operating activities		(53,499	)		(20,052	)

Investing activities:
Purchases of property and equipment		(708	)		(844	)
Capitalized software development costs		(3,428	)		(2,601	)
Cash paid for acquisition of business		(2,434	)		—

Net cash used in investing activities		(6,570	)		(3,445	)

Financing activities:
Proceeds from stock options exercised		1,652			359
Proceeds from employee stock purchase plan purchases		2,674			—
Proceeds from debt financing		—			15,000
Proceeds from convertible preferred stock issuance, net of issuance costs		—			67,867
Proceeds from issuance of convertible notes, net of issuance costs		—			10,053
Proceeds from PPP loan		—			4,574
Repayment of PPP loan		—			(4,574	)
Debt repayments		—			(12,720	)
Payments of deferred offering costs		—			(222	)

Net cash provided by financing activities		4,326			80,337

Net increase (decrease) in cash and cash equivalents		(55,743	)		56,840
Cash and cash equivalents at beginning of period		212,185			13,384

Cash and cash equivalents at end of period	$	156,442		$	70,224

Supplemental disclosure of cash flow information:
Cash paid for taxes	$	84		$	—

Cash paid for interest	$	485		$	253

Non-cash operating activities:
Lease liability obtained in exchange for right-of-use asset	$	7,046		$	2,392

Non-cash investing and financing activities:
Property and equipment and capitalized software costs in accounts payable and accrued liabilities	$	47		$	421

Stock-based compensation included in capitalized software costs	$	748		$	—

Convertible preferred stock issuance costs included in accounts payable	$	600		$	600

Acquisition liability in accrued liabilities	$	429		$	—

Deferred offering costs in accounts payable and accrued liabilities	$	—		$	1,053

Derivative liability in connection with issuance of convertible promissory notes on issuance	$	—		$	2,879

Issuance of Series E convertible preferred stock upon extinguishment of convertible notes	$	—		$	12,818

Settlement of derivative liability in connection with extinguishment of convertible notes	$	—		$	3,085

Issuance of convertible preferred stock warrants in connection with debt financing	$	—		$	270

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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Eargo, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

roductory Note

On September 21, 2021, Eargo, Inc. (the “Company”) was informed that it was the target of a criminal investigation by the U.S. Department of Justice (the “DOJ”) related to insurance reimbursement claims the Company submitted on behalf of its customers covered by various federal employee health plans under the Federal Employee Health Benefits (“FEHB”) program. The investigation also pertained to Eargo’s role in customer reimbursement claim submissions to federal employee health plans (collectively, the “DOJ investigation”). Additionally, the Company’s largest third-party payor conducted an audit of insurance reimbursement claims (“claims”) submitted by the Company (the “Primary Audit”), which included a review of medical records. The Company was informed by the third-party payor conducting the Primary Audit that the DOJ was the principal contact related to the subject matter of the Primary Audit. On January 4, 2022, the DOJ confirmed to the Company that the investigation had been referred to the Civil Division of the DOJ and the U.S. Attorney’s Office for the Northern District of Texas and the criminal investigation was no longer active.

On April

29,

2022, the Company entered into a civil settlement agreement with the U.S. government that resolved the DOJ investigation related to the Company’s role in customer reimbursement claim submissions to various federal employee health plans under the FEHB program. The settlement agreement provided for the Company’s payment of approximately $34.4 million to the U.S. government and resolved allegations that the Company submitted or caused the submission of claims for payment to the FEHB program using unsupported hearing loss-related diagnostic codes.

From the time the Company learned of the DOJ investigation and until December 8, 2021, the Company continued to process orders for customers with potential insurance benefits (including FEHB program members) but suspended all claims submission activities and has offered affected customers (

i.e.

, customers using insurance benefits as a method of direct payment for transactions prior to December 8, 2021) the option to return their hearing aids or purchase their hearing aids without the use of their insurance benefits in case their claim is denied or ultimately not submitted by the Company to their insurance plan for payment (the “extended right of return”).

Beginning on December 8, 2021, the Company made the decision to stop accepting insurance benefits as a method of direct payment and it is uncertain when, if ever, the Company will resume accepting insurance benefits as a method of direct payment. While the Company intends to work with the government and third-party payors at the appropriate time with the objective of validating

and establishing

processes to support any future claims that it may submit for reimbursement, the Company may not be able to arrive at acceptable processes or submit any future claims.

Total

life-to-date

payments the Company has received

through

December 31, 2021 from the government in relation to claims submitted under the FEHB program, net of any product returns and associated refunds,

were

approximately $44 million. As discussed further in Note 6, based on the settlement agreement with the U.S. government, the Company has recorded a settlement liability of $34.4

million as of September 30, 2021. The settlement amount

was

treated as

consideration payable to a customer and was recorded as a reduction in revenue in the condensed consolidated statements of operations and comprehensive loss during the three and nine months ended September 30, 2021.

The Company determined that customer transactions using insurance benefits as a method of direct payment occurring subsequent to learning of the DOJ investigation on September 21, 2021 did not meet the criteria for revenue recognition under Accounting Standards Codification (“ASC”) 606. As such, the Company did not recognize revenue for shipments to customers with potential insurance benefits, substantially all of whom were covered under the FEHB program, subsequent to that date.

The Company estimates that a majority of customers with unsubmitted claims as of September 30, 2021 will choose to return the hearing aid system if their insurance provider denies their claim or the claim is ultimately not submitted by the Company for payment, resulting in an increase in expected product returns from such transactions that occurred prior to September 21, 2021. As a result, the Company recorded $13.3 million

of estimated sales returns as a

reduction in revenue in the third quarter of 2021 related to

shipments to customers with potential insurance benefits. This $13.3 million of estimated sales returns include

a change in accounting estimate of $5.1 million from transactions that occurred during the first and second quarters of 2021 (see the caption “Sales returns reserve” under Note 4 for more information).

the

$15.6 million

sales returns reserve

recorded

as of September 30, 2021

, $12.5 million

relates to unsubmitted claims that are included in accounts receivable, net. Returns associated with unsubmitted claims will reduce the sales returns reserve, with a corresponding reduction in the related accounts receivable at the time the product is returned.

