The following discussion and analysis should be read in conjunction with the audited consolidated financial statements and notes thereto included elsewhere in this Annual Report (this "Report"). This discussion contains forward-looking statements about our business, operations and industry that involve risks and uncertainties, such as statement's regarding our plans, objectives, expectations and intentions. Our results may differ materially from those currently described in the sections entitled "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements" disclosed in this Report. Throughout this Item 7, unless otherwise noted, "we", "us", "our" and the "Company" refer to
Owlet Baby Care Inc.and its consolidated subsidiary before the Merger transaction with Sandbridge Acquisition Corporationand to Owlet, Inc.and its consolidated subsidiaries after the Merger transaction with Sandbridge Acquisition Corporation.
Our mission is to empower parents with the right information at the right time, to give them more peace of mind and help them find more joy in the journey of parenting. Our digital parenting platform aims to give parents real-time data and insights to help parents feel calmer and more confident. We believe that every parent deserves peace of mind and the opportunity to feel their well-rested best. We also believe that every child deserves to live a long, happy, and healthy life, and we are working to develop products to help facilitate that belief.
July 14, 2021, Sandbridge Acquisition Corporation("SBG") held the Special Meeting of Stockholders (the "Special Meeting"), at which the SBG stockholders considered and adopted, among other matters, a proposal to approve the Merger Agreement and related transactions (the "Merger"). On July 15, 2021, the parties consummated the Merger. In connection with the Closing, SBG changed its name from Sandbridge Acquisition Corporationto Owlet, Inc.("Owlet"). Following the consummation of the Merger, Owlet became an SEC-registrant and its common stock and warrants commenced trading on the New York Stock Exchange(''NYSE'') under the symbols "OWLT" and "OWLT WS", respectively. As a result of the Merger, each share of Owlet Baby Care Inc.'spreferred stock and common stock was converted into the right to receive approximately 2.053 shares of Owlet's common stock, par value $0.0001per share ("Common Stock"). Additionally, the shares of Sandbridge Class B common stock held by Sandbridge Acquisition Holdingsautomatically converted to 5,750,000 shares of Common Stock (of which 2,807,500 shares were subjected to certain vesting conditions). An aggregate of $197.6 millionwas paid from SBG's trust account to holders that properly exercised their right to have initial shares redeemed.
FDA warning letter
October 1, 2021, the Company received a Warning Letter, dated the same date (the "Warning Letter"), from the U.S. Food and Drug Administration("FDA") regarding the Owlet Smart Sock. The Warning Letter asserts that the Company's marketing of its Owlet Smart Sock product in the U.S.renders the Owlet Smart Sock a medical device requiring premarket clearance or approval from the FDA, and that the Company has not obtained such clearance or approval in violation of the Federal, Food, Drug, and Cosmetic Act. The Warning Letter is focused solely on the regulatory classification of the product in the U.S.as a result of the heart rate and oxygen notifications and related claims. Pursuant to the Warning Letter and in response to the request by the FDA to cease distribution of the Owlet Smart Sock in the U.S., the Company suspended distribution of the Owlet Smart Sock in the U.S.in October 2021. The suspension is specific to shipments by the Company to customers and retailers in the U.S.Operations in other countries remain unaffected. In response to the Warning Letter, several national retailers unilaterally suspended U.S.sales of the Owlet Smart Sock and Owlet Duo. During the fourth quarter of 2021, the Company agreed with certain customers and retailers to accept returns of the Owlet Smart Sock and Owlet Duo. The Company began initial distribution of the Owlet Dream Sock in December 2021through our ecosystem partners and in January 2022launched the Owlet Dream Sock to consumers in the retail and direct-to-consumer channels. The Company's results of operations for the fourth quarter and year ended December 31, 2021were substantially and negatively impacted due to the reversal of sales for received and anticipated returns of Owlet Smart Sock and Owlet Duo product. For the quarter and year ended December 31, 2021, the Company recorded contra-revenue of $23.2 millionbased on an estimate of customer returns. A refund liability of $20.1 millionhas been accrued as of December 31, 2021in accrued and other expenses and represents the amount due to customers for returns that have not been received as of year-end. The Company also recorded a reduction to cost of revenues of $8.2 millionfor the year ended December 31, 2021for the cost of the inventory associated with these customer returns. As of December 31, 2021, the Company has recorded $1.4 millionwithin inventory for returned inventory received prior to year-end, 64 --------------------------------------------------------------------------------
