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EX-32.2 - EX-32.2 - Eargo, Inc.ear-ex322_6.htm
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EX-31.2 - EX-31.2 - Eargo, Inc.ear-ex312_8.htm
EX-31.1 - EX-31.1 - Eargo, Inc.ear-ex311_9.htm

 

 

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, 2020

OR

 

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

27-3879805

( State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer
Identification No.)

1600 Technology Drive, 6th Floor

San Jose, California 95110

95110

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (650) 351-7700

 

 

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

 

 

 

 

 

 

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. Se e the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

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  

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.     Yes      No  

As of November 18, 2020, the registrant had 38,186,515 shares of common stock, par value $0.0001 outstanding.

 

 

 

 


 

Table of Contents

 

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

1

Item 1.

Financial Statements (Unaudited)

 

1

 

Condensed Consolidated Balance Sheets

 

1

 

Condensed Consolidated Statements of Operations and Comprehensive Loss

 

2

 

Condensed Consolidated Statements of Convertible Preferred Stock and Stockholders’ Deficit

 

3

 

Condensed Consolidated Statements of Cash Flows

 

5

 

Notes to Condensed Consolidated Financial Statements

 

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

33

Item 4.

Controls and Procedures

 

33

PART II.

OTHER INFORMATION

 

34

Item 1.

Legal Proceedings

 

34

Item 1A.

Risk Factors

 

34

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

68

Item 3.

Defaults Upon Senior Securities

 

68

Item 4.

Mine Safety Disclosures

 

68

Item 5.

Other Information

 

68

Item 6.

Exhibits

 

69

 

 

 

i


 

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,

 

 

 

2020

 

 

2019

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

70,224

 

 

$

13,384

 

Accounts receivable, net

 

 

2,576

 

 

 

2,051

 

Inventories

 

 

3,289

 

 

 

2,880

 

Prepaid expenses and other current assets

 

 

1,379

 

 

 

1,598

 

Total current assets

 

 

77,468

 

 

 

19,913

 

Operating lease right-of-use assets

 

 

1,369

 

 

 

 

Property and equipment, net

 

 

6,946

 

 

 

5,400

 

Other assets

 

 

2,304

 

 

 

1,992

 

Total assets

 

$

88,087

 

 

$

27,305

 

LIABILITIES, CONVERTIBLE PREFERRED STOCK AND

   STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

6,658

 

 

$

5,428

 

Accrued expenses

 

 

10,809

 

 

 

9,939

 

Long-term debt, current portion

 

 

 

 

 

4,800

 

Other current liabilities

 

 

2,079

 

 

 

1,717

 

Deferred revenue, current

 

 

441

 

 

 

406

 

Lease liability, current portion

 

 

1,097

 

 

 

 

Total current liabilities

 

 

21,084

 

 

 

22,290

 

Lease liability, noncurrent portion

 

 

412

 

 

 

 

Deferred revenue, noncurrent portion

 

 

17

 

 

 

269

 

Long-term debt, noncurrent portion

 

 

14,502

 

 

 

7,446

 

Convertible preferred stock warrant liability

 

 

544

 

 

 

396

 

Other liabilities

 

 

 

 

 

127

 

Total liabilities

 

 

36,559

 

 

 

30,528

 

Commitments and contingencies (Note 5)

 

 

 

 

 

 

 

 

Convertible preferred stock, $0.0001 par value; 73,108,323 and 36,269,166 shares

   authorized as of September 30, 2020 and December 31, 2019, respectively; 24,229,281

   and 11,825,812 issued and outstanding as of September 30, 2020

   and December 31, 2019, respectively

 

 

223,125

 

 

 

152,880

 

Stockholders’ deficit:

 

 

 

 

 

 

 

 

Common stock; $0.0001 par value; 110,000,000 and 55,190,000 shares authorized as of

   September 30, 2020 and December 31, 2019, respectively; 534,599 and 265,943 shares

   issued and outstanding as of September 30, 2020 and December 31, 2019, respectively

 

 

 

 

 

 

Additional paid in capital

 

 