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Further, the Company also estimates that, in addition to the customers who choose to return their hearing aid systems, a significant number of customers whose claims are denied by insurance providers or not submitted by the Company for payment may not pay for or return the hearing aid system. As a result, the Company recorded $8.7 million of bad debt expense during the third quarter of 2021 related to insurance claims receivable balances, which are recorded as a component of accounts receivable, net, in the condensed consolidated balance sheets. Of this $8.7 million in bad debt expense, $5.8 million relates to submitted claims that have been denied or have not been paid and was written off during the third quarter of 2021.

Notwithstanding the settlement, the Company remains subject to prepayment review of claims by its largest third-party payor before any insurance payments are made. The Company does not intend to submit any claims through the FEHB program until it is able to align with the Office of Personnel Management (the “OPM”) on and establish processes for supporting the submission of these claims, and the Company may be unable to do so.

1. Description of business

The Company is a medical device company dedicated to improving the quality of life of people with hearing loss. The Company’s innovative product and

go-to-market

approach address the major challenges of traditional hearing aid adoption, including social stigma, accessibility and cost.

Liquidity and going concern

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America applicable to a going concern, which contemplates the realization of assets and the satisfaction of liabilities during the normal course of business. The Company has incurred losses and negative cash flows from operations since its inception and management expects to incur additional substantial losses in the foreseeable future. As of September 30, 2021, the Company had cash and cash equivalents of

$156.4 million

and an accumulated deficit of

$311.3 million.

The Company believes that without any future financing, its current resources are insufficient to satisfy its obligations as they become due within one year after the date that the financial statements are issued. The negative cash flows and current lack of financial resources of the Company raise substantial doubt as to the Company’s ability to continue as a going concern.

The Company’s future operating requirements will be substantial and it will need to raise significant additional resources to fund its operations through equity or debt financing, or some variation thereof. The Company is currently exploring fundraising opportunities to meet these capital requirements. If the Company is unable to raise additional funding to meet its operational needs, it will be forced to limit or cease its operations.

The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of the uncertainty.

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While the extent to which the Company is able to validate and establish processes to support the submission of claims for reimbursement to health plans, including those under the FEHB program, if at all, in the future, and the future impacts of the anticipated implementation of a pending over-the-counter (“OTC”) hearing aid regulatory framework (which may lead insurance providers to take actions limiting the Company’s ability to access insurance coverage and may also generally result in additional compliance or other regulatory requirements for the Company) difficult to assess or predict at this time, since the announcement of the DOJ investigation, there has been and may continue to be a significant reduction in shipments, revenue and gross margin, which could negatively impact the Company’s liquidity and working capital, including by impacting its ability to increase its existing credit facility or access any additional capital.

2. Summary of significant accounting policies

Basis of presentation and principles of consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and applicable rules and regulations of the SEC regarding interim financial reporting of Eargo, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

These unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, include all adjustments of a normal recurring nature necessary to present fairly the Company’s consolidated financial position, results of operations and cash flows. The unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes included in the Company’s Annual Report on Form

10-K

for the year ended December 31, 2020, filed with the SEC on March 16, 2021.

Use of estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made in the accompanying unaudited condensed consolidated financial statements include, but are not limited to, the sales returns reserve, the present value of lease liabilities, the fair value of equity securities, the fair value of financial instruments, the allowance for doubtful accounts, the net realizable value of inventory, the fair value of assets acquired in a business combination, the useful lives of long-lived assets, accrued product warranty reserve, legal and other contingencies, certain other accruals and recoverability of the Company’s net deferred tax assets and the related valuation allowance. Management periodically evaluates its estimates, which are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from those estimates.

Significant accounting policies

There have been no significant changes to the accounting policies during the nine months ended September 30, 2021, as compared to the significant accounting policies described in Note 2 of the “Notes to Consolidated Financial Statements” in the Company’s audited consolidated financial statements included in the Annual Report on Form

10-K.

Concentration of credit risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist of demand deposit accounts, money market accounts and accounts receivable, including credit card receivables. The Company maintains its cash and cash equivalents, which may, at times, exceed federally insured limits, with financial institutions of high credit standing. As of September 30, 2021, the Company has not experienced any losses on its deposit accounts and money market accounts. As of September 30, 2021, the Company does not believe there is significant financial risk from nonperformance by the issuers of the Company’s deposit accounts and money market accounts.

Approximately 92% and 74% of the Company’s gross accounts receivable as of September 30, 2021 and December 31, 2020, respectively, were for customers with insurance benefits, substantially all of whom were covered under the FEHB program. Furthermore, approximately 85% and 45% of the Company’s gross accounts receivable as of September 30, 2021 and December 31, 2020, respectively, were related to shipments of Eargo hearing aids to customers insured under a single insurance plan whose claims are processed through the Company’s largest third-party payor, which

conducted

the Primary Audit. The increase in gross accounts receivable as of September 30, 2021 was primarily due to the Primary Audit, during which

certain

claims with a service date after March 1, 2021, have not yet and may never be submitted for reimbursement.

We remain subject to a prepayment review of claims by the payor who conducted the Primary Audit.

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Please see Introductory Note at the beginning of these Notes to Unaudited Condensed Consolidated Financial Statements for more information regarding the DOJ investigation and settlement and claims audits.

Accounts receivable, net

Accounts receivable represents amounts due from third-party institutions for credit card and debit card transactions and trade accounts receivable. Trade accounts receivable are primarily insurance claims receivable amounts due from third-party payors and

end-users.

Accounts receivable are recorded at invoiced amounts, net of allowances for doubtful accounts. The allowance for doubtful accounts is based on an assessment of the collectability of accounts. Management regularly reviews the adequacy of the allowance for doubtful accounts by considering the age of each outstanding invoice, each customer’s expected ability to pay, and the collection history with each customer, when applicable, to determine whether a specific allowance is appropriate. Bad debt expense is recorded as a component of general and administrative expenses in the condensed consolidated statements of operations and comprehensive loss. Accounts receivable balances are written off when they are ultimately determined to be uncollectible.