Impact of COVID-19
There continues to be worldwide impact from the novel coronavirus ("COVID-19") pandemic. The impact of COVID-19 includes changes in consumer and business behavior, pandemic fears, market downturns, and restrictions on business and individual activities, which have created significant volatility in the global economy that has led to reduced economic activity. The full extent to which the COVID-19 pandemic will directly or indirectly impact our cash flow, business, financial condition, results of operations and prospects will depend on future developments that are uncertain. As a result of the COVID-19 pandemic, we have safety procedures in place at our headquarters and encourage our employees and contractors to work remotely, where possible, in accordance with local public health recommendations, each of which represented a significant change in how we operate our business. In light of the pandemic, we expect to continue to take actions as may be required or recommended by government authorities or as we determine are in the best interest of our employees. We have experienced relatively minor impacts on our inventory availability and delivery capacity since the outbreak, neither of which has materially impacted our ability to service our customers. We continue to work with our existing manufacturing, logistics and other supply chain partners to build key processes to ensure that our ability to service our customers is not significantly disrupted. Ongoing actions to bolster key aspects of the supply chain to support our continued growth include geographically diversifying manufacturing operations to ensure adequate manufacturing capacity and to shorten transit times, implementing alternative order fulfillment options to reduce warehousing costs, developing contingency plans for unexpected third-party manufacturing disruptions, and increasing headcount dedicated to managing and optimizing supply chain processes. We have experienced cost inflation resulting from the increased demand for raw materials and distribution services associated with the impact of COVID-19.
Components of operating results
We recognize revenue from the following sources: (1) products, (2) mobile applications, and (3) content. Revenues are recognized when control of goods and services is transferred to customers in an amount that reflects the consideration expected to be received by us in exchange for those goods and services. Substantially all of the Company's revenues were derived from product sales. Cost of Revenues Cost of revenues consists of product costs, including contract manufacturing, shipping and handling, depreciation and amortization relating to tooling and manufacturing equipment and software, warranty replacement, fulfillment costs, warehousing, hosting, and reserves for excess and obsolete inventory.
General and Administrative. General and administrative expenses consist primarily of salaries, benefits, stock-based compensation, and bonuses for finance and accounting, legal, human resources and administrative executives and employees; third-party legal, accounting, and other professional services; corporate travel and entertainment; depreciation and amortization of property and equipment; and facilities rent. We expect that our general and administrative expenses will increase in future periods compared to periods prior to the Merger as a result of additional costs related to being a public company, including Securities Exchange Act of 1934, as amended (the "Exchange Act") reporting expenses; expenses associated with Sarbanes-Oxley compliance; incremental independent auditor fees; incremental legal fees; investor relations expenses; registrar and transfer agent fees; incremental director and officer liability insurance costs; and director compensation. Sales and Marketing. Sales and marketing expenses consist primarily of salaries, commissions, benefits, stock-based compensation, commissions, and bonuses for sales and marketing employees and contractors; third-party marketing expenses such as social media and search engine marketing; email marketing and print marketing.
We expect sales and marketing expenses to continue to increase in future periods as we drive sales growth through new and existing marketing initiatives and expand into other international markets.
65 -------------------------------------------------------------------------------- Research and Development. Research and development expenses consist primarily of salaries, benefits, stock-based compensation, and bonuses for employees and contractors engaged in the design, development, maintenance and testing of our products and platforms.
We plan to make significant investments in the development of our monitoring pipeline in future periods and expect our research and development expenditures to increase.
