You should read the following discussion and analysis of our financial condition
and results of operations together with our unaudited condensed consolidated
financial statements and the related notes included in Part I, Item 1 of this
Quarterly Report on Form 10-Q, and for a full understanding of Eargo's results
of operations and financial condition, in conjunction with the consolidated
financial statements and notes for the fiscal year ended December 31, 2021
contained in the Company's Form 10-K filed on May 13, 2022. The following
discussion and analysis of our financial condition and results of operations
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 item, including statements
regarding factors affecting our business, trends and uncertainties, are
forward-looking statements. As a result of many factors, including those factors
set forth in the "Risk Factors" section of this Quarterly Report on Form 10-Q,
our actual results could differ materially from the results described in or
implied by these forward-looking statements. You should carefully read the "Risk
Factors" to gain an understanding of the important factors that could cause
actual results to differ materially from our forward-looking statements.

Overview



We are a medical device company dedicated to improving the quality of life of
people with hearing loss. We developed the Eargo solution to create a hearing
aid that consumers actually want to use. Our innovative product and go-to-market
approach address the major challenges of traditional hearing aid adoption,
including social stigma, accessibility and cost.

We believe our Eargo hearing aids are the first ever virtually invisible,
rechargeable, completely-in-canal, United States Food and Drug Administration
("FDA") regulated, exempt Class I or Class II devices indicated to compensate
for mild to moderate hearing loss. Our rapid pace of innovation is enabled by
our deep industry and technical expertise across mechanical engineering, product
design, audio processing, clinical and hearing science, consumer electronics and
embedded software design, and is supported by our strategic intellectual
property portfolio.

We market and sell our hearing aids direct to consumers with a personalized,
consumer-centric approach. Our commercial organization consists of a talented
marketing team with deep experience in consumer-focused brand and performance
marketing, a team of inside sales consultants, and a dedicated customer support
team that includes audiologists and hearing professionals. We generate revenue
from orders processed primarily through our website and over the phone by our
sales consultants.

We believe that our differentiated hearing aids and consumer-oriented approach
have fueled the rapid adoption of our hearing aids and high customer
satisfaction, as evidenced by over 97 thousand Eargo hearing aid systems sold,
net of returns, as of March 31, 2022.

For the three months ended March 31, 2022, we generated net revenue of $9.2
million, a decrease of $12.9 million from the three months ended March 31, 2021.
The revenue decline was primarily due to a decrease in the volume of Eargo
hearing aid systems shipped that was primarily due to our selling our products
on a "cash-pay" basis only during the three months ended March 31, 2022 as
compared to our having accepted both cash pay and insurance as a method of
direct payment during the three months ended March 31, 2021. We previously
accepted insurance as a method of direct payment, but suspended all claims
submission activities on September 22, 2021 when we learned of the investigation
by the DOJ related to our role in customer reimbursement claim submissions to
various federal employee health plans under the FEHB program, as discussed in
more detail below under "-DOJ investigation and settlement and claims audits."
We have sold our products on a "cash-pay" basis only since December 8, 2021. To
date, all our revenue has been generated from customers in the United States.

Our net losses were $30.6 million and $13.6 million for the three months ended
March 31, 2022 and 2021, respectively. As of March 31, 2022, we had an
accumulated deficit of $387.5 million. We expect to continue to incur losses for
the foreseeable future.

DOJ investigation and settlement and claims audits



As previously disclosed, on September 21, 2021, we were informed that we were
the target of a criminal investigation by the DOJ related to insurance
reimbursement claims we submitted on behalf of our 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
("OPM"). The investigation also pertained to our role in customer reimbursement
claim submissions to federal employee health plans (collectively, the "DOJ
investigation"). Also as previously disclosed, our historically largest
third-party payor, one of the carriers contracted with the OPM under the FEHB
program ("largest third-party payor"), conducted an audit of insurance
reimbursement claims ("claims") submitted by us (the "Primary Audit"), which
included a review of medical records. We were 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. In addition to the Primary Audit, we
have been subject to a number of other audits of insurance reimbursement claims
submitted to additional third-party payors (collectively with the Primary Audit,
the "claims audits"). One of these claims audits does not relate to claims
submitted under the FEHB program. On January 4, 2022, the DOJ confirmed to us
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.

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On April 29, 2022, we entered into a civil settlement agreement with the U.S.
government that resolved the previously disclosed DOJ investigation related to
our role in customer reimbursement claim submissions to various federal employee
health plans under the FEHB program. We cooperated fully with the DOJ
investigation. We deny the allegations in the settlement agreement, and the
settlement is not an admission of liability by us. The allegations did not
pertain to the quality or performance of our product. The settlement agreement
provided for our payment of approximately $34.4 million to the U.S. government
and resolved allegations that we submitted or caused the submission of claims
for payment to the FEHB program using unsupported hearing loss-related
diagnostic codes. On May 2, 2022, the Company paid the settlement amount.

The settlement with the U.S. government may not resolve all of the audits of
insurance reimbursement claims by the various third-party payors, and
additionally we remain subject to a prepayment review of claims by the payor who
conducted the Primary Audit.

From the time we learned of the DOJ investigation and until December 8, 2021, we
continued to process orders for customers with potential insurance benefits
(including FEHB program members) but suspended all claims submission activities
and 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 us to their insurance plan for payment (the "extended right of
return").

Beginning on December 8, 2021, we made the decision to stop accepting insurance
benefits as a method of direct payment and it is uncertain when, if ever, we
will resume accepting insurance benefits as a method of direct payment. While we
intend 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 we may submit for reimbursement, we may not be able to arrive
at acceptable processes or submit any future claims.