Goodwill, finite-lived acquired intangible assets, and impairment

Goodwill represents the excess of the purchase price paid over the fair value of tangible and identifiable intangible net assets acquired in business combinations. In November of each fiscal year, or more frequently if indicators of impairment exist, management performs a review to determine if the carrying value of goodwill is impaired. Impairment testing is performed at the reporting unit level. There were no impairments to goodwill during the three and nine months ended September 30, 2021.

The following table presents the changes in the carrying amount of goodwill:


	Total
	(in thousands)
Balance December 31, 2020	$	—
Addition due to business acquisition		873

Balance September 30, 2021	$	873

The Company’s intangible assets consist of intangible assets acquired in a business combination. These assets are amortized using the straight-line method over their estimated useful lives ranging from one to four years reflecting the period in which the economic benefits of the assets are expected to be realized.

The Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets or group of assets may not be fully recoverable. Recoverability is measured by comparing the carrying amount to the future net undiscounted cash flows which the assets are expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the asset. The Company has not identified any such impairment losses to date.

Revenue recognition

The Company’s revenue is generated from the sale of products (hearing aid systems and related accessories) and services (extended warranties). These products and services are primarily sold directly to customers through the Eargo website and the Company’s sales representatives.

Under ASC 606, revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services by following a five step process: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation.

Identify the contract with a customer

. The Company generally considers completion of an Eargo sales order (which requires customer acceptance of the Company’s click-through terms and conditions for website sales and authorization of payment through credit card or another form of payment for sales made over the phone) as a customer contract provided that collection is considered probable. For payments that are not made upfront by credit card, the Company assesses insurance eligibility or customer creditworthiness based on credit checks, payment history, and/or other circumstances. For orders involving insurance payors, the Company validates customer eligibility and potential reimbursement amounts prior to shipping the product. If the criteria to establish a contract with a customer is not met, revenue is not recognized in accordance with ASC 606.

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Identify the performance obligations in the contract

. Product performance obligations include hearing aid systems and related accessories and service performance obligations include extended warranty coverage. The Company also offers customers a

one-time

replacement of certain components of the hearing aid system for a fee (

i.e.

, “loss and damage policy”), which represents an option with material right. However, as the historical redemption rate under the policy has been low, the option is not accounted for as a separate performance obligation. The Company does not assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer.

The Company has elected to treat shipping and handling activities performed after a customer obtains control of products as a fulfillment activity.

Determine the transaction price and allocation to performance obligations

. The transaction price in the Company’s customer contracts consists of both fixed and variable consideration. Fixed consideration includes amounts to be contractually billed to the customer while variable consideration includes the

45-day

right of return that applies to all products and the extended right of return offered for certain shipments involving insurance payors prior to December 8, 2021 (at which time the Company ceased accepting insurance benefits as a method of direct payment). Please see Introductory Note at the beginning of these Notes to Unaudited Condensed Consolidated Financial Statements for more information regarding the extended right of return. To estimate product returns, the Company analyzes various factors, including historical return levels, current economic trends, and insurance coverage. Based on this information, the Company reserves a percentage of product sale revenue and accounts for the estimated impact as a reduction in the transaction price. Consideration paid or payable to a customer that is not for a distinct good or service is accounted for as a reduction of the transaction price and recorded as a reduction in revenue in the period it becomes payable.

Allocate the transaction price to the performance obligations in the contract.

For contracts that contain multiple performance obligations, the Company allocates the transaction price to the performance obligations on a relative standalone selling price basis. Standalone selling prices are based on multiple factors including, but not limited to, historical discounting trends for products and services, gross margin objectives, internal costs, competitor pricing strategies, and industry technology lifecycles.

Recognize revenue when or as the Company satisfies a performance obligation

. Revenue for products (hearing aid systems and related accessories) is recognized at a point in time, which is generally upon shipment, provided all other revenue recognition criteria have been met. Revenue for services (extended warranty) is recognized over time on a ratable basis over the warranty period. The Company does not have material contract liabilities related to unsatisfied performance obligations as of September 30, 2021 and December 31, 2020.

Contract costs

The Company applies the practical expedient to recognize the incremental costs of obtaining a contract as expense when incurred if the amortization period would be one year or less. These incremental costs include processing fees paid to third-party financing vendors, who provide the Company’s customers with the option to finance their purchases. If a customer elects to utilize this service, the Company receives a

non-recourse

upfront payment for the product sold, less processing fee withheld by the financing vendor. These processing fees are recognized in cost of revenue in the condensed consolidated statements of operations and comprehensive loss as incurred.

Net income (loss) per share attributable to common stockholders

The Company follows the

two-class

method when computing net income (loss) per share in periods in which shares that meet the definition of participating securities are outstanding. The

two-class

method determines net income (loss) per share for each class of common and participating securities according to dividends declared or accumulated and participation rights in undistributed earnings. The

two-class

method requires income available to common stockholders for the period to be allocated between common and participating securities based upon their respective rights to receive dividends as if all income for the period had been distributed.

Basic net income (loss) per share attributable to common stockholders is calculated by dividing the net income (loss) attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period, without consideration for potential dilutive securities. Diluted net income (loss) attributable to common stockholders is computed by adjusting net income (loss) attributable to common stockholders to reallocate undistributed earnings based on the potential impact of dilutive securities. Diluted net income (loss) per share is computed by dividing the net loss by the weighted-average number of common shares and common share equivalents of potentially dilutive securities outstanding for the period. Potentially dilutive securities are not assumed to have been issued if their effect is anti-dilutive.

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Recent accounting pronouncements not yet adopted

In June 2016, the FASB issued ASU

2016-13,

Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

, which replaces the existing incurred loss impairment model with an expected credit loss model and requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected. The Company no longer qualifies as an emerging growth company as of December 31, 2021 and will first present the application of this standard in its annual financial statements for the year ended December 31, 2021. This new standard must be adopted using a modified retrospective approach, with certain exceptions. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.

In December 2019, the FASB issued ASU

No. 2019-12,

Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes

, which is intended to simplify the accounting for income taxes. This standard removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing standards to improve consistent application. This new standard is effective for the Company in the fiscal year beginning January 1, 2022. An entity that elects early adoption must adopt all the amendments in the same period. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.