Other Income (Expense)
Gain on loan forgiveness. The gain on loan forgiveness is the gain recognized as a result of loan forgiveness from the Small Business Administration’s Paycheck Protection Program.
Interest Expense, Net. Interest expense consists of interest incurred on our outstanding borrowings and amortization of the associated deferred financing costs net of interest income earned on our money market account. Interest Expense from Contingent Beneficial Conversion Feature. Interest expense from contingent beneficial conversion feature relates to a charge associated with the contingent beneficial conversion feature described in Part II. Item 8. "Financial Statements and Supplementary Data - Note 7," included in this Report.
Adjustment to liability related to preferred share purchase warrants. Mark-to-market adjustment to recognize the change in fair value of the liability related to preferred share purchase warrants in other income (expense).
Adjustment to liability related to common share purchase warrants. Mark-to-market adjustment to recognize the change in fair value of the common share purchase warrant liability in other income (expense).
Other income (expenses), net. Other income (expense), net, includes our net foreign exchange gain (loss) and loss on extinguishment of debt.
Income tax provision. The income tax provision mainly consists of
The following table sets forth our results of operations for the periods indicated in millions (note that amounts within this Item 7 shown in millions may not sum due to rounding): For the years ended December 31, 2021 2020 Revenues $ 75.8 $ 75.4 Cost of revenues 40.8 39.5 Gross profit 35.1 35.9 Operating expenses: General and administrative 32.3 13.1 Sales and marketing 37.1 19.3 Research and development 21.4 10.5 Total operating expenses 90.9 42.9 Operating loss (55.8) (7.0) Other income (expense): Gain on loan forgiveness 2.1 - Interest expense, net (1.8) (1.4)
Debit interest related to the potential profit conversion function
(26.1) - Preferred stock warrant liability adjustment (5.6) (2.0) Common stock warrant liability adjustment 15.7 - Other income (expense), net (0.3) (0.2) Total other income (expense), net (15.9) (3.5) Loss before income tax provision (71.7) (10.5) Income tax provision 0.0 0.0 Net loss and comprehensive loss
$ (71.7) $ (10.5)Revenues For the years ended December 31, Change (dollars in millions) 2021 2020 $ % Revenues $ 75.8 $ 75.4 $ 0.40.6 % Revenues increased by $0.4 million, or 0.6%, from $75.4 millionfor the year ended December 31, 2020to $75.8 millionfor the year ended December 31, 2021. The increase was due to an increase of revenues during the first nine months of 2021 of $23.9 million, primarily from increased sales volume of the Owlet Smart Sock. The increase during the first nine months of 2021 was substantially offset by net contra-revenue in the fourth quarter of 2021 due to the impact of the Warning Letter. During the fourth quarter of 2021 and for the year ended December 31, 2021, the Company recorded a contra-revenue adjustment of $23.2 millionresulting from received and anticipated returns of the Owlet Smart Sock and Owlet Duo product from U.S.retailers. 67 --------------------------------------------------------------------------------
Revenue cost and gross profit
For the years ended December 31, Change (dollars in millions) 2021 2020 $ % Cost of revenues $ 40.8
$ 39.5 $ 1.33.2 % Gross profit $ 35.1 $ 35.9 $ (0.8)(2.3 %) Gross margin 46.2 % 47.6 % Cost of revenues increased by $1.3 million, or 3.2%, from $39.5 millionfor the year ended December 31, 2020to $40.8 millionfor the year ended December 31, 2021. The increase was primarily due to cost inflation, including increased material, transportation, and hosting costs, partially offset by lower warranty expense. The decrease in warranty expense was partially attributable to the significant decrease in product shipment during the fourth quarter of 2021. Gross margin decreased from 47.6% for the year ended December 31, 2020to 46.2% for the year ended December 31, 2021primarily due to higher returns and cost inflation partially offset by lower warranty expense.