Total life-to-date payments we have received through March 31, 2022 from the
government in relation to claims submitted under the FEHB program, net of any
product returns and associated refunds, were approximately $44 million, which is
unchanged from December 31, 2021. As discussed further in Note 5 to the
Unaudited Condensed Consolidated Financial Statements included in this Quarterly
Report on Form 10-Q, based on the settlement agreement with the U.S. government,
we recorded a settlement liability of $34.4 million in the condensed
consolidated balance sheets as of March 31, 2022 and December 31, 2021. The
settlement amount was recorded as a reduction of revenue in the third quarter of
2021.

We 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 ASC
606. As such, we 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.

We estimated that a majority of customers with unsubmitted claims will choose to
return the hearing aid system if their insurance provider denies their claim or
the claim is ultimately not submitted by us for payment, resulting in an
increase in expected product returns from such transactions that occurred prior
to September 21, 2021 that was recorded during the year ended December 31, 2021.
Of the $13.7 million sales returns reserve recorded as of March 31, 2022, $11.3
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.

Further, we also estimated 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 us for payment may not pay
for or return the hearing aid system, resulting in bad debt expense that was
recorded during the year ended December 31, 2021.

Notwithstanding the settlement, we remain subject to prepayment review of claims
by our largest third-party payor before any insurance payments are made. We do
not intend to submit any claims through the FEHB program until we are able to
establish processes with applicable third-party payors to support the submission
of these claims, and we may be unable to do so. While we intend to work as
quickly as possible toward establishing processes with applicable third-party
payors to support the submission of claims, we cannot provide any assurance as
to the timing or costs associated with establishing such processes, if we can do
so at all, or the impact that such processes may have on our business and
results of operations. Further, the pending over-the-counter ("OTC") hearing aid
regulatory framework, if finalized as currently proposed, may lead such payors
to take additional actions further limiting our ability to access insurance
coverage, which may have a material adverse effect on our financial condition,
results of operations or cash flows.

In addition, based on our correspondence to date with the OPM and the largest
third-party payor, we expect that any such processes will require additional
testing by a licensed healthcare provider to establish medical necessity, with
supporting clinical documentation. Because our current operating structure does
not permit us to perform diagnostic tests, we are evaluating alternatives for
testing, including but not limited to accepting clinical documentation and
prescriptions from third-party healthcare professionals, contracting with third
parties or existing networks, and/or establishing a management services
organization. We cannot provide any assurance as to the timing or costs
associated with these alternatives, whether we will be successful in
implementing them, or the impact that such changes may have on our business and
operations.

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On January 5, 2022, the U.S. District Court for the Northern District of
California consolidated three purported securities class actions brought against
the Company (the "Securities Class Action"). While the lead plaintiffs have not
yet filed a consolidated amended complaint, the complaints of the individual
lawsuits filed prior to the consolidation generally alleged that certain of the
Company's disclosures about its business, operations and prospects, including
reimbursements from third-party payors, violated federal securities laws. On
December 3, 2021, a putative stockholder filed a derivative complaint
purportedly on the Company's behalf against members of the Company's Board of
Directors and the Company as nominal defendant (the "Derivative Action"),
alleging (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. See Note 5 of the Notes to Unaudited Condensed Consolidated Financial
Statements included in this Quarterly Report on Form 10-Q for more information.

As a result of the uncertainty created by the DOJ investigation and the claims audits, we took certain actions including, but not limited to:

• We suspended our practice of granting equity awards, except for new

restricted stock unit grants that we have the option to settle in cash at

the time of vesting, suspended our 2020 Employee Stock Purchase Plan

("ESPP") and deferred the settlement of outstanding restricted stock units

("RSUs"), in each case effective as of November 9, 2021 (collectively, the

"employee equity actions").

• Our Board of Directors suspended the non-employee director compensation

program with respect to the option awards that would otherwise have been

awarded to non-employee directors automatically on the date of our annual

meeting of stockholders held on November 9, 2021.

• On December 7, 2021, we announced a plan to reduce our employee workforce to

streamline our organization in response to declines in customer orders since

we announced the investigation of the Company by the DOJ. We substantially


      completed the employee workforce reduction during the fourth quarter of
      2021, resulting in a reduction of approximately 27% of our employee
      workforce, or approximately 90 people.

Factors affecting our business

We believe that our future performance will depend on many factors, including those described below and in the section titled "Risk Factors" included elsewhere in this Quarterly Report on Form 10-Q.

Efficient acquisition of new customers



We have spent significant amounts on sales and marketing designed to build a
strong brand, achieve broad awareness of our Eargo system, acquire new customers
and convert sales leads. Since our public disclosure of the DOJ investigation on
September 22, 2021 and our related decision to stop accepting insurance benefits
as a method of direct payment, we have experienced and may continue to
experience a material decline in gross systems shipped.

Beginning on December 8, 2021, as a result of the DOJ investigation and claims
audits (as further described in "-DOJ investigation and settlement and claims
audits") we do not currently accept insurance as a direct method of payment, and
all sales from such date are considered by us to be "cash-pay," which includes
upfront payment, credit card, third-party financing, and distributor payment. We
have refocused our sales and marketing efforts and related spend to prioritize
conversion of cash-pay consumer leads into satisfied customers. While we intend
to work with the government and third-party payors at the appropriate time with
the objective of validating and establishing the process to support any future
claims that we may submit for reimbursement, we may not be able to arrive at an
acceptable process or submit any future claims. The shift to a model that
excludes insurance as a direct method of payment will likely result in a
sustained increased cost of customer acquisition and require significant sales
and marketing investments, based on the historically lower conversion rate for
cash-pay customers as compared to customers with potential insurance benefits.
Further, the exclusion of insurance as a direct payment method may also
necessitate identifying commercial partnerships, omni-channel, including retail,
or other opportunities, as well as the potential implementation of cost-savings
measures, in order to drive cost-efficient cash-pay customer acquisition and
offset the significantly higher return rates as well as the related negative
impact on revenue and gross margin historically applicable to cash-pay customers

Changes to the regulatory landscape



Hearing aids are considered medical devices subject to regulation by the FDA. We
currently market our products pursuant to the FDA regulatory framework for
air-conduction hearing aids, which are classified as Class I or Class II devices
exempt from premarket review procedures. In addition, while applicable FDA
regulations establish certain "conditions for sale" of all hearing aids,
including that prospective hearing aid users must have a medical evaluation by a
licensed physician within the six months prior to hearing aid dispensation or
sign a waiver of medical evaluation, the FDA has stated that it does not intend
to enforce these medical evaluation and

                                       21
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waiver requirements prior to the dispensing of Class I air-conduction and Class
II wireless air-conduction hearing aids to individuals 18 years of age and
older. Accordingly, while we are required to comply with other FDA requirements,
including specific hearing aid labeling requirements and provision of a User
Instructional Brochure, our products have not been reviewed by the FDA and are
not dispensed by licensed physicians.