In August 2020, the FASB issued ASU

No. 2020-06,

Debt—

Debt with Conversion and Other Options (Subtopic

470-20)

and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic

815-40)

, which is intended to simplify the accounting for convertible debt instruments and convertible preferred stock. This standard removes the existing guidance in ASC

470-20

that requires companies to account for cash conversion features and beneficial conversion features in equity separately from the host convertible debt or preferred stock. This new standard is effective for the Company beginning January 1, 2022. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements.

3. Fair value measurements

There were no financial assets and liabilities outstanding that were remeasured at fair value on a recurring basis as of September 30, 2021 or December 31, 2020.

The carrying amounts reflected in the condensed consolidated balance sheets for cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair values due to their short-term nature. The fair value of the Company’s outstanding term loan is estimated using the net present value of the payments, discounted at an interest rate that is consistent with a market interest rate. The fair value of the outstanding term loan approximates the carrying amount as the term loan bears a floating rate that approximates the market interest rate.

4. Balance sheet components

Inventories

Inventories consist primarily of raw materials related to component parts and finished goods. The following is a summary of the Company’s inventories by category:


	September 30,		December 31,
	2021		2020

	(in thousands)
Raw materials	$	1,553	$	853
Finished goods		4,721		1,886

Total inventories	$	6,274	$	2,739

Property and equipment, net

Property and equipment, net, consists of the following:


	September 30,			December 31,
	2021			2020

	(in thousands)
Capitalized software	$	10,775		$	6,744
Tools and lab equipment		4,696			4,426
Furniture and fixtures		906			906
Leasehold improvements		757			757
Computer and equipment		288			288

		17,422			13,121
Less accumulated depreciation and amortization		(7,630	)		(5,087	)

Total property and equipment, net	$	9,792		$	8,034

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Depreciation and amortization

expense

for the three months ended September 30, 2021 and 2020 amounted to $1.4 million and $0.7 million, respectively, which includes amortization of capitalized software costs of $0.8 million and $0.2 million, respectively. Depreciation and amortization for the nine months ended September 30, 2021 and 2020 amounted to $2.8 million and $1.8 million, respectively, which includes amortization of capitalized software costs of $1.2 million and $0.6 million, respectively.

Intangible assets, net

Intangible assets, net consist of the following as of September 30, 2021:


	Gross carrying value		Accumulated amortization		Net carrying value

	(in thousands)
Developed technologies	$	1,700	$	107	$	1,593
Other		290		48		242

Total intangible assets, net	$	1,990	$	155	$	1,835

Amortization expense was $0.2 million for the three and nine months ended September 30, 2021.

The following table summarizes estimated future amortization expense of finite-lived intangible assets, net as of September 30, 2021:


	Amount
	(in thousands)
Remainder of 2021	$	154
2022		618
2023		425
2024		425
2025		213

Total	$	1,835

Accrued expenses

Accrued expenses consist of the following:


	September 30,		December 31,
	2021		2020

	(in thousands)
Accrued compensation	$	5,404	$	5,861
Accrued warranty reserve		3,562		2,390
Refunds due to customers		665		581
Accrued vendor costs		442		751
Other accruals		429		—

Total accrued expenses	$	10,502	$	9,583

Sales returns reserve

During the three months ended September 30, 2021, the Company made a change in its accounting estimate of the sales returns reserve based on its estimate that a majority of customers with unsubmitted claims as of September 30, 2021 will choose to return the hearing aid system if their insurance provider denies their claim or the claim is ultimately not submitted by the Company for payment. The effect of the change in estimate for the three months and nine months ended September 30, 2021, is a reduction of revenue and an increase in net loss and comprehensive loss of

$5.1 million

, or a decrease

$0.13 per

both basic and diluted share. This change in estimate is related to unsubmitted claims as of September 30, 2021, from transactions that occurred during the first and second quarters of 2021.

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The sales returns reserve consists of the following activity:


	Nine months ended September 30,
	2021			2020

	(in thousands)
Sales returns reserve, beginning balance	$	4,326		$	3,759
Reduction of revenue		32,612			15,906
Utilization of sales returns reserve		(21,319	)		(16,542	)

Sales returns reserve, ending balance	$	15,619		$	3,123

Allowance for doubtful accounts

During the three months ended September 30, 2021, the Company made a change in its accounting estimate of the allowance for doubtful accounts as of September 30, 2021 based on its estimate that

a significant number of customers with an extended right of return and whose claims are denied by insurance providers or not submitted by the Company for payment

may

not pay for or return the hearing aid system. The effect of the change in estimate for the three months and nine months ended September 30, 2021 is an increase in general and administrative expenses and net loss and comprehensive loss of $6.1 million, or a decrease of $0.16 per both basic and diluted share. This change in estimate is related to insurance claims receivable balances as of September 30, 2021, from transactions that occurred during the first and second quarters of 2021.

Of the $9.3 million recorded to bad debt expense during the nine months ended September 30, 2021, $5.8 million relates to submitted claims that have been denied or have not been paid and was written off during the third quarter of 2021.

The allowance for doubtful accounts consists of the following activity:


	Nine months ended September 30,
	2021			2020

	(in thousands)
Allowance for doubtful accounts, beginning balance	$	1,868		$	225
Charged to expense		9,331			2,135
Accounts written off, net of recoveries		(6,628	)		(63	)

Allowance for doubtful accounts, ending balance	$	4,571		$	2,297

Accrued warranty reserve

The accrued warranty reserve consists of the following activity:


	Nine months ended September 30,
	2021			2020

	(in thousands)
Accrued warranty reserve, beginning balance	$	2,390		$	450
Charged to cost of revenue		2,145			2,318
Utilization of accrued warranty reserve		(973	)		(998	)

Accrued warranty reserve, ending balance	$	3,562		$	1,770

5. Acquisitions

In June 2021, the Company completed the purchase of certain

web-based

hearing screening technology assets (“Clementine”) for $2.9 million in cash, of which $2.4 million has been paid as of September 30, 2021. This purchase was accounted for as a business combination. Clementine offers remote audiology solutions and self-administered hearing screen technology to consumers across digital and

in-person

settings with an online tool. The Company believes that integrating this technology with the Company’s telecare infrastructure has the potential to further advance its core mission of making it easier for consumers to assess their hearing, consult with hearing professionals, and purchase Eargo hearing devices more conveniently.