General and administrative
For the years ended December 31, Change (dollars in millions) 2021 2020 $ % General and administrative $ 32.3
$ 13.1 $ 19.2146.1 % General and administrative expense increased by $19.2 million, or 146.1%, from $13.1 millionfor the year ended December 31, 2020to $32.3 millionfor the year ended December 31, 2021. The increase was driven primarily by compensation expense, including share-based compensation, from additional general and administrative headcount. Additionally, the Company saw an increase in legal, accounting, and consulting costs related to the Merger as well as incremental ongoing costs of being a public company. Sales and Marketing For the years ended December 31, Change (dollars in millions) 2021 2020 $ % Sales and marketing $ 37.1 $ 19.3 $ 17.892.5 % Sales and marketing expense increased by $17.8 million, or 92.5%, from $19.3 millionfor the year ended December 31, 2020to $37.1 millionfor the year ended December 31, 2021. The increase was primarily driven by increases in digital advertising and retail channel marketing spend and an increase in compensation expense, including share-based compensation, from additional sales and marketing headcount. Research and Development For the years ended December 31, Change (dollars in millions) 2021 2020 $ % Research and development $ 21.4 $ 10.5 $ 11.0104.7 % Research and development expense increased by $11.0 million, or 104.7%, from $10.5 millionfor the year ended December 31, 2020to $21.4 millionfor the year ended December 31, 2021. These increases were primarily driven by an increase in compensation expense, including share-based compensation, from additional research and development headcount and an increase in consulting expenses. 68 --------------------------------------------------------------------------------
Other Income (Expense) For the years ended December 31, Change (dollars in millions) 2021 2020 $ % Gain on loan forgiveness $ 2.1 $ -
$ 2.1NM Interest expense, net $ (1.8) $ (1.4) $ (0.4)28.2 % Interest expense from contingent beneficial conversion feature $ (26.1) $ - $ (26.1)NM Preferred stock warrant liability adjustment $ (5.6) $ (2.0) $ (3.6)185.8 % Common stock warrant liability adjustment $ 15.7 $ - $ 15.7NM Other income, net $ (0.3) $ (0.2) $ (0.1)77.8 % NM - Not meaningful
For the year ended
For the year ended
December 31, 2021, we recognized interest expense from the contingent beneficial conversion feature as a charge recorded at the date of the Merger, which is described in the notes to the consolidated financial statements in Item 8. For the year ended December 31, 2021, we recognized a loss of $5.6 millionfor the year ended December 31, 2021resulting from the increase in the fair value of the preferred stock warrants prior to the Merger. We recognized a gain of $15.7 millionfor the mark to market adjustment for common stock warrants resulting from the decrease in the fair value of the common stock warrants assumed in the Merger.
Cash and capital resources
Prior to the Merger, we funded our operations primarily with proceeds from issuances of our convertible preferred stock, borrowings under our loan facilities, issuances of convertible promissory notes, and sales of our products and services. As of
December 31, 2021, we had cash and cash equivalents of $95.1 million. Funding Requirements Since inception, we have generated recurring losses which have resulted in an accumulated deficit of $143.4 millionand $71.7 millionas of December 31, 2021and December 31, 2020, respectively, and we expect to incur additional losses in the future. On July 15, 2021, we consummated the Merger and received approximately $133.9 millionin net proceeds from the Merger and PIPE Investment. Therefore, as of the date on which these consolidated financial statements were issued, the Company believes that its cash on hand, together with cash generated from sales to customers, will satisfy its working capital and capital requirements for at least the next twelve months. However, we are still in the growth stage of our business and expect to continue to make substantial investments in our business, including in the expansion of our product portfolio and in our research and development, sales and marketing teams, in addition to incurring additional costs as a result of being a public company. There can be no assurance that we will be able to obtain additional debt or equity financing on terms acceptable to us, if at all, or that we will generate sufficient future revenues. Failure to secure additional funding may require us to modify, delay, or abandon some of our planned future expansion or development, or to otherwise enact operating cost reductions available to management, which could have a material adverse effect on our business, operating results, financial condition, and ability to achieve our intended business objectives.
