SEC Filing | Eargo, Inc.

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10-Q

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, 2023


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

For the transition period from to

Commission File Number: 001-39616

Eargo, Inc.

(Exact Name of Registrant as Specified in its Charter)


Delaware	27-3879804
(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

Not Applicable

(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 October 30, 2023, the registrant had 20,762,389 shares of common stock, par value $0.0001 outstanding.

Table of Contents


		Page
	SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS	1
PART I.	FINANCIAL INFORMATION	3
Item 1.	Condensed Consolidated Financial Statements (Unaudited)	3
	Condensed Consolidated Balance Sheets (Unaudited)	3
	Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)	4
	Condensed Consolidated Statements of Stockholders’ Equity (Unaudited)	5
	Condensed Consolidated Statements of Cash Flows (Unaudited)	6
	Notes to Unaudited Condensed Consolidated Financial Statements (Unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	34
PART II.	OTHER INFORMATION	35
Item 1.	Legal Proceedings	35
Item 1A.	Risk Factors	35
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	77
Item 3.	Defaults Upon Senior Securities	77
Item 4.	Mine Safety Disclosures	77
Item 5.	Other Information	77
Item 6.	Exhibits	78
	SIGNATURES	79

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,” “can,” “contemplate,” “continue,” “could,” “design,” “due,” “estimate,” “expect,” “forecast,” “future,” “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. The forward-looking statements in this report, other than statements regarding the proposed Merger (as defined herein), do not assume the consummation of the Merger unless specifically stated otherwise. These forward-looking statements include, but are not limited to, statements about:

•

our expectations regarding the structure, timing and completion of the proposed Merger; our ability to obtain any required regulatory approvals in connection with the proposed Merger; expenses related to the proposed Merger and any potential future costs; our ability to satisfy the conditions to closing or otherwise complete the Merger; the occurrence of any event, change, or other circumstances that could delay or prevent completion of the proposed Merger or give rise to the termination of the Merger Agreement (as defined herein); the impact the pending Merger may have on our current plans and operations, including potentially diverting management’s attention from our business; the effects of the Merger on our future business and financial and operating results; and our ability to retain key personnel and maintain relationships with customers, suppliers and others with whom we do business;

•

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 claims for reimbursement submitted to various federal employee health plans under the Federal Employee Health Benefits (“FEHB”) program, the extent to which we may be able to validate and establish additional processes to support the submission of claims for reimbursement to health plans under the FEHB program, and our ability to obtain, maintain or increase insurance coverage for our hearing aids in the future;

•

our expectations with regard to changes in the regulatory landscape for hearing aid devices and related opportunities, including the implementation of the United States Food and Drug Administration’s new over-the-counter (“OTC”) hearing aid regulatory framework and any potential Medicare coverage for certain hearing aids, as well as any potential actions insurance providers may take following such regulatory changes;

•

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 reimbursement 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;

•

estimates of our future revenue and expenses;

•

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 ability to continue as a going concern;

•

our strategy and expectations regarding our omni-channel business, including commercial partnerships with retailers, resellers and other distributors, and our ability to execute additional commercial partnerships and expand our customers’ experience of and access to our devices through such commercial partnerships;

•

our ability to attract and retain customers and to optimize our customer acquisition process;

•

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 additional 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 manage costs and the timing, scope and impact of our current and any future cost reduction plans, including any adverse impact on our business;

•

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;

•

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, any 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 expectations regarding macroeconomic conditions, including but not limited to, the impact of COVID-19, inflationary trends, uncertainty or volatility in the market (including recent and potential disruption in the banking system and financial markets) and geopolitical events (such as the conflict in Ukraine and the Middle East and tensions across the Taiwan Strait) 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.

PART I—FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (Unaudited).

Eargo, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except share and per share amounts)