15,662

 

 

 

3,100

 

Accumulated deficit

 

 

(187,259

)

 

 

(159,203

)

Total stockholders’ deficit

 

 

(171,597

)

 

 

(156,103

)

Total liabilities, convertible preferred stock and stockholders’ deficit

 

$

88,087

 

 

$

27,305

 

 

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

1


 

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,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Revenue, net

 

$

18,186

 

 

$

7,730

 

 

$

46,776

 

 

$

22,175

 

Cost of revenue

 

 

5,434

 

 

 

3,583

 

 

 

15,295

 

 

 

11,033

 

Gross profit

 

 

12,752

 

 

 

4,147

 

 

 

31,481

 

 

 

11,142

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

 

2,871

 

 

 

3,219

 

 

 

7,888

 

 

 

8,781

 

Sales and marketing

 

 

12,354

 

 

 

9,290

 

 

 

34,041

 

 

 

24,698

 

General and administrative

 

 

5,163

 

 

 

3,683

 

 

 

14,498

 

 

 

8,781

 

Total operating expenses

 

 

20,388

 

 

 

16,192

 

 

 

56,427

 

 

 

42,260

 

Loss from operations

 

 

(7,636

)

 

 

(12,045

)

 

 

(24,946

)

 

 

(31,118

)

Other income (expense), net:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

3

 

 

 

136

 

 

 

26

 

 

 

555

 

Interest expense

 

 

(279

)

 

 

(218

)

 

 

(1,422

)

 

 

(492

)

Other income (expense), net

 

 

(187

)

 

 

(30

)

 

 

(87

)

 

 

(84

)

Loss on extinguishment of debt

 

 

(1,627

)

 

 

 

 

 

(1,627

)

 

 

 

Total other income (expense), net

 

 

(2,090

)

 

 

(112

)

 

 

(3,110

)

 

 

(21

)

Loss before income taxes

 

 

(9,726

)

 

 

(12,157

)

 

 

(28,056

)

 

 

(31,139

)

Income tax provision

 

 

 

 

 

 

 

 

 

 

 

 

Net loss and comprehensive loss

 

$

(9,726

)

 

$

(12,157

)

 

$

(28,056

)

 

$

(31,139

)

Net income (loss) attributable to common stockholders, basic and

   diluted

 

$

 

 

$

(12,157

)

 

$

(18,216

)

 

$

(31,139

)

Net income (loss) per share attributable to common stockholders,

   basic and diluted

 

$

 

 

$

(46.26

)

 

$

(57.73

)

 

$

(122.74

)

Weighted-average shares used in computing net income (loss) per

   share attributable to common stockholders, basic and diluted

 

 

398,895

 

 

 

262,785

 

 

 

315,546

 

 

 

253,701

 

 

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

2


 

Eargo, Inc.

Condensed Consolidated Statements of Convertible Preferred Stock and Stockholders’ 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 $4.1 million

 

 

10,513,921

 

 

 

67,267

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of Series E

   convertible preferred stock,

   upon extinguishment of

   convertible notes (Note 6)

 

 

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

)

 

3


 

Eargo, Inc.

Condensed Consolidated Statements of Convertible Preferred Stock and Stockholders’ 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, 2018

 

 

11,761,159

 

 

$

152,015

 

 

 

 

231,831

 

 

$

 

 

$

1,718

 

 

$

(114,717

)

 

$

(112,999

)

Issuance of Series D

   convertible preferred stock,

   net of issuance

   costs of $0

 

 

64,653

 

 

 

865

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

107

 

 

 

 

 

 

107

 

Exercise of stock options

 

 

 

 

 

 

 

 

 

27,557

 

 

 

 

 

 

36

 

 

 

 

 

 

36

 

Net loss and comprehensive

   loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(9,223

)

 

 

(9,223

)

Balance March 31, 2019

 

 

11,825,812

 

 

 

152,880

 

 

 

 

259,388

 

 

 

 

 

 

1,861

 

 

 

(123,940

)

 

 

(122,079

)

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

433

 

 

 

 

 