Loan and guarantee agreement with
December 31, 2021we had an amended and restated loan and security agreement (the "A&R LSA") with Silicon Valley Bank(''SVB'') which we entered into on April 22, 2020, and which replaced the loan and security agreement previously in place (the ''Original LSA''). These agreements provided us with both a line of credit (the ''SVB Revolver'') and a term loan (the ''Term Note''). 69 -------------------------------------------------------------------------------- Our borrowing capacity under the SVB Revolver was $17.5 millionas of December 31, 2021. The SVB Revolver is an asset based lending facility subject to borrowing base capacity which is limited by borrowing base calculations based on the sum of specified percentages of eligible accounts receivable and eligible inventory. As of December 31, 2021, the SVB Revolver bore interest at an annual rate equal to (i) the greater of the bank's prime rate plus 0.75%, or 5.50% when a streamline period is in effect and (ii) the greater of the bank's prime rate plus 1.25%, or 6.00% at all other times. Each streamline period commences the first day of the month following a written report of our liquidity and ends the first day after we fail to maintain a required cash and cash availability streamline threshold, provided no event of default has occurred and is continuing. If an event of default has occurred and is continuing, SVB may maintain our streamline status at its discretion. The required cash and cash availability streamline threshold was $8.0 millionas of December 31, 2021, and we were within a streamline period. The actual interest rate on the SVB Revolver was 5.50% as of December 31, 2021. The SVB Revolver is subject to renewal and is scheduled to mature on April 22, 2024. As of December 31, 2021, there were no outstanding borrowings under the SVB Revolver. Our Term Note had an aggregate principal balance of $14.0 millionas of December 31, 2021, bore interest at a rate equal to the greater of the bank's prime rate plus 3.50%, or 6.50%, and required 30 consecutive equal monthly payments of principal beginning on November 1, 2021. The Term Note matures on April 1, 2024.
Our borrowings under the LSA A&R and subsequent amendments are secured by substantially all of our present and future assets.
January 31, 2022, the Company further amended the A&R LSA, which modified the Term Note annual interest rate equal to the greater of the bank's prime rate plus 2.50% or 5.75%, modified the SVB Revolver annual interest rate equal to (i) the greater of the bank's prime rate plus 0.75% or 5.00% when the streamline period is in effect and (ii) the greater of the bank's prime rate plus 1.25% or 5.00% at all other times, and decreased the advance rate for borrowing base receivables and inventory, and increased the cash and cash availability streamline threshold from $8,000to $50,000.
The amendment replaced the existing EBITDA clause for 2022 and beyond with a net revenue clause and increased the minimum cash and cash availability threshold by
Financed insurance premium
September 2020, the Company entered into a short-term commercial premium finance agreement with AFCO Credit Corporationfor various corporate liability insurance policies totaling $0.6 millionto be paid in eight equal monthly payments. The financed insurance premium accrued interest at a rate of 4.09%. As of December 31, 2020, the remaining principal balance on the financed insurance premium was $0.3 million. During the year ended December 31, 2021, the Company renewed its corporate liability policies and entered into several new short-term commercial premium finance agreements with AFCO Credit Corporationtotaling $4.7 millionto be paid in ten equal monthly payments, all of which accrue interest at a rate of 3.59%. As of December 31, 2021, the remaining principal balance on the financed insurance premium was $2.5 million.