The regulatory landscape for hearing aid devices has been subject to recent
changes that may alter or increase our requirements for regulatory compliance.
The FDA Reauthorization Act of 2017 ("FDARA") set forth a process to create a
new category of OTC hearing aids that are intended to be available without
supervision, prescription, or other order, involvement or intervention of a
licensed practitioner. The language in FDARA is not self-implementing, and on
October 20, 2021, the FDA published the Proposed Rule to establish new
regulatory categories for OTC and prescription hearing aids.

The Proposed Rule also includes revised requirements for labeling, conditions
for sale, performance standards and other provisions applicable to either OTC or
prescription hearing aids, or both. Under the Proposed Rule, devices that
require 510(k) clearance to come into compliance with the new requirements would
need to be cleared by the effective date of the Final Rule to continue
marketing. For all other currently marketed devices, the proposed compliance
date is 180 days after the effective date of the Final Rule (240 days after the
publication of the Final Rule).

We market the Eargo system devices as Class I air-conduction hearing aids or
Class II wireless air-conduction hearing aids, both of which are exempt from
510(k) premarket review. Our hearing aids may be marketed under the current FDA
framework during the FDA's rulemaking proceeding. However, we cannot know to
what extent the Final Rule may differ from the Proposed Rule. Once the FDA
issues a Final Rule, we will need to expend time and resources evaluating the
Final Rule and ensuring that our devices and processes come into compliance with
the new requirements in order to market our products in line with our primary
direct-to-consumer business and omni-channel models in the future. It is
possible that a finalized regulatory framework for OTC hearing aids may lead to
additional commercial partnership, omni-channel, including retail, or other
opportunities, although there are no assurances that it will do so. The Final
Rule and the responses thereto by leading insurance providers could also
materially impact our efforts to resume submitting claims for customers with
potential insurance benefits or have other unforeseen impacts on our business
and results of operations.

Please see the Risk Factor titled, "Changes in the regulatory landscape for
hearing aid devices could render our direct-to-consumer business model contrary
to applicable regulatory requirements, and we may be required to seek additional
clearance or approval for our products" for more information.

Omni-channel marketing and distribution activities through commercial partnerships

Eargo's self-administered hearing screens are intended to be part of our retail
customer experience and are expected to be located in physical retail settings
so customers can obtain general information regarding their hearing and see
Eargo hearing aids in person. We also have a select number of commercial
partnerships to, among other things, facilitate the retail experience, and we
intend to continue to pursue additional opportunities for in-person customer
engagement. We believe that if the Proposed Rule by the FDA regarding an OTC
regulation of hearing aids is finalized in substantially the same form as
proposed, the Final Rule will facilitate negotiation and execution of additional
retail opportunities in the future.

Third-party payors



A significant portion of our revenue has historically been dependent on payments
from third-party payors; for example, in the year ended December 31, 2021, 44%
of total gross systems shipped were to customers with potential insurance
coverage. Historically, we submitted claims on behalf of our customers to a
concentrated number of third-party payors under certain benefit plans, and
substantially all such claims related to the FEHB program.

As described in Note 2 of the Notes to Unaudited Condensed Consolidated
Financial Statements included in this Quarterly Report on Form 10-Q,
approximately 95% and 93% of our gross accounts receivable as of March 31, 2022
and December 31, 2021, respectively, were for customers with potential insurance
benefits, substantially all of whom were covered under the FEHB program.
Furthermore, approximately 92% and 90% of our gross accounts receivable as of
March 31, 2022 and December 31, 2021, respectively, were related to shipments of
Eargo hearing aids to customers insured under a single insurance plan whose
claims are processed through our largest third-party payor, which conducted the
Primary Audit. We remain subject to a prepayment review of claims by the payor
who conducted the Primary Audit. In addition to the Primary Audit, we are
currently subject to a number of other ongoing audits of insurance reimbursement
claims. One of these claims audits does not relate to claims submitted under the
FEHB program. During the claims audits, the third-party payors (including our
largest third-party payor) conducting such claims audits have generally
suspended payments for, and in some cases denied, claims we submitted on behalf
of customers, other than one third-party payor that has continued to process
claims for payment throughout its ongoing audit.

We recorded a sales returns reserve of $13.7 million and $13.8 million as of
March 31, 2022 and December 31, 2021, respectively, largely related to our
estimate that a majority of customers with unsubmitted claims will choose to
return the hearing aid system if

                                       22
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their insurance provider denies their claim or the claim is ultimately not
submitted by us for payment. We recorded an allowance for credit losses of $4.7
million and $4.8 million as of March 31, 2022 and December 31, 2021,
respectively, primarily related to insurance claims receivable due from
third-party payors and end-users as we estimate that, in addition to the
customers who choose to return their hearing aid systems, a significant number
of customers with an extended right of return and claims that have not yet and
may never be submitted by us for payment may not pay for or return the hearing
aid system.