 

433

 

Exercise of stock options

 

 

 

 

 

 

 

 

 

3,220

 

 

 

 

 

 

4

 

 

 

 

 

 

4

 

Net loss and comprehensive

   loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(9,759

)

 

 

(9,759

)

Balance June 30, 2019

 

 

11,825,812

 

 

 

152,880

 

 

 

 

262,608

 

 

 

 

 

 

2,298

 

 

 

(133,699

)

 

 

(131,401

)

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

457

 

 

 

 

 

 

457

 

Exercise of stock options

 

 

 

 

 

 

 

 

 

304

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss and comprehensive

   loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(12,157

)

 

 

(12,157

)

Balance September 30, 2019

 

 

11,825,812

 

 

$

152,880

 

 

 

 

262,912

 

 

$

 

 

$

2,755

 

 

$

(145,856

)

 

$

(143,101

)

 

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

4


 

Eargo, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

 

 

Nine months ended September 30,

 

 

 

2020

 

 

2019

 

Operating activities:

 

 

 

 

 

 

 

 

Net loss

 

$

(28,056

)

 

$

(31,139

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

1,805

 

 

 

1,011

 

Stock-based compensation

 

 

2,363

 

 

 

997

 

Non-cash interest expense and amortization of debt discount

 

 

1,178

 

 

 

200

 

Non-cash operating lease expense

 

 

838

 

 

 

 

Bad debt expense

 

 

2,135

 

 

 

44

 

Loss on extinguishment of debt

 

 

1,627

 

 

 

 

Change in fair value of warrant liability

 

 

(122

)

 

 

84

 

Change in fair value of derivative liability

 

 

206

 

 

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(2,660

)

 

 

(113

)

Inventories

 

 

(409

)

 

 

(1,110

)

Prepaid expenses and other current assets

 

 

219

 

 

 

(199

)

Other assets

 

 

963

 

 

 

(311

)

Accounts payable

 

 

579

 

 

 

(585

)

Accrued expenses

 

 

147

 

 

 

1,750

 

Other current liabilities

 

 

362

 

 

 

(172

)

Deferred revenue

 

 

(217

)

 

 

409

 

Operating lease liabilities

 

 

(883

)

 

 

 

Other liabilities

 

 

(127

)

 

 

(59

)

Net cash used in operating activities

 

 

(20,052

)

 

 

(29,193

)

Investing activities:

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(844

)

 

 

(1,616

)

Capitalized software development costs

 

 

(2,601

)

 

 

(1,017

)

Net cash used in investing activities

 

 

(3,445

)

 

 

(2,633

)

Financing activities:

 

 

 

 

 

 

 

 

Proceeds from stock options exercised

 

 

359

 

 

 

40

 

Proceeds from debt financing

 

 

15,000

 

 

 

5,000

 

Proceeds from convertible preferred stock issuance, net of issuance costs

 

 

67,867

 

 

 

865

 

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

 

 

80,337

 

 

 

5,905

 

Net increase (decrease) in cash and cash equivalents and restricted cash

 

 

56,840

 

 

 

(25,921

)

Cash and cash equivalents and restricted cash at beginning of period

 

 

13,384

 

 

 

51,201

 

Cash and cash equivalents and restricted cash at end of period

 

$

70,224

 

 

$

25,280

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

253

 

 

$

275

 

Non-cash operating activities:

 

 

 

 

 

 

 

 

Lease liability obtained in exchange for right-of-use asset

 

$

2,392

 

 

$

 

Non-cash investing and financing activities:

 

 

 

 

 

 

 

 

Property and equipment and capitalized software costs in accounts payable and accrued liabilities

 

$

421

 

 

$

307

 

Deferred offering costs in accounts payable and accrued liabilities

 

$

1,053

 

 

$

 

Convertible preferred stock issuance costs included in accounts payable

 

$

600

 

 

$

 

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

 

 

$

41

 

 

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

 

5


 

Eargo, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Description of business

Eargo, Inc. (the “Company”) is a medical device company dedicated to improving the quality of life of people with hearing loss. The Eargo solution was developed to create a hearing aid that consumers actually want to use. 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.