Paycheck Protection Program Loan
April 2020, we applied for and received proceeds from the U.S. Small Business Administration(''SBA'') Paycheck Protection Program (''PPP'') in the amount of $2.1 million, with SVB as lender for the loan (the ''PPP Loan''), under the Federal Coronavirus Aid, Relief, and Economic Security Act (the ''CARES Act''). The PPP Loan was considered necessary to support our ongoing operations due to economic uncertainty at the time resulting from the COVID-19 pandemic and reduced access to alternative sources of liquidity. Under the terms of the PPP Loan, interest accrued on the outstanding principal at a rate of 1.0% per annum. The CARES Act and the PPP provide a mechanism for forgiveness of up to the full amount borrowed. Under the PPP, we applied for forgiveness for all of the PPP Loan. On June 15, 2021, we received forgiveness for the PPP loan for the full amount of $2.1 millionof principal. As a result of the PPP loan being forgiven, we recognized a $2.1 milliongain for the year ended December 31, 2021. 70
The following table summarizes our cash flows (in millions):
December 31, 2021
Net cash used in operating activities
Net cash used in investing activities (2.0)
Net cash provided by financing activities 120.6
Net change in cash and cash equivalents
$ 78.0 $ 5.3Operating Activities For the year ended December 31, 2021, net cash used in operating activities was $40.6 millionas compared to net cash used in operating activities of $0.1 millionin the prior year. The change in operating cash flows was primarily driven by a higher net loss. The higher net loss was partially offset by higher non-cash charges, net, primarily driven by the interest expense from contingent beneficial conversion features, and a larger net decrease in net assets and liabilities as compared to the prior year, primarily driven by an increase in accrued returns from accepted and anticipated customer returns for products subject to the Warning Letter. The Company expects the settlement of the higher accrued returns resulting from the Warning Letter to have a negative impact to cash flows from operations for 2022.
For the year ended
December 31, 2021, net cash used in investing activities increased to $2.0 millionfrom $1.1 millionfor the year ended December 31, 2020due to higher purchases of intangible assets. We expect our capital expenditures to continue to grow in future periods, primarily driven by investments to expand our production capabilities to additional factories in other geographical locations, as well as investments in tooling and equipment to manufacture new products. Financing Activities For the year ended December 31, 2021, net cash provided by financing activities increased to $120.6 millionfrom $6.5 millionfor the year ended December 31, 2020, primarily driven by cash provided from the reverse recapitalization and PIPE financing, partially offset by higher net repayment on our line of credit. Indemnification In the ordinary course of business, we enter into agreements that may include indemnification provisions. Pursuant to such agreements, we may indemnify, hold harmless, and defend an indemnified party for losses suffered or incurred by the indemnified party. Some of the provisions will limit losses to those arising from third-party actions. In some cases, the indemnification will continue after the termination of the agreement. The maximum potential amount of future payments we could be required to make under these provisions is not determinable. We have never incurred material costs to defend lawsuits or settle claims related to these indemnification provisions. In connection with the consummation of the Merger, we entered into indemnification agreements with our directors and officers that may require us to indemnify our directors and officers against liabilities that may arise by reason of their status or service as directors or officers to the fullest extent permitted by Delawarecorporate law. We currently have directors' and officers' insurance coverage that reduces our exposure and enables us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is immaterial.
Significant Accounting Policies and Estimates
Our significant accounting policies are fundamental to understanding our results of operations and financial condition as they require that we use estimates and assumptions that may affect the value of our assets or liabilities and financial results. For a summary of the Company's significant accounting policies, estimates, and methods used in the preparation of the consolidated financial statements, see Part II. Item 8. "Financial Statements and Supplementary Data" - Note 1.
The accounting policies and estimates described below are those that the Company considers to be the most critical in the preparation of its consolidated financial statements because they require management to make subjective and complex judgments.
on inherently uncertain issues. Actual results may differ from these estimates under different assumptions or conditions.