	September 30,			December 31,
	2023			2022
ASSETS
Current assets:
Cash and cash equivalents	$	46,023		$	101,238
Accounts receivable, net		1,012			1,910
Inventories		4,386			5,036
Prepaid expenses and other current assets		5,271			7,846
Total current assets		56,692			116,030
Operating lease right-of-use assets		7,327			5,765
Property and equipment, net		4,384			7,441
Intangible assets, net		744			1,063
Goodwill		—			873
Other assets		606			906
Total assets	$	69,753		$	132,078
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,047		$	6,504
Accrued expenses		6,818			12,715
Sales returns reserve		3,767			3,942
Other current liabilities		1,338			1,462
Lease liability, current portion		624			628
Total current liabilities		17,594			25,251
Lease liability, noncurrent portion		7,030			5,973
Total liabilities		24,624			31,224
Commitments and contingencies (Note 5)
Stockholders’ equity:
Preferred stock, $0.0001 par value per share; 5,000,000 shares authorized as of September 30, 2023 and December 31, 2022, respectively; zero shares issued and outstanding as of September 30, 2023 and December 31, 2022, respectively		—			—
Common stock; $0.0001 par value; 450,000,000 shares authorized as of September 30, 2023 and December 31, 2022, respectively; 20,762,389 and 20,726,965 shares issued and outstanding as of September 30, 2023 and December 31, 2022, respectively		2			2
Additional paid-in capital		623,828			615,151
Accumulated deficit		(578,701	)		(514,299	)
Total stockholders’ equity		45,129			100,854
Total liabilities and stockholders’ equity	$	69,753		$	132,078

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

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,
	2023			2022			2023			2022
Revenue, net	$	8,270		$	7,908		$	28,191		$	24,331
Cost of revenue		3,937			6,007			17,105			16,231
Gross profit		4,333			1,901			11,086			8,100
Operating expenses:
Research and development		4,742			4,963			14,711			14,689
Sales and marketing		9,281			11,282			35,309			37,306
General and administrative		7,385			11,702			26,739			43,980
Impairment charge		873			—			873			—
Total operating expenses		22,281			27,947			77,632			95,975
Loss from operations		(17,948	)		(26,046	)		(66,546	)		(87,875	)
Other income (expense), net:
Interest income		620			419			2,144			480
Interest expense		—			—			—			(549	)
Change in fair value of convertible notes		—			(25,000	)		—			(25,000	)
Loss on extinguishment of debt		—			—			—			(772	)
Total other income (expense), net		620			(24,581	)		2,144			(25,841	)
Loss before income taxes		(17,328	)		(50,627	)		(64,402	)		(113,716	)
Income tax provision		—			—			—			—
Net loss and comprehensive loss	$	(17,328	)	$	(50,627	)	$	(64,402	)	$	(113,716	)
Net loss attributable to common stockholders, basic and diluted	$	(17,328	)	$	(50,627	)	$	(64,402	)	$	(113,716	)
Net loss per share attributable to common stockholders, basic and diluted	$	(0.83	)	$	(25.70	)	$	(3.10	)	$	(57.78	)
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted		20,756,123			1,969,856			20,745,534			1,968,074

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

Eargo, Inc.

Condensed Consolidated Statements of Stockholders’ Equity

(Unaudited)

(In thousands, except share amounts)


	Common stock				Additional paid-in		Accumulated			Total stockholders’
	Shares		Amount		capital		deficit			equity
Balance December 31, 2022		20,726,965	$	2	$	615,151	$	(514,299	)	$	100,854
Stock-based compensation		—		—		3,408		—			3,408
Release of restricted stock units		14,876		—		—		—			—
Net loss and comprehensive loss		—		—		—		(21,922	)		(21,922	)
Balance March 31, 2023		20,741,841	$	2	$	618,559	$	(536,221	)	$	82,340
Stock-based compensation		—		—		2,629		—			2,629
Release of restricted stock units		7,738		—		—		—			—
Net loss and comprehensive loss		—		—		—		(25,152	)		(25,152	)
Balance June 30, 2023		20,749,579	$	2	$	621,188	$	(561,373	)	$	59,817
Stock-based compensation		—		—		2,640		—			2,640
Release of restricted stock units		12,810		—		—		—			—
Net loss and comprehensive loss		—		—		—		(17,328	)		(17,328	)
Balance September 30, 2023		20,762,389	$	2	$	623,828	$	(578,701	)	$	45,129


	Common stock				Additional paid-in			Accumulated			Total stockholders’
	Shares		Amount		capital			deficit			equity
Balance December 31, 2021		1,965,347	$	—	$	425,976		$	(356,812	)	$	69,164
Stock-based compensation		—		—		3,024			—			3,024
Exercise of stock options		1,871		—		92			—			92
Restricted stock units cash settlement		—		—		(69	)		—			(69	)
Net loss and comprehensive loss		—		—		—			(30,645	)		(30,645	)
Balance March 31, 2022		1,967,218	$	—	$	429,023		$	(387,457	)	$	41,566
Stock-based compensation		—		—		1,511			—			1,511
Exercise of stock options and release of restricted stock units		2,045		—		33			—			33
Tax withholdings on settlement of restricted stock units		—		—		(22	)		—			(22	)
Issuance costs		—		—		600			—			600
Net loss and comprehensive loss		—		—		—			(32,444	)		(32,444	)
Balance June 30, 2022		1,969,263	$	—	$	431,145		$	(419,901	)	$	11,244
Stock-based compensation		—		—		3,057			—			3,057
Exercise of stock options and release of restricted stock units		1,281		—		9			—			9
Tax withholdings on settlement of restricted stock units		—		—		(7	)		—			(7	)
Net loss and comprehensive loss		—		—		—			(50,627	)		(50,627	)
Balance September 30, 2022		1,970,544	$	—	$	434,204		$	(470,528	)	$	(36,324	)