Initial public offering

On October 20, 2020, the Company closed its initial public offering (“IPO”) of its common stock in which the Company issued and sold 7,851,852 shares of its common stock, and concurrently sold an additional 1,177,777 shares upon the full exercise of the underwriters’ option to purchase additional shares. In connection with the IPO, including the underwriters’ option, the Company issued and sold an aggregate of 9,029,629 shares of common stock at $18.00 per share, raising approximately $148.1 million in proceeds, net of underwriting discounts and commissions of $11.4 million and estimated offering costs of $3.1 million, of which $1.3 million were incurred as of September 30, 2020.

Immediately prior to the closing of the IPO, all outstanding shares of convertible preferred stock were converted into 28,196,388 shares of common stock. Further, all outstanding convertible preferred stock warrants were converted into warrants to purchase 137,812 shares of common stock (see Note 10). The condensed consolidated financial statements as of September 30, 2020, including share and per share amounts, do not give effect to the IPO or the conversion of the convertible preferred stock into common stock, as the IPO and such conversions were completed subsequent to September 30, 2020.

Reverse stock split

In October 2020, the Company’s board of directors approved an amended and restated certificate of incorporation to effect a reverse split of shares of the Company’s common stock and convertible preferred stock on a 3-for-1 basis (the “Reverse Stock Split”), which was filed and effective on October 8, 2020. The number of authorized shares and the par values of the common stock and convertible preferred stock were not adjusted as a result of the Reverse Stock Split. All references to common stock, options to purchase common stock, convertible preferred stock, warrants to purchase convertible preferred stock, share data, per share data and related information contained in the condensed consolidated financial statements have been retrospectively adjusted to reflect the effect of the Reverse Stock Split for all periods presented.

Liquidity

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, 2020, the Company had cash and cash equivalents of $70.2 million and an accumulated deficit of $187.3 million.

The Company believes that its existing cash and cash equivalents as of September 30, 2020, together with the net proceeds of approximately $148.1 million received from its IPO (see Note 10), will be sufficient for the Company to continue as a going concern for at least one year from its unaudited condensed consolidated financial statements filed with the Securities and Exchange Commission (“SEC”). The Company’s future capital requirements will depend on many factors, including its growth rate, the timing and extent of its spending to support research and development activities and the timing and cost of establishing additional sales and marketing capabilities.

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 (“GAAP”) and applicable rules and regulations SEC regarding interim financial reporting. All intercompany balances and transactions have been eliminated.

The interim condensed consolidated balance sheet as of September 30, 2020, the condensed consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2020 and 2019, the condensed consolidated statements of convertible preferred stock and stockholders’ deficit and the statements of cash flows for the nine months ended September 30, 2020 and 2019 are unaudited. The unaudited condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s consolidated financial position as of September 30, 2020 and its results of operations and comprehensive loss for the three and nine months ended September 30, 2020 and 2019, and cash flows for the nine months ended September 30, 2020 and 2019. The financial data and the other financial information contained in these notes to the condensed consolidated financial statements related to the three and nine months periods are also unaudited. The results of

6


Eargo, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 

operations and comprehensive loss for the three and nine months ended September 30, 2020 are not necessarily indicative of the results to be expected for the year ending December 31, 2020 or for any other future annual or interim period. The condensed consolidated balance sheet as of December 31, 2019 included herein was derived from the audited financial statements as of that date. These condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements included in the prospectus dated October 15, 2020 (“Prospectus”) that forms a part of the Company's Registration Statements on Form S-1 (File No. 333-24907), as filed with the SEC pursuant to Rule 424(b)(4) promulgated under the Securities Act of 1933, as amended.

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 condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made in the accompanying condensed consolidated financial statements include, but are not limited to, allowance for sales returns, the fair value of lease liabilities, the fair value of equity securities, the fair value of financial instruments, the allowance for doubtful accounts, net realizable value of inventory, accrued product warranty reserve, 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.