While we intend to work with third-party payors at the appropriate time with the
objective of validating and establishing processes to support any future claims
that we may submit for reimbursement, we may not be able to arrive at acceptable
processes or submit any future claims. For example, we do not currently conduct
in-person hearing tests, as they run counter to our primary direct-to-consumer
business and omni-channel models. Based on our correspondence to date with the
OPM and the largest third-party payor, we expect that any such processes to
support claims for reimbursement will require additional testing by a licensed
healthcare provider to establish medical necessity, with supporting clinical
documentation. Because our current operating structure does not permit us to
perform diagnostic tests, we are evaluating alternatives for testing, including
but not limited to accepting clinical documentation and prescriptions from
third-party healthcare professionals, contracting with third parties or existing
networks, and/or establishing a management services organization. We cannot
provide any assurance as to the timing or costs associated with these
alternatives, whether we will be successful in implementing them, or the impact
that such changes may have on our business and operations. In addition, it is
possible that such testing would be required to be conducted in-person,
representing a significant change from our past processes and customer
experience that may adversely impact the attractiveness of our offerings to
customers, and we may not be able to efficiently or effectively integrate such
tests into our operating model. In light of the DOJ investigations, claims
audits and pending OTC hearing aids regulatory framework, we may need to make
significant changes to our business and operating model, including a potential
long-term shift to a model that excludes insurance as a direct method of
payment, which would likely result in a sustained increased cost of customer
acquisition and require identification of commercial partnership, omni-channel,
including retail, or other opportunities, to drive cost efficient acquisition of
cash-pay customers.

See "-DOJ investigation and settlement and claims audits" for more information.
Please see the Risk Factors titled, "We are subject to risks from legal
proceedings, investigations, and inquiries, including a number of recent legal
proceedings and investigations, which have had and could continue to have a
material adverse effect on our reputation, business, financial condition, cash
flows and results of operations, and could result in additional claims and
material liabilities," and "We face considerable uncertainty in our business
prospects, as a significant portion of our revenue has historically been
dependent upon reimbursement from third-party payors participating in the FEHB
program but we have operated on a "cash pay" only basis since December 8, 2021.
Following the civil settlement with the U.S. government on April 29, 2022, we
may be unsuccessful in validating and establishing processes to support the
submission of claims for reimbursement from third-party payors participating in
the FEHB program in the future. As a result, we have faced a significant
reduction in revenue and any failure to establish processes to support
reimbursement from third-party payors in the future may significantly and
adversely impact our business and growth prospects and our ability to sell our
products."

Sales returns rate

Our return policy generally allows our customers to return hearing aids for any
reason within the first 45 days of delivery for a full refund, subject to a
handling fee in certain states, and can be extended under certain circumstances,
including the extended right of return offered for shipments involving insurance
payors. Historically, the most commonly cited reason for returning our hearing
aids is unsatisfactory fit, which we believe is a byproduct of our
direct-to-consumer model and online distribution that results in nearly all of
our customers ordering our product without trying it first. In addition to
unsatisfactory fit, the next most cited reason for returns is that our hearing
aids do not provide sufficient audio amplification.

We report revenue net of expected returns, which is an estimate informed in part
by historical return rates. As such, our returns rate impacts our reported net
revenue and gross profit or loss. Sales returns rates, as defined under "-Key
business metrics," were 32% for the year ended December 31, 2021 and 34% for the
three months ended March 31, 2022.

New product introductions



Our technical capabilities and commitment to innovation have allowed us to
deliver product enhancements on a rapid development timeline and support a
compelling new product roadmap that we believe will continue to differentiate
our competitive position over the next several years. With the full commercial
launch of the Eargo 5 in July 2021 and the launch of Eargo 6 in January 2022, we
have now launched six generations of our hearing aids since 2017, with each
iteration having increased functionality and improved sound quality,
amplification, noise reduction, physical fit, comfort, water resistance and
ease-of-use, as well as reduced costs of goods and better connectivity. We are
focused on continuing to launch new versions of the Eargo hearing aid devices
that further improve these attributes. We believe that the continued
introduction of new products is critical to maintaining existing customers,
attracting new customers, achieving market acceptance of our products and
maintaining or increasing our competitive position in the market.

We expect to continue refining and improving Eargo hearing aids, and we have the
intention of an approximate annual cadence of new product launches. To this end,
we are working on the development of a cost-conscious offering as well as the
next Eargo hearing aid

                                       23
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model with improved functionality. Accordingly, we expect to continue to invest
in research and development to support new product introductions. In connection
with our product innovation and iteration, we also need to successfully manage
our product transitions to avoid delays in customer purchases, excess or
obsolete inventory and increased returns as customers wait for our new products
to become available. Our development priorities are focused, in part, on
expanding refurbishment capability for returned hearing aids. Our refurbishment
capabilities include full refurbishment, conversion, and components, and allow
us to refurbish and resell or reuse certain returned devices.

Recruitment and retention of personnel



Our success depends in part upon our continued ability to recruit, retain and
motivate high-quality employees, including management, administrative, our
clinical and scientific personnel and our direct sales force (among others), and
competition for qualified personnel can be intense due to the limited number of
individuals possessing the requisite training, skill and experience we require.
As a result of uncertainty created by the DOJ investigation and the claims
audits, we suspended our practice of granting equity awards (except for new
restricted stock unit grants that we have the option to settle in cash at the
time of vesting), suspended our employee stock purchase plan and deferred the
settlement of outstanding restricted stock units, in each case effective as of
November 9, 2021. In addition, on December 7, 2021, we announced a plan to
reduce our employee workforce to streamline our organization in response to
declines in customer orders since we announced the DOJ investigation. We
substantially completed the employee workforce reduction during the fourth
quarter of 2021, resulting in a reduction of approximately 27% of our employee
workforce, or approximately 90 people. Both the suspension of equity awards and
reduction in workforce, in addition to any negative perceptions of employment
with us as a result of the DOJ investigation, the settlement with the U.S.
government, and the claims audits, could continue to adversely affect employee
morale and have a material adverse impact on our ability to recruit, retain and
motivate the high-quality employees critical to our operations, which in turn
could have a material adverse effect on our business, results of operations and
financial condition.