The table below presents the purchase price allocation.


	(in thousands)
Goodwill	$	873
Intangible assets		1,990

Total fair value of consideration	$	2,863

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The intangible assets acquired in the Clementine acquisition are comprised primarily of developed technologies and have a weighted-average amortization period of 3.6 years as of the date of the acquisition.

6. Commitments and contingencies

Operating leases

The Company has entered into

non-cancelable

operating leases for its offices. These leases generally contain scheduled rent increases and renewal options, which are not included in the determination of lease term unless the Company is reasonably certain that the renewal option would be exercised.

New San Jose lease

In September 2021, the Company entered into a lease agreement, as amended, for approximately 30,000 square feet of office and laboratory space located in San Jose, California, which the Company plans to use as its headquarters starting in early 2022. The lease commenced in September 2021 and has a

93-month

term with two

60-month

renewal options. The Company recorded a

right-of-use

(“ROU”) asset of $6.9 million and lease liability of $6.8 million as of commencement of the lease.

Nashville lease

In February 2021, the Company amended the operating lease for its Nashville, Tennessee office to extend the term of the initial lease through March 2023 and reduce the size of office space leased. This extension was accounted for as a lease modification and the Company recorded an increase to the ROU asset and lease liability of $0.4 million at the time of the amendment.

As of September 30, 2021, the Company recorded an aggregate ROU asset of $7.6 million and an aggregate lease liability of $7.6 million in the accompanying condensed consolidated balance sheet. The ROU asset and corresponding lease liability were estimated using a weighted-average incremental borrowing rate of 7.7%. The weighted-average remaining lease term is 7.1 years.

For the three and nine months ended September 30, 2021, the Company incurred $0.3 million and $0.9 million of operating lease costs. Variable lease payments for operating expenses and costs related to short-term leases were immaterial for the three and nine months ended September 30, 2021.

As of September 30, 2021, undiscounted future minimum lease payments due under the

non-cancelable

operating leases are as follows:


	Operating leases
	(in thousands)
Remainder of 2021	$	308
2022		1,327
2023		1,114
2024		1,081
2025		1,331
Thereafter		4,979

Total minimum future lease payments		10,140
Present value adjustment for minimum lease commitments		(2,585	)

Total lease liability	$	7,555

Legal and other contingencies

The Company is involved in legal proceedings in the ordinary course of its business and may become involved in additional legal proceedings. Other than those listed below, the Company does not believe that any lawsuits or claims currently pending against it, individually or in the aggregate, are material or will have a material adverse effect on its financial condition, results of operations or cash flows. The Company may enter into settlement discussions, and may enter into settlement agreements, if it believes settlement is in the best interest of the Company and its shareholders. Unless stated otherwise, the matters discussed below, if decided adversely or settled by the Company, individually or in the aggregate, may result in a liability material to the Company’s financial condition, results of operations or cash flows.

The Company is also subject to review from federal and state taxing authorities in order to validate the amounts of income, sales and/or use taxes which have been claimed and remitted. The Company has estimated exposure and established reserves for its estimated sales tax audit liability.

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In the normal course of business, the Company may agree to indemnify third parties with whom it enters into contractual relationships, including customers, lessors, and parties to other transactions with the Company, with respect to certain matters. The Company has agreed, under certain conditions, to hold these third parties harmless against specified losses, such as those arising from a breach of representations or covenants, other third-party claims that the Company’s products, when used for their intended purposes, infringe the intellectual property rights of such other third parties, or other claims made against certain parties. It is not possible to determine the maximum potential amount of liability under these indemnification obligations due to the Company’s limited history of prior indemnification claims and the unique facts and circumstances that are likely to be involved in any particular claim.

DOJ Investigation and Settlement.

On September 21, 2021, the Company was informed that it was the target of a criminal investigation by the DOJ related to insurance reimbursement claims the Company submitted on behalf of its customers covered by various federal employee health plans under the FEHB program. The investigation also pertained to the Company’s role in customer reimbursement claim submissions to federal employee health plans. Additionally, the Company was the subject of an ongoing claims audit by an insurance company that is the Company’s largest third-party payor and was informed by such insurance company that the DOJ was the principal contact related to the subject matter of the audit. In addition to such audit, the Company has been subject to a number of other audits of insurance reimbursement claims submitted to additional third-party payors. One of these claims audits does not relate to claims submitted under the FEHB program. On January 4, 2022, the DOJ confirmed to the Company that the investigation had been referred to the Civil Division of the DOJ and the U.S. Attorney’s Office for the Northern District of Texas and the criminal investigation was no longer active.

On April

29,

2022, the Company entered into a civil settlement agreement with the U.S. government that resolved the DOJ investigation

including allegations that the Company violated the False Claims Act by knowingly submitting or causing the submission of false claims for payment under the FEHB program during the period from February 1, 2021 through September 22, 2021.

The settlement agreement provided for the payment by the Company of approximately $34.4

million to the U.S. government and resolved allegations that the Company submitted or caused the submission of claims for payment to the FEHB program using unsupported hearing loss-related diagnostic codes. The Company recorded a

$34.4

million settlement liability in the condensed consolidated balance sheets as of September 30, 2021 in connection with the settlement. The settlement amount was treated as consideration payable to a customer and was recorded as a reduction in revenue in the condensed consolidated statements of operations and comprehensive loss during the three and nine months ended September 30, 2021.

The settlement of the investigation may not resolve all of the audits of insurance reimbursement claims by additional third-party payors, and additionally the Company remains subject to a prepayment review of claims by the payor who conducted the Primary Audit. The Company will need to work with the government (including the OPM) and third-party payors to potentially validate and establish processes to support any future claims that it may submit for reimbursement, and there are no guarantees that the Company will be able to arrive at any such acceptable processes or submit any future claims. The Company does not intend to submit any claims through the FEHB program until it is able to align with the OPM on and establish processes for supporting the submission of these claims.