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, 2020, the Company has not experienced any losses on its deposit accounts and money market accounts. As of September 30, 2020, 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.

Fair value measurement

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, or an exit price, in the principal or most advantageous market for that asset or liability in an orderly transaction between market participants on the measurement date.

The Company measures fair value based on a three-level hierarchy of inputs, of which the first two are considered observable and the last unobservable. Unobservable inputs reflect the Company’s own assumptions about current market conditions. The Company maximizes the use of observable inputs, where available, and minimizes the use of unobservable inputs when measuring fair value. The three-level hierarchy of inputs is as follows:

Level 1—Observable inputs such as unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;

Level 2—Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

7


Eargo, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 

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, which is a Level 2 input. 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.

Accounts receivable, net

Accounts receivable represents amounts due from third-party institutions for credit card and debit card transactions and trade accounts receivable. Accounts receivable are recorded at invoiced amounts, net of allowances for doubtful accounts. The allowance for doubtful accounts is based on the Company’s assessment of the collectibility 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. As of September 30, 2020 and December 31, 2019, the Company recorded an allowance for doubtful accounts of $2.3 million and $0.2 million, respectively. The allowance for doubtful accounts charges are recorded as a component of general and administrative expenses in the unaudited condensed consolidated statements of operations and comprehensive loss.

Leases

The Company adopted Accounting Standards Codification (“ASC”) Topic 842, “Leases” (“ASC 842”) on January 1, 2020, as discussed below in the section titled “Recently adopted accounting pronouncements”. Under ASC 842, the Company determines if an arrangement is a lease at inception. Operating leases are included in operating lease right-of-use (“ROU”) assets and the current and noncurrent portions of the operating lease liability are included as operating lease liabilities in the Company’s condensed consolidated balance sheets.

ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized based on the present value of lease payments over the lease term at the commencement date of the lease. ROU assets also include any initial direct costs incurred and any lease payments made at or before the lease commencement date, less any lease incentive received. As the Company’s leases do not provide an implicit interest rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term.

The Company elected to exclude from its condensed consolidated balance sheet recognition of leases having a term of 12 months or less (short-term leases) and elected to not separate lease components and non-lease components for its real estate leases. The Company’s non-lease components are primarily related to property maintenance, which varies based on future outcomes, and is recognized in rent expense when incurred.

Deferred offering costs

Offering costs consisting of legal, accounting, printer, and filing fees related to the Company’s planned IPO are deferred and will be offset against proceeds from the IPO upon effectiveness of the offering. As of December 31, 2019, the Company recorded deferred offering costs of $1.2 million as other assets on the condensed consolidated balance sheets. In March 2020, the Company terminated its offering and expensed all of its deferred offering costs amounting to $1.6 million as a component of general and administrative expenses in the unaudited condensed consolidated statements of operations and comprehensive loss. As of September 30, 2020, the Company recorded deferred offering costs of $1.3 million as other assets on the condensed consolidated balance sheets. Upon closing of the IPO in October 2020, all deferred offering costs were offset against the IPO proceeds.

Convertible preferred stock warrant liability

The Company accounts for its convertible preferred stock warrants issued in connection with its various financing transactions based upon the characteristics and provisions of the instrument. Convertible preferred stock warrants classified as liabilities are recorded on the unaudited condensed consolidated balance sheets at their fair value on the date of issuance and remeasured to fair value at each reporting period, with the changes in fair value recognized as other income (expense), net in the unaudited condensed consolidated statements of operations and comprehensive loss. The Company will continue to adjust the liability for changes in the fair value of these warrants until the earlier of the exercise of the warrants, the expiration of the warrants, or until such time as the warrants are no longer considered liability instruments. Upon the closing of the IPO in October 2020, the convertible preferred stock warrants were converted into warrants to purchase common stock and the warrant liabilities were reclassified to additional paid in capital.