COVID-19 pandemic

We believe the COVID-19 pandemic has accelerated the pace of consumer awareness
of our vertically integrated telecare model and has facilitated customer
adoption of the same. Shelter-in-place restrictions and increased reluctance of
consumers to conduct in-person activities, particularly among older individuals
that comprise a majority of the population needing hearing aids has resulted in
increased knowledge of our business and sales. We cannot be sure this trend will
continue.

Although we believe the COVID-19 pandemic has largely resulted in favorable
trends for our business, we have experienced business disruptions, particularly
at our California headquarters, where a majority of our employees have been
working remotely (which we permitted as an accommodation to our employees
despite the fact that we were never required to close our facilities because we
were deemed to have an essential workforce under the relevant California
COVID-19 measures). Moreover, travel restrictions, factory closures and
disruptions in global supply chains have resulted in industry-wide component
supply shortages (such as in semiconductors), and we may not be able to obtain
adequate inventory on a timely basis or at all. To date, increases in component
pricing have occurred but have not had a material impact on supply continuity or
gross margin. We have taken steps to monitor our supply chain and actions to
address limited supply and increasing lead times, including outreach to critical
suppliers and spot market purchases. While we have not been impacted by any
disruptions to our supply chain that have impacted our ability to service
customers or access to necessary raw materials and component parts for the
manufacture of our products to date, disruptions have occurred across a number
of industries and we cannot provide any assurance that future disruptions will
not emerge as a result of the ongoing supply chain issues, inflation, the
COVID-19 pandemic or other extrinsic factors. Future disruptions in our supply
chain, including the sourcing of certain components and raw materials, such as
semiconductor and memory chips, as well as increased logistics costs, could
impact our sales and gross margins.

Key business metrics

To analyze our business performance, determine financial forecasts and help develop long-term strategic plans, we review the following key business metrics, each of which is an important measure that represents the state of our business:

• Gross systems shipped. We define our gross systems shipped as the number of

hearing aid systems shipped during the period. However, we have not recorded

revenue and related sales returns reserve for approximately 670 shipments of

Eargo hearing aid systems to customers with potential insurance benefits

during the three months ended September 30, 2021 but subsequent to learning

of the DOJ investigation, and approximately 1,560 of such shipments during

the three months ended December 31, 2021. Since our public disclosure of the

DOJ investigation on September 22, 2021 and our related decision to stop

accepting insurance benefits as a method of direct payment, we have

experienced and may continue to experience a material decline in gross

systems shipped. Continued negative publicity, including in relation to the

DOJ investigation, the claims audits, and other legal proceedings could

further harm our reputation and lead to a further decline in gross systems


      shipped. See "-DOJ investigation and settlement and claims audits" and
      "-Factors affecting our business."


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• Sales returns rates. Sales returns rates are determined by management at the

end of each reporting period to estimate the percentage of products for

which we have recorded revenue during that period that are expected to be

returned. This determination is informed in part by historical actual return

rates. Sales returns rates do not represent actual returns during a period

as customers may return the product for a period of time that can extend

beyond the period end, which can result in a hearing aid being returned

after the period in which the revenue from its sale was recognized. If

actual returns differ from the sales returns rate determined at period end

or new factors arise, indicating a rate of return that is different from the

original estimated sales returns rate, revenue is adjusted in subsequent

periods to reflect the actual returns made. Such an adjustment to revenue is

not included in the sales returns rates disclosed in the table below.

The following table details the number of gross systems shipped and sales returns rates for the periods presented below:



                                                       Three months ended
                         March 31,       June 30,       September 30,      December 31,       March 31,
                           2021            2021             2021               2021             2022

Gross systems shipped        11,704         12,548              13,117             7,767           5,773
Sales returns rate             23.2 %         24.1 %              46.4 %            34.0 %          33.9 %


We believe these key business metrics provide useful information to help
investors understand and evaluate our business performance. Gross systems
shipped is a key measure of sales volume, which drives potential revenue, while
sales returns rates are an indicator of expected reductions to revenue and an
indicator of change in customer mix and factors affecting the returns rates by
customer type. However, as discussed elsewhere in this report, our sales volume,
sales returns rate and revenue during the current period were not consistent
with the prior periods as a result of the DOJ investigation and settlement and
claims audits. See "-DOJ investigation and settlement and claims audits."

Due to the historically higher return rate for cash-pay customers as compared to
insurance customers, we expect that revenue, gross profit and gross margin may
remain depressed as compared to prior periods for so long as we are unable to
accept insurance benefits as a direct method of payment.

Components of our results of operations



See the discussion under "-DOJ investigation and settlement and claims audits,"
which describes a variety of circumstances currently affecting our business and
results of operations, and which require that we continually evaluate and adapt
our business model and expenditures as new information becomes available.

Revenue, net



We generate revenue from the sale of Eargo hearing aid systems, accessories and,
to a lesser extent, sales of extended warranties, with the majority of our
revenue coming from sales of our Eargo hearing aid systems. Following the launch
of Eargo 6 in January 2022, we currently offer four versions of our hearing aid
systems, the Eargo Max, the Eargo Neo HiFi, the Eargo 5, and the Eargo 6, each
at different price points, and we periodically offer discounts and promotions,
including holiday promotions. For product sales, control is transferred upon
shipment to the customer. We report revenue net of expected returns, which is an
estimate informed in part by historical return rates.

Since learning of the DOJ investigation, we have suspended all insurance claims
submissions and, beginning on December 8, 2021, do not currently accept
insurance as a direct method of payment. Instead, we are currently focused on
"cash-pay" customers, which includes upfront payment, credit card, third-party
financing and distributor payment. Historically, cash-pay customers have had
significantly higher return rates than customers with potential insurance
benefits, and therefore the current shift to cash-pay only sales may adversely
impact revenue, net.