Securities Class

Action

Fazio v. Eargo, Inc., Christian Gormsen, & Adam Laponis.

, No.

21-cv-07848

(N.D. Cal. Oct. 6, 2021);

Chung v. Eargo, Inc., Christian Gormsen, & Adam Laponis.

, No.

21-cv-08597

(N.D. Cal. Nov. 4, 2021);

IBEW Local 353 Pension Plan v. Eargo, Inc., Christian Gormsen, Adam Laponis, Josh Makower, Juliet Bakker, Peter Tuxen Bisgaard, Doug Hughes, Geoff Pardo, Nina Richardson, A. Brooke Seawell, David Wu, J.P. Morgan Securities LLC, BofA Securities, Inc., Wells Fargo Securities, LLC, & William Blair

& Company, L.L.C.

, No.

21-cv-08747

(N.D. Cal. Nov. 10, 2021). On October 6, 2021, putative shareholder Joseph Fazio filed a purported securities class action against the Company and certain of its officers (the “Fazio action”). Plaintiff alleges that certain of the Company’s disclosures about its business, operations and prospects, including reimbursements from third-party payors, violated federal securities laws. Fazio voluntarily dismissed his complaint on December 6, 2021. On November 4, 2021, putative shareholder Alden Chung filed a substantially similar purported class action lawsuit (the “Chung action”). On November 10, 2021, putative shareholder IBEW Local 353 Pension Plan filed a similar purported class action, and also asserted claims under the federal securities laws against current and former members of the Company’s Board of Directors (the “Board of Directors”) and the underwriters of the Company’s October 15, 2020 initial public offering of common stock (the “IBEW action”). These class actions, which seek damages and other relief, were filed in the U.S. District Court for the Northern District of California. The Fazio and Chung actions were brought purportedly on behalf of a class of investors who purchased or otherwise acquired Eargo securities between February 25, 2021 and September 22, 2021. The IBEW Local 353 action was brought purportedly on behalf of a class of investors who purchased or otherwise acquired: (i) Eargo shares in or traceable to the Company’s October 15, 2020 initial public offering of common stock; and/or (ii) shares of Eargo common stock between October 15, 2020 and September 22, 2021. On January 5, 2022, the court consolidated the foregoing class actions (as consolidated, the “Securities Class Action”) under the caption

In re Eargo, Inc. Securities Litigation

, No.

21-cv-08597-CRB,

and appointed IBEW Local 353 Pension Plan and Xiaobin Cai as Lead Plaintiffs and Bernstein Litowitz Berger & Grossmann LLP and Block & Leviton LLP as Lead Counsel. Lead Plaintiffs have not yet filed a consolidated amended complaint.

The Company intends to vigorously defend the Securities Class Action and cannot reasonably estimate any loss or range of loss that may arise from the litigation. Accordingly, the Company can provide no assurance as to the scope and outcome of this matter and no assurance as to whether its business, financial position, results of operations, or cash flows will not be materially adversely affected.

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Derivative Action.

Wolfson v. Christian Gormsen, Joshua Makower, Douglas J. Hughes, Nina Louise Richardson, Katie J. Bayne, Peter Tuxen
Bisgaard, A. Brooke Seawell, David Wu, and Eargo, Inc.

, No.

21-cv-09342

(N.D. Cal. Dec. 3, 2021). On December 3, 2021, putative shareholder Barbara Wolfson filed a derivative complaint purportedly on Eargo’s behalf against members of the Board of Directors and the Company as nominal defendant (the “Derivative Action”). Plaintiff asserts, among other things, that the defendants breached their fiduciary duties by allegedly failing to implement and maintain an effective system of internal controls related to the Company’s financial reporting, public disclosures and compliance with laws, rules and regulations governing the business. Plaintiff purports to assert derivative claims on the Company’s behalf for alleged violations of Section 14(a) of the Securities Exchange Act of 1934, as amended, breach of fiduciary duty, waste of corporate assets, and aiding and abetting. On March 1, 2022, the court entered the parties’ stipulation staying the Derivative Action

until the anticipated motion to dismiss in the Securities Class Action is decided.

The defendants intend to vigorously defend the Derivative Action and cannot reasonably estimate any loss or range of loss that may arise from the litigation. Accordingly, the Company can provide no assurance as to the scope and outcome of this matter and no assurance as to whether its business, financial position, results of operations, or cash flows will not be materially adversely affected.

7. Debt obligations

2018 Loan Agreement

In June 2018, the Company entered into a Loan and Security Agreement (the “2018 Loan Agreement”) with Silicon Valley Bank. Under the terms of the 2018 Loan Agreement, Silicon Valley Bank made available to the Company term loans in an aggregate principal amount of $12.5 million and the Company borrowed $7.0 million in 2018. The Company’s existing subsidiaries are, and any additional future domestic subsidiaries of the Company are required to be,

co-borrowers

jointly and severally liable under the 2018 Loan Agreement.

In connection with the execution of the 2018 Loan Agreement, the Company issued warrants to purchase 30,173 shares of Series C convertible preferred stock. The estimated fair value of the warrants at issuance was recorded as a discount on the loan and is amortized to interest expense over the term of the agreement using the effective interest method.

Amendments to the 2018 Loan Agreement

In January 2019, the Company executed the First Amendment to the Loan and Security Agreement, which extended the interest-only period for all borrowings under the agreement until January 2020. No other terms were amended. In June 2019, the Company borrowed an additional $5.0 million to increase the total principal balance to $12.0 million. In connection with the June 2019 borrowing, the Company issued Silicon Valley Bank warrants to purchase 14,999 shares of Series C convertible preferred stock.

In May 2020, the Company executed the Second Amendment to its Loan and Security Agreement, which deferred the principal payments due between May 2020 and July 2020 such that the deferred amounts will be repaid in equal monthly payments that started in August 2020 through the scheduled maturity of the loan in June 2022. The amendment was accounted for as a modification.