Returns of sales, discounts, discounts and discounts
Our contract liabilities include promises to provide customers rights of return as well as promises to issue discounts and provide rebates or allowances to certain retail channel customers if specified conditions are met. Revenues are reduced in the accompanying consolidated statements of operations and comprehensive loss for anticipated sales returns, discounts, and allowances, based on our analysis of historical sales returns and contractual discounts and allowances. Expected returns, as well as estimated discounts and allowances that have been earned but not yet honored or paid out, are included in accrued and other expenses in the accompanying balance sheets. Actual returns may vary from estimates if we experience a change in actual sales returns or exchange patterns due to unanticipated changes in products or competitive pressures. Sales return rates, excluding the impact of regulatory actions, have been sufficiently predictable to allow us to estimate expected future returns. We review the actual returns as a percentage of sales to determine the historical rate of return. The historical rate of return is used as a basis for estimating future returns based on current sales. The sales return estimate can be affected by the release of new products and changes to sales channels. Actual returns may vary from estimates if we experience a change in actual sales returns or exchange patterns due to unanticipated changes in products, competitive pressures, or regulatory actions. As a result of the FDA Warning Letter received
October 1, 2021, the Company's results of operations for the fourth quarter and year-ended 2021 were substantially and negatively impacted due to the reduction of revenues for received and anticipated returns of Owlet Smart Sock and Owlet Monitor Duo product. For the quarter and year ended December 31, 2021, the Company recorded contra-revenue of $23.2 millionand accrued returns of $20.1 millionas of December 31, 2021. Sales rebates, discounts, and allowances provided to our customers have been sufficiently predictable to allow us to estimate expected future discounts and allowances. Discounts and allowances are estimable based on existing and expected promotional programs and contractual terms in place at the time of sale. New promotional programs or changes to existing promotional programs could impact the estimated sales rebates, discounts, and allowances The estimates and assumptions used to reserve for rights of return, rebates, discounts, and allowances have been accurate in all material respects and have not materially changed in the past.
Our products include an assurance-type limited warranty. The estimated warranty costs, which are expensed at the time of sale and included in cost of revenues, are based on the results of historical trends and warranty claim rates incurred and are adjusted for any current or expected trends as appropriate. The warranty reserve estimate can be affected by the release of new products or updates which could have failure rates that differ from historical products. We regularly assess and adjust the estimate of accrued warranty claims by updating claims rates for actual trends and projected claim costs.
Determination of the fair value of common shares before the merger
For the period during which the Company's common stock was not publicly traded, the estimated fair value of our common stock has been determined by our Board as of the date of each option award grant with input from management, considering our most recently available third-party valuation of common stock, and our Board's assessment of additional objective and subjective factors that it believed were relevant and which may have changed from the date of the most recent valuation through the date of the grant. We believe that the Board has the relevant experience and expertise to determine fair value of our common stock. Third-party valuations were performed in accordance with the guidance outlined in the
American Institute of Certified Public Accountants' Accounting and Valuation Guide, Valuation of Privately-Held-Company Equity SecuritiesIssued as Compensation. Management has considered numerous factors in determining the best estimate of fair value of our common stock, including the following:
•the valuation carried out by unrelated specialist third parties;
•our results of operations, financial condition and capital resources;
• our stage of development and current business conditions and projections, including the introduction of new products;
•the lack of marketability of our common stock;
•the hiring of key personnel and the experience of our management;
•the likelihood of a liquidity event occurring, such as an IPO or sale of our company given prevailing market conditions;
•the nature and history of our activities;
•industry trends and the competitive environment;
•the illiquidity of stock-based awards involving securities of a private company; and
•General economic, regulatory and capital market conditions.
The assumptions underlying these valuations were highly complex and subjective and represented management's best estimates, which involved inherent uncertainties and the application of management's judgment. As a result, if we had used significantly different assumptions or estimates, the fair value of our common stock and our stock-based compensation expense could be materially different. Since a public trading market for our common stock has been established after the Merger, it will no longer be necessary for our Board to estimate the fair value of our common stock in connection with our accounting for granted stock options and other such awards we may grant, as the fair value of our common stock will be determined based on the quoted market price of our common stock.