Cost of revenue and gross margin



Cost of revenue consists of expenses associated with the cost of finished goods,
freight, personnel costs, consumables, product warranty costs, transaction fees,
reserves for excess and obsolete inventory, depreciation and amortization, and
related overhead.

Our gross margin has been and will continue to be affected by a variety of
factors, including sales volumes, product mix, channel mix, pricing strategies,
sales returns rates, costs of finished goods, product warranty claim rates and
refurbishment strategies, and our ability to service insurance customers in the
future and any potential actions insurance providers may take following the
anticipated implementation of a pending OTC hearing aid regulatory framework
that may limit our ability to access insurance coverage (which OTC framework may
also generally result in additional compliance or other regulatory requirements
for Eargo).

We expect our gross margin to remain depressed for so long as we are unable to accept insurance benefits as a direct method of payment unless we can successfully target and convert new customers with a similarly low rate of return.


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Research and development expenses



Research and development ("R&D") expenses, consist primarily of engineering and
product development costs to develop and support our products, regulatory
expenses, non-recurring engineering and other costs associated with products and
technologies that are in development, as well as related overhead costs. These
expenses include personnel-related costs, including salaries and stock-based
compensation, supplies, consulting fees, prototyping, testing, materials, travel
expenses, depreciation and allocated facility overhead costs. Additionally, R&D
expenses include internal and external costs associated with our regulatory
compliance and quality assurance functions, and related overhead costs. The
uncertainty regarding the anticipated implementation of a pending OTC hearing
aid regulatory framework will require that we evaluate our R&D expenses as new
information becomes available.

Sales and marketing expenses



Our sales and marketing expenses are the largest component of our operating
expenses and consist primarily of personnel-related costs, including salaries
and stock-based compensation, direct and channel marketing, advertising and
promotional expenses, consulting fees, public relations costs and allocated
facility overhead costs. Sales and marketing personnel include our inside sales
consultants, hearing professionals, marketing professionals and related support
personnel. We expect our sales and marketing expenses to fluctuate over time as
a percentage of revenue. In response to the factors discussed in "-DOJ
investigation and settlement and claims audits," we have reduced sales and
marketing resources that were previously focused on insurance customers to
prioritize the conversion of cash-pay consumers into satisfied customers,
including as part of the reduction in force announced on December 8, 2021.

General and administrative expenses



Our general and administrative expenses consist primarily of compensation for
executive, finance, legal, information technology and administrative personnel,
including stock-based compensation. Other significant expenses include
professional fees for legal and accounting services, consulting fees, recruiting
fees, information technology costs, corporate insurance, bad debt expense,
general corporate expenses and allocated facility overhead costs.

Excluding the costs associated with the DOJ investigation, we expect our general
and administrative expenses will increase in absolute dollars in future periods
as a result of operating as a public company, including expenses related to
compliance with the rules and regulations of the SEC, and those of the Nasdaq
Stock Market, additional insurance costs, investor relations activities and
other administrative and professional services, as well as professional service
and legal fees and expenses related to shareholder litigation that has been
filed and that may be filed in the future.

Interest income

Interest income consists of interest earned on cash and cash equivalents.

Interest expense

Interest expense consists of interest related to borrowings under our debt obligations.

Income tax provision



We use the asset and liability method to account for income taxes. Under this
method, deferred tax assets and liabilities are determined based on differences
between the financial statement carrying amounts of existing assets and
liabilities and their tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates applied to taxable income in the years in which
those temporary differences are expected to be recovered or settled. A valuation
allowance is established when necessary to reduce deferred tax assets to the
amount expected to be realized. Due to our historical operating performance and
our recorded cumulative net losses in prior fiscal periods, our net deferred tax
assets have been fully offset by a valuation allowance.

Financial statement effects of uncertain tax positions are recognized when it is
more-likely-than-not, based on the technical merits of the position, that it
will be sustained upon examination. Interest and penalties related to
unrecognized tax benefits are included within the provision for income tax.

                                       26
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Results of operations

Comparison of the three months ended March 31, 2022 and 2021



                                      Three months ended
                                           March 31,                   Change
(dollars in thousands)                2022          2021         Amount          %
Revenue, net                        $   9,176     $  22,048     $ (12,872 )     (58.4 )%
Cost of revenue                         5,491         6,297          (806 )     (12.8 )
Gross profit                            3,685        15,751       (12,066 )     (76.6 )
Operating expenses:
Research and development                5,847         4,778         1,069        22.4
Sales and marketing                    13,290        16,855        (3,565 )     (21.2 )
General and administrative             14,934         7,487         7,447        99.5
Total operating expenses               34,071        29,120         4,951        17.0
Loss from operations                  (30,386 )     (13,369 )     (17,017 )     127.3
Other income (expense), net:
Interest income                             5            11            (6 )     (54.5 )
Interest expense                         (264 )        (263 )          (1 )

0.4

Total other income (expense), net (259 ) (252 ) (7 )


      2.8
Loss before income taxes              (30,645 )     (13,621 )     (17,024 )     125.0
Income tax provision                        -             -             -           -

Net loss and comprehensive loss $ (30,645 ) $ (13,621 ) $ (17,024 )


      125 %


* Not meaningful

Revenue, net

                           Three months ended
                                March 31,                   Change
(dollars in thousands)     2022           2021        Amount          %
Revenue, net             $   9,176      $ 22,048     $ (12,872 )     (58.4 )%


Revenue decreased by $12.9 million, or 58.4%, from $22.0 million during the
three months ended March 31, 2021, to $9.2 million during the three months ended
March 31, 2022, primarily due to a decrease in the volume of Eargo hearing aid
systems shipped from 11,704 gross systems shipped during the three months ended
March 31, 2021 to 5,773 during the three months ended March 31, 2022 as we no
longer accepted insurance as a method of direct payment as of December 8, 2021.
The decrease in revenue was also attributable to an increase in sales returns
rate as we operated on a cash-pay basis only during the three months ended March
31, 2022, whereas we accepted both cash pay and insurance as a direct method of
payment in the comparable period. We have experienced a historically higher
return rate for cash-pay customers as compared to insurance customers.