In September 2020, the Company executed the Third Amendment to the Loan and Security Agreement (the “Third Amendment”), under which Silicon Valley Bank made available to the Company additional term loans in an aggregate principal amount of $20.0 million through December 31, 2020. The Company borrowed $15.0 million in September 2020 and used $10.2 million of the proceeds to repay the outstanding balance of $9.5 million and final payment fee of $0.7 million, or 6.0% of the original aggregate principal amount, on the existing term loan. The Company’s ability to borrow any additional principal under the Third Amendment expired unused on December 31, 2020.

The term loan under the Third Amendment matures in September 2024 with interest-only monthly payments until January 2022, which was extended to July 2022 upon the completion of the Company’s initial public offering (“IPO”) in October 2020. The term loan accrues interest at a per annum rate equal to the Wall Street Journal prime rate plus 1.0% (4.25% as of September 30, 2021) and includes a final payment fee equal to 6.25% of the original aggregate principal amount. In connection with the execution of the Third Amendment, the Company issued Silicon Valley Bank a warrant to purchase 53,487 shares of Series E convertible preferred stock. The amendment was accounted for as a modification.

Borrowings under the Third Amendment are collateralized by substantially all the assets of the Company, excluding intellectual property (but including rights to payment and proceeds thereof). The Third Amendment contains customary affirmative and restrictive covenants, including with respect to the Company’s ability to enter into fundamental transactions, incur additional indebtedness, grant liens, pay any dividend or make any distributions to its holders, make investments, merge or consolidate with any other person or engage in transactions with the Company’s affiliates, but do not include any financial covenants. The Company was in compliance with all of the covenants as of September 30, 2021.

As of September 30, 2021, outstanding principal on the term loan and accrual for the final payment fee amounted to $15.3 million. During the nine months ended September 30, 2021 and 2020, the Company recognized interest expense related to the term loans of $0.8 million and $0.5 million, respectively, which is inclusive of amortization of debt discount. The effective interest rate was 7.12% as of September 30, 2021.

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2020 Convertible Promissory Notes

The Company issued an aggregate of $8.9 million in convertible promissory notes in March 2020 and an additional aggregate of $1.2 million in April 2020 in a subsequent closing (the “2020 Notes”). The 2020 Notes accrued interest at a rate of 6.0% per annum.

The 2020 Notes contained a redemption feature such that in the event of a qualified sale of preferred stock or other equity securities resulting in aggregate gross proceeds to the Company of at least $15.0 million, all principal and accrued and unpaid interest under the 2020 Notes will automatically convert into the preferred stock issued in such a financing at a price per share equal to 80% of the lowest price per share of the preferred stock sold in the financing. This redemption feature and other features contained in the 2020 Notes were determined to be embedded derivatives requiring bifurcation and were separately accounted for as a single compound derivative instrument.

Upon the issuances of the 2020 Notes, the Company recorded the fair value of the derivative liability of $2.9 million as a debt discount on the 2020 Notes and as a single compound derivative instrument. The debt discount was being amortized to interest expense using the effective interest method over the term of the 2020 Notes. During the nine months ended September 30, 2020, the Company recognized interest expense related to the 2020 Notes of $0.9 million, which is inclusive of amortization of debt discount.

In July 2020, the 2020 Notes were redeemed whereby the outstanding principal balance of $10.1 million and accrued interest of $0.2 million was converted into shares of Series E convertible preferred stock at a price equal to 80% of the amount per share paid by the investors in the Series E preferred stock financing. The redemption of the 2020 Notes was accounted for as a debt extinguishment, which resulted in a loss of $1.6 million that was recognized in other income (expense) in the consolidated statement of operations and comprehensive loss. The loss on extinguishment was calculated as the difference between (i) the fair value of the shares of Series E convertible preferred stock issued to settle the 2020 Notes and (ii) the carrying value of the 2020 Notes, net of the unamortized debt discount, plus the fair value of the derivative liability associated with the 2020 Notes at the time of extinguishment.

8. Convertible preferred stock

Series E convertible preferred stock issuances

In July and August 2020, the Company issued an aggregate of 10,513,921 shares of Series E convertible preferred stock at a purchase price of $6.7836 per share in exchange for net proceeds of approximately $67.3 million.

Contemporaneous with the initial closing of the Series E convertible preferred stock financing, the 2020 Notes (see Note 7) were redeemed whereby all of the outstanding principal and accrued interest amounting to $10.3 million was converted into 1,889,548 shares of Series E convertible preferred stock.

In connection with the Series E convertible preferred stock financing, the Company amended and restated its certificate of incorporation. The amended and restated certificate of incorporation amended the liquidation right held by holders of Series C and Series

C-1

convertible preferred stock under which such holders were entitled to an aggregate liquidation amount per share from up to two times the original issue price to one times the original issuance price for the related series upon the event of a liquidation, dissolution, or winding up of the Company. This amendment of the liquidation right was determined to be significant using the qualitative approach. As such, the Company accounted for the amendment as an extinguishment of the outstanding Series C and Series

C-1

convertible preferred stock and recorded a gain on extinguishment of $9.8 million on the date of the filing of the charter. The gain on the extinguishment of Series C and Series

C-1

convertible preferred stock was calculated by taking the difference between the net carrying value of $59.7 million of Series C and Series

C-1

convertible preferred stock immediately prior to the amendment of the liquidation right and the fair value of $49.9 million of the new of Series C and Series

C-1

convertible preferred stock that for accounting purposes was deemed to be issued in connection with the amended and restated certificate of incorporation filed in connection with the Series E convertible preferred stock financing. The gain on extinguishment was recorded as a deemed contribution in equity and was recorded as a decrease to the net loss attributable to common stockholders for the three and nine months ended September 30, 2020 and as an increase to additional paid in capital.

In October 2020, immediately prior to the completion of the IPO, all of the then-outstanding shares of convertible preferred stock automatically converted into 28,196,388 shares of common stock at the applicable conversion ratio then in effect.

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9. Stock-based compensation

Total stock-based compensation is as follows:


	Three months ended September 30,				Nine months ended September 30,
	2021		2020		2021		2020

	(in thousands)
Cost of revenue	$	104	$	9	$	403	$	17
Research and development		1,584		295		3,751		550
Sales and marketing		1,841		344		5,595		594
General and administrative		1,949		719		6,101		1,202

Total stock-based compensation	$	5,478	$	1,367	$	15,850	$	2,363

Stock-based compensation costs capitalized as part of capitalized software costs was $0.2 million and $0.7 million during the three and nine months ended September 30, 2021, respectively. No such costs were capitalized during the three and nine months ended September 30, 2020.