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

Eargo, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)


	Nine months ended September 30,
	2023			2022
Operating activities:
Net loss	$	(64,402	)	$	(113,716	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		3,477			4,023
Stock-based compensation		8,677			7,592
Non-cash interest expense and amortization of debt discount		—			209
Debt issuance costs from convertible notes		—			5,662
Change in fair value of convertible notes		—			25,000
Loss on extinguishment of debt		—			772
Non-cash operating lease expense		734			828
Bad debt expense		409			524
Impairment charges		1,702			—
Changes in operating assets and liabilities:
Accounts receivable		489			10,867
Inventories		650			759
Prepaid expenses and other current assets		2,323			6,869
Other assets		(1,292	)		999
Accounts payable		(1,152	)		(2,366	)
Accrued expenses		(5,897	)		1,986
Sales returns reserve		(175	)		(12,037	)
Settlement liability		—			(34,372	)
Other current and noncurrent liabilities		(124	)		89
Operating lease liabilities		(346	)		(550	)
Net cash used in operating activities		(54,927	)		(96,862	)
Investing activities:
Purchases of property and equipment		(217	)		(2,531	)
Capitalized software development costs		(71	)		(296	)
Net cash used in investing activities		(288	)		(2,827	)
Financing activities:
Proceeds from stock options exercised		—			134
Debt repayments		—			(16,238	)
Proceeds from issuance of convertible notes, net of issuance costs paid to lender		—			99,903
Payment of convertible notes issuance costs to third parties		—			(5,565	)
Payment of deferred transaction costs		—			(872	)
Payment of taxes related to net share settlement of restricted stock units		—			(29	)
Restricted stock units settled in cash		—			(69	)
Net cash provided by financing activities		—			77,264
Net decrease in cash and cash equivalents		(55,215	)		(22,425	)
Cash and cash equivalents at beginning of period		101,238			110,500
Cash and cash equivalents at end of period	$	46,023		$	88,075
Non-cash operating activities:
Lease liability obtained in exchange for right-of-use asset	$	1,399		$	—
Non-cash investing and financing activities:
Property and equipment and capitalized software costs in accounts payable and accrued liabilities	$	642		$	229
Deferred transaction costs included in accounts payable	$	—		$	182

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

Eargo, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Description of business and other matters

Eargo, Inc. (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.

Reverse stock split

In January 2023, the Company effected a reverse split of shares of the Company’s common stock on a 1-for-20 basis (the “Reverse Stock Split”). The Company’s common stock began trading on a post-split basis on January 18, 2023. The number of authorized shares of the common stock was not adjusted as a result of the Reverse Stock Split. All share and per share data in these unaudited condensed consolidated financial statements have been retrospectively adjusted to reflect the effect of the Reverse Stock Split for all periods presented. The shares of common stock retain a par value of $0.0001 per share. Accordingly, an amount equal to the par value of the decreased shares resulting from the Reverse Stock Split was reclassified from common stock to additional paid-in capital.

DOJ investigation and settlement

On September 21, 2021, 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 claims for reimbursement the Company submitted on behalf of its customers covered by various federal employee health plans under the Federal Employee Health Benefits (“FEHB”) program, which is administered by the Office of Personnel Management (the “OPM”). The investigation also pertained to Eargo’s role in claim submissions to federal employee health plans (collectively, the “DOJ investigation”). Total payments the Company received from the government in relation to claims submitted under the FEHB program, as subject to the DOJ investigation, net of any product returns and associated refunds, were approximately $44.0 million. Additionally, the third-party payor with whom the Company historically had the largest volume, which is one of the carriers contracted with the OPM under the FEHB program, conducted an audit of insurance claims for reimbursement (“claims”) submitted by the Company, which included a review of medical records. 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 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. As discussed further in Note 5, based on the settlement agreement with the U.S. government, the Company recorded a settlement liability of $34.4 million as of December 31, 2021. The settlement amount was treated as consideration payable to a customer and was recorded as a reduction of revenue in the third quarter of 2021. On May 2, 2022, the Company paid the settlement amount.