Cost of revenue, gross profit, and gross margin



                           Three months ended
                                March 31,                   Change
(dollars in thousands)     2022           2021        Amount          %
Cost of revenue          $   5,491      $  6,297     $    (806 )     (12.8 )%
Gross profit                 3,685        15,751       (12,066 )     (76.6 )%
Gross margin                  40.2 %        71.4 %


Cost of revenue decreased by $0.8 million, or 12.8%, from $6.3 million during
the three months ended March 31, 2021 to $5.5 million during the three months
ended March 31, 2022. The change was primarily due to the decrease in the volume
of Eargo hearing aid systems shipped.

Gross margin decreased to 40.2% during the three months ended March 31, 2022,
compared to 71.4% during the three months ended March 31, 2021. The change in
gross margin percentage was primarily due to an increase in sales returns rates,
an increase in cost of goods per product sold due to a change in product mix,
and an increase in amortization of capitalized software costs subsequent to the
launch of Eargo 5 in July 2021 and Eargo 6 in January 2022.

                                       27
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Research and development (R&D)



                             Three months ended
                                  March 31,                  Change

(dollars in thousands) 2022 2021 Amount % Research and development $ 5,847 $ 4,778 $ 1,069 22.4 %





R&D expenses increased by $1.1 million, or 22.4%, from $4.8 million during the
three months ended March 31, 2021 to $5.8 million during the three months ended
March 31, 2022. The change was primarily due to a net increase of $0.8 million
in personnel and personnel-related costs due in part to a decrease in the amount
of internal use software development costs being capitalized subsequent to the
launch of Eargo 5 in July 2021 and Eargo 6 in January 2022.

Sales and marketing

                           Three months ended
                                March 31,                   Change
(dollars in thousands)      2022          2021        Amount         %
Sales and marketing      $   13,290     $ 16,855     $ (3,565 )     (21.2 )%



Sales and marketing expenses decreased by $3.6 million, or 21.2%, from $16.9
million during the three months ended March 31, 2021 to $13.3 million during the
three months ended March 31, 2022. The change was primarily due to decreases in
direct marketing, advertising and promotional expenses of $1.8 million due to a
reduction in media following our decision to stop accepting insurance benefits
as a method of direct payment on December 8, 2021 and decreases in personnel and
personnel-related costs of $1.8 million, which includes a $1.2 million decrease
in stock-based compensation.

General and administrative


                               Three months ended
                                    March 31,                  Change

(dollars in thousands) 2022 2021 Amount % General and administrative $ 14,934 $ 7,487 $ 7,447 99.5 %





General and administrative expenses increased by $7.4 million, or 99.5%, from
$7.5 million during the three months ended March 31, 2021 to $14.9 million
during the three months ended March 31, 2022. This change was primarily due to
an increase in general corporate costs of $7.3 million, which includes a $6.7
million increase in legal and other professional fees as a result of the DOJ
investigation.

Liquidity and capital resources

Sources of liquidity and operating capital requirements



Since our inception, we have incurred net losses and negative cash flows from
operations. We have funded our operations primarily from the net proceeds
received from the sale of our equity securities, indebtedness and revenue from
the sale of our products.

As of March 31, 2022, we had $15.0 million in principal outstanding under the
2018 Loan, which matures in September 2024 with interest-only payments until
July 2022. Interest on the 2018 Loan accrues at a per annum rate equal to the
Wall Street Journal prime rate plus 1.0%, or 4.50% as of March 31, 2022.

As of March 31, 2022, we had cash and cash equivalents of $89.2 million, which are available to fund operations, and an accumulated deficit of $387.5 million.



We expect to incur additional substantial losses in the foreseeable future. We
believe that without any future financing, our current resources are
insufficient to satisfy our obligations as they become due within one year after
the date that the financial statements are issued. Our negative cash flows and
current lack of financial resources raise substantial doubt as to our ability to
continue as a going concern.

We anticipate our future operating requirements will be substantial and that we
will need to raise significant additional resources to fund our operations
through equity or debt financing, or some combination thereof. We are currently
exploring fundraising opportunities to meet these capital requirements. If we
are unable to raise additional funding to meet our operational needs, we will be
forced to limit or cease our operations.

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In addition to our current capital needs, we regularly consider fundraising
opportunities and may decide, from time to time, to raise capital based on
various factors, including market conditions and our plans of operation. We may
seek funds through borrowings or through additional rounds of financing,
including private or public equity or debt offerings. Additional capital may not
be available to us on acceptable terms on a timely basis, or at all. If adequate
funds are not available, or if the terms of potential funding sources are
unfavorable, our business and our ability to develop our technology and our
products would be harmed. Furthermore, any new equity or convertible debt
securities we issue may result in the dilution of our stockholders, and any debt
financing may include covenants that restrict our business.