Liability related to preferred share purchase warrants
We classify warrants to purchase shares of our redeemable convertible preferred stock as a liability on our consolidated balance sheets as each warrant is a free-standing instrument that may require us to transfer consideration upon exercise. The preferred stock warrants were settled immediately prior to the Merger on
July 15, 2021, as further described in Part II. Item 8. "Financial Statements and Supplementary Data - Note 3." Each warrant is initially recorded at fair value upon issuance, net of issuance costs, using the Black-Scholes option pricing model, and is subsequently re-measured to fair value at each subsequent balance sheet date. Changes in fair value of warrants are recognized as a component of preferred stock warrant liability adjustment in the consolidated statements of operations and comprehensive loss. The Black-Scholes valuation model requires significant estimates including the expected volatility of our common stock, expected dividend yield, option term and risk-free rate. We derive our volatility from the average historical stock volatilities of peer public companies over a period equivalent to the expected term of the awards. As our historical share option exercise experience does not provide a reasonable basis upon which to estimate the expected term, we estimate the expected term using the simplified method based on the vesting and contractual terms of the award. Under the simplified method, the expected term is equal to the average of the stock-based award's weighted average vesting period and its contractual term. The risk-free interest rate is based on the U.S. Treasuryyield curve in effect at the time of grant. Expected dividend yield is 0.0% as we do not anticipate paying dividends on our common stock for the foreseeable future. Income Taxes In evaluating the ability to recover our deferred income tax assets, we consider all available positive and negative evidence, including our operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction-by-jurisdiction basis. In the event we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance that would reduce the provision for income taxes. Conversely, in the event that all or part of the net deferred tax assets are determined to not be realizable in the future, an adjustment to the valuation allowance would be charged to earnings in the period when such a determination is made. As of December 31, 2021and December 31, 2020, we recorded a full valuation allowance on our deferred tax assets. Uncertain tax positions are recorded when it is more likely than not that a given tax position would not be sustained upon examination by taxing authorities. Based on positions taken in our tax filings, we concluded that there are no significant uncertain tax positions requiring disclosure as of December 31, 2021and December 31, 2020, and that there are no material amounts of unrecognized tax benefits. Our policy for recording interest and penalties related to income taxes, including uncertain tax positions, is to record such items as a component of the provision for income taxes.
Emerging Growth Company Status
Following the Merger, we qualify as an emerging growth company (''EGC'') as defined in the Jumpstart our Business Startups (''JOBS'') Act. The JOBS Act permits companies with EGC status to take advantage of an extended transition period to comply with new or revised accounting standards, delaying the adoption of these accounting standards until they would apply to private companies. We intend to use this extended transition period 73 -------------------------------------------------------------------------------- to enable us to comply with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date we (i) are no longer an EGC or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our consolidated financial statements may not be comparable to companies that comply with the new or revised accounting standards as of public company effective dates. In addition, we intend to rely on the other exemptions and reduced reporting requirements provided by the JOBS Act. Subject to certain conditions set forth in the JOBS Act, as an EGC, we are not required to, among other things: (i) provide an auditor's attestation report on our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act; (ii) provide all of the compensation disclosures that may be required of non-EGCs under the Dodd-Frank Wall Street Reform and Consumer Protection Act; (iii) comply with the requirements of the
Public Company Accounting Oversight Boardregarding the communication of critical audit matters in the auditor's report on the consolidated financial statements (auditor discussion and analysis); and (iv) disclose certain executive compensation-related items such as the correlation between executive compensation and performance and comparisons of the Chief Executive Officer's compensation to median employee compensation. We anticipate that we will remain an EGC under the JOBS Act until the earliest of (i) December 31, 2025, (ii) the last date of our fiscal year in which we have total annual gross revenues of at least $1.07 billion, (iii) the date on which we are deemed to be a ''large accelerated filer'' under the rules of the SEC, or (iv) the date on which we have issued more than $1.0 billionin non-convertible debt securities during the previous three years.
Additionally, we are a "smaller reporting company" as defined in Item 10(f)(1) of Regulation S-K. Smaller reporting companies may take advantage of certain reduced disclosure obligations, including, among other things, providing only two years of audited consolidated financial statements. We will remain a smaller reporting company until the last day of the fiscal year in which (i) the market value of our Common Stock held by non-affiliates exceeds
$250 millionas of the prior June 30, or (ii) our annual revenues exceeded $100 millionduring such completed fiscal year and the market value of our Common Stock held by non-affiliates exceeds $700 millionas of the prior June 30.
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