In September 2022, the Company made the determination not to seek payment for approximately $16.1 million from customers with unsubmitted and unpaid claims which was accounted for as a pricing concession (the “Pricing Concession”). During the year ended December 31, 2022, the Company recorded a $16.1 million reduction to its insurance-related accounts receivable balance along with related reduction to net revenue of $11.6 million and an allowance for credit losses balance of $4.5 million for such unsubmitted and unpaid claims. Further, the Company simultaneously recorded a decrease in its insurance-related sales return reserve of $11.3 million along with a corresponding increase of $11.3 million to net revenue for the year ended December 31, 2022 related to unsubmitted and unpaid claims. These changes resulted in a decrease in net revenue of $0.3 million for the year ended December 31, 2022.

Liquidity and going concern

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) 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, 2023, the Company had cash and cash equivalents of $46.0 million and an accumulated deficit of $578.7 million.

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 has and could continue to negatively impact the Company’s liquidity and working capital, including by impacting its ability to access additional capital. It is difficult to assess or predict at this time the extent to which the Company is able to validate and establish additional processes to support the submission of claims for reimbursement to health plans, including those under the FEHB program, and the future or long-term impacts of the implementation of an over-the-counter (“OTC”) hearing aid

regulatory framework (which may, for example, lead insurance providers to take actions limiting the Company’s ability to access insurance coverage or have other long-term impacts on the Company’s omni-channel business that are not yet known).

The Company believes that, without an alternative future financing, its current resources are insufficient to satisfy its obligations as they become due within one year after the date that these unaudited condensed consolidated 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. If the Company is unable to raise additional funding to meet its operational needs, it will be forced to limit or cease its operations.

These unaudited 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.

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 GAAP and applicable rules and regulations of the Securities and Exchange Commission (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, in all material respects, 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, 2022, filed with the SEC on March 23, 2023.

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 credit losses, the net realizable value of inventory, the fair value of assets acquired in a business combination, the useful lives of long-lived assets, impairment 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, 2023, 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.

Revenue recognition

The Company’s revenue is generated from the sale of products, including hearing aid systems and related accessories. Revenue is recognized when promised goods or services are transferred to end-use customers, distributors, or retail partners 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.

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 may include concessions, product returns, discounts, incentives, or other similar items. Variable consideration is estimated based on contractual terms and historical analysis using specific data for the type of consideration being assessed.

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Product Returns: The Company’s customer contracts include the general 45-day right of return that applies to all products and the extended right of return offered for certain shipments to direct plan access customers involving certain insurance payors. 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.

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Concessions: Concessions are generally viewed as any post-execution change to the original agreement between the Company and customer that increase the customer’s rights or the Company’s obligations without a commensurate increase to the consideration due the Company. Concessions may take many forms and include, but are not limited to, (i) accepting returns that are not required under the terms of the original arrangement, (ii) reducing the arrangement fee, and (iii) extending the terms of payment. While the Company granted a price concession to its customers with unsubmitted and unpaid claims during the year ended December 31, 2022 (please see caption “DOJ investigation and settlement” in Note 1), the Company does not have an established history of providing concessions to its customers and has determined that no adjustments should made to the transaction price in the Company’s ongoing customer arrangements. However, for each reporting period, the Company will re-evaluate the occurrence and level of materiality of concessions and will assess any potential impact on the transaction price accordingly.

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. The Company does not have material contract liabilities related to unsatisfied performance obligations as of September 30, 2023.

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 consolidated statements of operations and comprehensive loss as incurred.

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, 2023, the Company has not experienced any losses on its deposit accounts and money market accounts. As of September 30, 2023, 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 36% of the Company's gross accounts receivable as of September 30, 2023 was from one of the Company's retail partners. There was no credit risk concentration in the Company's accounts receivable as of December 31, 2022. There was no concentration of net revenue during the three months ended September 30, 2023. During the nine months ended September 30, 2023,

the Company derived approximately 11% of net revenue from sales to its retail partners. There was no concentration of revenue during the three and nine months ended September 30, 2022.

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, 2023 and December 31, 2022. 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.

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,
	2023		2022
	(in thousands)
Raw materials	$	209	$	410
Finished goods		4,177		4,626
Total inventories	$	4,386	$	5,036