Our longer term future capital requirements and ability to raise additional capital will depend on many forward-looking factors and are not limited to the following:

• investor confidence in our ability to continue as a going concern;

• the timing, receipt and amount of sales from our current and future products;

• the costs involved in resolving the third-party claims audits and potential

recoupment of previous claims paid, as well as other legal proceedings

(including the shareholder class action and derivative suits discussed in

Note 5 to the Unaudited Condensed Consolidated Financial Statements included

in this Quarterly Report on Form 10-Q), and their duration and impact on our

business generally (particularly with respect to our ability in future

periods to accept insurance as a direct method of payment);

• the availability of insurance coverage for our hearing aid devices, and any

costs associated with reimbursement and compliance, including the

anticipated implementation of a pending OTC regulatory framework (which may

lead insurance providers to take actions limiting our ability to access

insurance coverage and may also generally result in additional compliance or

other regulatory requirements for us), and any resulting changes to our

business model, including a potential long-term shift to a model that

excludes insurance benefits as a method of direct payment to Eargo, which

would likely result in a sustained increased cost of customer acquisition;

• the cost and timing of expanding our sales, marketing and distribution

capabilities and our continued success in reducing our customer acquisition

costs;

• any expenses, as well as the impact to our business and operating model, as

a result of changes in the regulatory landscape for hearing aid devices;




   •  the cost of manufacturing, either ourselves or through third-party
      manufacturers, our products;


   •  the terms, timing and success of any other licensing, partnership,

omni-channel, including retail, or other arrangements that we may establish;

• any product liability or other lawsuits related to our current or future


      products;


  • the expenses needed to attract, hire and retain skilled personnel;

• the extent of our spending to support research and development activities


      and the expansion of our product offerings;


  • the costs associated with being a public company;

• the duration and severity of the COVID-19 pandemic and its impact on our

business and financial markets generally;

• the costs involved in preparing, filing, prosecuting, maintaining, defending


      and enforcing our intellectual property portfolio; and


  • the extent to which we acquire or invest in businesses.


Our liquidity is subject to various risks, including the risks identified in the
section titled "Risk Factors" in Item 1A of Part II. While the extent to which
we are 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 OTC hearing aid regulatory framework (which may lead
insurance providers to take actions limiting our ability to access insurance
coverage and may also generally result in additional compliance or other
regulatory requirements for Eargo) are difficult to assess or predict at this
time, since the announcement of the DOJ investigation and our related decision
to stop accepting insurance benefits as a method of direct payment, there has
been and may continue to be a significant reduction in shipments, revenue and
gross margin which could in the future negatively impact our liquidity and
working capital, including by impacting our ability to access any additional
capital.

Contractual obligations and commitments

There have been no changes to our contractual obligations and commitments included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, except for the following:


                                       29
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The Wall Street Journal prime rate increased from 3.25% from 3.50% in March 2022, resulting in an increase in the interest rate on our 2018 Loan from 4.25% to 4.50% per annum. This increase will result in an additional $24,000 in payments during 2022 and $27,000 in payments thereafter as compared to the amounts previously reported.

Cash flows

The following table summarizes our cash flows for the periods indicated:



                                              Three months ended
                                                   March 31,
(in thousands)                                2022          2021

Net cash used in operating activities $ (20,350 ) $ (9,309 ) Net cash used in investing activities

            (942 )      (1,370 )
Net cash provided by financing activities          24           118
Net decrease in cash                        $ (21,268 )   $ (10,561 )




Operating activities

During the three months ended March 31, 2022, cash used in operating activities
was $20.4 million, attributable to a net loss of $30.6 million, partially offset
by a net change in our net operating assets and liabilities of $5.2 million and
non-cash charges of $5.1 million. Non-cash charges primarily consisted of $3.0
million in stock-based compensation, $1.4 million in depreciation and
amortization expense and $0.4 million in non-cash operating lease expense. The
change in our net operating assets and liabilities was primarily due to a $3.0
million increase in accounts payable, $1.3 million decrease in prepaid expenses
and other current assets, $0.7 million decrease in other assets and $0.3 million
increase in other current and noncurrent liabilities.

During the three months ended March 31, 2021, cash used in operating activities
was $9.3 million, attributable to a net loss of $13.6 million and a net change
in our net operating assets and liabilities of $2.0 million, partially offset by
non-cash charges of $6.3 million. Non-cash charges primarily consisted of $5.1
million in stock-based compensation and $0.7 million in depreciation and
amortization expense. The change in our net operating assets and liabilities was
primarily due to a $1.6 million decrease in accrued expense, a $1.6 million
increase in account receivable and a $1.4 million decrease in sales return
reserve. These changes were partially offset by a $1.4 million increase in other
current and noncurrent liabilities, $0.7 million increase in account payable and
$0.6 million decrease in prepaid expenses and other current assets.

Investing activities



During the three months ended March 31, 2022, cash used in investing activities
was $0.9 million, which consisted of $0.7 million related to the purchase of
property and equipment and approximately $0.3 million in capitalized costs
related to the development of internal use software.

During the three months ended March 31, 2021, cash used in investing activities
was $1.4 million, which consisted of $1.1 million in capitalized costs related
to the development of internal use software and $0.3 million related to the
purchase of property and equipment.

Financing activities

During the three months ended March 31, 2022, cash provided by financing activities consisted of $93,000 in proceeds from the exercise of stock options, partially offset by $69,000 in cash paid to settle restricted stock units.

During the three months ended March 31, 2021, cash provided by financing activities was $0.1 million from the exercise of stock options.

Critical accounting estimates



Management's discussion and analysis of our financial condition and results of
operations is based on our unaudited condensed consolidated financial
statements, which have been prepared in accordance with U.S. generally accepted
accounting principles. The preparation of these unaudited condensed consolidated
financial statements requires us to make estimates and assumptions regarding the
reported amounts of assets, liabilities, revenue, expenses and related
disclosures. Our estimates are based on our historical experience and on various
other factors that we believe are reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying value of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions and any such differences may be material.

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There have been no significant changes in our critical accounting estimates as
compared to the critical accounting estimates disclosed in the section titled
"Management's Discussion and Analysis of Financial Condition and Operations"
included in our Annual Report on Form 10-K for the fiscal year ended December
31, 2021.

Recent accounting pronouncements



See Note 2 of the Notes to Unaudited Condensed Consolidated Financial Statements
included in this Quarterly Report on Form 10-Q for more information about recent
accounting pronouncements, the timing of their adoption, and our assessment.

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