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Eargo, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 

Derivative liability

The Company’s convertible notes issued in 2020 (the “2020 Notes”) contain certain features that meet the definition of being embedded derivatives requiring bifurcation from the 2020 Notes as a separate compound financial instrument. The derivative liability is initially measured at fair value on issuance and is subject to remeasurement at each reporting period with changes in fair value recognized in other income (expense), net in the unaudited condensed consolidated statements of operations and comprehensive loss. In July 2020, the derivative liability was settled upon the extinguishment of the 2020 Notes. Refer to Note 3 and Note 6 for further discussion.

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 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 as appropriate.

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. To estimate product returns, the Company analyzes historical return levels, current economic trends, and changes in customer demand. 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.

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. Revenue for services (extended warranty) is recognized over time on a ratable basis over the warranty period.

 

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 purchase. 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.

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Eargo, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 

Stock-based compensation

The Company accounts for stock-based awards at fair value. The fair value of stock options is measured using the Black-Scholes option-pricing model. For stock-based awards that vest subject to the satisfaction of a service requirement, the fair value measurement date is the date of grant and the expense is recognized on a straight-line basis over the requisite service period. For stock-based awards with performance-based vesting conditions, the expense is recognized over the requisite service period using the accelerated attribution method.

Prior to the Company’s IPO in October 2020, the Company had not recognized any stock-based compensation associated with grants that vest upon satisfaction of both a service condition and a performance condition that is satisfied upon the closing of the IPO as the performance condition was not considered probable. Upon the closing of the IPO, the Company recorded stock-based compensation (see Note 10 for further details) using the accelerated attribution method for the service period rendered from the date of grant through the closing of the IPO as the performance condition was achieved. The Company accounts for forfeitures as they occur.

Net income (loss) per share attributable to common stockholders

The Company follows the two-class method when computing net income (loss) per share as the Company has issued shares that meet the definition of participating securities. 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 income (loss) by the weighted-average number of common shares and common share equivalents of potentially dilutive securities outstanding for the period. For purposes of the diluted net income (loss) per share calculation, convertible preferred stock, convertible notes, convertible preferred stock warrants and common stock options are considered to be potentially dilutive securities.

Recently adopted accounting pronouncements

In February 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), which provides revised accounting requirements for both lessees and lessors. Lessees will recognize ROU assets and lease liabilities for virtually all leases (other than short-term leases upon election). Operating lease ROU assets and liabilities are recognized based on the present value of lease payments over the lease term at the commencement date of the lease. For statement of operations purposes, ASU 2016-02 requires leases to be classified as either operating or finance. Operating leases will result in straight-line expense while finance leases will result in a front-loaded expense pattern. The Company early adopted this standard in the fiscal year beginning January 1, 2020. Upon adoption of Topic 842, on January 1, 2020, the Company recorded operating right-of-use assets of $2.2 million, operating lease liabilities of $2.4 million and derecognized the deferred rent liability of $0.2 million. Results for the three and nine months ended September 30, 2020 are presented under Topic 842. Prior period amounts have not been adjusted and continue to be reported in accordance with the Company’s historical accounting under previous lease guidance, ASC 840: Leases (Topic 840). The Company elected the practical expedients to not reassess whether any expired or existing contracts are or contain leases, carry forward its historical lease classification and determination of whether initial direct costs qualify for capitalization.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which amends the disclosure requirements for fair value measurements by removing, modifying and adding certain disclosures. This standard was effective for the Company in the fiscal year beginning January 1, 2020. The adoption of this standard did not materially impact the Company’s condensed consolidated financial statements and related disclosures.

Recent accounting pronouncements

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. This new standard is effective for the Company in the fiscal year beginning January 1, 2023 and must be adopted using a modified retrospective approach, with certain exceptions. The Company is currently evaluating the impact of this standard on its condensed consolidated financial statements.

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Eargo, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 

3. Fair value measurements

The following tables summarize the Company’s financial assets and liabilities that were measured at fair value on a recurring basis by level within the fair value hierarchy:

 

 

 

September 30, 2020

 

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

 

 

(in thousands)

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Convertible preferred stock warrant liability

 

$

 

 

$

 

 

$

544

 

 

$

544

 

 

 

 

December 31, 2019

 

 

 

Level 1

 

 

Level 2