Equity incentive plans

As of September 30, 2021, 5,219,664 shares of common stock are issuable upon the exercise of outstanding awards under the 2010 Equity Incentive Plan. As of September 30, 2021, the Company had reserved 6,931,546 shares of common stock for issuance under the 2020 Equity Incentive Plan (the “2020 Plan”), of which 6,111,083 are available for issuance in connection with grants of future awards.

Stock options

Stock option activity for the nine months ended September 30, 2021 is set forth below:


	Number of shares			Weighted average exercise price		Weighted average remaining contractual term		Aggregate intrinsic value
						(in years)		(in thousands)
Balance December 31, 2020		6,468,844		$	2.78		8.77	$	271,944
Grants		305,665			49.27
Exercises		(822,555	)		2.01
Cancelled/forfeited		(408,720	)		9.61

Balance September 30, 2021		5,543,234		$	4.96		8.18	$	21,327

Vested and exercisable at September 30, 2021		2,040,950		$	2.93		7.40	$	9,003

The weighted-average grant-date fair value of options granted during the nine months ended September 30, 2021 and 2020 was $25.94 and $3.05 per share, respectively.

The aggregate intrinsic values of options outstanding and vested and exercisable were calculated as the difference between the exercise price of the options and the fair value of the Company’s common stock.

As of September 30, 2021, total unrecognized stock-based compensation related to outstanding unvested stock options was $15.4 million, which the Company expects to recognize over a remaining weighted-average period of approximately 2.6 years.

The estimated grant-date fair value of the Company’s stock options was calculated using the Black-Scholes option pricing model, based on the following assumptions:


	Nine months ended September 30,
Valuation assumptions:	2021	2020
Expected volatility	54% - 57%	60% - 71%
Expected term	5.8 - 6.7 years	5.1 -7.0 years
Risk-free interest rate	0.62% - 1.09%	0.23% - 1.20%
Dividend yield	—	—

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Restricted stock units

Restricted stock units (“RSUs”) granted under the 2020 Plan are share awards that generally entitle the holder to receive freely tradable shares of the Company’s common stock upon vesting. RSUs cannot be transferred, and the awards are subject to forfeiture if the holder’s service to the Company terminates prior to the release of the vesting restrictions. The fair value of the RSUs is equal to the closing price of the Company’s common stock on the grant date.

RSU activity for the nine months ended September 30, 2021 is set forth below:


	Number of shares			Weighted average grant date fair value per share
Balance December 31, 2020		8,270		$	50.70
RSUs granted		481,100			45.61
RSUs vested		(26,549	)		54.44
RSUs forfeited		(63,156	)		50.90

Balance September 30, 2021		399,665		$	44.29

As of September 30, 2021, total unrecognized stock-based compensation related to unvested RSUs was $16.7 million, which the Company expects to recognize over a remaining weighted-average period of approximately 3.6 years.

Performance-based restricted stock units

In June 2021, the Company granted 80,000 RSUs with performance-based vesting conditions primarily related to sales targets that must be met by December 31, 2022 for the awards to vest. The vesting conditions were deemed probable as of September 30, 2021. The grant date fair value of the awards was $3.0 million. None of these awards have vested or were forfeited as of September 30, 2021.

Employee stock purchase plan

In October 2020, the Board of Directors and stockholders adopted and approved the ESPP. As of September 30, 2021, the Company reserved 1,109,239 shares of common stock for issuance under the ESPP, of which 934,496 are available for future issuance. The ESPP provides for consecutive, overlapping

24-month

offering periods, which are generally divided into four purchase periods of approximately six months. The offering periods are scheduled to start on the first trading day on or after May 16 and November 16 of each year, with exception of the first offering period which commenced on October 16, 2020, the first trading day after the effective date of the Company’s registration statement. Contributions under the ESPP are generally limited to a maximum of 15% of an employee’s eligible compensation.

Each offering period consists of four

six-month

purchase periods. On each purchase date, which falls on the last date of each purchase period, ESPP participants will purchase shares of common stock at a price per share equal to 85% of the lesser of (1) the fair market value per share of the common stock at the start of the offering period or (2) the fair market value of the common stock on the purchase date.

The Company recorded $2.3 million and $8.4 million of stock-based compensation related to the ESPP for the three and nine months ended September 30, 2021. 174,743 shares were issued under the ESPP during the nine months ended September 30, 2021. The fair value of the ESPP shares is estimated using the Black-Scholes option pricing model, based on the following assumptions for the offering period that started in May 2021:


		Nine months ended
Valuation assumptions:		September 30, 2021
Expected volatility		44% - 57%
Expected term		0.5 - 2.0 years
Risk-free interest rate		0.04% - 0.16%
Dividend yield		—

As of September 30, 2021, total unrecognized stock-based compensation related to the ESPP was $9.0 million, which the Company expected to recognize over a remaining weighted-average period of approximately 1.1 years. However, as a result of the uncertainty created by the DOJ investigation and the claims audits, the ESPP was suspended on November 9, 2021. All outstanding participant contribution amounts of $2.2 million were refunded to participants during the fourth quarter of 2021 and all future purchases under the current offering periods were cancelled. The Company will account for the suspension of the ESPP as a cancellation of the ESPP awards and will accelerate and recognize $9.0 million of stock-based compensation in the fourth quarter of 2021.

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10. Net income (loss) per share attributable to common stockholders

The following outstanding potentially dilutive common stock equivalents have been excluded from the computation of diluted net income (loss) per share for the periods presented due to their anti-dilutive effect:


	Three months ended September 30,				Nine months ended September 30,
	2021		2020		2021		2020
Convertible preferred stock		—		28,196,388		—		28,196,388
Common stock options issued and outstanding		5,543,234		6,761,512		5,543,234		6,761,512
Restricted stock units		479,665		—		479,665		—